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EX-31.2 - EXHIBIT 31.2 - Whitestone REITexhibit312certificationofc.htm
EX-32.1 - EXHIBIT 32.1 - Whitestone REITexhibit321certificationofc.htm
EX-32.2 - EXHIBIT 32.2 - Whitestone REITexhibit322certificationofc.htm
EX-31.1 - EXHIBIT 31.1 - Whitestone REITexhibit311certificationofc.htm
EX-12.1 - EXHIBIT 12.1 - Whitestone REITexhibit121computationofrat.htm
EX-10.1 - EXHIBIT 10.1 - Whitestone REITexhibit101restrictedunitaw.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
 
(Mark One)
[x]
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2015

OR

[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________

Commission file number 001-34855
WHITESTONE REIT
(Exact Name of Registrant as Specified in Its Charter)
 
Maryland
 
76-0594970
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)

2600 South Gessner, Suite 500
Houston, Texas
 
77063
(Address of Principal Executive Offices)
 
(Zip Code)

(713) 827-9595
(Registrant's Telephone Number, Including Area Code)
 
N/A
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  ýYes     ¨No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  ýYes    ¨No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer ¨                                                                                      Accelerated filer ý
Non-accelerated filer ¨                                                                                       Smaller reporting company ¨
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨Yes   ý No

As of August 5, 2015, there were 26,977,682 common shares of beneficial interest, $0.001 par value per share, outstanding.



PART I - FINANCIAL INFORMATION


PART II - OTHER INFORMATION





PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Whitestone REIT and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

 
 
June 30, 2015
 
December 31, 2014
 
 
(unaudited)
 
 
ASSETS
Real estate assets, at cost
 
 
 
 
Property
 
$
730,165

 
$
673,655

Accumulated depreciation
 
(80,138
)
 
(71,587
)
Total real estate assets
 
650,027

 
602,068

Cash and cash equivalents
 
6,251

 
4,236

Marketable securities
 
422

 
973

Escrows and acquisition deposits
 
4,864

 
4,092

Accrued rents and accounts receivable, net of allowance for doubtful accounts
 
12,830

 
11,834

Unamortized lease commissions and loan costs
 
8,351

 
8,879

Prepaid expenses and other assets
 
2,858

 
2,215

Total assets
 
$
685,603

 
$
634,297

 
 
 
 
 
LIABILITIES AND EQUITY
Liabilities:
 
 
 
 
Notes payable
 
$
403,287

 
$
394,093

Accounts payable and accrued expenses
 
15,940

 
15,882

Tenants' security deposits
 
4,639

 
4,372

Dividends and distributions payable
 
7,800

 
6,627

Total liabilities
 
431,666

 
420,974

Commitments and contingencies:
 

 

Equity:
 
 
 
 
Preferred shares, $0.001 par value per share; 50,000,000 shares authorized; none issued and outstanding as of June 30, 2015 and December 31, 2014
 

 

Common shares, $0.001 par value per share; 400,000,000 shares authorized; 26,978,270 and 22,835,695 issued and outstanding as of June 30, 2015 and December 31, 2014, respectively
 
27

 
23

Additional paid-in capital
 
356,517

 
304,078

Accumulated deficit
 
(105,140
)
 
(93,938
)
Accumulated other comprehensive loss
 
(461
)
 
(91
)
Total Whitestone REIT shareholders' equity
 
250,943

 
210,072

Noncontrolling interest in subsidiary
 
2,994

 
3,251

Total equity
 
253,937

 
213,323

Total liabilities and equity
 
$
685,603

 
$
634,297



See accompanying notes to Consolidated Financial Statements

1


Whitestone REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Unaudited)
(in thousands, except per share data)

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
Property revenues
 
 
 
 
 
 
 
 
Rental revenues
 
$
17,176

 
$
13,443

 
$
33,641

 
$
27,057

Other revenues
 
4,794

 
3,819

 
9,581

 
7,580

Total property revenues
 
21,970

 
17,262

 
43,222

 
34,637

 
 
 
 
 
 
 
 
 
Property expenses
 
 
 
 
 
 
 
 
Property operation and maintenance
 
4,339

 
4,013

 
8,422

 
7,537

Real estate taxes
 
2,925

 
2,205

 
5,829

 
4,482

Total property expenses
 
7,264

 
6,218

 
14,251

 
12,019

 
 
 
 
 
 
 
 
 
Other expenses (income)
 
 
 
 
 
 
 
 
General and administrative
 
4,998

 
3,582

 
9,483

 
6,539

Depreciation and amortization
 
4,675

 
3,834

 
9,239

 
7,663

Interest expense
 
3,516

 
2,434

 
6,924

 
4,763

Interest, dividend and other investment income
 
(162
)
 
(19
)
 
(171
)
 
(40
)
Total other expense
 
13,027

 
9,831

 
25,475

 
18,925

 
 
 
 
 
 
 
 
 
Income from continuing operations before gain (loss) on sale or disposal of assets and income taxes
 
1,679

 
1,213

 
3,496

 
3,693

 
 
 
 
 
 
 
 
 
Provision for income taxes
 
(91
)
 
(55
)
 
(174
)
 
(136
)
Gain (loss) on sale or disposal of assets
 
5

 
(24
)
 
(100
)
 
(111
)
Income from continuing operations
 
1,593

 
1,134

 
3,222

 
3,446

 
 
 
 
 
 
 
 
 
Income (loss) from discontinued operations
 
(33
)
 
146

 
(41
)
 
266

Income (loss) from discontinued operations
 
(33
)
 
146

 
(41
)
 
266

 
 
 
 
 
 
 
 
 
Net income
 
1,560

 
1,280

 
3,181

 
3,712

 
 
 
 
 
 
 
 
 
Less: Net income attributable to noncontrolling interests
 
26

 
27

 
53

 
87

 
 
 
 
 
 
 
 
 
Net income attributable to Whitestone REIT
 
$
1,534

 
$
1,253

 
$
3,128

 
$
3,625










See accompanying notes to Consolidated Financial Statements

2


Whitestone REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Unaudited)
(in thousands, except per share data)

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
Basic Earnings Per Share:
 
 
 
 
 
 
 
 
Income from continuing operations attributable to Whitestone REIT excluding amounts attributable to unvested restricted shares
 
$
0.06

 
$
0.05

 
$
0.13

 
$
0.15

Income from discontinued operations attributable to Whitestone REIT
 
0.00

 
0.00

 
0.00

 
0.01

Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.06

 
$
0.05

 
$
0.13

 
$
0.16

Diluted Earnings Per Share:
 
 
 
 
 
 
 
 
Income from continuing operations attributable to Whitestone REIT excluding amounts attributable to unvested restricted shares
 
$
0.06

 
$
0.05

 
$
0.12

 
$
0.15

Income from discontinued operations attributable to Whitestone REIT
 
0.00

 
0.00

 
0.00

 
0.01

Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.06

 
$
0.05

 
$
0.12

 
$
0.16

 
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
22,869

 
22,235

 
22,724

 
22,030

Diluted
 
23,401

 
22,443

 
23,314

 
22,192

 
 
 
 
 
 
 
 
 
Distributions declared per common share / OP unit
 
$
0.2850

 
$
0.2850

 
$
0.5700

 
$
0.5700

 
 
 
 
 
 
 
 
 
Consolidated Statements of Comprehensive Income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
$
1,560

 
$
1,280

 
$
3,181

 
$
3,712

 
 
 
 
 
 
 
 
 
Other comprehensive gain (loss)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain (loss) on cash flow hedging activities
 
43

 
(259
)
 
(276
)
 
(297
)
Unrealized gain (loss) on available-for-sale marketable securities
 
(139
)
 
22

 
(98
)
 
105

 
 
 
 
 
 
 
 
 
Comprehensive income
 
1,464

 
1,043

 
2,807

 
3,520

 
 
 
 
 
 
 
 
 
Less: Comprehensive income attributable to noncontrolling interests
 
24

 
23

 
47

 
82

 
 
 
 
 
 
 
 
 
Comprehensive income attributable to Whitestone REIT
 
$
1,440

 
$
1,020

 
$
2,760

 
$
3,438




See accompanying notes to Consolidated Financial Statements

3


Whitestone REIT and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(Unaudited)
(in thousands)

 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
 
 
 
 
 
Additional
 
 
 
Other
 
Total
 
Noncontrolling
 
 
 
 
Common Shares
 
Paid-In
 
Accumulated
 
Comprehensive
 
Shareholders'
 
interests
 
Total
 
 
Shares
 
Amount
 
Capital
 
Deficit
 
Gain (Loss)
 
Equity
 
Units
 
Dollars
 
Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2014
 
22,836

 
$
23

 
$
304,078

 
$
(93,938
)
 
$
(91
)
 
$
210,072

 
398

 
$
3,251

 
$
213,323

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exchange of noncontrolling interest OP units for common shares
 
8

 

 
84

 

 
(3
)
 
81

 
(8
)
 
(81
)
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of shares under dividend reinvestment plan
 
3

 

 
47

 

 

 
47

 

 

 
47

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares, net of offering costs
 
3,750

 
4

 
49,721

 

 

 
49,725

 

 

 
49,725

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Repurchase of common shares (1)
 
(52
)
 

 
(772
)
 

 

 
(772
)
 

 

 
(772
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Share-based compensation
 
433

 

 
3,359

 

 

 
3,359

 

 

 
3,359

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Distributions
 

 

 

 
(14,330
)
 

 
(14,330
)
 

 
(222
)
 
(14,552
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized loss on change in value of cash flow hedge
 

 

 

 

 
(271
)
 
(271
)
 

 
(5
)
 
(276
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized loss on change in fair value of available-for-sale marketable securities
 

 

 

 

 
(96
)
 
(96
)
 

 
(2
)
 
(98
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 
3,128

 

 
3,128

 

 
53

 
3,181

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, June 30, 2015
 
26,978

 
$
27

 
$
356,517

 
$
(105,140
)
 
$
(461
)
 
$
250,943

 
390

 
$
2,994

 
$
253,937


(1) 
During the six months ended June 30, 2015, the Company acquired common shares held by employees who tendered owned common shares to satisfy the tax withholding on the lapse of certain restrictions on restricted common shares.



See accompanying notes to Consolidated Financial Statements


4


Whitestone REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
 
 
Six Months Ended June 30,
 
 
2015
 
2014
 
 
 
 
 
Cash flows from operating activities:
 
 
 
 
Net income from continuing operations
 
$
3,222

 
$
3,446

Net income (loss) from discontinued operations
 
(41
)
 
266

Net income
 
3,181

 
3,712

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
9,239

 
7,663

Amortization of deferred loan costs
 
601

 
405

Amortization of notes payable discount
 
149

 
153

Gain on sale of marketable securities
 
(44
)
 

Loss on sale or disposal of assets and properties
 
100

 
111

Bad debt expense
 
771

 
1,052

Share-based compensation
 
3,359

 
1,564

Changes in operating assets and liabilities:
 
 
 
 
Escrows and acquisition deposits
 
(772
)
 
(324
)
Accrued rent and accounts receivable
 
(1,767
)
 
(1,357
)
Unamortized lease commissions
 
(610
)
 
(557
)
Prepaid expenses and other assets
 
323

 
345

Accounts payable and accrued expenses
 
(235
)
 
(739
)
Tenants' security deposits
 
267

 
219

Net cash provided by operating activities
 
14,603

 
11,981

Net cash provided by (used in) operating activities of discontinued operations
 
(41
)
 
250

Cash flows from investing activities:
 
 
 
 
Acquisitions of real estate
 
(51,800
)
 

Additions to real estate
 
(5,009
)
 
(4,847
)
Proceeds from sales of marketable securities
 
496

 

Net cash used in investing activities
 
(56,313
)
 
(4,847
)
Net cash used in investing activities of discontinued operations
 

 
(143
)
Cash flows from financing activities:
 
 
 
 
Distributions paid to common shareholders
 
(13,127
)
 
(12,598
)
Distributions paid to OP unit holders
 
(224
)
 
(310
)
Proceeds from issuance of common shares, net of offering costs
 
49,725

 
5,267

Payments of exchange offer costs
 

 
(6
)
Proceeds from revolving credit facility, net
 
9,500

 
3,000

Repayments of notes payable
 
(1,336
)
 
(1,114
)
Repurchase of common shares
 
(772
)
 
(24
)
Net cash provided by (used in) financing activities
 
43,766

 
(5,785
)
Net cash used in financing activities of discontinued operations
 

 
(2,905
)
Net increase (decrease) in cash and cash equivalents
 
2,015

 
(1,449
)
Cash and cash equivalents at beginning of period
 
4,236

 
6,491

Cash and cash equivalents at end of period
 
$
6,251

 
$
5,042


See accompanying notes to Consolidated Financial Statements

5


Whitestone REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)

 
 
Six Months Ended June 30,
 
 
2015
 
2014
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid for interest
 
$
6,409

 
$
4,447

Cash paid for taxes
 
$
315

 
$
238

Non cash investing and financing activities:
 
 
 
 
Disposal of fully depreciated real estate
 
$
48

 
$
2,560

Financed insurance premiums
 
$
1,057

 
$
888

Value of shares issued under dividend reinvestment plan
 
$
47

 
$
50

Value of common shares exchanged for OP units
 
$
81

 
$
870

Change in fair value of available-for-sale securities
 
$
(98
)
 
$
105

Change in fair value of cash flow hedge
 
$
(276
)
 
$
(297
)


























See accompanying notes to Consolidated Financial Statements


6

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2015
(Unaudited)

The use of the words “we,” “us,” “our,” “Company” or “Whitestone” refers to Whitestone REIT and our consolidated subsidiaries, except where the context otherwise requires.

1.  INTERIM FINANCIAL STATEMENTS
 
The consolidated financial statements included in this report are unaudited; however, amounts presented in the consolidated balance sheet as of December 31, 2014 are derived from our audited consolidated financial statements as of that date.  The unaudited financial statements as of and for the period ended June 30, 2015 have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information on a basis consistent with the annual audited consolidated financial statements and with the instructions to Form 10-Q.
 
The consolidated financial statements presented herein reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position of Whitestone and our subsidiaries as of June 30, 2015, and the results of operations for the three and six month periods ended June 30, 2015 and 2014, the consolidated statements of changes in equity for the six month period ended June 30, 2015 and cash flows for the six month periods ended June 30, 2015 and 2014.  All of these adjustments are of a normal recurring nature.  The results of operations for the interim periods are not necessarily indicative of the results expected for a full year.  The statements should be read in conjunction with the audited consolidated financial statements and the notes thereto which are included in our Annual Report on Form 10-K for the year ended December 31, 2014.
 
Business.  Whitestone was formed as a real estate investment trust (“REIT”), pursuant to the Texas Real Estate Investment Trust Act on August 20, 1998.  In July 2004, we changed our state of organization from Texas to Maryland pursuant to a merger where we merged directly with and into a Maryland REIT formed for the sole purpose of the reorganization and the conversion of each of our outstanding common shares of beneficial interest of the Texas entity into 1.42857 common shares of beneficial interest of the Maryland entity.  We serve as the general partner of Whitestone REIT Operating Partnership, L.P. (the “Operating Partnership”), which was formed on December 31, 1998 as a Delaware limited partnership.  We currently conduct substantially all of our operations and activities through the Operating Partnership.  As the general partner of the Operating Partnership, we have the exclusive power to manage and conduct the business of the Operating Partnership, subject to certain customary exceptions.  As of June 30, 2015 and December 31, 2014, Whitestone owned and operated 65 and 63 commercial properties, respectively, in and around Austin, Chicago, Dallas-Fort Worth, Houston, Phoenix and San Antonio.


2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Basis of Consolidation.  We are the sole general partner of the Operating Partnership and possess full legal control and authority over the operations of the Operating Partnership.  As of June 30, 2015 and December 31, 2014, we owned a majority of the partnership interests in the Operating Partnership.  Consequently, the accompanying consolidated financial statements include the accounts of the Operating Partnership.  All significant inter-company balances have been eliminated. Noncontrolling interests in the accompanying consolidated financial statements represents the share of equity and earnings of the Operating Partnership allocable to holders of partnership interests other than us.  Net income or loss is allocated to noncontrolling interests based on the weighted average percentage ownership of the Operating Partnership during the period.  Issuance of additional common shares of beneficial interest in Whitestone (the “common shares”) and units of limited partnership interest in the Operating Partnership that are convertible into cash or, at our option, common shares on a one-for-one basis (the “OP units”) changes the ownership interests of both the noncontrolling interests and Whitestone.
  
Basis of Accounting.  Our financial records are maintained on the accrual basis of accounting whereby revenues are recognized when earned and expenses are recorded when incurred.
 

7

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2015
(Unaudited)

Use of Estimates.   The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates that we use include the estimated fair values of properties acquired, the estimated useful lives for depreciable and amortizable assets and costs, the estimated allowance for doubtful accounts, the estimated fair value of interest rate swaps and the estimates supporting our impairment analysis for the carrying values of our real estate assets.  Actual results could differ from those estimates.
 
Reclassifications.  We have reclassified certain prior period amounts in the accompanying consolidated financial statements in order to be consistent with the current period presentation.  These reclassifications had no effect on net income, total assets, total liabilities or equity.
 
Marketable Securities. We classify our existing marketable equity securities as available-for-sale in accordance with the Financial Accounting Standards Board's (“FASB”) Investments-Debt and Equity Securities guidance. These securities are carried at fair value with unrealized gains and losses reported in equity as a component of accumulated other comprehensive income or loss. The fair value of the marketable securities is determined using Level 1 inputs under FASB Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures.” Level 1 inputs represent quoted prices available in an active market for identical investments as of the reporting date. Gains and losses on securities sold are based on the specific identification method, and are reported as a component of interest, dividend and other investment income.

Derivative Instruments and Hedging Activities. We occasionally utilize derivative financial instruments, principally interest rate swaps, to manage our exposure to fluctuations in interest rates. We have established policies and procedures for risk assessment, and the approval, reporting and monitoring of derivative financial instruments. We recognize our interest rate swaps as cash flow hedges with the effective portion of the changes in fair value recorded in comprehensive income (loss) and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. Any ineffective portion of a cash flow hedges' change in fair value is recorded immediately into earnings. Our cash flow hedges are determined using Level 2 inputs under ASC 820. Level 2 inputs represent quoted prices in active markets for similar assets or liabilities; quoted prices in markets that are not active; and model-derived valuations whose inputs are observable. As of June 30, 2015, we consider our cash flow hedges to be highly effective.
        
Development Properties. Land, buildings and improvements are recorded at cost. Expenditures related to the development of real estate are carried at cost which includes capitalized carrying charges and development costs. Carrying charges (interest, real estate taxes, loan fees, and direct and indirect development costs related to buildings under construction), are capitalized as part of construction in progress. The capitalization of such costs ceases when the property, or any completed portion, becomes available for occupancy. For the three months ended June 30, 2015, approximately $32,000 and $21,000 in interest expense and real estate taxes, respectively, were capitalized, and for the six months ended June 30, 2015, approximately $58,000 and $37,000 in interest expense and real estate taxes, respectively, were capitalized. For the three months ended June 30, 2014, approximately $26,000 and $7,000 in interest expense and real estate taxes, respectively, were capitalized, and for the six months ended June 30, 2014, approximately $51,000 and $32,000 in interest expense and real estate taxes, respectively, were capitalized.

Share-Based Compensation.   From time to time, we award nonvested restricted common share awards or restricted common share unit awards, which may be converted into common shares, to executive officers and employees under our 2008 Long-Term Equity Incentive Ownership Plan (the “2008 Plan”).  The vast majority of the awarded shares and units vest when certain performance conditions are met.  We recognize compensation expense when achievement of the performance conditions is probable based on management's most recent estimates using the fair value of the shares as of the grant date. We recognized $1,669,000 and $1,234,000 in share-based compensation for the three months ended June 30, 2015 and 2014, respectively, and we recognized $3,343,000 and $1,607,000 in share-based compensation for the six months ended June 30, 2015 and 2014, respectively.


8

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2015
(Unaudited)

Noncontrolling Interests.  Noncontrolling interests is the portion of equity in a subsidiary not attributable to a parent.  The ownership interests not held by the parent are considered noncontrolling interests.  Accordingly, we have reported noncontrolling interests in equity on the consolidated balance sheets but separate from Whitestone's equity.  On the consolidated statements of operations, subsidiaries are reported at the consolidated amount, including both the amount attributable to Whitestone and noncontrolling interests.  The consolidated statement of changes in equity is included for quarterly financial statements, including beginning balances, activity for the period and ending balances for shareholders' equity, noncontrolling interests and total equity.
 
See our Annual Report on Form 10-K for the year ended December 31, 2014 for further discussion on significant accounting policies.
 
Recent Accounting Pronouncements.  In April 2014, the FASB issued guidance updating the criteria for reporting the disposal of a component of an entity as a discontinued operation. This guidance was effective for reporting periods beginning on or after December 15, 2014 with early adoption permitted only for disposals that have not been reported in financial statements previously issued or available for issuance. We have adopted the guidance beginning with the year ended December 31, 2014.

In April 2015, the FASB issued guidance requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. This guidance is effective retrospectively for reporting periods beginning on or after December 15, 2015 with early adoption permitted only for financial statements that have not been previously issued. We are currently in the process of evaluating the impact of adoption on our consolidated balance sheets.

3. MARKETABLE SECURITIES

All of our marketable securities were classified as available-for-sale securities as of June 30, 2015 and December 31, 2014. Available-for-sale securities consisted of the following (in thousands):

 
 
June 30, 2015
 
 
Amortized Cost
 
Gains in Accumulated Other Comprehensive Income
 
Losses in Accumulated Other Comprehensive Income
 
Estimated Fair Value
Real estate sector common stock
 
$
654

 
$

 
$
(232
)
 
$
422

Total available-for-sale securities
 
$
654

 
$

 
$
(232
)
 
$
422


 
 
December 31, 2014
 
 
Amortized Cost
 
Gains in Accumulated Other Comprehensive Income
 
Losses in Accumulated Other Comprehensive Income
 
Estimated Fair Value
Real estate sector common stock
 
$
1,106

 
$

 
$
(133
)
 
$
973

Total available-for-sale securities
 
$
1,106

 
$

 
$
(133
)
 
$
973


During the three and six months ended June 30, 2015, available-for-sale securities were sold for total proceeds of $496,000. The gross realized gain on these sales during the three months ended June 30, 2015 were $44,000. During the three and six months ended June 30, 2014, no available-for-sale securities were sold. For the purpose of determining gross realized gains and losses, the cost of securities sold is based on specific identification. A net unrealized holding loss on available-for-sale securities in the amount of $232,000 and $124,000 for the six months ended June 30, 2015 and 2014, respectively, has been included in accumulated other comprehensive income.


9

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2015
(Unaudited)

4. ACCRUED RENTS AND ACCOUNTS RECEIVABLE, NET

Accrued rents and accounts receivable, net consists of amounts accrued, billed and due from tenants, allowance for doubtful accounts and other receivables as follows (in thousands):

 
 
June 30, 2015
 
December 31, 2014
 
 
 
 
 
Tenant receivables
 
$
9,167

 
$
7,998

Accrued rents and other recoveries
 
9,156

 
8,800

Allowance for doubtful accounts
 
(5,493
)
 
(4,964
)
Total
 
$
12,830

 
$
11,834


5. UNAMORTIZED LEASE COMMISSIONS AND LOAN COSTS

Costs which have been deferred consist of the following (in thousands):
 
 
June 30, 2015
 
December 31, 2014
 
 
 
 
 
Lease commissions
 
$
6,121

 
$
5,936

Deferred financing cost
 
5,821

 
5,785

Total cost
 
11,942

 
11,721

Less: lease commissions accumulated amortization
 
(2,521
)
 
(2,373
)
Less: deferred financing cost accumulated amortization
 
(1,070
)
 
(469
)
Total cost, net of accumulated amortization
 
$
8,351

 
$
8,879


6. DEBT

Certain subsidiaries of Whitestone are the borrowers under various financing arrangements. These subsidiaries are separate legal entities and their respective assets and credit are not available to satisfy the debt of Whitestone or any of its other subsidiaries.

10


Debt consisted of the following as of the dates indicated (in thousands):
Description
 
June 30, 2015
 
December 31, 2014
Fixed rate notes
 
 
 
 
$10.5 million, LIBOR plus 2.00% Note, due September 24, 2018 (1)
 
$
10,340

 
$
10,460

$50.0 million, 0.84% plus 1.75% to 2.50% Note, due February 17, 2017 (2)
 
50,000

 
50,000

$37.0 million 3.76% Note, due December 1, 2020
 
35,623

 
36,090

$6.5 million 3.80% Note, due January 1, 2019
 
6,273

 
6,355

$19.0 million 4.15% Note, due December 1, 2024
 
19,000

 
19,000

$20.2 million 4.28% Note, due June 6, 2023
 
20,200

 
20,200

$14.0 million 4.34% Note, due September 11, 2024
 
14,000

 
14,000

$14.3 million 4.34% Note, due September 11, 2024
 
14,300

 
14,300

$16.5 million 4.97% Note, due September 26, 2023
 
16,450

 
16,450

$15.1 million 4.99% Note, due January 6, 2024
 
15,060

 
15,060

$9.2 million, Prime Rate less 2.00%, due December 29, 2017 (3)
 
7,887

 
7,888

$2.6 million 5.46% Note, due October 1, 2023
 
2,568

 
2,583

$11.1 million 5.87% Note, due August 6, 2016
 
11,457

 
11,607

$0.9 million 2.97% Note, due November 28, 2015
 
529

 

Floating rate notes
 
 
 
 
Unsecured line of credit, LIBOR plus 1.40% to 1.95%, due November 7, 2018
 
129,600

 
120,100

$50.0 million, LIBOR plus 1.35% to 1.90% Note, due November 7, 2019
 
50,000

 
50,000

 
 
$
403,287

 
$
394,093


(1) 
Promissory note includes an interest rate swap that fixed the interest rate at 3.55% for the duration of the term.

(2) 
Promissory note includes an interest rate swap that fixed the LIBOR portion of our $50 million term loan under our previous unsecured revolving credit facility at 0.84%.

(3) 
Promissory note includes an interest rate swap that fixed the interest rate at 5.72% for the duration of the term. As part of our acquisition of Paradise Plaza in August 2012, we recorded a discount on the note of $1.3 million, which amortizes into interest expense over the life of the loan and results in an imputed interest rate of 4.13%.

On December 24, 2014, we assumed a $2.6 million promissory note as part of our acquisition of the hard corner at Village Square at Dana Park (See Note 14). The 5.46% fixed interest rate note matures October 1, 2023.

On November 26, 2014, we, operating through our subsidiary, Whitestone Headquarters Village, LLC, a Delaware limited liability company, entered into a $19.0 million promissory note (the “Headquarters Note”), with a fixed interest rate of 4.15% payable to Morgan Stanley Bank, N.A. and a maturity date of December 1, 2024. Proceeds from the Headquarters Note were used to repay a portion of our unsecured revolving credit facility.

On November 7, 2014, we, through our Operating Partnership, entered into an unsecured revolving credit facility (the “Facility”) with the lenders party thereto, with BMO Capital Markets, Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, and U.S. Bank, National Association, as co-lead arrangers and joint book runners, and Bank of Montreal, as administrative agent (the “Agent”). The Facility amended and restated our previous unsecured revolving credit facility. Proceeds from the Facility were used for general corporate purposes, including property acquisitions, debt repayment, capital expenditures, the expansion, redevelopment and re-tenanting of properties in our portfolio and working capital. We intend to use the additional proceeds from the Facility for general corporate purposes, including property acquisitions, debt repayment, capital expenditure, the expansion, redevelopment and re-tenanting of properties in our portfolio and working capital.


11


The Facility is comprised of three tranches:

$400 million unsecured revolving credit facility (the “Revolver”);
$50 million unsecured term loan (the “Term Loan 1”); and
$50 million unsecured term loan (the “Term Loan 2”).

The Facility includes an accordion feature that will allow the Operating Partnership to increase the borrowing capacity to $700 million, upon the satisfaction of certain conditions. The Revolver will mature on November 7, 2018, with an option to extend for one additional year to November 7, 2019, subject to certain conditions, including payment of an extension fee. The Term Loan 1 will mature on February 17, 2017, and the Term Loan 2 will mature on November 7, 2019.

Borrowings under the Facility accrue interest (at the Operating Partnership's option) at a Base Rate or an Adjusted LIBOR plus an applicable margin based upon our then existing leverage. The applicable margin for Adjusted LIBOR borrowings ranges from 1.40% to 1.95% for the Revolver and 1.35% to 1.90% for the term loans. Base Rate means the higher of: (a) the Agent's prime commercial rate, (b) the sum of (i) the average rate quoted by the Agent by two or more federal funds brokers selected by the Agent for sale to the Agent at face value of federal funds in the secondary market in an amount equal or comparable to the principal amount for which such rate is being determined, plus (ii) 1/2 of 1.00%, and (c) the LIBOR rate for such day plus 1.00%. Adjusted LIBOR means LIBOR divided by one minus the Eurodollar Reserve Percentage. The Eurodollar Reserve Percentage means the maximum reserve percentage at which reserves are imposed by the Board of Governors of the Federal Reserve System on eurocurrency liabilities.

We serve as the guarantor for funds borrowed by the Operating Partnership under the Facility. The Facility contains customary terms and conditions, including, without limitation, affirmative and negative covenants such as information reporting requirements, maximum secured indebtedness to total asset value, minimum EBITDA (earnings before interest, taxes, depreciation, amortization or extraordinary items) to fixed charges, and maintenance of a minimum net worth. The Facility also contains customary events of default with customary notice and cure, including, without limitation, nonpayment, breach of covenant, misrepresentation of representations and warranties in a material respect, cross-default to other major indebtedness, change of control, bankruptcy and loss of REIT tax status. As of June 30, 2015, we were in compliance with all covenants under the Facility.

As of June 30, 2015, $229.6 million was drawn on the Facility, and our remaining borrowing capacity was $270.4 million. Proceeds from the Facility were used for general corporate purposes, including property acquisitions, debt repayment, capital expenditures, the expansion, redevelopment and retenanting of properties in our portfolio and working capital.

On September 3, 2014, we, operating through our subsidiary, Whitestone Pecos Ranch, LLC, a Delaware limited liability company, entered into a $14.0 million promissory note (the “Pecos Note”), with a fixed interest rate of 4.34% payable to Wells Fargo Bank, National Association and a maturity date of September 11, 2024. Proceeds from the Pecos Note were used to repay a portion of our previous unsecured revolving credit facility.

On August 26, 2014, we, operating through our subsidiary, Whitestone Shops at Starwood, LLC, a Delaware limited liability company, entered into a $14.3 million promissory note (the “Starwood Note”), with a fixed interest rate of 4.34% payable to Wells Fargo Bank, National Association and a maturity date of September 11, 2024. Proceeds from the Starwood Note were used to repay a portion of our previous unsecured revolving credit facility.

As of June 30, 2015, our $173.2 million in secured debt was collateralized by 20 properties with a carrying value of $215.7 million.  Our loans contain restrictions that would require the payment of prepayment penalties for the acceleration of outstanding debt and are secured by deeds of trust on certain of our properties and by assignment of the rents and leases associated with those properties.  As of June 30, 2015, we were in compliance with all loan covenants.


12


Scheduled maturities of our outstanding debt as of June 30, 2015 were as follows (in thousands):
Year
 
Amount Due
 
 
 
2015
 
$
1,549

2016
 
13,269

2017
 
60,212

2018
 
141,736

2019
 
58,049

Thereafter
 
128,472

Total
 
$
403,287

 
7.  DERIVATIVES AND HEDGING ACTIVITIES

The fair value of our interest rate swaps is as follows (in thousands):
 
 
Balance Sheet Location
 
Estimated Fair Value
Interest rate swaps:
 
 
 
 
June 30, 2015
 
Accounts payable and accrued expenses
 
$
1,116

December 31, 2014
 
Accounts payable and accrued expenses
 
$
1,016


A summary of our interest rate swap activity is as follows (in thousands):
 
 
Amount Recognized as Comprehensive Income (Loss)
 
Location of Loss Recognized in Earnings
 
Amount of Loss Recognized in Earnings (1)
Three months ended June 30, 2015
 
$
43

 
Interest expense
 
$
(203
)
Three months ended June 30, 2014
 
$
(259
)
 
Interest expense
 
$
(192
)
 
 
 
 
 
 
 
Six months ended June 30, 2015
 
$
(276
)
 
Interest expense
 
$
(410
)
Six months ended June 30, 2014
 
$
(297
)
 
Interest expense
 
$
(382
)

(1) 
We did not recognize any ineffective portion of our interest rate swaps in earnings for the three and six months ended June 30, 2015 and 2014.

8.  EARNINGS PER SHARE
 
Basic earnings per share for our common shareholders is calculated by dividing income from continuing operations excluding amounts attributable to unvested restricted shares and the net income attributable to noncontrolling interests by our weighted average common shares outstanding during the period.  Diluted earnings per share is computed by dividing the net income attributable to common shareholders excluding amounts attributable to unvested restricted shares and the net income attributable to noncontrolling interests by the weighted average number of common shares including any dilutive unvested restricted shares.
 
Certain of our performance-based restricted common shares are considered participating securities that require the use of the two-class method for the computation of basic and diluted earnings per share.  During the three months ended June 30, 2015 and 2014, 390,323 and 506,513 OP units, respectively, were excluded from the calculation of diluted earnings per share because their effect would be anti-dilutive, and during the six months ended June 30, 2015 and 2014, 391,455 and 530,961 OP units, respectively, were excluded from the calculation of diluted earnings per share because their effect would be anti-dilutive.
 

13

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2015
(Unaudited)

For the three months ended June 30, 2015 and 2014, distributions of $172,000 and $78,000, respectively, were made to holders of certain restricted common shares, $9,000 and $25,000, respectively, of which were charged against earnings. For the six months ended June 30, 2015 and 2014, distributions of $288,000 and $116,000, respectively, were made to holders of certain restricted common shares, $18,000 and $44,000, respectively, of which were charged against earnings. See Note 11 for information related to restricted common shares under the 2008 Plan.

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in thousands, except per share data)
 
2015
 
2014
 
2015
 
2014
Numerator:
 
 
 
 
 
 
 
 
Income from continuing operations
 
$
1,593

 
$
1,134

 
$
3,222

 
$
3,446

Less: Net income attributable to noncontrolling interests
 
(26
)
 
(24
)
 
(54
)
 
(81
)
Distributions paid on unvested restricted shares
 
(163
)
 
(54
)
 
(270
)
 
(73
)
Income from continuing operations attributable to Whitestone REIT excluding amounts attributable to unvested restricted shares
 
1,404

 
1,056

 
2,898

 
3,292

Income (loss) from discontinued operations
 
(33
)
 
146

 
(41
)
 
266

Less: Net (income) loss attributable to noncontrolling interests
 

 
(3
)
 
1

 
(6
)
Income (loss) from discontinued operations attributable to Whitestone REIT
 
(33
)
 
143

 
(40
)
 
260

Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
1,371

 
$
1,199

 
$
2,858

 
$
3,552

 
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
 
Weighted average number of common shares - basic
 
22,869

 
22,235

 
22,724

 
22,030

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Unvested restricted shares
 
532

 
208

 
590

 
162

Weighted average number of common shares - dilutive
 
23,401

 
22,443

 
23,314

 
22,192

 
 
 
 
 
 
 
 
 
Earnings Per Share:
 
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
 
Income from continuing operations attributable to Whitestone REIT excluding amounts attributable to unvested restricted shares
 
$
0.06

 
$
0.05

 
$
0.13

 
$
0.15

Income from discontinued operations attributable to Whitestone REIT
 
0.00

 
0.00

 
0.00

 
0.01

Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.06

 
$
0.05

 
$
0.13

 
$
0.16

Diluted:
 
 
 
 
 
 
 
 
Income from continuing operations attributable to Whitestone REIT excluding amounts attributable to unvested restricted shares
 
$
0.06

 
$
0.05

 
$
0.12

 
$
0.15

Income from discontinued operations attributable to Whitestone REIT
 
0.00

 
0.00

 
0.00

 
0.01

Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.06

 
$
0.05

 
$
0.12

 
$
0.16



14

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2015
(Unaudited)

9. INCOME TAXES
 
Federal income taxes are not provided because we intend to and believe we qualify as a REIT under the provisions of the Internal Revenue Code (the “Code”) and because we have distributed and intend to continue to distribute all of our taxable income to our shareholders.  As a REIT, we must distribute at least 90% of our real estate investment trust taxable income to our shareholders and meet certain income sources and investment restriction requirements.  In addition, REITs are subject to a number of organizational and operational requirements.  If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate tax rates.
 
Taxable income differs from net income for financial reporting purposes principally due to differences in the timing of recognition of interest, real estate taxes, depreciation and rental revenue. 

We are subject to the Texas Margin Tax, which is computed by applying the applicable tax rate (1% for us) to the profit margin, which generally will be determined for us as total revenue less a 30% standard deduction.  Although the Texas Margin Tax is not an income tax, FASB ASC 740, “Income Taxes” applies to the Texas Margin Tax.  For the three months ended June 30, 2015 and 2014, we recognized approximately $106,000 and $42,000 in margin tax provision, respectively, and for the six months ended June 30, 2015 and 2014, we recognized approximately $188,000 and $109,000 in margin tax provision, respectively.

10.  EQUITY

Common Shares    

Under our declaration of trust, as amended, we have authority to issue up to 400,000,000 common shares of beneficial interest, $0.001 par value per share, and up to 50,000,000 preferred shares of beneficial interest, $0.001 par value per share.
  
Equity Offerings

On June 26, 2015, we completed the sale of 3,750,000 common shares, $0.001 par value per share, at a purchase price of $13.3386 per share. Total net proceeds from the offering, after deducting offering expenses, were approximately $49.7 million, which we contributed to the Operating Partnership in exchange for OP units. The Operating Partnership used the net proceeds from this offering to repay a portion of our unsecured credit facility and for general corporate purposes.

On June 19, 2013, we entered into five equity distribution agreements for an at-the-market distribution program.  On August 14, 2013, we entered into a sixth equity distribution agreement on substantially similar terms as the existing equity distribution agreements and amended the existing equity distribution agreements in order to add an additional placement agent (together, the “2013 equity distribution agreements”). Pursuant to the terms and conditions of the 2013 equity distribution agreements, we could issue and sell up to an aggregate of $50 million of our common shares. Actual sales would depend on a variety of factors to be determined by us from time to time, including (among others) market conditions, the trading price of our common shares, capital needs and our determinations of the appropriate sources of funding for us, and were made in transactions that were deemed to be “at-the-market” offerings as defined in Rule 415 under the Securities Act of 1933, as amended. We had no obligation to sell any of our common shares, and could at any time suspend offers under the 2013 equity distribution agreements or terminate the 2013 equity distribution agreements. During the three and six months ended June 30, 2015, we did not sell any common shares under the 2013 equity distribution program. During the three and six months ended June 30, 2014, we sold 377,983 common shares under the 2013 equity distribution program, with net proceeds to us of approximately $5.3 million. In connection with such sales, we paid compensation of $0.1 million to the placement agents.


15

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2015
(Unaudited)

On June 4, 2015, we entered into six amended and restated equity distribution agreements (the “2015 equity distribution agreements”). Pursuant to the terms and conditions of the 2015 equity distribution agreements, we can issue and sell up to an aggregate of $50 million of our common shares. Actual sales will depend on a variety of factors to be determined by us from time to time, including (among others) market conditions, the trading price of our common shares, capital needs and our determinations of the appropriate sources of funding for us, and will be made in transactions that will be deemed to be “at-the-market” offerings as defined in Rule 415 under the Securities Act of 1933, as amended. We have no obligation to sell any of our common shares, and can at any time suspend offers under the 2015 equity distribution agreements or terminate the 2015 equity distribution agreements. We have not sold any common shares under the 2015 equity distribution agreements.

Operating Partnership Units 

Substantially all of our business is conducted through our Operating Partnership.  We are the sole general partner of the Operating Partnership.  As of June 30, 2015, we owned a 98.6% interest in the Operating Partnership.
 
Limited partners in the Operating Partnership holding OP units have the right to convert their OP units into cash or, at our option, common shares at a ratio of one OP unit for one common share.  Distributions to OP unit holders are paid at the same rate per unit as distributions per share to holders of Whitestone common shares.  As of June 30, 2015 and December 31, 2014, there were 27,247,256 and 22,926,599 OP units outstanding, respectively.  We owned 26,857,448 and 22,528,207 OP units as of June 30, 2015 and December 31, 2014, respectively. The balance of the OP units is owned by third parties, including certain trustees.  Our weighted average share ownership in the Operating Partnership was approximately 98.4% and 97.8% for the three months ended June 30, 2015 and 2014, respectively, and 98.3% and 97.7% for the six months ended June 30, 2015 and 2014, respectively. During the three months ended June 30, 2015 and 2014, 802 and 84,431 OP units, respectively, were redeemed for an equal number of common shares, and during the six months ended June 30, 2015 and 2014, 8,584 and 95,834 OP units, respectively, were redeemed for an equal number of common shares.

 Distributions
 
The following table summarizes the cash distributions paid or payable to holders of common shares and to holders of noncontrolling OP units during each quarter during 2014 and the six months ended June 30, 2015 (in thousands, except per share/unit data):

 
 
Common Shares
 
Noncontrolling OP Unit Holders
 
Total
Quarter Paid
 
Distributions Per Common Share
 
Total Amount Paid
 
Distributions Per OP Unit
 
Total Amount Paid
 
Total Amount Paid
2015
 
 
 
 
 
 
 
 
 
 
Second Quarter
 
$
0.2850

 
$
6,601

 
$
0.2850

 
$
111

 
$
6,712

First Quarter
 
0.2850

 
6,526

 
0.2850

 
113

 
6,639

Total
 
$
0.5700

 
$
13,127

 
$
0.5700

 
$
224

 
$
13,351

 
 
 
 
 
 
 
 
 
 
 
2014
 
 
 
 
 
 
 
 
 
 
Fourth Quarter
 
$
0.2850

 
$
6,484

 
$
0.2850

 
$
114

 
$
6,598

Third Quarter
 
0.2850

 
6,457

 
0.2850

 
126

 
6,583

Second Quarter
 
0.2850

 
6,367

 
0.2850

 
152

 
6,519

First Quarter
 
0.2850

 
6,231

 
0.2850

 
158

 
6,389

Total
 
$
1.1400

 
$
25,539

 
$
1.1400

 
$
550

 
$
26,089



16

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2015
(Unaudited)

11.  INCENTIVE SHARE PLAN
 
On July 29, 2008, our shareholders approved the 2008 Plan. On December 22, 2010, our board of trustees amended the 2008 Plan to allow for awards in or related to Class B common shares pursuant to the 2008 Plan. On June 27, 2012, our Class B common shares were redesignated as “common shares.” The 2008 Plan, as amended, provides that awards may be made with respect to common shares of Whitestone or OP units, which may be converted into cash or, at our option, common shares of Whitestone. The maximum aggregate number of common shares that may be issued under the 2008 Plan is increased upon each issuance of common shares by Whitestone so that at any time the maximum number of shares that may be issued under the 2008 Plan shall equal 12.5% of the aggregate number of common shares of Whitestone and OP units issued and outstanding (other than shares and/or OP units issued to or held by Whitestone).

The Compensation Committee of our board of trustees administers the 2008 Plan, except with respect to awards to non-employee trustees, for which the 2008 Plan is administered by our board of trustees.  The Compensation Committee is authorized to grant share options, including both incentive share options and non-qualified share options, as well as share appreciation rights, either with or without a related option. The Compensation Committee is also authorized to grant restricted common shares, restricted common share units, performance awards and other share-based awards. 

On April 2, 2014, the Compensation Committee approved the modification of the vesting provisions with respect to awards of an aggregate of 633,704 restricted common shares and restricted common share units for 51 of our employees. The modified time-based shares will vest annually in three equal installments. The modified performance-based restricted common shares and restricted common share units were modified to include performance-based vesting based on achievement of certain absolute financial goals, as well as one to two years of time-based vesting post achievement of financial goals. Continued employment is required through the applicable vesting date. Additionally, 2,049,116 restricted performance-based common share units were granted with the same vesting conditions as the modified performance-based grants described above. If the performance targets are not met prior to December 31, 2018, any unvested performance-based restricted common shares and restricted common units will be forfeited.

On June 30, 2015, the Compensation Committee approved the grant of an aggregate of 143,000 time-based restricted common share units to James C. Mastandrea and David K. Holeman.

A summary of the share-based incentive plan activity as of and for the six months ended June 30, 2015 is as follows:
 
 
Shares
 
Weighted Average
Grant Date
Fair Value
Non-vested at January 1, 2015
 
2,411,068

 
$
14.45

Granted
 
267,280

 
13.65

Vested
 
(192,844
)
 
14.47

Forfeited
 
(71,995
)
 
14.44

Non-vested at June 30, 2015
 
2,413,509

 
$
14.36

Available for grant at June 30, 2015
 
970,051

 
 


17

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2015
(Unaudited)

A summary of our non-vested and vested shares activity for the six months ended June 30, 2015 and years ended December 31, 2014, 2013, 2012 and 2011 is presented below:
 
 
Shares Granted
 
Shares Vested
 
 
Non-Vested Shares Issued
 
Weighted Average Grant-Date Fair Value
 
Vested Shares
 
Total Vest-Date Fair Value
 
 
 
 
 
 
 
 
(in thousands)
Six Months Ended June 30, 2015
 
267,280

 
$
13.65

 
(192,844
)
 
$
2,791

Year Ended December 31, 2014
 
2,058,930

 
14.40

 
(133,774
)
 
1,721

Year Ended December 31, 2013
 
328,005

 
15.43

 
(15,270
)
 
224

Year Ended December 31, 2012
 
99,700

 
13.03

 
(16,208
)
 
223

Year Ended December 31, 2011
 

 

 
(5,169
)
 

    
Total compensation recognized in earnings for share-based payments was $1,669,000 and $1,234,000 for the three months ended June 30, 2015 and 2014, respectively, and $3,343,000 and $1,607,000 for the six months ended June 30, 2015 and 2014, respectively.

Based on our current financial projections, we expect approximately 82% of the unvested awards to vest over the next 45 months. As of June 30, 2015, there was approximately $11.5 million in unrecognized compensation cost related to outstanding non-vested performance-based shares, which are expected to vest over a period of 45 months and approximately $4.8 million in unrecognized compensation cost related to outstanding non-vested time-based shares, which are expected to be recognized over a period of approximately 21 months beginning on July 1, 2015.

We expect to record approximately $6.9 million in non-cash share-based compensation expense in 2015 and $12.8 million subsequent to 2015. The unrecognized share-based compensation cost is expected to vest over a weighted average period of 31 months. The dilutive impact of the performance-based shares will be included in the denominator of the earnings per share calculation beginning in the period that the performance conditions are expected to be met.

12. GRANTS TO TRUSTEES

On October 24, 2014, each of our four independent trustees and one trustee emeritus was granted 1,500 common shares, which vested immediately. The 7,500 common shares granted to our trustees had a grant date fair value of $14.53 per share. On December 9, 2014, two of our independent trustees elected to receive a total of 2,314 common shares with a grant date fair value of $14.69 in lieu of cash for board fees. The fair value of the shares granted were determined using quoted prices available on the date of grant.

13. SEGMENT INFORMATION

Historically, our management has not differentiated results of operations by property type or location and, therefore, does not present segment information.

14. REAL ESTATE

Property Acquisitions. On May 27, 2015, we acquired Davenport Village, a property that meets our Community Centered Property™ strategy, for approximately $45.5 million in cash and net prorations. The 128,934 square foot property was 85% leased at the time of purchase and is located in Austin, Texas.

On March 31, 2015, we acquired City View Village, a property that meets our Community Centered Property™ strategy, for approximately $6.3 million in cash and net prorations. The 17,870 square foot property was 100% leased at the time of purchase and is located in San Antonio, Texas.


18

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2015
(Unaudited)

On December 24, 2014, we acquired the hard corner at our Village Square at Dana Park property for approximately $4.7 million, in exchange for the assumption of a $2.6 million non-recourse loan and cash of $2.1 million. The 12,047 square foot property was 88% leased at the time of purchase and is located in the Mesa submarket of Phoenix, Arizona.

On December 24, 2014, we acquired The Shops at Williams Trace, a property that meets our Community Centered Property™ strategy, for approximately $20.2 million in cash and net prorations. The 132,991 square foot property was 87% leased at the time of purchase and is located in Sugar Land, Texas.

On December 24, 2014, we acquired Williams Trace Plaza, a property that meets our Community Centered Property™ strategy, for approximately $20.4 million in cash and net prorations. The 129,222 square foot property was 95% leased at the time of purchase and is located in Sugar Land, Texas.

On December 19, 2014, we acquired a 1.39 acre parcel of undeveloped land for $0.9 million in cash and net prorations. The undeveloped land parcel is adjacent to our Fulton Ranch Towne Center property.

On November 5, 2014, we acquired Fulton Ranch Towne Center, a property that meets our Community Centered Property strategy, for approximately $29.3 million in cash and net prorations. The 113,281 square foot property was 86% leased at the time of purchase and is located in Chandler, Arizona.

On November 5, 2014, we acquired The Promenade at Fulton Ranch, a property that meets our Community Centered Property strategy, for approximately $18.6 million in cash and net prorations. The 98,792 square foot property was 76% leased at the time of purchase and is located in Chandler, Arizona.

On September 19, 2014, we acquired The Strand at Huebner Oaks, a property that meets our Community Centered Property™ strategy, for approximately $18.0 million in cash and net prorations. The 73,920 square foot property was 90% leased at the time of purchase and is located in San Antonio, Texas.

On July 1, 2014, we acquired Heritage Trace Plaza, a property that meets our Community Centered Property strategy, for approximately $20.1 million in cash and net prorations. The 70,431 square foot property was 98% leased at the time of purchase and is located in Fort Worth, Texas.    

Property Dispositions. On December 31, 2014, we completed the sale of three office buildings (Zeta, Royal Crest and Featherwood), located in the Clear Lake suburb of Houston, Texas, for $10.3 million. This disposition was pursuant to our strategy of recycling capital by disposing of non-core properties that do not fit our Community Centered Property™ strategy. As part of the transaction, we provided short-term seller financing of $2.5 million. We recorded a gain on sale of $4.4 million, including recognizing a $1.9 million gain on sale for the year ended December 31, 2014 and deferring the remaining $2.5 million gain on sale to be recognized upon receipt of principal payments on the financing provided by us.

The operating results for properties classified as discontinued operations consists of the following (in thousands):

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
Property revenues
 
$

 
$
412

 
1

 
824

Property expenses
 
36

 
175

 
44

 
344

Depreciation and amortization
 

 
74

 

 
153

Interest expense
 

 
15

 

 
58

Provision for income taxes
 
(2
)
 
2

 
(2
)
 
5

Loss (gain) on sale or disposal of assets
 
(1
)
 

 

 
(2
)
    Income (loss) from discontinued operations
 
$
(33
)
 
$
146

 
$
(41
)
 
$
266



19

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2015
(Unaudited)

15. SUBSEQUENT EVENTS

On July 2, 2015, we acquired Parkside Village North, a property that meets our Community Centered Property™ strategy, for approximately $12.5 million in cash and net prorations. The 27,045 square foot property was 100% leased at the time of purchase and is located in Austin, Texas.

On July 2, 2015, we acquired Parkside Village South, a property that meets our Community Centered Property™ strategy, for approximately $32.5 million in cash and net prorations. The 90,101 square foot property was 100% leased at the time of purchase and is located in Austin, Texas.


20


Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion of our financial condition and results of operations in conjunction with our unaudited consolidated financial statements and the notes thereto included in this Quarterly Report on Form 10-Q (the “Report”), and the consolidated financial statements and the notes thereto and “Management's Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2014.  For more detailed information regarding the basis of presentation for the following information, you should read the notes to the unaudited consolidated financial statements included in this Report.

This Report contains forward-looking statements within the meaning of the federal securities laws, including discussion and analysis of our financial condition, anticipated capital expenditures required to complete projects, amounts of anticipated cash distributions to our shareholders in the future and other matters.  These forward-looking statements are not historical facts but are the intent, belief or current expectations of our management based on its knowledge and understanding of our business and industry.  Forward-looking statements are typically identified by the use of terms such as “may,” “will,” “should,” “potential,” “predicts,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates” or the negative of such terms and variations of these words and similar expressions, although not all forward-looking statements include these words.  These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements.
     
Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false.  You are cautioned not to place undue reliance on forward-looking statements, which reflect our management's view only as of the date of this Report.  We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results.  Factors that could cause actual results to differ materially from any forward-looking statements made in this Report include:

the imposition of federal taxes if we fail to qualify as a REIT in any taxable year or forego an opportunity to ensure REIT status;
uncertainties related to the national economy, the real estate industry in general and in our specific markets;
legislative or regulatory changes, including changes to laws governing REITs;
adverse economic or real estate developments in Texas, Arizona or Illinois;
increases in interest rates and operating costs;
availability and terms of capital and financing, both to fund our operations and to refinance our indebtedness as it matures;
decreases in rental rates or increases in vacancy rates;
litigation risks;
lease-up risks, including leasing risks arising from exclusivity and consent provisions in leases with significant tenants;
our inability to renew tenants or obtain new tenants upon the expiration of existing leases;
our inability to generate sufficient cash flows due to market conditions, competition, uninsured losses, changes in tax or other applicable laws; and
the need to fund tenant improvements or other capital expenditures out of operating cash flow.
 
The forward-looking statements should be read in light of these factors and the factors identified in the “Risk Factors” sections of our Annual Report on Form 10-K for the year ended December 31, 2014, as previously filed with the Securities and Exchange Commission (“SEC”) and of this Report below.
 
Overview

We are a fully integrated real estate company that owns, redevelops, repositions, leases, manages and operates Community Centered PropertiesTM .  We define Community Centered PropertiesTM as visibly located properties in established or developing culturally diverse neighborhoods in our target markets.  Founded in 1998, we are internally managed with a portfolio of commercial properties in Texas, Arizona and Illinois.


21


In October 2006, our current management team joined the Company and adopted a strategic plan to acquire, redevelop, own and operate Community Centered PropertiesTM.  We market, lease and manage our centers to match tenants with the shared needs of the surrounding neighborhood.  Those needs may include specialty retail, grocery, restaurants and medical, educational and financial services.  Our goal is for each property to become a Whitestone-branded business center or retail community that serves a neighboring five-mile radius around our property.  We employ and develop a diverse group of associates who understand the needs of our multicultural communities and tenants.

We serve as the general partner of Whitestone REIT Operating Partnership, L.P. (the “Operating Partnership”), which was formed on December 31, 1998 as a Delaware limited partnership. We currently conduct substantially all of our operations and activities through the Operating Partnership. As the general partner of the Operating Partnership, we have the exclusive power to manage and conduct the business of the Operating Partnership, subject to certain customary exceptions.

As of June 30, 2015, we owned and operated 65 commercial properties consisting of:

Operating Portfolio
39 retail properties containing approximately 3.4 million square feet of gross leasable area and having a total carrying value (net of accumulated depreciation) of $431.1 million;
four office properties containing approximately 0.5 million square feet of gross leasable area and having a total carrying value (net of accumulated depreciation) of $36.4 million; and
11 office/flex properties containing approximately 1.2 million square feet of gross leasable area and having a total carrying value (net of accumulated depreciation) of $36.9 million.
Redevelopment, New Acquisitions Portfolio
five retail properties containing approximately 0.5 million square feet of gross leasable area and having a total carrying value (net of accumulated depreciation) of $136.1 million; and
six parcels of land held for future development having a total carrying value of $9.5 million.

As of June 30, 2015, we had an aggregate of 1,381 tenants.  We have a diversified tenant base with our largest tenant comprising only 2.1% of our annualized rental revenues for the six months ended June 30, 2015.  Lease terms for our properties range from less than one year for smaller tenants to over 15 years for larger tenants.  Our leases generally include minimum monthly lease payments and tenant reimbursements for payment of taxes, insurance and maintenance.  We completed 193 new and renewal leases during the six months ended June 30, 2015, totaling 463,466 square feet and approximately $24.5 million in total lease value.  This compares to 215 new and renewal leases totaling 452,233 square feet and approximately $26.3 million in total lease value during the same period in 2014.

We employed 83 full-time employees as of June 30, 2015.  As an internally managed REIT, we bear our own expenses of operations, including the salaries, benefits and other compensation of our employees, office expenses, legal, accounting and investor relations expenses and other overhead costs.

How We Derive Our Revenue
 
Substantially all of our revenue is derived from rents received from leases at our properties. We had rental income and tenant reimbursements of approximately $22.0 million and $17.3 million for the three months ended June 30, 2015 and 2014, respectively, and $43.2 million and $34.6 million for the six months ended June 30, 2015 and 2014, respectively.


22


Known Trends in Our Operations; Outlook for Future Results
 
Rental Income
 
We expect our rental income to increase year-over-year due to the addition of properties and rent increases on renewal leases. The amount of net rental income generated by our properties depends principally on our ability to maintain the occupancy rates of currently leased space and to lease currently available space, newly acquired properties with vacant space, and space available from unscheduled lease terminations. The amount of rental income we generate also depends on our ability to maintain or increase rental rates in our submarkets. Over the past two years, we have seen modest improvement in the overall economy in our markets, which has allowed us to maintain overall occupancy rates, with slight increases in occupancy at certain of our properties, and to recognize modest increases in rental rates. We expect this trend to continue in 2015.
 
Scheduled Lease Expirations
 
We tend to lease space to smaller businesses that desire shorter term leases. As of June 30, 2015, approximately 25% of our gross leasable area was subject to leases that expire prior to December 31, 2016.  Over the last two years, we have renewed leases covering approximately 76% of the square footage subject to expiring leases. We routinely seek to renew leases with our existing tenants prior to their expiration and typically begin discussions with tenants as early as 18 months prior to the expiration date of the existing lease. While our early renewal program and other leasing and marketing efforts target these expiring leases, we hope to re-lease most of that space prior to expiration of the leases. In the markets in which we operate, we obtain and analyze market rental rates through review of third-party publications, which provide market and submarket rental rate data and through inquiry of property owners and property management companies as to rental rates being quoted at properties that are located in close proximity to our properties and we believe display similar physical attributes as our nearby properties. We use this data to negotiate leases with new tenants and renew leases with our existing tenants at rates we believe to be competitive in the markets for our individual properties. Due to the short term nature of our leases, and based upon our analysis of market rental rates, we believe that, in the aggregate, our current leases are at market rates. Market conditions, including new supply of properties, and macroeconomic conditions in our markets and nationally affecting tenant income, such as employment levels, business conditions, interest rates, tax rates, fuel and energy costs and other matters, could adversely impact our renewal rate and/or the rental rates we are able to negotiate. We continue to monitor our tenants' operating performances as well as overall economic trends to evaluate any future negative impact on our renewal rates and rental rates, which could adversely affect our cash flow and ability to make distributions to our shareholders.
 
Acquisitions
 
We have continued to successfully grow our gross leasable area through the acquisition of additional properties, and we expect to actively pursue and consummate additional acquisitions in the foreseeable future. We believe that over the next few years we will continue to have excellent opportunities to acquire quality properties at historically attractive prices. We have extensive relationships with community banks, attorneys, title companies and others in the real estate industry, which we believe enables us to take advantage of these market opportunities and maintain an active acquisition pipeline.
 
Property Acquisitions
 
We seek to acquire commercial properties in high-growth markets. Our acquisition targets are properties that fit our Community Centered PropertiesTM strategy.  We define Community Centered PropertiesTM as visibly located properties in established or developing, culturally diverse neighborhoods in our target markets, primarily in and around Austin, Chicago, Dallas-Fort Worth, Houston, Phoenix and San Antonio.  We may acquire properties in other high-growth cities in the future. We market, lease and manage our centers to match tenants with the shared needs of the surrounding neighborhood.  Those needs may include specialty retail, grocery, restaurants, medical, educational and financial services.  Our goal is for each property to become a Whitestone-branded business center or retail community that serves a neighboring five-mile radius around our property.

On July 2, 2015, we acquired Parkside Village North, a property that meets our Community Centered Property™ strategy, for approximately $12.5 million in cash and net prorations. The 27,045 square foot property was 100% leased at the time of purchase and is located in Austin, Texas.

On July 2, 2015, we acquired Parkside Village South, a property that meets our Community Centered Property™ strategy, for approximately $32.5 million in cash and net prorations. The 90,101 square foot property was 100% leased at the time of purchase and is located in Austin, Texas.


23


On May 27, 2015, we acquired Davenport Village, a property that meets our Community Centered Property™ strategy, for approximately $45.5 million in cash and net prorations. The 128,934 square foot property was 85% leased at the time of purchase and is located in Austin, Texas.

On March 31, 2015, we acquired City View Village, a property that meets our Community Centered PropertyTM strategy, for approximately $6.3 million in cash and net prorations. The 17,870 square foot property was 100% leased at the time of purchase and is located in San Antonio, Texas.

On December 24, 2014, we acquired the hard corner at our Village Square at Dana Park property for approximately $4.7 million, in exchange for the assumption of a $2.6 million non-recourse loan and cash of $2.1 million. The 12,047 square foot property was 88% leased at the time of purchase and is located in the Mesa submarket of Phoenix, Arizona.

On December 24, 2014, we acquired The Shops at Williams Trace, a property that meets our Community Centered PropertyTM strategy, for approximately $20.2 million in cash and net prorations. The 132,991 square foot property was 87% leased at the time of purchase and is located in Sugar Land, Texas.

On December 24, 2014, we acquired Williams Trace Plaza, a property that meets our Community Centered PropertyTM strategy, for approximately $20.4 million in cash and net prorations. The 129,222 square foot property was 95% leased at the time of purchase and is located in Sugar Land, Texas.

On December 19, 2014, we acquired a 1.39 acre parcel of undeveloped land for $0.9 million in cash and net prorations. The undeveloped land parcel is adjacent to our Fulton Ranch Towne Center property.

On November 5, 2014, we acquired Fulton Ranch Towne Center, a property that meets our Community Centered PropertyTM strategy, for approximately $29.3 million in cash and net prorations. The 113,281 square foot property was 86% leased at the time of purchase and is located in Chandler, Arizona.

On November 5, 2014, we acquired The Promenade at Fulton Ranch, a property that meets our Community Centered PropertyTM strategy, for approximately $18.6 million in cash and net prorations. The 98,792 square foot property was 76% leased at the time of purchase and is located in Chandler, Arizona.

On September 19, 2014, we acquired The Strand at Huebner Oaks, a property that meets our Community Centered PropertyTM strategy, for approximately $18.0 million in cash and net prorations. The 73,920 square foot property was 90% leased at the time of purchase and is located in San Antonio, Texas.

On July 1, 2014, we acquired Heritage Trace Plaza, a property that meets our Community Centered PropertyTM strategy, for approximately $20.1 million in cash and net prorations. The 70,431 square foot property was 98% leased at the time of purchase and is located in Fort Worth, Texas.


24


Leasing Activity
    
As of June 30, 2015, we owned 65 properties with 5,632,597 square feet of gross leasable area, which were approximately 86% occupied. Our occupancy rate for all properties was approximately 86% occupied as of both June 30, 2015 and June 30, 2014. The following is a summary of the Company's leasing activity for the six months ended June 30, 2015:

 
 
Number of Leases Signed
 
GLA Signed
 
Weighted Average Lease Term (2)
 
TI and Incentives per Sq. Ft. (3)
 
Contractual Rent Per Sq. Ft (4)
 
Prior Contractual Rent Per Sq. Ft. (5)
 
Straight-lined Basis Increase Over Prior Rent
Comparable (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Renewal Leases
 
117

 
235,088

 
2.7

 
$
1.76

 
$
14.51

 
$
13.44

 
15.1
%
   New Leases
 
34