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EX-32.2 - EXHIBIT 32.2 - Whitestone REITexhibit322certificationofc.htm
EX-32.1 - EXHIBIT 32.1 - Whitestone REITexhibit321certificationofc.htm
EX-31.2 - EXHIBIT 31.2 - Whitestone REITexhibit312certificationofc.htm
EX-31.1 - EXHIBIT 31.1 - Whitestone REITexhibit311certificationofc.htm
EX-12.1 - EXHIBIT 12.1 - Whitestone REITexhibit121computationofrat.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 September 30, 2017

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

Emerging growth company ¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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 November 1, 2017, there were 38,486,707 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 and per share data)

 
 
September 30, 2017
 
December 31, 2016
 
 
(unaudited)
 
 
ASSETS(1)
Real estate assets, at cost
 
 
 
 
Property
 
$
1,144,558

 
$
920,310

Accumulated depreciation
 
(124,268
)
 
(107,258
)
Total real estate assets
 
1,020,290

 
813,052

Cash and cash equivalents
 
6,338

 
4,168

Restricted cash
 
105

 
56

Marketable securities
 
242

 
517

Escrows and acquisition deposits
 
9,116

 
6,620

Accrued rents and accounts receivable, net of allowance for doubtful accounts
 
22,212

 
19,951

Unamortized lease commissions and loan costs
 
8,397

 
8,083

Prepaid expenses and other assets
 
3,448

 
2,762

Total assets
 
$
1,070,148

 
$
855,209

 
 
 
 
 
LIABILITIES AND EQUITY(2)
Liabilities:
 
 
 
 
Notes payable
 
$
662,675

 
$
544,020

Accounts payable and accrued expenses
 
35,041

 
28,692

Tenants' security deposits
 
6,746

 
6,125

Dividends and distributions payable
 
11,401

 
8,729

Total liabilities
 
715,863

 
587,566

Commitments and contingencies:
 

 

Equity:
 
 
 
 
Preferred shares, $0.001 par value per share; 50,000,000 shares authorized; none issued and outstanding as of September 30, 2017 and December 31, 2016, respectively
 

 

Common shares, $0.001 par value per share; 400,000,000 shares authorized; 38,524,480 and 29,468,563 issued and outstanding as of September 30, 2017 and December 31, 2016, respectively
 
38

 
29

Additional paid-in capital
 
509,774

 
396,494

Accumulated deficit
 
(167,397
)
 
(141,695
)
Accumulated other comprehensive gain
 
1,004

 
859

Total Whitestone REIT shareholders' equity
 
343,419

 
255,687

Noncontrolling interests:
 
 
 
 
Redeemable operating partnership units
 
11,002

 
11,941

Noncontrolling interest in Consolidated Partnership
 
(136
)
 
15

Total noncontrolling interests
 
10,866

 
11,956

Total equity
 
354,285

 
267,643

Total liabilities and equity
 
$
1,070,148

 
$
855,209



See accompanying notes to Consolidated Financial Statements.

1



Whitestone REIT and Subsidiaries
CONSOLIDATED BALANCE SHEETS - Continued
(in thousands, except share and per share data)
 
 
 
 
 
September 30, 2017
 
December 31, 2016
 
 
(unaudited)
 
 
(1) Assets of consolidated Variable Interest Entities included in the total assets above:
Real estate assets, at cost
 
 
 
 
Property
 
$
93,505

 
$
92,338

Accumulated depreciation
 
(35,089
)
 
(32,533
)
Total real estate assets
 
58,416

 
59,805

Cash and cash equivalents
 
2,246

 
1,236

Escrows and acquisition deposits
 
2,087

 
2,274

Accrued rents and accounts receivable, net of allowance for doubtful accounts
 
2,556

 
2,313

Unamortized lease commissions and loan costs
 
1,180

 
1,150

Prepaid expenses and other assets
 
130

 
82

Total assets
 
$
66,615

 
$
66,860

 
 
 
 
 
(2) Liabilities of consolidated Variable Interest Entities included in the total liabilities above:
Notes payable
 
$
49,137

 
$
50,001

Accounts payable and accrued expenses
 
3,480

 
3,481

Tenants' security deposits
 
1,129

 
996

Distributions payable
 
112

 

Total liabilities
 
$
53,858

 
$
54,478








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 September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Property revenues
 
 
 
 
 
 
 
 
Rental revenues
 
$
24,891

 
$
19,844

 
$
69,197

 
$
58,915

Other revenues
 
8,762

 
5,664

 
22,931

 
17,157

Total property revenues
 
33,653

 
25,508

 
92,128

 
76,072

 
 
 
 
 
 
 
 
 
Property expenses
 
 
 
 
 
 
 
 
Property operation and maintenance
 
6,104

 
4,904

 
16,973

 
14,381

Real estate taxes
 
5,181

 
3,414

 
13,588

 
10,072

Total property expenses
 
11,285

 
8,318

 
30,561

 
24,453

 
 
 
 
 
 
 
 
 
Other expenses (income)
 
 
 
 
 
 
 
 
General and administrative
 
5,581

 
6,218

 
17,598

 
16,467

Depreciation and amortization
 
7,247

 
5,449

 
19,936

 
16,362

Interest expense
 
6,376

 
4,669

 
17,158

 
14,221

Interest, dividend and other investment income
 
(142
)
 
(164
)
 
(381
)
 
(339
)
Total other expense
 
19,062

 
16,172

 
54,311

 
46,711

 
 
 
 
 
 
 
 
 
Income before gain (loss) on sale or disposal of properties or assets and income taxes
 
3,306

 
1,018

 
7,256

 
4,908

 
 
 
 
 
 
 
 
 
Provision for income taxes
 
(126
)
 
(80
)
 
(296
)
 
(247
)
Gain on sale of properties
 

 

 
16

 
2,890

Gain (loss) on sale or disposal of assets
 
(40
)
 
26

 
(135
)
 
10

 
 
 
 
 
 
 
 
 
Net income
 
3,140

 
964

 
6,841

 
7,561

 
 
 
 
 
 
 
 
 
Redeemable operating partnership units
 
84

 
15

 
201

 
131

Non-controlling interests in Consolidated Partnership
 
63

 

 
228

 

Less: Net income attributable to noncontrolling interests
 
147

 
15

 
429

 
131

 
 
 
 
 
 
 
 
 
Net income attributable to Whitestone REIT
 
$
2,993

 
$
949

 
$
6,412

 
$
7,430






See accompanying notes to Consolidated Financial Statements.

3


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

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Basic Earnings Per Share:
 
 
 
 
 
 
 
 
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.07

 
$
0.03

 
$
0.18

 
$
0.25

Diluted Earnings Per Share:
 
 
 
 
 
 
 
 
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.07

 
$
0.03

 
$
0.17

 
$
0.25

 
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
37,992

 
28,195

 
34,406

 
27,210

Diluted
 
38,589

 
29,024

 
35,211

 
28,013

 
 
 
 
 
 
 
 
 
Distributions declared per common share / OP unit
 
$
0.2850

 
$
0.2850

 
$
0.8550

 
$
0.8550

 
 
 
 
 
 
 
 
 
Consolidated Statements of Comprehensive Income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
$
3,140

 
$
964

 
$
6,841

 
$
7,561

 
 
 
 
 
 
 
 
 
Other comprehensive gain (loss)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain (loss) on cash flow hedging activities
 
172

 
1,529

 
124

 
(6,962
)
Unrealized gain (loss) on available-for-sale marketable securities
 
(7
)
 
(11
)
 
26

 
20

 
 
 
 
 
 
 
 
 
Comprehensive income
 
3,305

 
2,482

 
6,991

 
619

 
 
 
 
 
 
 
 
 
Less: Net income attributable to noncontrolling interests
 
147

 
15

 
429

 
131

Less: Comprehensive gain (loss) attributable to noncontrolling interests
 
5

 
26

 
5

 
(120
)
 
 
 
 
 
 
 
 
 
Comprehensive income attributable to Whitestone REIT
 
$
3,153

 
$
2,441

 
$
6,557

 
$
608




See accompanying notes to Consolidated Financial Statements.

4


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

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Noncontrolling Interests
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
General
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
Redeemable
 
Partners'
 
 
 
 
 
 
Additional
 
 
 
Other
 
Total
 
Operating
 
Interest in
 
 
 
 
Common Shares
 
Paid-In
 
Accumulated
 
Comprehensive
 
Shareholders'
 
Partnership
 
Consolidated
 
Total
 
 
Shares
 
Amount
 
Capital
 
Deficit
 
Gain
 
Equity
 
Units
 
Dollars
 
Partnership
 
Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2016
 
29,468

 
$
29

 
$
396,494

 
$
(141,695
)
 
$
859

 
$
255,687

 
1,103

 
$
11,941

 
$
15

 
$
267,643

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exchange of noncontrolling interest OP units for common shares
 
19

 

 
206

 

 

 
206

 
(19
)
 
(206
)
 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of shares under dividend reinvestment plan
 
7

 

 
95

 

 

 
95

 

 

 

 
95

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares - ATM Program, net of offering costs
 
567

 
1

 
7,723

 

 

 
7,724

 

 

 

 
7,724

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares - Overnight, net of offering costs
 
8,019

 
8

 
99,887

 

 

 
99,895

 

 

 

 
99,895

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Repurchase of common shares (1)
 
(154
)
 

 
(1,987
)
 

 

 
(1,987
)
 

 

 

 
(1,987
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Share-based compensation
 
598

 

 
7,347

 

 

 
7,347

 

 

 

 
7,347

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Distributions
 

 

 

 
(32,114
)
 

 
(32,114
)
 

 
(930
)
 
(379
)
 
(33,423
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain on change in fair value of available-for-sale marketable securities
 

 

 

 

 
25

 
25

 

 
1

 

 
26

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain on change in value of cash flow hedge
 

 

 

 

 
120

 
120

 

 
4

 

 
124

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reallocation of ownership percentage between parent and subsidiary
 

 

 
9

 

 

 
9

 

 
(9
)
 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 
6,412

 

 
6,412

 

 
201

 
228

 
6,841

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, September 30, 2017
 
38,524

 
$
38

 
$
509,774

 
$
(167,397
)
 
$
1,004

 
$
343,419

 
1,084

 
$
11,002

 
$
(136
)
 
$
354,285


(1) 
During the nine months ended September 30, 2017, 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.


5


Whitestone REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
 
 
Nine Months Ended
 
 
September 30,
 
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net income
 
$
6,841

 
$
7,561

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
19,936

 
16,362

Amortization of deferred loan costs
 
953

 
1,202

Amortization of notes payable discount
 
447

 
241

Gain on sale of marketable securities
 
(5
)
 

Loss (gain) on sale or disposal of assets and properties
 
119

 
(2,900
)
Bad debt expense
 
1,442

 
1,298

Share-based compensation
 
7,347

 
6,874

Changes in operating assets and liabilities:
 
 
 
 
Escrows and acquisition deposits
 
(2,496
)
 
485

Accrued rent and accounts receivable
 
(3,703
)
 
(2,802
)
Unamortized lease commissions
 
(2,196
)
 
(2,126
)
Prepaid expenses and other assets
 
411

 
725

Accounts payable and accrued expenses
 
(1,718
)
 
261

Tenants' security deposits
 
621

 
812

Net cash provided by operating activities
 
27,999

 
27,993

Cash flows from investing activities:
 
 
 
 
Acquisitions of real estate
 
(124,557
)
 
(60,616
)
Additions to real estate
 
(13,499
)
 
(15,362
)
Proceeds from sales of properties
 
26

 
3,957

Proceeds from sales of marketable securities
 
306

 

Net cash used in investing activities
 
(137,724
)
 
(72,021
)
Cash flows from financing activities:
 
 
 
 
Distributions paid to common shareholders
 
(29,494
)
 
(23,606
)
Distributions paid to OP unit holders
 
(932
)
 
(415
)
Distributions paid to noncontrolling interest in Consolidated Partnership
 
(379
)
 

Proceeds from issuance of common shares, net of offering costs
 
107,619

 
26,686

Net proceeds from credit facility
 
40,600

 
64,000

Repayments of notes payable
 
(2,788
)
 
(13,552
)
Payments of loan origination costs
 
(695
)
 

Change in restricted cash
 
(49
)
 
18

Repurchase of common shares
 
(1,987
)
 
(2,904
)
Net cash provided by financing activities
 
111,895

 
50,227

 
 
 
 
 
Net increase in cash and cash equivalents
 
2,170

 
6,199

Cash and cash equivalents at beginning of period
 
4,168

 
2,587

Cash and cash equivalents at end of period
 
$
6,338

 
$
8,786


See accompanying notes to Consolidated Financial Statements.

6


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

 
 
Nine Months Ended
 
 
September 30,
 
 
2017
 
2016
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid for interest
 
$
16,311

 
$
13,700

Cash paid for taxes
 
$
329

 
$
284

Non cash investing and financing activities:
 
 
 
 
Disposal of fully depreciated real estate
 
$
995

 
$
544

Financed insurance premiums
 
$
1,115

 
$
1,060

Value of shares issued under dividend reinvestment plan
 
$
95

 
$
83

Value of common shares exchanged for OP units
 
$
206

 
$
125

Change in fair value of available-for-sale securities
 
$
26

 
$
20

Change in fair value of cash flow hedge
 
$
124

 
$
(6,962
)
Acquisition of real estate in exchange for OP units
 
$

 
$
8,738

Reallocation of ownership percentage between parent and subsidiary
 
$
9

 
$








See accompanying notes to Consolidated Financial Statements.


7

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(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, 2016 are derived from our audited consolidated financial statements as of that date.  The unaudited financial statements as of and for the period ended September 30, 2017 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 September 30, 2017, and the results of operations for the three and nine month periods ended September 30, 2017 and 2016, the consolidated statements of changes in equity for the nine month period ended September 30, 2017 and cash flows for the nine month periods ended September 30, 2017 and 2016.  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, 2016.
 
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 the 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 September 30, 2017 and December 31, 2016, Whitestone owned or held a majority interest in 72 and 69 commercial properties, respectively, in and around Austin, Chicago, Dallas-Fort Worth, Houston, Phoenix and San Antonio.

These properties consist of:

Consolidated Operating Portfolio

51 wholly-owned properties that meet our Community Centered Properties® strategy; and

through our 81.4% majority interest in our consolidated subsidiary, Pillarstone Capital REIT Operating Partnership LP (“Pillarstone OP”) an interest in 14 consolidated properties that do not meet our Community Centered Properties® strategy.

Redevelopment, New Acquisitions Portfolio

two retail properties that meet our Community Centered Properties® strategy; and

five parcels of land held for future development.




8

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)

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 September 30, 2017 and December 31, 2016, 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. We also consolidate a variable interest entity (“VIE”) when we are determined to be the primary beneficiary. Determination of the primary beneficiary is based on whether an entity has (1) the power to direct activities that most significantly impact the economic performance of the VIE and (2) the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. Our determination of the primary beneficiary considers all relationships between us and the VIE, including management and other contractual agreements. See Note 6 for additional disclosure on our VIE.

Noncontrolling interest 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 percentage of 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.
 
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.
 
Restricted Cash. We classify all cash pledged as collateral to secure certain obligations and all cash whose use is limited as restricted cash. During 2015, pursuant to the terms of our $15.1 million 4.99% Note, due January 6, 2024 (see Note 7), which is collateralized by our Anthem Marketplace property, we were required by the lenders thereunder to establish a cash management account controlled by the lenders to collect all amounts generated by our Anthem Marketplace property in order to collateralize such promissory note. As a result, these amounts are reported in the consolidated statements of cash flows under cash flows from financing activities as change in restricted cash.

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.


9

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)

Derivative Instruments and Hedging Activities. We 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 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 September 30, 2017, 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 September 30, 2017, approximately $146,000 and $96,000 in interest expense and real estate taxes, respectively, were capitalized, and for the nine months ended September 30, 2017, approximately $302,000 and $189,000 in interest expense and real estate taxes, respectively, were capitalized. For the three months ended September 30, 2016, approximately $103,000 and $16,000 in interest expense and real estate taxes, respectively, were capitalized, and for the nine months ended September 30, 2016, approximately $235,000 and $48,000 in interest expense and real estate taxes, respectively, were capitalized.

Real Estate Held for Sale and Discontinued Operations. We consider a commercial property to be held for sale when it meets all of the criteria established under ASC 205, “Presentation of Financial Statements.” For commercial properties classified as held for sale, assets and liabilities are presented separately for all periods presented.

In accordance with ASC 205, a discontinued operation may include a component of an entity or a group of components of an entity. A disposal of a component of an entity or a group of components of an entity is reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results when the component of an entity or group of components of an entity is classified as held for sale, disposed of by sale or disposed of other than by sale, respectively. In addition, ASC 205 requires us to provide additional disclosures about both discontinued operations and the disposal of an individually significant component of an entity that does not meet the criteria for a discontinued operation.

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 $2,704,000 and $3,042,000 in share-based compensation for the three months ended September 30, 2017 and 2016, respectively, and we recognized $7,545,000 and $6,886,000 in share-based compensation for the nine months ended September 30, 2017 and 2016, respectively.

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, 2016 for further discussion on significant accounting policies.
 

10

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)

Recent Accounting Pronouncements.  In February 2016, the FASB issued guidance requiring lessees to recognize a lease liability and a right-of-use asset for all leases. Lessor accounting will remain largely unchanged with the exception of changes related to costs which qualify as initial direct costs. The guidance will also require new qualitative and quantitative disclosures to help financial statement users better understand the timing, amount and uncertainty of cash flows arising from leases. This guidance will be effective for reporting periods beginning on or after December 15, 2018, with early adoption permitted. We are currently evaluating the impact of this guidance and its impact on our consolidated financial statements.

In March 2016, the FASB issued guidance simplifying the accounting for share-based payment transactions, including the income tax consequences, balance sheet classification of awards and the classification on the statement of cash flows. We have adopted this guidance as of January 1, 2017. The main provision regarding excess tax benefits did not have an impact on our consolidated financial statements due to our status as a REIT for taxation purposes. We have elected to continue estimating the number of shares expected to vest in order to determine compensation cost, and we will continue to classify cash paid by us for employee taxes when common shares were repurchased to cover minimum statutory requirements as financing activity.

In November 2016, the FASB issued guidance requiring that the statement of cash flows explain the change during the period in the total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This guidance will become effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We are currently evaluating the impact of this guidance and its impact on our consolidated financial statements.

In January 2017, the FASB issued guidance clarifying the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This guidance will become effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We are currently evaluating the impact of this guidance and its impact on our consolidated financial statements.

In February 2017, the FASB issued guidance clarifying the scope of asset derecognition guidance, adds guidance for partial sales of nonfinancial assets and clarifies recognizing gains and losses from the transfer of nonfinancial assets in contracts with noncustomers. This guidance will become effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We are currently evaluating the impact of this guidance and its impact on our consolidated financial statements.

3. MARKETABLE SECURITIES

All of our marketable securities were classified as available-for-sale securities as of September 30, 2017 and December 31, 2016. Available-for-sale securities consisted of the following (in thousands):

 
 
September 30, 2017
 
 
Amortized Cost
 
Gains in Accumulated Other Comprehensive Income
 
Losses in Accumulated Other Comprehensive Income
 
Estimated Fair Value
Real estate sector common stock
 
$
353

 
$

 
$
(111
)
 
$
242

Total available-for-sale securities
 
$
353

 
$

 
$
(111
)
 
$
242



11

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)

 
 
December 31, 2016
 
 
Amortized Cost
 
Gains in Accumulated Other Comprehensive Income
 
Losses in Accumulated Other Comprehensive Income
 
Estimated Fair Value
Real estate sector common stock
 
$
654

 
$

 
$
(137
)
 
$
517

Total available-for-sale securities
 
$
654

 
$

 
$
(137
)
 
$
517


During the three months ended September 30, 2017, available-for-sale securities were sold for total proceeds of $306,000. The gross realized gain on these sales during the three months ended September 30, 2017 was $5,000. During the three and nine months ended September 30, 2016, no available-for-sale securities were sold. For purposes 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 $111,000 and $198,000 for the nine months ended September 30, 2017 and 2016, respectively, has been included in accumulated other comprehensive income.


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):

 
 
September 30, 2017
 
December 31, 2016
 
 
 
 
 
Tenant receivables
 
$
14,420

 
$
12,972

Accrued rents and other recoveries
 
15,996

 
14,237

Allowance for doubtful accounts
 
(8,204
)
 
(7,258
)
Total
 
$
22,212

 
$
19,951


5. UNAMORTIZED LEASE COMMISSIONS, LEGAL FEES AND LOAN COSTS

Costs which have been deferred consist of the following (in thousands):
 
 
September 30, 2017
 
December 31, 2016
 
 
 
 
 
Leasing commissions
 
$
10,263

 
$
8,720

Deferred legal cost
 
326

 

Deferred financing cost
 
4,071

 
4,071

Total cost
 
14,660

 
12,791

Less: leasing commissions accumulated amortization
 
(4,394
)
 
(3,597
)
Less: deferred legal cost accumulated amortization
 
(45
)
 

Less: deferred financing cost accumulated amortization
 
(1,824
)
 
(1,111
)
Total cost, net of accumulated amortization
 
$
8,397

 
$
8,083



12

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)

6. VARIABLE INTEREST ENTITIES

On December 8, 2016, we, through our Operating Partnership, entered into a Contribution Agreement (the “Contribution Agreement”) with Pillarstone Capital REIT Operating Partnership LP (“Pillarstone,” “Pillarstone OP” or the “Consolidated Partnership”) and Pillarstone Capital REIT (“Pillarstone REIT”) pursuant to which we contributed all of the equity interests in four of our wholly-owned subsidiaries: Whitestone CP Woodland Ph. 2, LLC, a Delaware limited liability company (“CP Woodland”); Whitestone Industrial-Office, LLC, a Texas limited liability company (“Industrial-Office”); Whitestone Offices, LLC, a Texas limited liability company (“Whitestone Offices”); and Whitestone Uptown Tower, LLC, a Delaware limited liability company (“Uptown Tower,” and together with CP Woodland, Industrial-Office and Whitestone Offices, the “Entities”) that own 14 non-core properties that do not fit our Community Centered Property® strategy (the “Pillarstone Properties”), to Pillarstone OP for aggregate consideration of approximately $84 million, consisting of (1) approximately 18.1 million Class A units representing limited partnership interests in Pillarstone OP (“Pillarstone OP Units”), issued at a price of $1.331 per Pillarstone OP Unit; and (2) the assumption of approximately $65.9 million of liabilities, consisting of (a) approximately $15.5 million of our liability under the 2014 Facility (as defined in Note 7); (b) an approximately $16.3 million promissory note of Uptown Tower under the Loan Agreement, dated as of September 26, 2013, between Uptown Tower, as borrower, and U.S. Bank, National Association, as successor to Morgan Stanley Mortgage Capital Holdings LLC, as lender; and (c) an approximately $34.1 million promissory note (the “Industrial-Office Promissory Note”) of Industrial-Office issued under the Loan Agreement, dated as of November 26, 2013 (the “Industrial-Office Loan Agreement”), between Industrial-Office, as borrower, and Jackson National Life Insurance Company, as lender (collectively, the “Contribution”).

In connection with the Contribution, on December 8, 2016, the Operating Partnership entered into an OP Unit Purchase Agreement (the “OP Unit Purchase Agreement”) with Pillarstone REIT and Pillarstone OP pursuant to which the Operating Partnership agreed to purchase up to an aggregate of $3.0 million of Pillarstone OP Units at a price of $1.331 per Pillarstone OP Unit over the two-year term of the OP Unit Purchase Agreement on the terms set forth therein. The OP Unit Purchase Agreement contains customary closing conditions and the parties have made certain customary representations, warranties and indemnifications to each other in the OP Unit Purchase Agreement. In addition, pursuant to the OP Unit Purchase Agreement, in the event of a Change of Control (as defined therein) of the Company, Pillarstone OP shall have the right, but not the obligation, to repurchase the Pillarstone OP Units issued thereunder from the Operating Partnership at their initial issue price of $1.331 per Pillarstone OP Unit.

In connection with the Contribution, (1) with respect to each Pillarstone Property (other than Uptown Tower), Whitestone TRS, Inc., a subsidiary of the Company (“Whitestone TRS”), entered into a Management Agreement with the Entity that owns such Pillarstone Property and (2) with respect to Uptown Tower, Whitestone TRS entered into a Management Agreement with Pillarstone OP (collectively, the “Management Agreements”). Pursuant to the Management Agreements with respect to each Pillarstone Property (other than Uptown Tower), Whitestone TRS agreed to provide certain property management, leasing and day-to-day advisory and administrative services to such Pillarstone Property in exchange for (x) a monthly property management fee equal to 5.0% of the monthly revenues of such Pillarstone Property and (y) a monthly asset management fee equal to 0.125% of GAV (as defined in each Management Agreement as, generally, the purchase price of the respective Pillarstone Property based upon the purchase price allocations determined pursuant to the Contribution Agreement, excluding all indebtedness, liabilities or claims of any nature) of such Pillarstone Property. Pursuant to the Management Agreement with respect to Uptown Tower, Whitestone TRS agreed to provide certain property management, leasing and day-to-day advisory and administrative services to Pillarstone OP in exchange for (x) a monthly property management fee equal to 3.0% of the monthly revenues of Uptown Tower and (y) a monthly asset management fee equal to 0.125% of GAV of Uptown Tower.

In connection with the Contribution, on December 8, 2016, the Operating Partnership entered into a Tax Protection Agreement with Pillarstone REIT and Pillarstone pursuant to which Pillarstone agreed to indemnify the Operating Partnership for certain tax liabilities resulting from its recognition of income or gain prior to December 8, 2021 if such liabilities result from a transaction involving a direct or indirect taxable disposition of all or a portion of the Pillarstone Properties or if Pillarstone fails to maintain and allocate to the Operating Partnership for taxation purposes minimum levels of liabilities as specified in the Tax Protection Agreement, the result of which causes such recognition of income or gain and the Company incurs taxes that must be paid to maintain its REIT status for federal income tax purposes.


13

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)

As of September 30, 2017, we owned approximately 81.4% of the total outstanding units of Pillarstone OP. Additionally, certain of our officers and trustees serve as officers and trustees of Pillarstone REIT. We have determined that we are the primary beneficiary of Pillarstone OP, through our power to direct the activities of Pillarstone OP, additional working capital required by Pillarstone OP under the OP Unit Purchase Agreement and our obligation to absorb losses and receive benefits based on our ownership percentage. Accordingly, we account for Pillarstone OP as a VIE and fully consolidate in our consolidated financial statements.

The carrying amounts and classification of certain assets and liabilities for Pillarstone OP in our consolidated balance sheets as of September 30, 2017 and December 31, 2016 consists of the following (in thousands):

 
 
September 30, 2017
 
December 31, 2016
Real estate assets, at cost
 
 
 
 
  Property
 
$
93,505

 
$
92,338

  Accumulated depreciation
 
(35,089
)
 
(32,533
)
    Total real estate assets
 
58,416

 
59,805

Cash and cash equivalents
 
2,246

 
1,236

Escrows and acquisition deposits
 
2,087

 
2,274

Accrued rents and accounts receivable, net of allowance for doubtful accounts(1)
 
2,556

 
2,313

Unamortized lease commissions and loan costs
 
1,180

 
1,150

Prepaid expenses and other assets(2)
 
130

 
82

     Total assets
 
$
66,615

 
$
66,860

 
 
 
 
 
Liabilities
 
 
 
 
  Notes payable(3)
 
$
49,137

 
$
50,001

  Accounts payable and accrued expenses(4)
 
3,480

 
3,481

  Tenants' security deposits
 
1,129

 
996

  Distributions payable (5)
 
112

 

     Total liabilities
 
$
53,858

 
$
54,478


(1) 
Excludes approximately $2.1 million and $0.5 million in accounts receivable due from Whitestone that were eliminated in consolidation as of September 30, 2017 and December 31, 2016, respectively.

(2) 
Excludes approximately $0.9 million in prepaid expenses due from Whitestone that were eliminated in consolidation as of December 31, 2016.

(3) 
Excludes approximately $15.5 million and $15.5 million in notes payable due to Whitestone that were eliminated in consolidation as of September 30, 2017 and December 31, 2016, respectively.

(4) 
Excludes approximately $1.3 million and $0.3 million in accounts payable due to Whitestone that were eliminated in consolidation as of September 30, 2017 and December 31, 2016, respectively.

(5) 
Excludes approximately $0.5 million in distributions payable to Whitestone that were eliminated in consolidation as of September 30, 2017.

7. 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.

14

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


Debt consisted of the following as of the dates indicated (in thousands):
Description
 
September 30, 2017
 
December 31, 2016
Fixed rate notes
 
 
 
 
$10.5 million, LIBOR plus 2.00% Note, due September 24, 2018 (1)
 
$
9,800

 
$
9,980

$50.0 million, 0.84% plus 1.35% to 1.90% Note, due October 30, 2020 (2)
 
50,000

 
50,000

$50.0 million, 1.50% plus 1.35% to 1.90% Note, due January 29, 2021 (3)
 
50,000

 
50,000

$100.0 million, 1.73% plus 1.65% to 2.25% Note, due October 30, 2022 (4)
 
100,000

 
100,000

$80.0 million, 3.72% Note, due June 1, 2027
 
80,000

 

$37.0 million 3.76% Note, due December 1, 2020 (5)
 
33,406

 
34,166

$6.5 million 3.80% Note, due January 1, 2019
 
5,887

 
6,019

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

 
19,000

$20.2 million 4.28% Note, due June 6, 2023
 
19,449

 
19,708

$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 (5)
 
16,119

 
16,298

$15.1 million 4.99% Note, due January 6, 2024
 
14,919

 
15,060

$9.2 million, Prime Rate less 2.00% Note, due December 29, 2017 (6)
 
7,844

 
7,869

$2.6 million 5.46% Note, due October 1, 2023
 
2,483

 
2,512

$1.1 million 2.97% Note, due November 28, 2017
 
217

 

Floating rate notes
 
 
 
 
Unsecured line of credit, LIBOR plus 1.40% to 1.95%, due October 30, 2019 (7)
 
227,200

 
186,600

Total notes payable principal
 
664,624

 
545,512

Less deferred financing costs, net of accumulated amortization
 
(1,949
)
 
(1,492
)
Total notes payable
 
$
662,675

 
$
544,020


(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 Term Loan 1 (as defined below) at 0.84% through February 3, 2017 and 1.75% beginning February 3, 2017 through October 30, 2020.

(3) 
Promissory note includes an interest rate swap that fixed the LIBOR portion of Term Loan 2 (as defined below) at 1.50%.

(4) 
Promissory note includes an interest rate swap that fixed the LIBOR portion of Term Loan 3 (as defined below) at 1.73%,

(5) 
Promissory notes were assumed by Pillarstone in December 2016.

(6) 
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%.

(7) 
Unsecured line of credit includes certain Pillarstone Properties (as defined and described in more detail below) in determining the amount of credit available under the Facility (as defined and described in more detail below).

On May 26, 2017, we, through our subsidiary, Whitestone Houston BLVD Place LLC, a Delaware limited liability company, issued a $80.0 million promissory note to American General Life Insurance Company (the “BLVD Note”). The BLVD Note has a fixed interest rate of 3.72% and a maturity date of June 1, 2027. Proceeds from the BLVD Note were used to fund a portion of the purchase price of the acquisition of BLVD Place (See Note 15 below).

15

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


On November 7, 2014, we, through our Operating Partnership, entered into an unsecured revolving credit facility (the “2014 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 2014 Facility amended and restated our previous unsecured revolving credit facility. On October 30, 2015, we, through our Operating Partnership, entered into the First Amendment to the 2014 Facility (the “First Amendment”) with the guarantors party thereto, the lenders party thereto and the Agent. We refer to the 2014 Facility, as amended by the First Amendment, as the “Facility.”

Pursuant to the First Amendment, the Company made the following amendments to the 2014 Facility:

extended the maturity date of the $300 million unsecured revolving credit facility under the 2014 Facility (the “Revolver”) to October 30, 2019 from November 7, 2018;

converted $100 million of outstanding borrowings under the Revolver to a new $100 million unsecured term loan under the 2014 Facility (“Term Loan 3”) with a maturity date of October 30, 2022;

extended the maturity date of the first $50 million unsecured term loan under the 2014 Facility (“Term Loan 1”) to October 30, 2020 from February 17, 2017; and

extended the maturity date of the second $50 million unsecured term loan under the 2014 Facility (“Term Loan 2” and together with Term Loan 1 and Term Loan 3, the “Term Loans”) to January 29, 2021 from 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 2.25% 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.

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, including new commitments from lenders. As of September 30, 2017, $427.2 million was drawn on the Facility, and our remaining borrowing capacity was $72.8 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. 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.


16

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)

On December 8, 2016, in connection with the Contribution, the Operating Partnership entered into the Second Amendment to the Facility and Reaffirmation of Guaranties (the “Second Amendment”) with Pillarstone, the Company and the other Guarantors party thereto, the lenders party thereto and the Agent. Pursuant to the Second Amendment, following the Contribution, Whitestone Offices, LLC and Whitestone CP Woodland Ph. 2, LLC were permitted to remain Material Subsidiaries (as defined in the Facility) and Guarantors under the Facility and their respective Pillarstone Properties were each permitted to remain an Eligible Property (as defined in the Facility) and be included in the Borrowing Base (as defined in the Facility) under the Facility. In addition, on December 8, 2016, Pillarstone entered into the Limited Guarantee (the “Limited Guarantee”) with the Agent, pursuant to which Pillarstone agreed to be joined as a party to the Facility to provide a limited guarantee up to the amount of availability generated by the Pillarstone Properties owned by Whitestone Offices, LLC and Whitestone CP Woodland Ph. 2, LLC. As of September 30, 2017, Pillarstone accounted for approximately $15.5 million of the total amount drawn on the Facility.

As of September 30, 2017, our $237.2 million in secured debt was collateralized by 20 properties with a carrying value of $342.0 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 September 30, 2017, we were in compliance with all loan covenants.

Scheduled maturities of our outstanding debt as of September 30, 2017 were as follows (in thousands):
Year
 
Amount Due
 
 
 
2017
 
$
8,767

2018
 
12,136

2019
 
235,249

2020
 
82,827

2021
 
51,918

Thereafter
 
273,727

Total
 
$
664,624

 
8.  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:
 
 
 
 
September 30, 2017
 
Accounts payable and accrued expenses
 
$
(1,050
)
December 31, 2016
 
Accounts payable and accrued expenses
 
$
(662
)

On November 19, 2015, we, through our Operating Partnership, entered into an interest rate swap with Bank of Montreal that fixed the LIBOR portion of Term Loan 3 under the Facility at 1.725%. In the fourth quarter of 2015, pursuant to the terms of the agreement governing the interest rate swap, Bank of Montreal assigned $35.0 million of the swap to U.S. Bank, National Association, and $15.0 million of the swap to SunTrust Bank. See Note 7 for additional information regarding the Facility. The swap began on November 30, 2015 and will mature on October 28, 2022. We have designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value to be recorded in comprehensive income and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value, if any, will be recognized directly in earnings.


17

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)

On November 19, 2015, we, through our Operating Partnership, entered into an interest rate swap with Bank of Montreal that fixed the LIBOR portion of Term Loan 1 under the Facility at 1.75%. In the fourth quarter of 2015, pursuant to the terms of the agreement governing the interest rate swap, Bank of Montreal assigned $3.8 million of the swap to Regions Bank, $6.5 million of the swap to U.S. Bank, National Association, $14.0 million of the swap to Wells Fargo Bank, National Association, $14.0 million of the swap to Bank of America, N.A., and $5.0 million of the swap to SunTrust Bank. See Note 7 for additional information regarding the Facility. The swap began on February 3, 2017 and will mature on October 30, 2020. We have designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value to be recorded in comprehensive income and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value, if any, will be recognized directly in earnings.

On November 19, 2015, we, through our Operating Partnership, entered into an interest rate swap with Bank of Montreal that fixed the LIBOR portion of Term Loan 2 under the Facility at 1.50%. In the fourth quarter of 2015, pursuant to the terms of the agreement governing the interest rate swap, Bank of Montreal assigned $3.8 million of the swap to Regions Bank, $6.5 million of the swap to U.S. Bank, National Association, $14.0 million of the swap to Wells Fargo Bank, National Association, $14.0 million of the swap to Bank of America, N.A., and $5.0 million of the swap to SunTrust Bank. See Note 7 for additional information regarding the Facility. The swap began on December 7, 2015 and will mature on January 29, 2021. We have designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value to be recorded in comprehensive income and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value, if any, will be recognized directly in earnings.

A summary of our interest rate swap activity is as follows (in thousands):
 
 
Amount Recognized as Comprehensive Income
 
Location of Loss Recognized in Earnings
 
Amount of Loss Recognized in Earnings (1)
Three months ended September 30, 2017
 
$
172

 
Interest expense
 
$
(317
)
Three months ended September 30, 2016
 
$
1,529

 
Interest expense
 
$
(602
)
 
 
 
 
 
 
 
Nine months ended September 30, 2017
 
$
124

 
Interest expense
 
$
(1,266
)
Nine months ended September 30, 2016
 
$
(6,962
)
 
Interest expense
 
$
(1,810
)

(1) 
There was no ineffective portion of our interest rate swaps to recognize in earnings for the three and nine months ended September 30, 2017 and 2016.

9.  EARNINGS PER SHARE
 
Basic earnings per share for our common shareholders is calculated by dividing income from continuing operations excluding the net income attributable to unvested restricted common 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 the net income attributable to unvested restricted common shares and the net income attributable to noncontrolling interests, by the weighted average number of common shares including any dilutive unvested restricted common 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 September 30, 2017 and 2016, 1,083,647 and 487,090 OP units, respectively, were excluded from the calculation of diluted earnings per share because their effect would be anti-dilutive, and during the nine months ended September 30, 2017 and 2016, 1,089,876 and 487,510 OP units, respectively, were excluded from the calculation of diluted earnings per share because their effect would be anti-dilutive.
 

18

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)

For the three months ended September 30, 2017 and 2016, distributions of $152,000 and $158,000, respectively, were made to holders of certain restricted common shares, $4,000 and $12,000, respectively, of which were charged against earnings, and for the nine months ended September 30, 2017 and 2016, distributions of $356,000 and $510,000, respectively, were made to holders of certain restricted common shares, $12,000 and $12,000, respectively, of which were charged against earnings See Note 12 for information related to restricted common shares under the 2008 Plan.

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(in thousands, except per share data)
 
2017
 
2016
 
2017
 
2016
Numerator:
 
 
 
 
 
 
 
 
Net income
 
$
3,140

 
$
964

 
$
6,841

 
$
7,561

Less: Net income attributable to noncontrolling interests
 
(147
)
 
(15
)
 
(429
)
 
(131
)
Distributions paid on unvested restricted shares
 
(148
)
 
(146
)
 
(344
)
 
(498
)
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
2,845

 
$
803

 
$
6,068

 
$
6,932

 
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
 
Weighted average number of common shares - basic
 
37,992

 
28,195

 
34,406

 
27,210

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Unvested restricted shares
 
597

 
829

 
805

 
803

Weighted average number of common shares - dilutive
 
38,589

 
29,024

 
35,211

 
28,013

 
 
 
 
 
 
 
 
 
Earnings Per Share:
 
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
 
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.07

 
$
0.03

 
$
0.18

 
$
0.25

Diluted:
 
 
 
 
 
 
 
 
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.07

 
$
0.03

 
$
0.17

 
$
0.25


10. INCOME TAXES
 
With the exception of our taxable REIT subsidiaries, federal income taxes are generally not provided because we intend to and believe we qualify as a REIT under the provisions of the Internal Revenue Code of 1986, as amended (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 REIT 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.
 
Income earned by our taxable REIT subsidiary, Whitestone Davenport TRS LLC (“Davenport TRS”), is subject to federal income tax. For the nine months ended September 30, 2016, we recognized $45,000 in income tax expense related to Davenport TRS taxable year. Davenport TRS was dissolved in the fourth quarter of 2016.

We are subject to the Texas Margin Tax, which is computed by applying the applicable tax rate (0.75% 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 September 30, 2017 and 2016, we recognized approximately $122,000 and $75,000 in margin tax provision, respectively, and for the nine months ended September 30, 2017 and 2016, we recognized approximately $292,000 and $237,000 in margin tax provision, respectively.


19

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)

11.  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 April 25, 2017, we completed the sale of 8,018,500 common shares, including 1,018,500 common shares purchased by the underwriters upon exercise of their option to purchase additional common shares, at a public offering price per share of $13.00 (the “April Offering”). Total net proceeds from the April Offering, after deducting offering expenses, were approximately $99.9 million, which we contributed to the Operating Partnership in exchange for OP units. The Operating Partnership used the net proceeds from the April Offering to repay a portion of the Facility and for general corporate purposes, including funding a portion of the purchase price of BLVD Place and Eldorado Plaza.

On June 4, 2015, we entered into six amended and restated equity distribution agreements for an at-the-market equity distribution program (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. 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 did not sell any common shares under the 2015 equity distribution agreements during the three months ended September 30, 2017. During the nine months ended September 30, 2017, we sold 567,302 common shares under the 2015 equity distribution agreements, with net proceeds to us of approximately $7.7 million. In connection with such sales, we paid compensation of approximately $139,000 to the sales agents. During the three months ended September 30, 2016, we sold 1,083,926 common shares under the 2015 equity distribution agreements, with net proceeds to us of approximately $16.1 million. In connection with such sales, we paid compensation of approximately $246,000 to the sales agents. During the nine months ended September 30, 2016, we sold 1,819,681 common shares under the 2015 equity distribution agreements, with net proceeds to us of approximately $26.7 million. In connection with such sales, we paid compensation of approximately $408,000 to the sales agents.

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 September 30, 2017, we owned a 97.3% interest in the Operating Partnership.
 
Limited partners in the Operating Partnership holding OP units have the right to redeem their OP units for 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 September 30, 2017 and December 31, 2016, there were 39,487,305 and 30,450,377 OP units outstanding, respectively.  We owned 38,403,658 and 29,347,741 OP units as of September 30, 2017 and December 31, 2016, respectively. The balance of the OP units is owned by third parties, including certain members of our board of trustees.  Our weighted average share ownership in the Operating Partnership was approximately 97.3% and 98.3% for the three months ended September 30, 2017 and 2016, respectively, and approximately 97.0% and 98.3% for the nine months ended September 30, 2017 and 2016. During the three months ended September 30, 2017 and 2016, 0 and 2,434 OP units, respectively, were redeemed for an equal number of common shares, and during the nine months ended September 30, 2017 and 2016, 18,989 and 15,450 OP units, respectively, were redeemed for an equal number of common shares.

20

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


 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 2016 and the nine months ended September 30, 2017 (in thousands, except per share/and per OP unit data):

 
 
Common Shares
 
Noncontrolling OP Unit Holders
 
Total
Quarter Paid
 
Distributions Per Common Share
 
Amount Paid
 
Distributions Per OP Unit
 
Amount Paid
 
 Amount Paid
2017
 
 
 
 
 
 
 
 
 
 
Third Quarter
 
$
0.2850

 
$
10,948

 
$
0.2850

 
$
309

 
$
11,257

Second Quarter
 
0.2850

 
10,093

 
0.2850

 
310

 
10,403

First Quarter
 
0.2850

 
8,453

 
0.2850

 
313

 
8,766

Total
 
$
0.8550

 
$
29,494

 
$
0.8550

 
$
932


$
30,426

 
 
 
 
 
 
 
 
 
 
 
2016
 
 
 
 
 
 
 
 
 
 
Fourth Quarter
 
$
0.2850

 
$
8,305

 
$
0.2850

 
$
314

 
$
8,619

Third Quarter
 
0.2850

 
8,109

 
0.2850

 
138

 
8,247

Second Quarter
 
0.2850

 
7,786

 
0.2850

 
138

 
7,924

First Quarter
 
0.2850

 
7,711

 
0.2850

 
139

 
7,850

Total
 
$
1.1400

 
$
31,911

 
$
1.1400

 
$
729

 
$
32,640


12.  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 redeemed for 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 common 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 common 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 certain 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 share units will be forfeited.


21

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)

The Compensation Committee approved the grant of an aggregate of 320,000 and 143,000 time-based restricted common share units on June 30, 2016 and 2015, respectively, to James C. Mastandrea and David K. Holeman.

On September 6, 2017, the Compensation Committee approved the grant of an aggregate of 267,783 performance-based restricted common share units under the 2008 Plan with market-based vesting conditions (the “TSR Units”) to certain of our employees. Vesting is contingent upon achieving Total Shareholder Return relative to the peer group defined in the TSR Unit award agreements over a three-year performance period. At the end of the performance period, the number of common shares awarded for each vested TSR Unit will vary from 0% to 200% depending on the Company's ranking in the peer group (the “TSR Peer Group Ranking”). Continued employment is required through the vesting date. The grant date fair value for each TSR Unit of $12.37 was determined using the Monte Carlo simulation method and is being recognized as share-based compensation expense ratably from the September 30, 2017 grant date to the end of the performance period, December 31, 2019. The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying the market condition stipulated in the award grant and calculates the fair value of the award. Expected volatilities utilized in the model were estimated using a historical period consistent with the performance period of approximately three years. The risk-free interest rate was based on the United States Treasury rate for a term commensurate with the expected life of the grant.

On September 6, 2017, the Compensation Committee approved the grant of an aggregate of 965,000 performance-based restricted common share units under the 2008 Plan which only vest immediately prior to the consummation of a Change in Control (as defined in the 2008 Plan) that occurs on or before September 30, 2024 (the “CIC Units”) to certain of our employees. Continued employment is required through the vesting date. If a Change in Control does not occur on or before September 30, 2024, the CIC Units shall be immediately forfeited. The Company considers a Change in Control on or before September 30, 2024 to be improbable, and no expense has been recognized for the CIC Units. If a Change in Control occurs, any outstanding CIC Units would be expensed immediately on the date of the Change in Control using the grant date fair value. The grant date fair value for each CIC Unit of $13.05 was determined based on the Company's closing share price on the grant date.

A summary of the share-based incentive plan activity as of and for the nine months ended September 30, 2017 is as follows:
 
 
Shares
 
Weighted Average
Grant Date
Fair Value
Non-vested at January 1, 2017
 
2,044,334

 
$
14.48

Granted
 
1,335,933

 
12.90

Vested
 
(399,005
)
 
14.62

Forfeited
 
(31,883
)
 
14.43

Non-vested at September 30, 2017
 
2,949,379

 
$
13.74

Available for grant at September 30, 2017
 
775,050

 
 

A summary of our non-vested and vested shares activity for the nine months ended September 30, 2017 and years ended December 31, 2016, 2015 and 2014 is presented below:
 
 
Shares Granted
 
Shares Vested
 
 
Non-Vested Shares Issued
 
Weighted Average Grant-Date Fair Value
 
Vested Shares