0001175535-18-000061.txt : 20180809 0001175535-18-000061.hdr.sgml : 20180809 20180809163959 ACCESSION NUMBER: 0001175535-18-000061 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 71 CONFORMED PERIOD OF REPORT: 20180630 FILED AS OF DATE: 20180809 DATE AS OF CHANGE: 20180809 FILER: COMPANY DATA: COMPANY CONFORMED NAME: Whitestone REIT CENTRAL INDEX KEY: 0001175535 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 760594970 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-34855 FILM NUMBER: 181005666 BUSINESS ADDRESS: STREET 1: 2600 SOUTH GESSNER STREET 2: SUITE 500 CITY: HOUSTON STATE: TX ZIP: 77063 BUSINESS PHONE: 713-827-9595 MAIL ADDRESS: STREET 1: 2600 SOUTH GESSNER STREET 2: SUITE 500 CITY: HOUSTON STATE: TX ZIP: 77063 FORMER COMPANY: FORMER CONFORMED NAME: HARTMAN COMMERCIAL PROPERTIES REIT DATE OF NAME CHANGE: 20020613 10-Q 1 wsr10-q2018x06.htm 10-Q Document
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, 2018

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 (§232.405 of this chapter) 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
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 August 7, 2018, there were 39,744,312 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)

 
 
June 30, 2018
 
December 31, 2017
 
 
(unaudited)
 
 
ASSETS
Real estate assets, at cost
 
 
 
 
Property
 
$
1,149,528

 
$
1,149,454

Accumulated depreciation
 
(141,442
)
 
(131,034
)
Total real estate assets
 
1,008,086

 
1,018,420

Cash and cash equivalents
 
3,125

 
5,005

Restricted cash
 
213

 
205

Marketable securities
 

 
32

Investment in real estate partnership
 
4,419

 
4,095

Escrows and acquisition deposits
 
6,515

 
7,916

Accrued rents and accounts receivable, net of allowance for doubtful accounts
 
20,464

 
21,140

Unamortized lease commissions and loan costs
 
6,911

 
7,157

Prepaid expenses and other assets
 
10,217

 
6,198

Total assets
 
$
1,059,950

 
$
1,070,168

 
 
 
 
 
LIABILITIES AND EQUITY
Liabilities:
 
 
 
 
Notes payable
 
$
667,595

 
$
659,068

Accounts payable and accrued expenses
 
29,157

 
35,536

Tenants' security deposits
 
5,769

 
5,694

Dividends and distributions payable
 
11,628

 
11,466

Total liabilities
 
714,149

 
711,764

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, 2018 and December 31, 2017, respectively
 

 

Common shares, $0.001 par value per share; 400,000,000 shares authorized; 39,743,829 and 39,221,773 issued and outstanding as of June 30, 2018 and December 31, 2017, respectively
 
38

 
38

Additional paid-in capital
 
524,191

 
521,314

Accumulated deficit
 
(194,520
)
 
(176,684
)
Accumulated other comprehensive gain
 
6,430

 
2,936

Total Whitestone REIT shareholders' equity
 
336,139

 
347,604

Noncontrolling interest in subsidiary
 
9,662

 
10,800

Total equity
 
345,801

 
358,404

Total liabilities and equity
 
$
1,059,950

 
$
1,070,168



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,
 
 
2018
 
2017
 
2018
 
2017
Property revenues
 
 
 
 
 
 
 
 
Rental revenues
 
$
24,650

 
$
23,010

 
$
49,596

 
$
44,306

Other revenues
 
8,422

 
7,198

 
17,072

 
14,169

Total property revenues
 
33,072

 
30,208

 
66,668

 
58,475

 
 
 
 
 
 
 
 
 
Property expenses
 
 
 
 
 
 
 
 
Property operation and maintenance
 
5,838

 
5,375

 
11,546

 
10,869

Real estate taxes
 
4,485

 
4,487

 
9,142

 
8,407

Total property expenses
 
10,323

 
9,862

 
20,688

 
19,276

 
 
 
 
 
 
 
 
 
Other expenses (income)
 
 
 
 
 
 
 
 
General and administrative
 
6,624

 
5,848

 
12,938

 
12,017

Depreciation and amortization
 
7,396

 
6,681

 
14,617

 
12,689

Interest expense
 
6,854

 
5,629

 
13,355

 
10,782

Interest, dividend and other investment income
 
(119
)
 
(101
)
 
(218
)
 
(239
)
Total other expense
 
20,755

 
18,057

 
40,692

 
35,249

 
 
 
 
 
 
 
 
 
Income before gain (loss) on sale or disposal of properties or assets and income taxes
 
1,994

 
2,289

 
5,288

 
3,950

 
 
 
 
 
 
 
 
 
Provision for income taxes
 
(84
)
 
(89
)
 
(213
)
 
(170
)
Gain on sale of properties
 

 
16

 
266

 
16

Profit sharing expense
 
(81
)
 
(101
)
 
(203
)
 
(165
)
Loss on sale or disposal of assets
 
(74
)
 
(72
)
 
(271
)
 
(95
)
 
 
 
 
 
 
 
 
 
Net income
 
1,755

 
2,043

 
4,867

 
3,536

 
 
 
 
 
 
 
 
 
Less: Net income attributable to noncontrolling interests
 
45

 
60

 
128

 
114

 
 
 
 
 
 
 
 
 
Net income attributable to Whitestone REIT
 
$
1,710

 
$
1,983

 
$
4,739

 
$
3,422






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,
 
 
2018
 
2017
 
2018
 
2017
Basic Earnings Per Share:
 
 
 
 
 
 
 
 
Net income attributable to common shareholders, excluding amounts attributable to unvested restricted shares
 
$
0.04

 
$
0.05

 
$
0.12

 
$
0.10

Diluted Earnings Per Share:
 
 
 
 
 
 
 
 
Net income attributable to common shareholders, excluding amounts attributable to unvested restricted shares
 
$
0.04

 
$
0.05

 
$
0.11

 
$
0.10

 
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
39,204

 
35,716

 
39,136

 
32,583

Diluted
 
40,679

 
36,544

 
40,519

 
33,493

 
 
 
 
 
 
 
 
 
Distributions declared per common share / OP unit
 
$
0.2850

 
$
0.2850

 
$
0.5700

 
$
0.5700

 
 
 
 
 
 
 
 
 
Consolidated Statements of Comprehensive Income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
$
1,755

 
$
2,043

 
$
4,867

 
$
3,536

 
 
 
 
 
 
 
 
 
Other comprehensive gain
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain (loss) on cash flow hedging activities
 
913

 
(780
)
 
3,558

 
(48
)
Unrealized gain on available-for-sale marketable securities
 

 
33

 
18

 
33

 
 
 
 
 
 
 
 
 
Comprehensive income
 
2,668

 
1,296

 
8,443

 
3,521

 
 
 
 
 
 
 
 
 
Less: Net income attributable to noncontrolling interests
 
45

 
60

 
128

 
114

Less: Comprehensive gain (loss) attributable to noncontrolling interests
 
23

 
(22
)
 
94

 
(1
)
 
 
 
 
 
 
 
 
 
Comprehensive income attributable to Whitestone REIT
 
$
2,600

 
$
1,258

 
$
8,221

 
$
3,408




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
 
Equity
 
Units
 
Dollars
 
Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2017
 
39,222

 
$
38

 
$
521,314

 
$
(176,684
)
 
$
2,936

 
$
347,604

 
1,084

 
$
10,800

 
$
358,404

Exchange of noncontrolling interest OP units for common shares
 
75

 

 
752

 

 

 
752

 
(75
)
 
(752
)
 

Exchange offer costs
 

 

 
(128
)
 

 

 
(128
)
 

 

 
(128
)
Issuance of shares under dividend reinvestment plan
 
6

 

 
66

 

 

 
66

 

 

 
66

Repurchase of common shares (1)
 
(92
)
 

 
(1,059
)
 

 

 
(1,059
)
 

 

 
(1,059
)
Share-based compensation
 
533

 

 
3,246

 

 

 
3,246

 

 

 
3,246

Distributions
 

 

 

 
(22,575
)
 

 
(22,575
)
 

 
(596
)
 
(23,171
)
Unrealized gain on change in value of cash flow hedge
 

 

 

 

 
3,464

 
3,464

 

 
94

 
3,558

Unrealized gain on change in fair value of available-for-sale marketable securities
 

 

 

 

 
18

 
18

 

 

 
18

Reallocation of ownership between parent and subsidiary
 

 

 

 

 
12

 
12

 

 
(12
)
 

Net income
 

 

 

 
4,739

 

 
4,739

 

 
128

 
4,867

Balance, June 30, 2018
 
39,744

 
$
38

 
$
524,191

 
$
(194,520
)
 
$
6,430

 
$
336,139

 
1,009

 
$
9,662

 
$
345,801


(1) 
During the six months ended June 30, 2018, 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,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net income
 
$
4,867

 
$
3,536

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
14,617

 
12,689

Amortization of deferred loan costs
 
653

 
624

Amortization of notes payable discount
 

 
298

Loss on sale of marketable securities
 
20

 

Loss on sale or disposal of assets and properties
 
5

 
79

Bad debt expense
 
761

 
907

Share-based compensation
 
3,246

 
4,833

Changes in operating assets and liabilities:
 
 
 
 
Escrows and acquisition deposits
 
1,401

 
(1,620
)
Accrued rent and accounts receivable
 
15

 
(1,357
)
Unamortized lease commissions
 
(852
)
 
(1,241
)
Prepaid expenses and other assets
 
504

 
448

Accounts payable and accrued expenses
 
(6,370
)
 
(5,649
)
Tenants' security deposits
 
75

 
397

Net cash provided by operating activities
 
18,942

 
13,944

Cash flows from investing activities:
 
 
 
 
Acquisitions of real estate
 

 
(124,557
)
Additions to real estate
 
(7,566
)
 
(8,279
)
Proceeds from sales of properties
 
4,433

 
26

Investment in real estate partnership
 
(649
)
 
(1,358
)
Proceeds from sales of marketable securities
 
30

 

Net cash used in investing activities
 
(3,752
)
 
(134,168
)
Cash flows from financing activities:
 
 
 
 
Distributions paid to common shareholders
 
(22,348
)
 
(18,546
)
Distributions paid to OP unit holders
 
(604
)
 
(623
)
Proceeds from issuance of common shares, net of offering costs
 

 
107,619

Payments of exchange offer costs
 
(128
)
 

Net proceeds from credit facility
 
9,000

 
40,600

Repayments of notes payable
 
(1,923
)
 
(1,826
)
Payments of loan origination costs
 

 
(695
)
Repurchase of common shares
 
(1,059
)
 
(1,987
)
Net cash provided by (used in) financing activities
 
(17,062
)
 
124,542

 
 
 
 
 
Net increase (decrease) in cash, cash equivalents and restricted cash
 
(1,872
)
 
4,318

Cash, cash equivalents and restricted cash at beginning of period
 
5,210

 
2,988

Cash, cash equivalents and restricted cash at end of period
 
$
3,338

 
$
7,306


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,
 
 
2018
 
2017
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid for interest
 
$
12,377

 
$
10,341

Cash paid for taxes
 
$
392

 
$
329

Non cash investing and financing activities:
 
 
 
 
Disposal of fully depreciated real estate
 
$
960

 
$
232

Financed insurance premiums
 
$
1,273

 
$
1,115

Value of shares issued under dividend reinvestment plan
 
$
66

 
$
63

Value of common shares exchanged for OP units
 
$
752

 
$
206

Change in fair value of available-for-sale securities
 
$
18

 
$
33

Change in fair value of cash flow hedge
 
$
3,558

 
$
(48
)
Reallocation of ownership percentage between parent and subsidiary
 
$
12

 
$
8








See accompanying notes to Consolidated Financial Statements.


6

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(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, 2017 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, 2018 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, 2018, and the results of operations for the three and six month periods ended June 30, 2018 and 2017, the consolidated statements of changes in equity for the six month period ended June 30, 2018 and cash flows for the six month periods ended June 30, 2018 and 2017.  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, 2017.
 
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 June 30, 2018 and December 31, 2017, Whitestone owned or held a majority interest in 72 and 73 commercial properties, respectively, in and around Austin, Chicago, Dallas-Fort Worth, Houston, Phoenix and San Antonio.

These properties consist of:

Operating Portfolio

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

through our 81.4% interest in Pillarstone Capital REIT Operating Partnership LP (“Pillarstone OP”), an interest in 14 properties that do not meet our Community Centered Properties® strategy. See Note 6 for additional information regarding our investment in real estate partnerships.

Redevelopment, New Acquisitions Portfolio

one retail property that meets our Community Centered Properties® strategy; and

six parcels of land held for future development.

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, 2018 and December 31, 2017, 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.


7

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

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.

Profit-sharing Method. In accordance with the Financial Accounting Standards Board's (“FASB”) guidance applicable to sales of real estate or interests therein, specifically FASB Accounting Standards Codification (“ASC”) 360-20, “Real Estate Sales,” ASC 606, “Revenue from Contracts with Customers” and ASC 610, “Other Income–Gains and Losses from the Derecognition of Nonfinancial Assets,” we have not recognized the sale of assets to Pillarstone OP and are accounting for the transaction under the profit-sharing method. Until we otherwise meet the requirements to recognize the sale as defined, we will continue to recognize Pillarstone OP's real estate assets and notes payables in our consolidated balance sheets, for all periods following the transaction. Additionally, the profits and losses of Pillarstone OP not attributable to the Company are reported as profit sharing expense. See Note 6 for additional disclosure on Pillarstone OP.
  
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. Other than the effects noted below, these reclassifications had no effect on net income, total assets, total liabilities or equity.

Immaterial Error Correction. During the second quarter of 2018, we determined that certain prior period amounts contained errors due to our initial determination that we were the primary beneficiary of a variable interest entity (“VIE”), Pillarstone OP. See Note 6 for additional disclosure on Pillarstone OP. Management evaluated the materiality of the errors quantitatively and qualitatively, and concluded that they were not material to the financial statements of any period presented, but has elected to correct them in the accompanying prior period consolidated financial statements.


8

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

The following table presents the effects of the immaterial error correction on the consolidated balance sheet as of December 31, 2017 (in thousands):
 
 
As of December 31, 2017
 
 
As Reported
 
Correction of Error
 
As Adjusted
Cash and cash equivalents
 
$
7,817

 
$
(2,812
)
 
$
5,005

Investment in real estate partnership
 

 
4,095

 
4,095

Escrows and acquisition deposits
 
10,104

 
(2,188
)
 
7,916

Accrued rents and accounts receivable, net of allowance for doubtful accounts
 
23,504

 
(2,364
)
 
21,140

Unamortized lease commissions and loan costs
 
8,422

 
(1,265
)
 
7,157

Prepaid expenses and other assets
 
6,263

 
(65
)
 
6,198

  Total assets
 
$
1,074,767

 
$
(4,599
)
 
$
1,070,168

 
 
 
 
 
 
 
Accounts payable and accrued expenses
 
$
39,030

 
$
(3,494
)
 
$
35,536

Tenants' security deposits
 
6,885

 
(1,191
)
 
5,694

  Total liabilities
 
716,449

 
(4,685
)
 
711,764

Total noncontrolling interests
 
10,714

 
86

 
10,800

  Total liabilities and equity
 
$
1,074,767

 
$
(4,599
)
 
$
1,070,168


The following table presents the effects of the immaterial error correction on the consolidated statements of operations and comprehensive income for the three and six months ended June 30, 2017 (in thousands):
 
 
For the Three Months Ended June 30, 2017
 
 
As Reported
 
Correction of Error
 
As Adjusted
Net income
 
$
2,144

 
$
(101
)
 
$
2,043

Net income attributable to noncontrolling interests
 
161

 
(101
)
 
60

 
 
 
 
 
 
 
 
 
For the Six Months Ended June 30, 2017
 
 
As Reported
 
Correction of Error
 
As Adjusted
Net income
 
$
3,701

 
$
(165
)
 
$
3,536

Net income attributable to noncontrolling interests
 
279

 
(165
)
 
114

 
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.

Marketable Securities. We classify our existing marketable equity securities as available-for-sale in accordance with the FASB's 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 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 CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(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 June 30, 2018, 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, 2018, approximately $147,000 and $26,000 in interest expense and real estate taxes, respectively, were capitalized, and for the six months ended June 30, 2018, approximately $291,000 and $129,000 in interest expense and real estate taxes, respectively, were capitalized. For the three months ended June 30, 2017, approximately $84,000 and $64,000 in interest expense and real estate taxes, respectively, were capitalized, and for the six months ended June 30, 2017, approximately $156,000 and $93,000 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 $1,489,000 and $2,390,000 in share-based compensation for the three months ended June 30, 2018 and 2017, respectively, and we recognized $3,397,000 and $4,841,000 in share-based compensation for the six months ended June 30, 2018 and 2017, 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, 2017 for further discussion on significant accounting policies.
 

10

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

Recent Accounting Pronouncements.  In May 2014, the FASB issued guidance, as amended in subsequent updates, establishing a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and superseding most of the existing revenue recognition guidance. The standard also requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services and also requires certain additional disclosures. This guidance became effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We adopted this guidance on a modified retrospective basis beginning January 1, 2018, and the adoption of this guidance did not have a material impact on our consolidated financial statements.

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 on or after December 15, 2018, with early adoption permitted. We will adopt this guidance on a modified retrospective basis beginning January 1, 2019, and such adoption will result in certain costs (primarily legal costs related to lease negotiations) being expensed rather than capitalized. We capitalized $20,000 in legal related costs for the six months ended June 30, 2018.

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 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 federal income tax 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 under cash flows from financing activities.

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 became effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We adopted this guidance effective January 1, 2018, and we have reconciled cash and cash equivalents and restricted cash and restricted cash equivalents on a retrospective basis, whereas under the previous guidance, we reported restricted cash and restricted cash equivalents under cash flows from financing activities.

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 dispositions) of assets or businesses. This guidance became effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We adopted this guidance on a prospective basis beginning January 1, 2018 and believe the majority of our future acquisitions will qualify as asset acquisitions and the associated transaction costs will be capitalized as opposed to expensed under previous guidance.

In February 2017, the FASB issued guidance clarifying the scope of asset derecognition guidance, adding guidance for partial sales of nonfinancial assets and clarifying recognizing gains and losses from the transfer of nonfinancial assets in contracts with noncustomers. This guidance became effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We adopted this guidance on a modified retrospective basis beginning January 1, 2018, and the adoption of this guidance did not have a material impact on our consolidated financial statements.


11

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

3. MARKETABLE SECURITIES

In January 2018, we sold all of our remaining marketable securities and had no marketable securities as of June 30, 2018. All of our marketable securities were classified as available-for-sale securities as of December 31, 2017. Available-for-sale securities consisted of the following as of December 31, 2017 (in thousands):

 
 
December 31, 2017
 
 
Amortized Cost
 
Gains in Accumulated Other Comprehensive Income
 
Losses in Accumulated Other Comprehensive Income
 
Estimated Fair Value
Real estate sector common stock
 
$
50

 
$

 
$
(18
)
 
$
32

Total available-for-sale securities
 
$
50

 
$

 
$
(18
)
 
$
32


During the six months ended June 30, 2018, available-for-sale securities were sold for total proceeds of $30,000. The gross realized loss on these sales during the six months ended June 30, 2018 was $20,000. During the three and six months ended June 30, 2017, 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 $104,000 for the six months ended June 30, 2017 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):

 
 
June 30, 2018
 
December 31, 2017
 
 
 
 
 
Tenant receivables
 
$
15,564

 
$
14,128

Accrued rents and other recoveries
 
13,969

 
15,620

Allowance for doubtful accounts
 
(9,069
)
 
(8,608
)
Total
 
$
20,464

 
$
21,140


5. UNAMORTIZED LEASE COMMISSIONS, LEGAL FEES AND LOAN COSTS

Costs which have been deferred consist of the following (in thousands):
 
 
June 30, 2018
 
December 31, 2017
 
 
 
 
 
Leasing commissions
 
$
8,504

 
$
7,861

Deferred legal cost
 
406

 
386

Deferred financing cost
 
4,071

 
4,071

Total cost
 
12,981

 
12,318

Less: leasing commissions accumulated amortization
 
(3,440
)
 
(3,046
)
Less: deferred legal cost accumulated amortization
 
(91
)
 
(52
)
Less: deferred financing cost accumulated amortization
 
(2,539
)
 
(2,063
)
Total cost, net of accumulated amortization
 
$
6,911

 
$
7,157



12

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

6. INVESTMENT IN REAL ESTATE PARTNERSHIP

On December 8, 2016, we, through our Operating Partnership, entered into a Contribution Agreement (the “Contribution Agreement”) with Pillarstone OP 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 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. The initial term of each Management Agreement expired on December 31, 2017, after which each Management Agreement became automatically renewable on a month to month basis; provided that each Management Agreement can be terminated by either party thereto upon not less than thirty days' prior written notice to the other party. None of the Management Agreements had been terminated as of June 30, 2018.

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 CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)


As of June 30, 2018, 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. In connection with the Contribution, in December 2016, we determined that we were 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 accounted for Pillarstone OP as a VIE and fully consolidated it in our consolidated financial statements for the year ended December 31, 2016 and in the subsequent periods.

In November 2017, we received a comment letter from the Staff of the Division of Corporation Finance of the SEC (the “Staff”) relating to our Annual Report on Form 10-K for the year ended December 31, 2016. In their letter, the Staff requested that we provide them with an analysis to support our determination that Pillarstone OP is a VIE of which we are the primary beneficiary and that Pillarstone OP should be consolidated in our financial statements in accordance with GAAP. In response to the Staff’s comment, we provided the Staff with our analysis of our accounting and financial reporting obligations relating to our interest in Pillarstone. After communicating our analysis and conclusions to the Staff and responding to additional questions from the Staff relating to this matter, the Staff did not object to or otherwise take exception to our initial determinations at the time of the consummation of the Contribution in December 2016 but provided a verbal reminder that the determination of the primary beneficiary of a VIE should be continually reassessed, noting that the initial terms of the Management Agreements expired in December 2017, and suggesting that we consider pre-clearing future accounting treatment of Pillarstone OP with the Staff of the Office of the Chief Accountant (“OCA”).

In connection with the preparation and review of our financial statements for the quarter ended March 31, 2018, we concluded, in accordance with the Staff’s recommendation, and after consultation with our outside accounting advisors, that it would be prudent to seek the pre-clearance of the OCA of our proposed treatment of Pillarstone OP in our financial statements for such quarter. Accordingly, in April 2018, we submitted a letter to the OCA seeking their concurrence with our determinations that we maintained our status as the primary beneficiary of Pillarstone OP and, accordingly, should continue to consolidate Pillarstone in our financial statements for the quarter ended March 31, 2018 in accordance with GAAP. After further correspondence, including telephonic meetings between us, our advisors and the OCA, the OCA informed us that it objected to our conclusions that we were the primary beneficiary of Pillarstone OP and were required to consolidate it in our financial statements since the Contribution in December 2016 and during the subsequent periods. We respectfully disagreed with the OCA's determination and made a formal appeal to the Chief Accountant of the SEC.

On July 30, 2018, the Chief Accountant of the SEC informed us that our formal appeal was denied and that the OCA objects to our consolidation of Pillarstone OP in our financial statements under the VIE accounting guidance since the contribution in December 2016. As a result, we should not have consolidated Pillarstone OP in our financial statements under VIE accounting guidance in our historical financial statements for the years ended December 31, 2016 and 2017 and the interim periods. After consideration of the OCA's objection to our original accounting, we determined that the Contribution did not meet the requirements for derecognition of the underlying assets, and we have revised our accounting treatment accordingly. Management evaluated the materiality of the errors relating to our prior consolidation of Pillarstone OP quantitatively and qualitatively, and concluded that they were not material to the financial statements of any period presented, but has elected to correct them in the accompanying prior period consolidated financial statements. See Note 2 for additional disclosure on our revised accounting treatment and the correction of an immaterial error as a result.


14

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

The carrying amounts and classification of certain assets and liabilities for Pillarstone OP are now reflected in our consolidated balance sheets according to the profit sharing method as of June 30, 2018 and December 31, 2017 and consisted of the following (in thousands):
 
 
June 30, 2018
 
December 31, 2017
Real estate assets, at cost
 
 
 
 
  Property
 
$
96,380

 
$
95,146

  Accumulated depreciation
 
(37,746
)
 
(35,980
)
    Total real estate assets
 
58,634

 
59,166

 
 
 
 
 
Investment in real estate partnership
 
4,419

 
4,095

 
 
 
 
 
Liabilities
 
 
 
 
  Notes payable(1)
 
$
(48,241
)
 
$
(48,840
)
 
 
 
 
 
Net carrying value
 
$
14,812

 
$
14,421


(1) 
Excludes approximately $15.5 million in notes payable due to Whitestone as of June 30, 2018 and December 31, 2017.

The Company's maximum exposure to loss relating to Pillarstone OP is limited to its investment in Pillarstone OP and its guarantee of promissory notes issued to Pillarstone OP. Since the date of the Contribution, the Company has not provided financial support to Pillarstone OP that it was not previously contractually required to provide under the Management Agreements or OP Unit Purchase Agreement. The Company's maximum exposure to loss relating to Pillarstone OP as of June 30, 2018 and December 31, 2017 is as follows (in thousands):
 
 
June 30, 2018
 
December 31, 2017
Net carrying value
 
$
14,812

 
$
14,421

OP Unit Purchase Agreement
 
3,000

 
3,000

Notes payable (1)
 
63,714

 
64,313

Maximum exposure to loss
 
$
81,526

 
$
81,734


(1) 
Includes approximately $15.5 million of Whitestone's liability under the Facility.

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.


15

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

Debt consisted of the following as of the dates indicated (in thousands):
Description
 
June 30, 2018
 
December 31, 2017
Fixed rate notes
 
 
 
 
$10.5 million, LIBOR plus 2.00% Note, due September 24, 2018 (1)
 
$
9,620

 
$
9,740

$50.0 million, 1.75% 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

 
80,000

$37.0 million 3.76% Note, due December 1, 2020 (5)
 
32,624

 
33,148

$6.5 million 3.80% Note, due January 1, 2019
 
5,750

 
5,842

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

 
19,000

$20.2 million 4.28% Note, due June 6, 2023
 
19,179

 
19,360

$14.0 million 4.34% Note, due September 11, 2024
 
13,832

 
13,944

$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)
 
15,932

 
16,058

$15.1 million 4.99% Note, due January 6, 2024
 
14,754

 
14,865

$2.6 million 5.46% Note, due October 1, 2023
 
2,451

 
2,472

$1.3 million 3.47% Note, due November 28, 2018
 
637

 

Floating rate notes
 
 
 
 
Unsecured line of credit, LIBOR plus 1.40% to 1.95%, due October 30, 2019 (6)
 
241,200

 
232,200

Total notes payable principal
 
669,279

 
660,929

Less deferred financing costs, net of accumulated amortization
 
(1,684
)
 
(1,861
)
Total notes payable
 
$
667,595

 
$
659,068


(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 OP in December 2016 and included in our consolidated balance sheets under the profit-sharing method of accounting as discussed in Note 2.

(6) 
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 an $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).


16

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(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 June 30, 2018, $441.2 million was drawn on the Facility, and our remaining borrowing capacity was $58.8 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 any 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.


17

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(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 OP, 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 OP entered into the Limited Guarantee (the “Limited Guarantee”) with the Agent, pursuant to which Pillarstone OP 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 June 30, 2018, Pillarstone accounted for approximately $15.5 million of the total amount drawn on the Facility.

As of June 30, 2018, our $227.4 million in secured debt was collateralized by 19 properties with a carrying value of $322.7 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, 2018, our tangible Net Worth (as defined in the Facility) was $345.8 million and, as a result, we were not in compliance with respect to the tangible Net Worth covenant in the Facility, which states that the tangible Net Worth of the Company shall not be less than the sum of $217.0 million plus 85% of the aggregate net proceeds received by the Company after December 8, 2016 in connection with any offering of stock or stock equivalents. We have received a one-time waiver as of June 30, 2018 and can make no assurances that we will be in compliance with this covenant or other covenants under the Facility in future periods or, if we are not in compliance, that we will be able to obtain another waiver. Had we been unable to obtain a waiver or other suitable relief from the lenders under the Facility, an Event of Default (as defined in the Facility) would have occurred, permitting the lenders holding a majority of the commitments under the Facility to, among other things, accelerate the outstanding indebtedness, which would make it immediately due and payable.

Scheduled maturities of our outstanding debt as of June 30, 2018 were as follows (in thousands):
Year
 
Amount Due
 
 
 
2018
 
$
11,558

2019
 
249,249

2020
 
82,827

2021
 
51,918

2022
 
102,007

Thereafter
 
171,720

Total
 
$
669,279

 
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:
 
 
 
 
June 30, 2018
 
Prepaid expenses and other assets
 
$
6,593

December 31, 2017
 
Prepaid expenses and other assets
 
$
3,036


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.

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 (Loss)
 
Location of Income (Loss) Recognized in Earnings
 
Amount of Income (Loss) Recognized in Earnings (1)
Three months ended June 30, 2018
 
$
913

 
Interest expense
 
$
138

Three months ended June 30, 2017
 
$
(780
)
 
Interest expense
 
$
(441
)
 
 
 
 
 
 
 
Six months ended June 30, 2018
 
$
3,558

 
Interest expense
 
$
103

Six months ended June 30, 2017
 
$
(48
)
 
Interest expense
 
$
(949
)

(1) 
There was no ineffective portion of our interest rate swaps to recognize in earnings for the three and six months ended June 30, 2018 and 2017.


18

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

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 June 30, 2018 and 2017, 1,032,949 and 1,086,332 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, 2018 and 2017, 1,058,015 and 1,093,042 OP units, respectively, were excluded from the calculation of diluted earnings per share because their effect would be anti-dilutive.
 
For the three months ended June 30, 2018 and 2017, distributions of $71,000 and $109,000, respectively, were made to holders of certain restricted common shares, $4,000 of which were charged against earnings in each period, and for the six months ended June 30, 2018 and 2017, distributions of $116,000 and $204,000, respectively, were made to holders of certain restricted common shares, $8,000 of which were charged against earnings in each period. See Note 12 for information related to restricted common shares under the 2008 Plan.

 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
(in thousands, except per share data)
 
2018
 
2017
 
2018
 
2017
Numerator:
 
 
 
 
 
 
 
 
Net income
 
$
1,755

 
$
2,043

 
$
4,867

 
$
3,536

Less: Net income attributable to noncontrolling interests
 
(45
)
 
(60
)
 
(128
)
 
(114
)
Distributions paid on unvested restricted shares
 
(67
)
 
(105
)
 
(108
)
 
(196
)
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
1,643

 
$
1,878

 
$
4,631

 
$
3,226

 
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
 
Weighted average number of common shares - basic
 
39,204

 
35,716

 
39,136

 
32,583

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Unvested restricted shares
 
1,475

 
828

 
1,383

 
910

Weighted average number of common shares - dilutive
 
40,679

 
36,544

 
40,519

 
33,493

 
 
 
 
 
 
 
 
 
Earnings Per Share:
 
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
 
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.04

 
$
0.05

 
$
0.12

 
$
0.10

Diluted:
 
 
 
 
 
 
 
 
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.04

 
$
0.05

 
$
0.11

 
$
0.10



19

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

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 continue to 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.
 
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 June 30, 2018 and 2017, we recognized approximately $102,000 and $89,000 in margin tax provision, respectively, and for the six months ended June 30, 2018 and 2017, we recognized approximately $217,000 and $170,000 in margin tax provision, respectively.

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 2017 Offering”). Total net proceeds from the April 2017 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 2017 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 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 did not sell any common shares under the 2015 equity distribution agreements during the three and six months ended June 30, 2018. During the three months ended June 30, 2017, we sold 176,576 common shares under the 2015 equity distribution agreements, with net proceeds to us of approximately $2.4 million. In connection with such sales, we paid compensation of approximately $27,000 to the sales agents. During the six months ended June 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.

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, 2018, we owned a 97.5% interest in the Operating Partnership.
 

20

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

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 June 30, 2018 and December 31, 2017, there were 40,631,179 and 40,184,532 OP units outstanding, respectively.  We owned 39,623,007 and 39,100,951 OP units as of June 30, 2018 and December 31, 2017, 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 97.4% and 97.1% for the three months ended June 30, 2018 and 2017, respectively and approximately 97.4% and 96.8% for the six months ended June 30, 2018 and 2017, respectively. During the three months ended June 30, 2018 and 2017, 75,032 and 11,634 OP units, respectively, were redeemed for an equal number of common shares, and during the six months ended June 30, 2018 and 2017, 75,409 and 18,989 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 2017 and the six months ended June 30, 2018 (in thousands, except per share/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
2018
 
 
 
 
 
 
 
 
 
 
Second Quarter
 
$
0.2850

 
$
11,203

 
$
0.2850

 
$
295

 
$
11,498

First Quarter
 
0.2850

 
11,145

 
0.2850

 
309

 
11,454

Total
 
$
0.5700

 
$
22,348

 
$
0.5700

 
$
604


$
22,952

 
 
 
 
 
 
 
 
 
 
 
2017
 
 
 
 
 
 
 
 
 
 
Fourth Quarter
 
$
0.2850

 
$
11,002

 
$
0.2850

 
$
309

 
$
11,311

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

 
8,429

 
0.2850

 
313

 
8,742

Total
 
$
1.1400

 
$
40,472

 
$
1.1400

 
$
1,241

 
$
41,713


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. 


21

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

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 vested 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 was 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.

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.

On March 16, 2018, the Compensation Committee approved the grant of an aggregate of 387,499 time-based restricted common share units under the 2008 Plan, which vest annually in three equal installments, and 4,300 performance-based restricted common share units to certain of our employees.

A summary of the share-based incentive plan activity as of and for the six months ended June 30, 2018 is as follows:
 
 
Shares
 
Weighted Average
Grant Date
Fair Value
Non-vested at January 1, 2018
 
2,481,331

 
$
13.60

Granted
 
391,799

 
8.74

Vested
 
(266,249
)
 
14.35

Forfeited
 
(56,142
)
 
13.02

Non-vested at June 30, 2018
 
2,550,739

 
$
12.79

Available for grant at June 30, 2018
 
533,952

 
 


22

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

A summary of our non-vested and vested shares activity for the six months ended June 30, 2018 and years ended December 31, 2017 and 2016 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, 2018
 
391,799

 
$
8.74

 
(266,249
)
 
$
3,821

Year Ended December 31, 2017
 
1,354,534

 
$
12.92

 
(881,710
)
 
$
12,829

Year Ended December 31, 2016
 
545,778

 
$
14.85

 
(734,261
)
 
$
10,577

    
Total compensation recognized in earnings for share-based payments was $1,489,000 and $2,390,000 for the three months ended June 30, 2018 and 2017, respectively, and $3,397,000 and $4,841,000 for the six months ended June 30, 2018 and 2017, respectively.

Based on our current financial projections, we expect approximately 68% of the unvested awards, exclusive of 965,000 CIC Units, to vest over the next 33 months. As of June 30, 2018, there was approximately $2.1 million in unrecognized compensation cost related to outstanding non-vested TSR Units, which are expected to vest over a period of 18 months, and approximately $4.3 million in unrecognized compensation cost related to outstanding non-vested time-based shares, which are expected to be recognized over a period of approximately 33 months beginning on July 1, 2018.

We expect to record approximately $5.6 million in non-cash share-based compensation expense in 2018 and $4.2 million subsequent to 2018. The unrecognized share-based compensation cost is expected to vest over a weighted average period of 23 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. The dilutive impact of the TSR Units is based on the Company's TSR Peer Group Ranking as of the reporting date and weighted according to the number of days outstanding in the period. As of June 30, 2018, the TSR Peer Group Ranking called for 200% attainment. The dilutive impact of the CIC Units is based on the probability of a Change in Control. Because the Company considers a Change in Control on or before September 30, 2024 to be improbable, no CIC Units are included in the Company's dilutive shares.

At our annual meeting of shareholders on May 11, 2017, our shareholders voted to approve the 2018 Long-Term Equity Incentive Ownership Plan (the “2018 Plan”). The 2018 Plan provides for the issuance of up to 3,433,831 common shares and OP units pursuant to awards under the 2018 Plan. The 2018 Plan will become effective on July 30, 2018, which is the day after the 2008 Plan expires.

13. GRANTS TO TRUSTEES

On December 12, 2017, each of our six independent trustees and one trustee emeritus were granted 3,000 common shares, which vested immediately and were prorated based on date appointed. The 16,281 common shares granted to our trustees had a grant date fair value of $14.46 per share. On December 12, 2017, three of our independent trustees each elected to receive a total of 2,320 common shares with a grant date fair value of $14.46 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.

14. SEGMENT INFORMATION

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


23

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

15. REAL ESTATE

Property acquisitions. On May 26, 2017, we acquired BLVD Place, a property that meets our Community Centered Property® strategy, for $158.0 million, including $80.0 million of asset level mortgage financing and $78.0 million in cash and net prorations using borrowings under our Facility and a portion of the net proceeds from the April 2017 Offering. BLVD Place, a 216,944 square foot property, was 99% leased at the time of purchase and is located in Houston, Texas. Included in the purchase of BLVD Place is approximately 1.43 acres of developable land.
    
On May 3, 2017, we acquired Eldorado Plaza, a property that meets our Community Centered Property® strategy, for $46.6 million in cash and net prorations using borrowings under our Facility and a portion of the net proceeds from the April 2017 Offering. Eldorado Plaza, a 221,577 square foot property, was 96% leased at the time of purchase and is located in McKinney, Texas, a suburb of Dallas, Texas.
    
Unaudited pro forma financial information. The following unaudited pro forma consolidated operating data is presented for the three and six months ended June 30, 2018 and 2017, as if the acquisition of BLVD Place had occurred on January 1, 2017. Revenue and net income attributable to BLVD Place of $3.6 million and $1.9 million, respectively, have been included in our results of operations for the three months ended June 30, 2018, and revenue and net income attributable to BLVD Place of $7.5 million and $4.0 million, respectively, have been included in our results of operations for the six months ended June 30, 2018. Revenue and net income attributable to BLVD Place of $1.5 million and $0.9 million, respectively, have been included in our results of operations for the three and six months ended June 30, 2017. The related acquisition expenses of $0.4 million for the year ended December 31, 2017 have been reflected as a pro forma expense as of January 1, 2017. The unaudited pro forma consolidated operating data is not necessarily indicative of what the actual results of operations of the Company would have been, assuming the transaction had been completed as set forth above, nor do they purport to represent the Company's results of operations for future periods.
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
(in thousands, except per share data)
 
2018
 
2017
 
2018
 
2017
 
 
Actual
 
Pro-Forma
 
Actual
 
Pro-Forma
Total property revenues
 
$
33,072

 
$
32,407

 
$
66,668

 
$
64,271

Net income
 
$
1,755

 
$
3,130

 
$
4,867

 
$
5,774

Net income attributable to Whitestone REIT (1)
 
$
1,710

 
$
3,038

 
$
4,739

 
$
5,588

 
 
 
 
 
 
 
 
 
Basic Earnings Per Share:
 
$
0.04

 
$
0.08

 
$
0.12

 
$
0.14

 
 
 
 
 
 
 
 
 
Diluted Earnings Per Share:
 
$
0.04

 
$
0.08

 
$
0.11

 
$
0.14

 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding:
 
 
 
 
 
 
 
 
Basic (2)
 
39,204

 
37,831

 
39,136

 
37,634

Diluted (2)
 
40,679

 
38,659

 
40,519

 
38,544


(1) 
Net income attributable to Whitestone REIT reflects historical ownership percentages and does not reflect the effects of the April 2017 Offering, assuming the sale of the common shares took place on January 1, 2017, as the related impact on ownership percentage is minimal.

(2) 
Pro forma weighted averages reflect the April 2017 Offering, assuming the sale of the common shares took place on January 1, 2017.

Development properties. As of March 31, 2017, we had substantially completed construction at our Pinnacle of Scottsdale Phase II property. As of June 30, 2018, we had incurred approximately $5.3 million in construction costs, including approximately $0.6 million in previously capitalized interest and real estate taxes. The 27,063 square foot Community Centered Property® was 91% leased as of June 30, 2018 and is located in Scottsdale, Arizona, and adjacent to Pinnacle of Scottsdale.


24

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(Unaudited)

On December 31, 2016, we had substantially completed construction at our Shops at Starwood Phase III property. As of June 30, 2018, we had incurred approximately $8.3 million in construction costs, including approximately $1.0 million in previously capitalized interest and real estate taxes. The 35,351 square foot Community Centered Property® was 72% leased as of June 30, 2018 and is located in Frisco, Texas, a northern suburb of Dallas, Texas, and adjacent to Shops at Starwood.

Property dispositions. On February 27, 2018, we completed the sale of Bellnott Square, located in Houston, Texas, for $4.7 million. This disposition was pursuant to our strategy of recycling capital by disposing of non-core properties, primarily properties that we owned at the time our current management team assumed the management of the Company, that do not fit our Community Centered Property® strategy. We recorded a gain on sale of $0.3 million. We have not included Bellnott Square in discontinued operations as it did not meet the definition of discontinued operations.     


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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, 2017.  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, pending acquisitions and the impact of such acquisitions on our financial condition and results of operations, 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 income taxes if we fail to qualify as a real estate investment trust (“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 and the impact of the legislation commonly known as the Tax Cuts and Jobs Act;
adverse economic or real estate developments or natural disasters in Texas, Arizona or Illinois;
increases in interest rates, operating costs or general and administrative expenses, including those incurred in connection with the nomination of trustees by a shareholder;
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 tenant leases or obtain new tenant leases 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;
the need to fund tenant improvements or other capital expenditures out of operating cash flow;
the risk that we are unable to raise capital for working capital, acquisitions or other uses on attractive terms or at all; and
our ability to regain compliance and to continue to comply with all covenants under the Facility.
 
The forward-looking statements should be read in light of these factors and the factors identified in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2017, 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 and operates commercial properties in culturally diverse markets in major metropolitan areas. Founded in 1998, we are internally managed with a portfolio of commercial properties in Texas, Arizona and Illinois.


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In October 2006, our current management team joined the Company and adopted a strategic plan to acquire, redevelop, own and operate Community Centered Properties®.  We define Community Centered Properties® as visibly located properties in established or developing culturally diverse neighborhoods in our target markets. 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 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, 2018, we owned or had a majority interest in 72 commercial properties consisting of:

Operating Portfolio

51 wholly-owned properties that meet our Community Centered Properties® strategy containing approximately 4.9 million square feet of gross leasable area (“GLA”) and having a total carrying amount (net of accumulated depreciation) of $920.3 million;

an interest in 14 properties that do not meet our Community Centered Properties® strategy containing approximately 1.5 million square feet of GLA and having a total carrying amount (net of accumulated depreciation) of $59.0 million; and

Redevelopment, New Acquisitions Portfolio

one retail property that meets our Community Centered Properties® strategy containing less than 0.1 million square feet of GLA and having a total carrying value (net of accumulated depreciation) of $11.4 million; and

six parcels of land held for future development having a total carrying value of $17.4 million.

As of June 30, 2018, we had an aggregate of 1,647 tenants.  We have a diversified tenant base with our largest tenant comprising only 2.6% of our annualized rental revenues for the six months ended June 30, 2018.  Lease terms for our properties range from less than one year for smaller tenants to over 15 years for larger tenants.  Our leases include minimum monthly lease payments and generally provide for tenant reimbursements for payment of taxes, insurance and maintenance. We completed 223 new and renewal leases during the six months ended June 30, 2018, totaling 632,108 square feet and approximately $50.0 million in total lease value.  This compares to 180 new and renewal leases totaling 451,537 square feet and approximately $37.3 million in total lease value during the same period in 2017.

We employed 96 full-time employees as of June 30, 2018.  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.

Pillarstone

In November 2017, we received a comment letter from the Staff of Division of Corporation Finance of the SEC (the “Staff”) relating to our Annual Report on Form 10-K for the year ended December 31, 2016. In their letter, the Staff requested that we provide them with an analysis to support our determination that Pillarstone OP is a VIE of which we are the primary beneficiary and that Pillarstone OP should be consolidated in our financial statements in accordance with GAAP. In response to the Staff’s comment, we provided the Staff with our analysis of our accounting and financial reporting obligations relating to our interest in Pillarstone. After communicating our analysis and conclusions to the Staff and responding to additional questions from the Staff relating to this matter, the Staff did not object to or otherwise take exception to our initial determinations at the time of the consummation of the Contribution in December 2016 but provided a verbal reminder that the determination of the primary beneficiary of a VIE should be continually reassessed, noting that the initial terms of the Management Agreements expired in December 2017, and suggesting that we consider pre-clearing future accounting treatment of Pillarstone OP with the Office of the Chief Accountant (“OCA”).


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In connection with the preparation and review of our financial statements for the quarter ended March 31, 2018, we concluded, in accordance with the Staff’s recommendation, and after consultation with our outside accounting advisors, that it would be prudent to seek the pre-clearance of the OCA of our proposed treatment of Pillarstone OP in our financial statements for such quarter. Accordingly, in April 2018, we submitted a letter to the OCA seeking their concurrence with our determinations that we maintained our status as the primary beneficiary of Pillarstone OP and, accordingly, should continue to consolidate Pillarstone in our financial statements for the quarter ended March 31, 2018 in accordance with GAAP. After further correspondence, including telephonic meetings between us, our advisors and the OCA, the OCA informed us that it objected to our conclusions that we were the primary beneficiary of Pillarstone OP and were required to consolidate it in our financial statements since the Contribution in December 2016 and during the subsequent periods. We respectfully disagreed with the OCA’s determination and have made a formal appeal to the Chief Accountant of the SEC.

On July 30, 2018, the Chief Accountant of the SEC informed us that our formal appeal was denied and that the OCA objects to our consolidation of Pillarstone OP in our financial statements under the VIE accounting guidance since the contribution in December 2016. As a result, we should not have consolidated Pillarstone OP in our financial statements under VIE accounting guidance in our historical financial statements for the years ended December 31, 2016 and 2017 and the interim periods. After consideration of the OCA’s objection to our original accounting, we determined that the Contribution did not meet the requirements for derecognition of the underlying assets, and we have revised our accounting treatment accordingly, pursuant to which we will not recognize the sale of assets to Pillarstone OP and will account for the transaction under the profit-sharing method. Management evaluated the materiality of the errors relating to our prior consolidation of Pillarstone OP quantitatively and qualitatively, and concluded that they were not material to the financial statements of any period presented, but has elected to correct them in the accompanying prior period consolidated financial statements.    
    
For more information, see Note 2 (Summary of Significant Accounting Policies—Profit-sharing Method) and Note 6 (Investment in Real Estate Partnership) to the accompanying consolidated financial statements.

April 2017 Offering

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 2017 Offering”). Total net proceeds from the April 2017 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 2017 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.

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 $33.1 million and $30.2 million for the three months ended June 30, 2018 and 2017, respectively.

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 three 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 2018.
 

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Scheduled Lease Expirations
 
We tend to lease space to smaller businesses that desire shorter term leases. As of June 30, 2018, approximately 22% of our GLA was subject to leases that expire prior to December 31, 2019.  Over the last three years, we have renewed expiring leases with respect to approximately 78% of our GLA. 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. Inasmuch as 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.
 
General and Administrative Expenses

On December 29, 2017, a shareholder of the Company notified us of its intention to nominate three trustees to our board of trustees at our 2018 Annual Meeting of Shareholders, which process concluded in our favor in May 2018. The process resulted in an increase in our general and administrative expenses compared to prior periods.

Acquisitions
 
We have continued to successfully grow our GLA 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, Dispositions and Development
 
We seek to acquire commercial properties in high-growth markets. Our acquisition targets are properties that fit our Community Centered Properties® strategy.  We may acquire properties in other high-growth cities in the future.

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