Whitestone REIT - 10-Q quarterly report FY

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PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements

 

 

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

 

1.  Interim Financial Statements

 

 The condensed consolidated financial statements included in this report are unaudited; however, amounts presented in the condensed consolidated balance sheet as of December 31, 2008 are derived from our audited consolidated financial statements at that date.  The unaudited financial statements as of June 30, 2009 have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information on a basis consistent with the annual audited consolidated financial statements and with the instructions to Form 10-Q, except for the adoptions in the first quarter of 2009 of Statement of Financial Accounting Standards (“SFAS”) No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS No. 160”); Financial Accounting Standards Board (“FASB”) Staff Position EITF No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities” (“FSP EITF No. 03-6-1”); SFAS No. 141(R), “Business Combinations”(“SFAS No. 141(R)”), which is applied prospectively to business combinations with acquisition dates on or after January 1, 2009; and SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), for all nonfinancial assets and nonfinancial liabilities not recognized or disclosed at fair value in the condensed consolidated financial statement on a recurring basis.  Accordingly, they do not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements.

 

The impact of SFAS No. 160 is discussed in more detail in Note 2, Summary of Significant Accounting Policies.  The impact of FSP EITF No. 03-6-1, is discussed in more detail in Note 8, Earnings Per Share.

 

The condensed 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, 2009 and the results of operations for the three and six month periods ended June 30, 2009 and 2008, the condensed consolidated statement of changes in equity for the six month period ended June 30, 2009 and cash flows for the six month periods ended June 30, 2009 and 2008.  All of these adjustments are of a normal recurring nature.  The results of operations for the interim period 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 which are included in our Annual Report on Form 10-K for the year ended December 31, 2008.

 

Business.  Whitestone was formed as a real estate investment trust, pursuant to the Texas Real Estate Investment Trust Act on August 20, 1998.  In July 2004, Whitestone changed its state of organization from Texas to Maryland pursuant to a merger of Whitestone directly with and into a Maryland real estate investment trust formed for the sole purpose of effectuating the reorganization and the conversion of each outstanding common share of beneficial interest of the Texas entity into 1.42857 common shares of beneficial interest of the Maryland entity (the “Common Shares”).  Whitestone serves 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.  Whitestone currently conducts substantially all of its operations and activities through the Operating Partnership.  As the general partner of the Operating Partnership, Whitestone has the exclusive power to manage and conduct the business of the Operating Partnership, subject to certain customary exceptions.  As of June 30, 2009 and December 31, 2008, we owned and operated 36 and 35 retail, warehouse and office properties, respectively, in and around Houston, Dallas, San Antonio, Chicago and Phoenix.

2.  Summary of Significant Accounting Policies

 

 

December 31, 2008, we owned a majority of the partnership interests in the Operating Partnership.  Consequently, the accompanying condensed consolidated financial statements include the accounts of the Operating Partnership.  All significant inter-company balances have been eliminated.  Noncontrolling interest in the accompanying condensed 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 year.  Issuance of additional Common Shares and units of limited partnership interest in the Operating Partnership that are convertible into Common Shares on a one-for-one basis (the “OP Units”) changes the ownership interests of both the noncontrolling interests and Whitestone.

 

Basis of Accounting.  Our financial records are maintained on the accrual basis of accounting whereby revenues are recognized when earned and expenses are recorded when incurred.

 

Use of Estimates.   The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at 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, estimates supporting our impairment analysis for the carrying values of our real estate assets and the estimated fair value of interest rate swaps.  Actual results could differ from those estimates.

 

Reclassifications.  We have reclassified certain prior fiscal year amounts in the accompanying condensed consolidated financial statements in order to be consistent with the current fiscal year presentation, including changes resulting from the adoption of SFAS No. 160 on January 1, 2009, as discussed later in this Note 2.  Other than the changes resulting from the implementation of SFAS No. 160, these reclassifications had no effect on net loss or equity.

 

Share-Based Compensation.   From time to time the Company awards nonvested Common Shares or Common Share Units to trustees, executive officers and employees which may be converted into Common Shares under the 2008 Long-Term Equity Incentive Ownership Plan (the “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 using the fair market value of the shares as of the grant date, in accordance with SFAS No. 123R, “Share-Based Payments,” as revised (“SFAS No. 123R”).  For the three and six months ended June 30, 2009, the Company recognized approximately $0.3 and $0.5 million in share-based compensation expense.  No share-based compensation expense was recognized prior to 2009 as no awards had been granted.

 

Noncontrolling Interests.  In December 2007, the FASB issued SFAS No. 160 which is effective for fiscal years beginning on or after December 15, 2008.  We adopted SFAS No. 160 effective January, 2009.  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 condensed consolidated balance sheets but separate from Whitestone’s equity as prescribed by SFAS No. 160.  On the consolidated statements of operations and comprehensive loss, subsidiaries are reported at the consolidated amount, including both the amount attributable to Whitestone and noncontrolling interests.  Consolidated statements of changes in equity are included for both quarterly and annual financial statements, including beginning balances, activity for the period and ending balances for shareholders’ equity, noncontrolling interests and total equity.

 

See Whitestone’s Annual Report on Form 10-K for the year ended December 31, 2008 for further discussion on significant accounting policies.

 

 

does not require new fair value measurements but is applied to the extent other accounting pronouncements require or permit fair value measurements. The statement emphasizes fair value as a market-based measurement which should be determined based upon assumptions market participants would use in pricing an asset or a liability. In February 2008, FASB issued FSP 157-2, “Effective Date of FASB Statement 157” (“FSP 157-2”) which deferred the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities except for those that are recognized or disclosed at fair value in the financial statements on a recurring basis to fiscal years beginning after November 15, 2008. Adoption of SFAS No. 157 on January 1, 2009 did not have a material effect on the Company.

 

In December 2007, FASB issued SFAS No. 141(R) which replaces SFAS No. 141, “Business Combinations” which, among other things, establishes principles and requirements for how an acquiring entity recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed (including intangibles) and any noncontrolling interests in the acquired entity. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  Adoption of SFAS No. 141(R) on January 1, 2009 impacts our accounting for acquisitions and related transaction costs.

 

In December 2007, FASB issued SFAS No. 160. SFAS No. 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It also amends certain of ARB 51’s consolidation procedures for consistency with the requirements of SFAS No. 141(R). SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. We adopted SFAS No. 160 on January 1, 2009.

In March 2008, FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS No. 161”).  SFAS No. 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.  SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.  Currently, we do not have any derivative instrument or hedging activities.

In June 2008, the FASB issued FSP EITF No. 03-6-1, “Determining Whether Instruments Granted in Share-based Payment Transactions are Participating Securities” (“FSP EITF No. 03-6-1”).  FSP EITF No. 03-6-1 affects entities which accrue non-returnable cash dividends on share-based payment awards during the awards’ service period. FASB concluded unvested share-based payment awards which are entitled to cash dividends, whether paid or unpaid, are participating securities any time the common shareholders receive dividends. Because the awards are considered participating securities, the issuing entity is required to apply the two-class method of computing basic and diluted earnings per share, as prescribed by EITF No. 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128.”.  FSP EITF No. 03-6-1 is effective for fiscal years beginning after December 15, 2008, and early adoption is not permitted. Adoption on January 1, 2009 impacts our earnings per share (“EPS”) calculation, as specified in Note 8.

 

quarter of 2009.

In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” (“SFAS 167”), which changes the approach to determining the primary beneficiary of a variable interest entity and requires companies to more frequently assess whether they must consolidate a VIE.  This new standard is effective on the first annual reporting period that begins after November 15, 2009.  We are currently assessing the potential impacts, if any, on our consolidated financial statements.

 

3.  Derivatives and Hedging

 

On September 28, 2007, we entered into an interest rate swap transaction which we designated as a cash flow hedge.  The effective date of the swap transaction was October 1, 2007, had a total notional amount of $70 million, and fixed the swap rate at 4.77% plus the LIBOR margin through October 1, 2008. The purpose of this swap was to mitigate the risk of future fluctuations in interest rates on our variable rate debt.  We determined that this swap was highly effective in offsetting future variable interest cash flows on variable rate debt.  This interest rate swap matured on October 1, 2008 and was not renewed by us.

Whitestone elected to implement SFAS No. 157 with the one-year deferral permitted by FASB Staff Position No.  FAS 157-2.  FSP No. 157-2, which was issued February 2008, defers the effective date of SFAS No. 157 for one year for certain nonfinancial assets and nonfinancial liabilities measured at fair value, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis.

SFAS No. 157 establishes a three-level valuation hierarchy for disclosure of fair value measurements.  The valuation hierarchy categorizes assets and liabilities measured at fair value into one of three different levels depending on the observability of the inputs employed in the measurement.  The three levels are defined as follows:

 

 

 

All of our derivative instruments which are included in the fair value requirements fall under the Level 2 criteria.  Interest rate swaps are valued by a third-party consultant using modeling techniques that include market inputs such as interest rate yield curves.

 4.  Real Estate

 

 

5.  Accrued Rent and Accounts Receivable, net

 

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

 

 

During the quarter ended June 30, 2009, we settled six of our sixteen insurance claims related to damages to our properties from Hurricane Ike for $1.7 million, of which we have received $0.6 million, $0.2 million of which is held in escrow pending completion of the repairs. 

 

We expect to settle the reimbursement amounts for the remaining ten properties during the third quarter of 2009.

 

6.  Unamortized Leasing Commissions and Loan Costs

Costs which have been deferred consist of the following (in thousands):

 

Mortgages and other notes payable consist of the following (in thousands):

Floating Rate Notes.  On January 25, 2008, we entered into a $6.4 million term loan agreement with KeyBank.  The term loan was secured by a pledge of the partnership interests in Whitestone REIT Operating Partnership III, L.P. (“WROP III”), and Whitestone Pima Norte LLC (“WPN”), a wholly owned subsidiary of the Operating Partnership that was formed to hold title to our Pima Norte property purchased in October 2007.  At June 30, 2009 and December 31, 2008, WROP III owned 13 and 17 properties, respectively, and WPN owned 1 property.

 

This loan contains certain financial covenants, some of which we were not in compliance with as of June 30, 2009, including the secured debt to fair market value ratio covenant.  This loan was paid in full on July 25, 2009.

 

Our loans are subject to customary financial covenants.  As of June 30, 2009, we are in compliance with all loan covenants other than the $6.4 million term loan described above, which was paid in full on its maturity date July 25, 2009.

 

Annual maturities of notes payable as of June 30, 2009, are due as set forth below (in thousands):

 

 

 

 

Basic earnings per share for Whitestone’s common shareholders is calculated by dividing income (loss) from continuing operations excluding amounts attributable to unvested restricted shares, income from discontinued operations, and the net income (loss) attributable to non-controlling interests by Whitestone’s weighted-average common shares outstanding during the period.  Diluted earnings per share is computed by dividing the net income (loss) attributable to common shareholders excluding amounts attributable to unvested restricted shares, income from discontinued operations, and the net income (loss) attributable to non-controlling interests by the weighted-average number of common shares including any dilutive unvested restricted shares.

On January 1, 2009, Whitestone adopted FSP EITF No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities,” (“FSP EITF No. 03-6-1”), which addresses whether share-based payment transaction instruments are considered participating securities prior to vesting, and in which all unvested stock awards which contain non-forfeitable rights to dividends, whether paid or unpaid, are to be included in the number of shares outstanding in Whitestone’s basic and diluted earnings per share (“EPS”) calculations.

Certain of Whitestone’s performance restricted common shares are considered participating securities which require the use of the two-class method for the computation of basic and diluted earnings per share.  For the three and six months ended June 30, 2009, basic EPS was not impacted by the two-class method because the Company’s participating securities are not obligated to participate in net operating losses, and diluted EPS was not impacted because the inclusion of these securities would have had an anti-dilutive effect on diluted EPS.  During the three months ended June 30, 2009 and 2008, 5,443,797 and 5,452,187 OP Units, respectively, were excluded from the calculation of diluted earnings per share because their effect would be anti-dilutive.  During the six months ended June 30, 2009 and 2008, 5,443,797 and 5,630,261 OP Units, respectively, were excluded from the calculation of diluted earnings per share because their effect would be anti-dilutive.

 

9.  Income Taxes

 

Federal income taxes are not assessed against us because we intend to and believe we qualify as a real estate investment trust (“REIT”) under the provisions of the Internal Revenue Code of 1986, as amended.  Our shareholders include their proportionate taxable income in their individual tax returns.  As a REIT, we must distribute at least 90% of our ordinary taxable income to our shareholders and meet certain income sources and investment restriction requirements.  In addition, REITs are subject to a number of organizational and operational requirements.  If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate tax rates.

 

Taxable income differs from net income for financial reporting purposes principally due to differences in the timing of recognition of interest, real estate taxes, depreciation, share-based compensation and rental revenue.

 

 

$53,000 and $110,000 for the three and six months ended June 30, 2008, respectively.

 

10.  Equity

 

Dividends and distributions. The following tables summarize the cash dividends/distributions paid to holders of Common Shares and holders of OP Units for the four quarters of 2008 and the first two quarters of 2009.

 

 

 

11.  Commitments and Contingencies

 

We are subject to various legal proceedings and claims that arise in the ordinary course of business.  These matters are generally covered by insurance.  While the resolution of these matters cannot be predicted with certainty, management believes the final outcome of such matters will not have a material adverse effect on our condensed consolidated financial statements.

 

Hurricane Ike.  Our 31 properties in Houston had minor to moderate harm, ranging from broken signage to uprooted landscaping; other properties had more significant issues, such as damaged roofing and exterior siding.  We maintain casualty and business interruption insurance at levels that we believe are adequate and have determined that 16 of these properties will have an insurance claim.  During the quarter ended June 30, 2009, insurance reimbursements were determined on 6 of the 16 properties.  We expect to settle the insurance claims for the remaining 10 properties during the third quarter of 2009.

 

12.  Property Dispositions

 

On May 30, 2008, as part of our settlement with Hartman Management L.P. and Allen R. Hartman (“Hartman”), we exchanged two retail properties, Garden Oaks, a 95,046 square foot retail property located in Houston, Texas and Northeast Square, a 40,525 square foot retail property located in Houston, Texas, for $11.4 million.  The $11.4 million purchase price was paid by Hartman in the form of 293,961.54 Common Shares and 1,068,451.271 OP Units.

The following is a summary of income (loss) from discontinued operations for the three and six months ended June 30, 2009 and 2008:

 

 

703,912 OP Units worth $3.6 million and credit for net prorations of $0.3 million.  The property, Spoerlein Commons, is a two story complex of retail, medical and professional office tenants.  James C. Mastandrea, our Chairman, President and Chief Executive Officer, was the controlling limited partner of Midwest Development Venture IV, the seller of Spoerlein Commons, and had an ownership interest in the property and was entitled to a portion of the proceeds from the sale of the property to the Operating Partnership.  Because of Mr. Mastandrea’s relationship with the seller, a special committee of the independent members of the Board of Trustees, including Donald F. Keating, Jack L. Mahaffey, and Chris A. Minton, negotiated the terms of the transaction, which included the use of an independent appraiser to value the property.  This purchase was accounted for using the acquisition method as prescribed under SFAS No. 141(R).  The assets acquired and liabilities accrued in this transaction were recorded at their estimated fair value at the time of purchase.

On July 29, 2008, our shareholders approved the 2008 Long-Term Equity Incentive Ownership Plan (the “Plan”). The Plan provides that awards may be made with respect to Common Shares or OP Units, which may be converted into Common Shares of Whitestone. The Plan authorizes awards in respect of an aggregate of 2,063,885 Common Shares. The maximum aggregate number of Common Shares that may be issued under the Plan will be increased upon each issuance of Common Shares by Whitestone (including issuances pursuant to the Plan) so that at any time the maximum number of shares that may be issued under the Plan shall equal 12.5% of the aggregate number of Common Shares of Whitestone and OP Units issued and outstanding (other than treasury shares and/or units issued to or held by Whitestone).

 

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

On January 6, 2009, the Compensation Committee, pursuant to the Plan, granted to certain of its officers restricted common share awards (the “Restricted Shares”) and restricted common share unit awards (the “Restricted Units”) subject to certain restrictions.  The Restricted Shares and Restricted Units will vest based on certain performance goals (as specified in the award agreement).  The grantee is the record owner of the Restricted Shares and has all rights of a shareholder with respect to the Restricted Shares, including the right to vote the Restricted Shares and to receive dividends and distributions with respect to the Restricted Shares. The grantee has no rights of a shareholder with respect to the Restricted Units, including no right to vote the Restricted Units and no right to receive current dividends and distributions with respect to the Restricted Units until the units are fully vested and convertible to Common Shares of Whitestone.

 

A summary of the stock-based incentive plan activity as of and for the six months ended June 30, 2009 is as follows:

Total compensation recognized in earnings for share-based payments for the three and six months ended June 30, 2009 was $0.3 and $0.5 million, respectively.  There was no share-based compensation expense prior to 2009.  As of June 30, 2009, there was $0.4 million of total unrecognized compensation cost related to outstanding nonvested shares issued under the Plan, which is expected to be recognized over a weighted-average period of six months.  The fair value of the shares granted during the six months ended June 30, 2009 was determined based on observable market transactions occurring near the date of the grants.

15.  Grants to Trustees

On March 25, 2009, each of our five independent trustees was granted 5,000 restricted common shares which vest in equal installments in 2010, 2011, and 2012.  These shares were granted pursuant to individual grant agreements and were not pursuant to our 2008 Long-Term Equity Incentive Ownership Plan.  The 25,000 shares had a weighted average grant date fair value of $4.94 per share, resulting in total unrecognized compensation cost of $0.1 million, which is expected to be recognized over a weighted-average period of approximately three years.  The fair value of the shares granted during the six months ended June 30, 2009 was determined based on observable market transactions occurring near the date of the grants.

 

16.  Segment Information

 

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

 

17.  Related Party Transactions

 

Spoerlein Commons Acquisition

 

On January 16, 2009, Whitestone, operating through the Operating Partnership, acquired Spoerlein Commons, a mixed use-garden style complex of retail, medical, and professional office tenants located in Buffalo Grove, Illinois.  The Operating Partnership acquired Spoerlein Commons pursuant to the terms and conditions of the purchase, sale and contribution agreement dated December 18, 2008 (the “Agreement”) between the Operating Partnership and Bank One, Chicago, NA, as trustee under a trust agreement dated January 29, 1986 (“Seller”). Midwest Development Venture IV, an Illinois limited partnership (“Midwest”), is the sole beneficiary of the Seller under the trust agreement.

 

 

Midwest, the sole beneficiary of the Seller, is entitled to all earnings and proceeds from the sale of Spoerlein Commons. James C. Mastandrea, our Chairman, President and Chief Executive Officer, is the controlling limited partner in Midwest and as such, had an ownership interest in Spoerlein Commons and is entitled to a portion of the proceeds from the sale of Spoerlein Commons to the Operating Partnership. Because of Mr. Mastandrea’s relationship with the Seller, a special committee of the independent members of the Board of Trustees including Donald F. Keating, Jack L. Mahaffey, and Chris A. Minton determined the terms of the transaction, which included the use of an independent appraiser to value Spoerlein Commons.

 

No brokerage commission was paid by Whitestone for this acquisition, and in relation to Mr. Mastandrea’s investment, there was no front-end-load, meaning that 100% of the amount paid is working for the benefit of Whitestone’s shareholders.

 

In connection with the closing of Spoerlein Commons and the investment on behalf of the Seller, the Operating Partnership issued 703,912 OP Units to Midwest for its contribution of Spoerlein Commons to the Operating Partnership.  The OP Units were issued in reliance on the exemption from registration provided by Section 4(2) under the Securities Act of 1933, as amended. The issuance was not effected using any form of general advertising or general solicitation and the issuance was made to a qualified investor.

 

The OP Units are convertible on a one-for-one basis into Common Shares at any time after July 1, 2009 in accordance with the terms of the Operating Partnership’s Limited Partnership Agreement, as amended (the “Limited Partnership Agreement”).  The Seller is not entitled to any distributions with respect to the OP Units prior to June 30, 2009.

 

18.  Subsequent Events

 

We have disclosed the following subsequent events in accordance with SFAS 165.  Subsequent events have been evaluated through August 13, 2009, the date the financial statements were filed.

 

On July 25, 2009, the stated maturity date, we paid the $6.4 million term loan with KeyBank.

 

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 condensed consolidated financial statements and the notes thereto included in this quarterly report on Form 10-Q (the “Report”).  For more detailed information regarding the basis of presentation for the following information, you should read the notes to the condensed consolidated financial statements included in this Report.

This Report contains forward-looking statements, including discussion and analysis of our financial condition, anticipated capital expenditures required to complete projects, amounts of anticipated cash distributions to our shareholders in the future and other matters.  These forward-looking statements are not historical facts but are the intent, belief or current expectations of our management based on its knowledge and understanding of our business and industry.  Forward-looking statements are typically identified by the use of terms such as “may,” “will,” “should,” “potential,” “predicts,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates” or the negative of such terms and variations of these words and similar expressions.  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 to not 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 forward-looking statements should be read in light of these factors and the factors identified in the “Risk Factors” sections of our Annual Report on Form 10-K for the year ended December 31, 2008, as previously filed with the Securities and Exchange Commission (the “SEC”).

 

Executive Overview

We are a self-administered real estate investment trust (“REIT”) engaged in owning and operating income-producing real properties.  Our investments include retail, office and warehouse properties located in the Houston, Dallas, San Antonio, Chicago and Phoenix metropolitan areas.  Whitestone serves as the general partner of Whitestone REIT Operating Partnership, L.P. (the “Operating Partnership,” or “WROP” or “OP”),  which was formed on December 31, 1998 as a Delaware limited partnership.  Whitestone currently conducts substantially all of its operations and activities through the Operating Partnership.  As the general partner of the Operating Partnership, Whitestone has the exclusive power to manage and conduct the business of the Operating Partnership, subject to certain customary exceptions.  As of June 30, 2009, we owned and operated 36 commercial properties consisting of:

 

 

 

 

Our primary source of income and cash is rents associated with commercial leases.  Our business objective is to increase shareholder value by employing a value-added investment strategy.  This strategy is focused on owning and renovating commercial real estate assets in markets with positive demographic trends, achieving diversification by property type and location, and acquiring properties within our targeted returns.

 

As of June 30, 2009, we had  694 total tenants.  We have a diversified tenant base with our largest tenant comprising only 2.7% of our total revenues for the three and six months ended June 30, 2009.  Lease terms for our properties range from less than one year for smaller tenants to over 15 years for larger tenants.  Our leases generally include minimum monthly lease payments and tenant reimbursements for payment of taxes, insurance and maintenance.

 

We employ 55 full-time employees as of June 30, 2009.  As a self-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.

 

 

In the fourth quarter of 2006, our Board approved our five-year business plan.  The key elements of the plan are as follows:

 

 

 

 

 

 

A summary of our progress on the execution of this five year plan is described in the following sections on redevelopment, acquisitions and dispositions.

 

We completed the redevelopment of the Westchase Plaza Retail and Office Center located in Houston, Texas during the three months ended March 31, 2009.  The total redevelopment of this center cost approximately $1.7 million, and it added approximately 6,600 square feet of leasable office space.

On January 16, 2009, we acquired a 41,396 square foot garden style mixed use property in Buffalo Grove, Illinois for approximately $9.4 million.  The property, Spoerlein Commons, is a two story complex of retail, medical and professional office tenants.  James C. Mastandrea, our Chairman, President and Chief Executive Officer, was the controlling limited partner of Midwest Development Venture IV, the seller of Spoerlein Commons, and had an ownership interest in the property and was entitled to a portion of the proceeds from the sale of the property to the Operating Partnership.  Because of Mr. Mastandrea’s relationship with the seller, a special committee of the independent members of the Board of Trustees, including Donald F. Keating, Jack L. Mahaffey, and Chris A. Minton, negotiated the terms of the transaction, which included the use of an independent appraiser to value the property.

In preparing the condensed consolidated financial statements, we have made estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported periods. Actual results may differ from these estimates.  A summary of our critical accounting policies is included in our Form 10-K for the year ended December 31, 2008, under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.  There have been no significant changes to these policies during the first six months of 2009 except for the adoptions in the first quarter of 2009 of  Statement of Financial Accounting Standards (“SFAS”) No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS No. 160”); Financial Accounting Standards Board (“FASB”) Staff Position EITF No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities” (“FSP EITF No. 03-6-1”); SFAS 141(R), “Business Combinations,” which is applied prospectively to business combinations with acquisition dates on or after January 1, 2009; and SFAS No. 157, “Fair Value Measurements” (SFAS No. 157), for all nonfinancial assets and nonfinancial liabilities.  For disclosure regarding recent accounting pronouncements and the anticipated impact they will have on our operations, please refer to Note 2 of the condensed consolidated financial statements.

 

Results of Operations

 

The following tables provide a general comparison of our results of operations for the three months ended June 30, 2009 and 2008 (in thousands, except for aggregate gross leasable area):

Property expenses.  Our total property expenses were $3.3 million for the three months ended June 30, 2009, as compared to $3.1 million for the three months ended June 30, 2008, an increase of $0.2 million, or 6%.  The primary components of operating expense are detailed in the table below (in thousands):

Increases during 2009 in real estate taxes and bad debt expense increased property expenses a total of approximately $350,000.  The increase of $138,000 in real estate taxes is the result of increased assessed values on our properties and the addition of the Spoerlein Commons property during January 2009.  Bad debt for the three months ended June 30, 2009 was $215,000 more than the same period in 2008.  The increase in bad debt is driven by slower paying tenants and abandonments.  We vigorously pursue past due accounts, but expect for collection of rents to continue to be challenging for the foreseeable future.  Hurricane Ike repairs, net of insurance reimbursements includes the known insurance reimbursements for six of the sixteen properties we filed claims on.  We expect to settle the reimbursement amounts for the remaining ten properties during the third quarter of 2009.

Other expenses.  Our other expenses were $4.8 million for the three months ended June 30, 2009, as compared to $5.3 million for the three months ended June 30, 2008, a decrease of $0.5 million, or 10%.  The primary components of other expense, net are detailed in the table below (in thousands):

 

 

Depreciation and amortization.  Depreciation and amortization decreased $81,000 for the three months ended June 30, 2009, as compared to the three months ended June 30, 2008.

 

Interest expense, net.  Interest expense for the three months ended June 30, 2009 was $1.5 million, an increase of $45,000 over the same period in 2008.  An increase in the average outstanding note payable balance of $21.2 million accounted for approximately $341,000 in increased interest expense during 2009, while a lower effective interest rate of 1.1% per annum (excluding amortized loan fees) accounted for approximately $296,000 in decreased interest expense during 2009.  The decrease in interest income of approximately $28,000 is primarily due to lower interest rates of return on our deposits.

 

Discontinued Operations.  Discontinued operations are comprised of the two properties known as Garden Oaks and Northeast Square.  The two properties were transferred to Mr. Hartman and Hartman Management, L.P. as part of a legal settlement on May 30, 2008.  Below is a recap of income from discontinued operations (in thousands):

 

The following tables provide a general comparison of our results of operations for the six months ended June 30, 2009 and 2008 (in thousands, except for aggregate gross leasable area):

 

Property revenues.  We had rental income and tenant reimbursements of approximately $16.2 million for the six months ended June 30, 2009 as compared to $15.5 million for the six months ended June 30, 2008, an increase of $0.7 million, or 5%.  The increase is primarily attributable to the addition of our Spoerlien Commons property during January 2009.

Property expenses.  Our total property expenses were $6.7 million for the six months ended June 30, 2009, as compared to $6.2 million for the six months ended June 30, 2008, an increase of $0.5 million, or 8%.  The primary components of operating expense are detailed in the table below (in thousands):

Increases during 2009 in real estate taxes, bad debt expense and repairs attributable to Hurricane Ike increased property expenses by a total of approximately $600,000.  The increase of $179,000 in real estate taxes is the result of increased assessed values on our properties and the addition of the Spoerlein Commons property during January 2009.  Bad debt for the six months ended June 30, 2009 was $242,000 more than the same period in 2008.  The increase in bad debt is driven by slower paying tenants and abandonments.  We vigorously pursue past due accounts, but expect for collection of rents to continue to be challenging for the foreseeable future.  Hurricane Ike repairs, net of insurance reimbursements includes the known insurance reimbursements for six of the sixteen properties we filed claims on.  We expect to settle the reimbursement amounts for the remaining ten properties during the third quarter of 2009.

Other expense.  Our other expenses were $9.3 million for the six months ended June 30, 2009, as compared to $10.2 million for the six months ended June 30, 2008, a decrease of $0.9 million, or 9%.  The primary components of other expense, net are detailed in the table below (in thousands):

 

 

General and administrative. The decrease of $1.1 million in general and administrative expense is primarily due to decreased legal fees as a result of the settlement of the litigation with Mr. Hartman and Hartman Management, L.P. in May 2008, offset by share-based compensation that was incurred in 2009 but not 2008.  Legal fees were $166,000 for the six months ended June 30, 2009, as compared to $1,660,000 for the same period in 2008.  Share-based compensation was $497,000 and $0 for the six months ended June 30, 2009 and 2008, respectively.

 

Depreciation and amortization.    Depreciation and amortization increased $71,000 for the six months ended June 30, 2009, as compared to the six months ended June 30, 2008.

 

Discontinued Operations.  Discontinued operations are comprised of the two properties known as Garden Oaks and Northeast Square.  The two properties were transferred to Mr. Hartman and Hartman Management, L.P. as part of a legal settlement on May 30, 2008.  Below is a recap of income from discontinued operations (in thousands):

 

 

Funds From Operations

 

The National Association of Real Estate Investment Trusts (“NAREIT”) defines funds from operations (“FFO”) as net income (loss) available to common shareholders computed in accordance with U.S. generally accepted accounting principles (“GAAP”), excluding gains or losses from sales of operating real estate assets and extraordinary items, plus depreciation and amortization of operating properties, including our share of unconsolidated real estate joint ventures and partnerships.  We calculate FFO in a manner consistent with the NAREIT definition.

 

Management uses FFO as a supplemental measure to conduct and evaluate our business because there are certain limitations associated with using GAAP net income alone as the primary measure of our operating performance.  Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time.  Because real estate values instead have historically risen or fallen with market conditions, management believes that the presentation of operating results for real estate companies that use historical cost accounting is insufficient by itself.  There can be no assurance that FFO presented by us is comparable to similarly titled measures of other REITs.

 

FFO should not be considered as an alternative to net income or other measurements under GAAP as an indicator of our operating performance or to cash flows from operating, investing or financing activities as a measure of liquidity.  FFO does not reflect working capital changes, cash expenditures for capital improvements or principal payments on indebtedness.

Liquidity and Capital Resources

Overview

Our primary liquidity demands are distributions to the holders of our Common Shares and holders of OP Units, capital improvements and repairs and maintenance for our properties, acquisition of additional properties, tenant improvements and debt repayments.

 

Primary sources of capital for funding our acquisitions and redevelopment programs are cash flows generated from operating activities, issuances of notes payable, sales of Common Shares, sales of OP Units and sales of non-core properties.

 

Our capital structure includes non-recourse secured debt that we assumed or originated on certain properties.  We may hedge the future cash flows of certain debt transactions principally through interest rate swaps with major financial institutions.

 

During the six months ended June 30, 2009, our cash provided from operating activities was $3.2 million and our total distributions were $3.4 million.  Therefore, we had distributions in excess of cash flow from operations of approximately $0.2 million.

We anticipate that cash flows from operating activities and our borrowing capacity will provide adequate capital for our working capital requirements, anticipated capital expenditures and scheduled debt payments during the next 12 months.  We also believe that cash flows from operating activities and our borrowing capacity will allow us to make all distributions required for us to continue to qualify to be taxed as a REIT.

 

Cash and Cash Equivalents

 

We had cash and cash equivalents of $14.0 million as of June 30, 2009, as compared to $13.0 million on December 31, 2008.  The increase of $1.0 million was primarily the result of the following:

 

 

 

 

 

 

 

We place all cash in short-term, highly liquid investments that we believe provide appropriate safety of principal.

 

 

Mortgages and other notes payable consist of the following (in thousands):