4. Fair Value Disclosures; Derivative Instruments

GAAP USA clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. GAAP USA also requires that a fair value measurement reflect the assumptions market participants would use in pricing an asset or liability based upon the best information available.

GAAP USA establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy categorizes assets and liabilities 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:

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Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

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Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs are observable for the asset or liability, or unobservable but corroborated by market data, for substantially the full term of the financial instrument.

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Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of the input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. The following table presents information about the Company’s liabilities measured at fair value on a recurring basis as of December 31, 2013 and 2012, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value:

	Amount as of
Description	12/31/2013		Level 1		Level 2		Level 3
Interest Rate Swap	$	60,000	$	-	$	60,000	$	-
Warrant Liability		816,000		-		816,000		-
	$	876,000			$	876,000

	Amount as of
Description	12/31/2012		Level 1		Level 2		Level 3
Interest Rate Swap	$	128,000	$	-	$	128,000	$	-
Warrant Liability		721,000		-		721,000		-
	$	849,000			$	849,000

The fair value of the detachable warrants was estimated on the date of the grant using the Black-Scholes option-pricing model. This model uses the assumptions listed in the table below as of July 17, 2012 (initial valuation date of the warrants). In the valuation of the warrants, it was determined that the warrants were required to be carried as a derivative liability at fair value. Changes in the fair value of the warrants have been recognized in the consolidated statement of operations.

The Company’s interest rate swap agreements were valued using the counterparty’s mark-to-market statement, which were validated using modeling techniques that include market inputs such as publically available interest rate yield curves, and were designated as Level 2 within the valuation hierarchy.

GAAP USA requires an entity to recognize all derivatives as either assets or liabilities in the consolidated balance sheet and to measure those instruments at fair value. Under certain conditions, a derivative may be specifically designated as a fair value hedge or a cash flow hedge.

As a result of the use of derivative instruments, the Company was exposed to risk that the counterparty might fail to meet their contractual obligations. Recent adverse developments in the global financial and credit markets could have negatively impacted the creditworthiness of our counterparty and caused them to fail to perform as expected. To mitigate the counterparty credit risk, we only entered into contracts with a major financial institution based upon their credit ratings and other factors, and continually assessed the creditworthiness of the counterparty. The counterparty performed in accordance with their contractual obligations.

On July 1, 2011, we entered into a swap agreement with BMO Capital Markets with respect to $6,780,000 of our loan balances with BMO Harris. This swap agreement limits the Company’s exposure to interest rate fluctuations on the Company’s floating rate loans. The swap agreement has the effect of fixing the interest rate on the loan balances covered by the swap at 4.65% per annum. The swap agreement is a derivative financial instrument and we determine and record the fair value of the swap agreement each quarter. This value is recorded on the balance sheet of the Company and the amount of the unrealized gain or loss for each period is recorded as interest income or expense on the statement of operations, as the swap is not designated as a hedge for accounting purposes.

Fair Values of Derivative Instruments in the Consolidated Balance Sheets

	Liability Derivatives
As of December 31,	2013			2012
Derivatives not designated as hedging instruments under Statement 133	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Interest Rate Contracts	Accrued Liabilities	$	60,000	Accrued Liabilities	$	128,000

The Effect of Derivative Instruments on the Consolidated Statements of Operations

December 31,	2013			2012
Derivatives not Designated as Hedging Instruments under Statement 133	Location of Gain Recognized in Income on Derivative	Amount of Gain Recognized in Income on Derivative		Location of Gain Recognized in Income on Derivative	Amount of Gain Recognized in Income on Derivative
Interest Rate Contracts	Interest Expense	$	(14,000)	Interest Expense	$	(67,000)
Interest on fixed/variable rate variances		$	82,000		$	80,000