Note 10: Financial Instruments

Derivatives: All derivative instruments are reported in the Consolidated Financial Statements at fair value. Changes in the fair value of derivatives are recorded each period in earnings or on the accompanying Consolidated Balance Sheets, depending on whether the derivative is designated and effective as part of a hedged transaction. Gains or losses on derivative instruments recorded in Accumulated OCI must be reclassified to earnings in the period in which earnings are affected by the underlying hedged item and the ineffective portion of all hedges must be recognized in earnings in the period that such portion is determined to be ineffective.

The criteria used to determine if hedge accounting treatment is appropriate are (i) the designation of the hedge to an underlying exposure; (ii) whether or not overall risk is being reduced; and (iii) if there is a correlation between the value of the derivative instrument and the underlying hedged item. On the date a derivative contract is entered into, Snap-on designates the derivative as a fair value hedge, a cash flow hedge, a hedge of a net investment in a foreign operation, or a natural hedging instrument whose change in fair value is recognized as an economic hedge against changes in the value of the hedged item. Snap-on does not use derivative instruments for speculative or trading purposes.

The company is exposed to global market risks, including the effect of changes in foreign currency exchange rates and interest rates, and therefore uses derivatives to manage financial exposures that occur in the normal course of business. The primary risks managed by using derivative instruments are foreign currency risk and interest rate risk.

Foreign currency risk management: Snap-on has significant international operations and is subject to certain risks inherent with foreign operations that include currency fluctuations. Foreign currency exchange risk exists to the extent that Snap-on has payment obligations or receipts denominated in currencies other than the functional currency, including intercompany loans denominated in foreign currencies. To manage these exposures, Snap-on identifies naturally offsetting positions and then purchases hedging instruments to protect the residual net exposures. Snap-on manages most of these exposures on a consolidated basis, which allows for netting of certain exposures to take advantage of natural offsets. Foreign currency forward contracts (“foreign currency forwards”) are used to hedge the net exposures. Gains or losses on net foreign currency hedges are intended to offset losses or gains on the underlying net exposures in an effort to reduce the earnings volatility resulting from fluctuating foreign currency exchange rates. Snap-on’s foreign currency forwards are typically not designated as hedges. The fair value changes of these contracts are reported in earnings as foreign exchange gain or loss, which is included in “Other income (expense) – net” on the accompanying Consolidated Statements of Earnings.

As of 2012 year end, Snap-on had $199.0 million of net foreign currency forward buy contracts outstanding comprised of buy contracts including $90.0 million in euros, $74.9 million in Swedish kronor, $34.7 million in Australian dollars, $33.0 million in British pounds, $12.0 million in Singapore dollars, $7.0 million in Hong Kong dollars, $5.1 million in South Korean won, $2.5 million in Chilean pesos, and $3.5 million in other currencies, and sell contracts including $41.6 million in Canadian dollars, $11.1 million in Japanese yen, $3.5 million in Argentine pesos, $2.6 million in Turkish lira, and $4.9 million in other currencies. As of 2011 year end, Snap-on had $183.8 million of net foreign currency forward buy contracts outstanding comprised of buy contracts including $85.2 million in euros, $59.8 million in Swedish kronor, $35.3 million in British pounds, $32.4 million in Australian dollars, $18.8 million in Singapore dollars, $6.1 million in Hong Kong dollars, $5.7 million in Norwegian kroner, $4.1 million in South Korean won, $4.1 million in Danish kroner, and $2.3 million in Chilean pesos, and sell contracts including $51.1 million in Canadian dollars, $12.3 million in Japanese yen, $3.6 million in Turkish lira, and $3.0 million in other currencies.

Interest rate risk management: Snap-on aims to control funding costs by managing the exposure created by the differing maturities and interest rate structures of Snap-on’s borrowings through the use of interest rate swap agreements. Treasury lock agreements are used from time to time to manage potential changes in interest rates in anticipation of the issuance or sale of certain financial instruments.

Interest rate swap agreements: Snap-on enters into interest rate swap agreements (“interest rate swaps”) to manage risks associated with changing interest rates related to the company’s fixed rate borrowings. Interest rate swaps are accounted for as fair value hedges. The differentials paid or received on interest rate swaps are recognized as adjustments to “Interest expense” on the accompanying Consolidated Statements of Earnings. The effective portion of the change in fair value of the derivative is recorded in “Long-term debt” on the accompanying Consolidated Balance Sheets, while any ineffective portion is recorded as an adjustment to “Interest expense” on the accompanying Consolidated Statements of Earnings. The notional amount of interest rate swaps outstanding and designated as fair value hedges was $100.0 million as of both 2012 and 2011 year end.

Treasury lock agreements: Snap-on enters into treasury lock agreements (“treasury locks”) from time to time to manage the potential change in interest rates in anticipation of issuing fixed rate debt. Treasury locks are accounted for as cash flow hedges. The effective differentials paid or received on treasury locks related to the anticipated issuance of fixed rate debt are recognized as adjustments to “Interest expense” on the accompanying Consolidated Statements of Earnings. There were no treasury locks outstanding as of 2012 or 2011 year end, and no treasury locks were settled in 2012 or 2011. In 2010, Snap-on settled treasury locks of $125 million associated with the company’s issuance of $250 million of fixed rate, long-term notes in December 2010.

Fair value measurements: Snap-on has derivative assets and liabilities that are measured at Level 2 fair value (primarily based on observable market information) on a recurring basis. The fair value of derivative instruments included within the Consolidated Balance Sheets as of 2012 and 2011 year end are as follows:


(Amounts in millions)	Balance Sheet Presentation	2012				2011
(Amounts in millions)	Balance Sheet Presentation	Asset Derivatives Fair Value		Liability Derivatives Fair Value		Asset Derivatives Fair Value		Liability Derivatives Fair Value
Derivatives designated as hedging instruments:
Interest rate swaps	Other assets	$	21.4	$	–	$	19.0	$	–

Derivatives not designated as hedging instruments:
Foreign currency forwards	Prepaid expenses and other assets		8.9		–		4.3		–
Foreign currency forwards	Other accrued liabilities		–		1.8		–		11.0

Total			8.9		1.8		4.3		11.0


Total derivative instruments		$	30.3	$	1.8	$	23.3	$	11.0

As of 2012 and 2011 year end, the fair value adjustment to long-term debt related to the interest rate swaps was $21.4 million and $19.0 million, respectively.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between participants at the measurement date. Level 2 fair value measurements for derivative assets and liabilities are measured using quoted prices in active markets for similar assets and liabilities. Interest rate swaps are valued based on the six-month LIBOR swap rate for similar instruments. Foreign currency forwards are valued based on exchange rates quoted by domestic and foreign banks for similar instruments. The company did not have any assets or liabilities measured at Level 1 or Level 3, or implement any changes in its valuation techniques as of and for the 2012 and 2011 years ended.

The effect of derivative instruments designated as fair value hedges as included in the Consolidated Statements of Earnings is as follows:


(Amounts in millions)	Statement of Earnings Presentation	Effective Portion of Gain Recognized in Income
(Amounts in millions)	Statement of Earnings Presentation	2012		2011		2010
Derivatives designated as fair value hedges:

Interest rate swaps	Interest expense	$	3.4	$	4.9	$	4.9

The effects of derivative instruments designated as cash flow hedges as included in Accumulated OCI on the Consolidated Balance Sheets and the Consolidated Statements of Earnings are as follows:


(Amounts in millions)	Effective Portion of Gain Recognized in Accumulated OCI						Statement of Earnings Presentation	Effective Portion of Gain Reclassified from Accumulated OCI into Income
	2012		2011		2010			2012		2011		2010
	2012		2011		2010			2012		2011		2010
Derivatives designated as cash flow hedges:

Treasury locks	$	–	$	–	$	2.1	Interest expense	$	0.4	$	0.4	$	–

Firm commitments		–		–		0.1	Net sales		–		–		0.1

The effect of derivative instruments not designated as hedging instruments as included in the Consolidated Statements of Earnings is as follows:


	Statement of Earnings Presentation	Gain Recognized in Income
(Amounts in millions)	Statement of Earnings Presentation	2012		2011		2010
Derivatives not designated as hedging instruments:

Foreign currency forwards	Other income (expense) – net	$	11.0	$	7.8	$	4.6

Snap-on’s foreign currency forwards are typically not designated as hedges for financial reporting purposes. The fair value changes of derivatives not designated as hedging instruments are reported in earnings as foreign exchange gain or loss in “Other income (expense) – net” on the accompanying Consolidated Statements of Earnings. The $11.0 million derivative gain recognized in 2012 was more than offset by transaction losses on net exposures of $11.7 million, resulting in a net foreign exchange loss of $0.7 million. The $7.8 million derivative gain recognized in 2011 was more than offset by transaction losses on net exposures of $10.4 million, resulting in a net foreign exchange loss of $2.6 million. The $4.6 million derivative gain recognized in 2010 was more than offset by transaction losses on net exposures of $5.3 million, resulting in a net foreign exchange loss of $0.7 million. The resulting net foreign exchange losses are included in “Other income (expense) – net” on the accompanying Consolidated Statements of Earnings. See Note 16 for additional information on “Other income (expense) – net.”

As of 2012 year end, the maximum maturity date of any fair value hedge was nine years. During the next 12 months, Snap-on expects to reclassify into earnings net gains from Accumulated OCI of approximately $0.3 million after tax at the time the underlying hedge transactions are realized.

See the accompanying Consolidated Statements of Comprehensive Income for additional information on changes in comprehensive income.

Counterparty risk: Snap-on is exposed to credit losses in the event of non-performance by the counterparties to its various financial agreements, including its foreign currency forward contracts and interest rate swap agreements. Snap-on does not obtain collateral or other security to support financial instruments subject to credit risk, but monitors the credit standing of the counterparties and generally enters into agreements with financial institution counterparties with a credit rating of A- or better. Snap-on does not anticipate non-performance by its counterparties, but cannot provide assurances.

Fair value of financial instruments: The fair values of financial instruments that do not approximate the carrying values in the financial statements as of 2012 and 2011 year end are as follows:


	2012				2011
(Amounts in millions)	Carrying Value		Fair Value		Carrying Value		Fair Value
Finance receivables – net	$	817.7	$	948.9	$	709.0	$	815.0
Contract receivables – net		257.1		300.6		214.8		246.7
Long-term debt and notes payable		975.6		1,126.7		984.1		1,101.5

The following methods and assumptions were used in estimating the fair value of financial instruments:

•

Finance and contract receivables include both short-term and long-term receivables. The fair value of finance and contract receivables was estimated, using Level 2 fair value measurements, based on a discounted cash flow analysis that was performed over the average life of the receivables using a current market discount rate of a similar term adjusted for credit quality.

•

Fair value of long-term debt was estimated, using Level 2 fair value measurements, based on quoted market values of Snap-on’s publicly traded senior debt. The carrying value of long-term debt includes adjustments related to fair value hedges. The fair value of notes payable approximates such instruments’ carrying value due to their short-term nature.

•

The fair value of all other financial instruments including cash equivalents, trade and other accounts receivable, accounts payable and other financial instruments approximates such instruments’ carrying value due to their short-term nature.