Note 9: Financial Instruments

Derivatives: All derivative instruments are reported in the Condensed Consolidated Financial Statements at fair value. Changes in the fair value of derivatives are recorded each period in earnings or on the accompanying Condensed 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 other comprehensive income (loss) (“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 effects of changes in foreign currency exchange rates, interest rates, and the company’s stock price, 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, interest rate risk and stock-based deferred compensation 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 Condensed Consolidated Statements of Earnings.

At October 3, 2015, Snap-on had $135.0 million of net foreign currency forward buy contracts outstanding comprised of buy contracts including $71.9 million in euros, $29.9 million in Australian dollars, $19.2 million in Swedish kronor, $10.2 million in Singapore dollars, $9.7 million in British pounds, $8.2 million in Hong Kong dollars, $6.4 million in South Korean won, and $9.9 million in other currencies, and sell contracts comprised of $11.2 million in Canadian dollars, $10.9 million in Japanese yen, and $8.3 million in other currencies. At January 3, 2015, Snap-on had $140.4 million of net foreign currency forward buy contracts outstanding comprised of buy contracts including $81.5 million in euros, $34.8 million in Australian dollars, $22.1 million in Swedish kronor, $16.3 million in British pounds, $10.1 million in Singapore dollars, $5.7 million in South Korean won, and $8.6 million in other currencies, and sell contracts comprised of $16.8 million in Canadian dollars, $10.9 million in Japanese yen, and $11.0 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 (“interest rate swaps”).

Snap-on enters into 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 Condensed 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 Condensed Consolidated Balance Sheets, while any ineffective portion is recorded as an adjustment to “Interest expense” on the accompanying Condensed 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 October 3, 2015, and January 3, 2015.

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 Condensed Consolidated Statements of Earnings. There were no treasury locks outstanding as of October 3, 2015, or January 3, 2015, nor were any settled during the first nine months of 2015 or 2014.

Stock-based Deferred Compensation Risk Management: Snap-on aims to manage market risk associated with the stock-based portion of its deferred compensation plans through the use of prepaid equity forward agreements (“equity forwards”). Equity forwards are used to aid in offsetting the potential mark-to-market effect on stock-based deferred compensation from changes in Snap-on’s stock price. Since stock-based deferred compensation liabilities increase as the company’s stock price rises and decrease as the company’s stock price declines, the equity forwards are intended to mitigate the potential impact on deferred compensation expense that may result from such mark-to-market changes. As of October 3, 2015, Snap-on had equity forwards in place intended to manage market risk with respect to 125,800 shares of Snap-on common stock associated with its deferred compensation plans.

Fair Value Measurements: Snap-on has derivative assets and liabilities related to interest rate swaps, foreign currency forwards and equity forwards that are measured at Level 2 fair value on a recurring basis. The fair value of derivative instruments included within the Condensed Consolidated Balance Sheets as of October 3, 2015, and January 3, 2015, are as follows:


		October 3, 2015				January 3, 2015
(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	$	14.5	$	—	$	14.0	$	—

Derivatives not designated as hedging instruments:
Foreign currency forwards	Prepaid expenses and other assets	$	4.0	$	—	$	6.6	$	—
Foreign currency forwards	Other accrued liabilities		—		6.0		—		14.7
Equity forwards	Prepaid expenses and other assets		19.0		—		15.4		—

Total		$	23.0	$	6.0	$	22.0	$	14.7


Total derivatives instruments		$	37.5	$	6.0	$	36.0	$	14.7

As of October 3, 2015, and January 3, 2015, the fair value adjustment to long-term debt related to the interest rate swaps was $14.5 million and $14.0 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. Foreign currency forwards are valued based on exchange rates quoted by domestic and foreign banks for similar instruments. Interest rate swap values are based on the six-month LIBOR swap rate for similar instruments. Equity forwards are valued using a market approach based primarily on the company’s stock price at the reporting date. The company did not have any derivative assets or liabilities measured at Level 1 or Level 3, nor did it implement any changes in its valuation techniques as of and for the nine month period ended October 3, 2015.

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


	Statement of Earnings Presentation	Effective Portion of Gain Recognized in Income
		Three Months Ended				Nine Months Ended
(Amounts in millions)		October 3, 2015		September 27, 2014		October 3, 2015		September 27, 2014
Derivatives designated as fair value hedges:

Interest rate swaps	Interest expense	$	0.8	$	1.0	$	2.8	$	3.0

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

(Amounts in millions)

Effective Portion of Gain
Recognized in
Accumulated OCI
Three Months Ended

Statement of
Earnings
Presentation

Effective Portion of Gain
Reclassified from Accumulated
OCI into Income
Three Months Ended

October 3,
2015

September 27,
2014

October 3,
2015

September 27,
2014

Derivatives designated as cash flow hedges:

Treasury locks

—

Interest expense

0.1

(Amounts in millions)

Effective Portion of Gain
Recognized in
Accumulated OCI
Nine Months Ended

Statement of
Earnings
Presentation

Effective Portion of Gain
Reclassified from Accumulated
OCI into Income
Nine Months Ended

October 3,
2015

September 27,
2014

October 3,
2015

September 27,
2014

Derivatives designated as cash flow hedges:

Treasury locks

—

Interest expense

0.3

The effects of derivative instruments not designated as hedging instruments as included in the Condensed Consolidated Statements of Earnings are as follows:


	Statement of Earnings Presentation	Gain (Loss) Recognized in Income
		Three Months Ended						Nine Months Ended
(Amounts in millions)		October 3, 2015			September 27, 2014			October 3, 2015			September 27, 2014
Derivatives not designated as hedging instruments:
Foreign currency forwards	Other income (expense) – net	$	(3.0	)	$	(11.5	)	$	(13.9	)	$	(10.5	)

Equity forwards	Operating expenses		(1.1	)		0.6			2.1			1.9

Snap-on’s foreign currency forwards are typically not designated as hedges for financial reporting purposes. The fair value changes of foreign currency forwards not designated as hedging instruments are reported in earnings as foreign exchange gain or loss in “Other income (expense) – net” on the accompanying Condensed Consolidated Statements of Earnings. The $3.0 million derivative loss recognized in the third quarter of 2015 was offset by transaction gains on net exposures of $2.4 million, resulting in a net foreign exchange loss of $0.6 million for the quarter. The $11.5 million derivative loss recognized in the third quarter of 2014 was offset by transaction gains on net exposures of $10.5 million, resulting in a net foreign exchange loss of $1.0 million for the quarter. The $13.9 million derivative loss recognized in the first nine months of 2015 was offset by transaction gains on net exposures of $11.8 million, resulting in a 2015 year-to-date net foreign exchange loss of $2.1 million. The $10.5 million derivative loss recognized in the first nine months of 2014 was offset by transaction gains on net exposures of $9.4 million, resulting in a 2014 year-to-date net foreign exchange loss of $1.1 million. The resulting net foreign exchange gains and losses are included in “Other income (expense) – net” on the accompanying Condensed Consolidated Statements of Earnings. See Note 15 for additional information on “Other income (expense) – net.”

Snap-on’s equity forwards are not designated as hedges for financial reporting purposes. Fair value changes of both the equity forwards and related stock-based (mark-to-market) deferred compensation liabilities are reported in “Operating expenses” on the accompanying Condensed Consolidated Statements of Earnings. The $1.1 million derivative loss recognized in the third quarter of 2015 was offset by $1.1 million of mark-to-market deferred compensation income. The $0.6 million derivative gain recognized in the third quarter of 2014 was largely offset by $0.5 million of mark-to-market deferred compensation expense. The $2.1 million derivative gain recognized in the first nine months of 2015 was largely offset by $2.0 million of mark-to-market deferred compensation expense. The $1.9 million derivative gain recognized in the first nine months of 2014 was offset by $1.9 million of mark-to-market deferred compensation expense.

As of October 3, 2015, the maximum maturity date of any fair value hedge was six years. During the next 12 months, Snap-on expects to reclassify into earnings net gains from Accumulated OCI of approximately $0.2 million after tax at the time the underlying hedge transactions are realized.

See the accompanying Condensed 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, interest rate swap agreements and prepaid equity forward 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 are as follows:


	October 3, 2015				January 3, 2015
(Amounts in millions)	Carrying Value		Fair Value		Carrying Value		Fair Value
Finance receivables – net	$	1,164.6	$	1,322.2	$	1,052.9	$	1,198.4
Contract receivables – net		347.1		378.6		316.5		348.2
Long-term debt and notes payable		937.7		1,040.4		919.3		1,031.3

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 estimates of finance and contract receivables are derived utilizing discounted cash flow analyses performed on groupings of receivables that are similar in terms of loan type and characteristics. The cash flow analyses consider recent prepayment trends where applicable. The cash flows are discounted over the average life of the receivables using a current market discount rate of a similar term adjusted for credit quality. Significant inputs to the fair value measurements of the receivables are unobservable and, as such, are classified as Level 3.

•

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.