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EX-32.2 - CERTIFICATION OF OUR CFO PURSUANT TO SECTION 906 - Keurig Dr Pepper Inc.dps-ex322_20170331.htm
EX-32.1 - CERTIFICATION OF OUR CEO PURSUANT TO SECTION 906 - Keurig Dr Pepper Inc.dps-ex321_20170331.htm
EX-31.2 - CERTIFICATION OF OUR CFO PURSUANT TO SECTION 302 - Keurig Dr Pepper Inc.dps-ex312_20170331.htm
EX-31.1 - CERTIFICATION OF OUR CEO PURSUANT TO SECTION 302 - Keurig Dr Pepper Inc.dps-ex311_20170331.htm
EX-12.1 - COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - Keurig Dr Pepper Inc.dps-ex121_20170331.htm
EX-10.1 - EXHIBIT 10.1 EXECUTIVE EMPLOYMENT AGREEMENT - Keurig Dr Pepper Inc.dps-ex101_20170331.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED March 31, 2017
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                     to     
dpsgigroupinca16.jpg           
Commission file number 001-33829
Delaware
 
98-0517725
(State or other jurisdiction of
 
(I.R.S. employer
incorporation or organization)
 
identification number)
 
 
 
5301 Legacy Drive, Plano, Texas
 
75024
(Address of principal executive offices)
 
(Zip code)
(972) 673-7000
(Registrant's telephone number, including area code)
 
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. Yes    x  No    o
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). Yes    x  No    o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Securities Exchange Act of 1934.
Large Accelerated Filer x
 
Accelerated Filer o
 
Non-Accelerated Filer  o
 
Smaller Reporting Company o
 
Emerging Growth Company o
 
 
(Do not check if a smaller reporting 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. o 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes    o   No    x

As of April 24, 2017, there were 183,814,527 shares of the registrant's common stock, par value $0.01 per share, outstanding.
 



DR PEPPER SNAPPLE GROUP, INC.
FORM 10-Q
INDEX
 
 
 
 
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


ii


PART I - FINANCIAL INFORMATION
ITEM 1.
Financial Statements (Unaudited)

DR PEPPER SNAPPLE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Three Months Ended March 31, 2017 and 2016
(Unaudited)
 
 
For the
 
 
Three Months Ended
 
 
March 31,
(in millions, except per share data)
 
2017
 
2016
Net sales
 
$
1,510

 
$
1,487

Cost of sales
 
607

 
602

Gross profit
 
903

 
885

Selling, general and administrative expenses
 
621

 
546

Depreciation and amortization
 
25

 
26

Other operating income, net
 
(28
)
 

Income from operations
 
285

 
313

Interest expense
 
40

 
33

Interest income
 
(1
)
 

Other income, net
 
(2
)
 
(1
)
Income before provision for income taxes and equity in earnings of unconsolidated subsidiaries
 
248

 
281

Provision for income taxes
 
71

 
99

Income before equity in earnings of unconsolidated subsidiaries
 
177

 
182

Equity in earnings of unconsolidated subsidiaries, net of tax
 

 

Net income
 
$
177

 
$
182

Earnings per common share:
 
 
 
 
Basic
 
$
0.97

 
$
0.97

Diluted
 
0.96

 
0.96

Weighted average common shares outstanding:
 
 
 
 
Basic
 
183.4

 
187.6

Diluted
 
184.6

 
189.0

Cash dividends declared per common share
 
$
0.58

 
$
0.53

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


1


DR PEPPER SNAPPLE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Three Months Ended March 31, 2017 and 2016
(Unaudited)

 
For the
 
Three Months Ended
 
March 31,
(in millions)
2017
 
2016
Comprehensive income
$
200

 
$
190

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


2


DR PEPPER SNAPPLE GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
As of March 31, 2017 and December 31, 2016
(Unaudited)
 
March 31,
 
December 31,
(in millions, except share and per share data)
2017
 
2016
Assets
Current assets:
 
 
 
Cash and cash equivalents
$
73

 
$
1,787

Restricted cash and restricted cash equivalents
87

 

Accounts receivable:
 
 
 
Trade, net
606

 
595

Other
55

 
51

Inventories
246

 
202

Prepaid expenses and other current assets
180

 
101

Total current assets
1,247

 
2,736

Property, plant and equipment, net
1,125

 
1,138

Investments in unconsolidated subsidiaries
23

 
23

Goodwill
3,560

 
2,993

Other intangible assets, net
3,784

 
2,656

Other non-current assets
206

 
183

Non-current deferred tax assets
63

 
62

Total assets
$
10,008

 
$
9,791

Liabilities and Stockholders' Equity
Current liabilities:
 
 
 
Accounts payable
$
353

 
$
303

Deferred revenue
64

 
64

Short-term borrowings and current portion of long-term obligations
10

 
10

Income taxes payable
24

 
4

Other current liabilities
696

 
670

Total current liabilities
1,147

 
1,051

Long-term obligations
4,467

 
4,468

Non-current deferred tax liabilities
842

 
812

Non-current deferred revenue
1,101

 
1,117

Other non-current liabilities
258

 
209

Total liabilities
7,815

 
7,657

Commitments and contingencies

 

Stockholders' equity:
 
 
 
Preferred stock, $0.01 par value, 15,000,000 shares authorized, no shares issued

 

Common stock, $0.01 par value, 800,000,000 shares authorized, 183,795,277 and 183,119,843 shares issued and outstanding as of March 31, 2017 and December 31, 2016, respectively
2

 
2

Additional paid-in capital
61

 
95

Retained earnings
2,336

 
2,266

Accumulated other comprehensive loss
(206
)
 
(229
)
Total stockholders' equity
2,193

 
2,134

Total liabilities and stockholders' equity
$
10,008

 
$
9,791

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


3


DR PEPPER SNAPPLE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2017 and 2016
(Unaudited)
 
For the
 
Three Months Ended
 
March 31,
(in millions)
2017
 
2016
Operating activities:
 
 
 
Net income
$
177

 
$
182

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation expense
49

 
48

Amortization expense
11

 
8

Amortization of deferred revenue
(16
)
 
(16
)
Employee stock-based compensation expense
6

 
11

Deferred income taxes
30

 
16

Gain on step acquisition of unconsolidated subsidiaries
(28
)
 

Unrealized gains on economic hedges
(5
)
 
(7
)
Other, net
4

 
2

Changes in assets and liabilities, net of effects of acquisition:
 
 
 
Trade accounts receivable
18

 
(5
)
Other accounts receivable
5

 
1

Inventories
(16
)
 
(25
)
Other current and non-current assets
(85
)
 
(82
)
Other current and non-current liabilities
(92
)
 
(70
)
Trade accounts payable
19

 
81

Income taxes payable
20

 
53

Net cash provided by operating activities
97

 
197

Investing activities:
 
 
 
Acquisition of business
(1,548
)
 

Cash acquired in step acquisition of unconsolidated subsidiaries
3

 

Purchase of property, plant and equipment
(16
)
 
(27
)
Purchase of intangible assets
(1
)
 

Investment in unconsolidated subsidiaries
(1
)
 
(6
)
Proceeds from disposals of property, plant and equipment
1

 
1

Other, net
(7
)
 
(8
)
Net cash used in investing activities
(1,569
)
 
(40
)
Financing activities:
 
 
 
Repayment of senior unsecured notes

 
(500
)
Repurchase of shares of common stock
(28
)
 
(179
)
Dividends paid
(97
)
 
(90
)
Tax withholdings related to net share settlements of certain stock awards
(30
)
 
(31
)
Proceeds from stock options exercised
17

 
7

Deferred financing charges paid
(1
)
 

Capital lease payments
(3
)
 
(2
)
Net cash used in financing activities
(142
)
 
(795
)
Cash, cash equivalents, restricted cash and restricted cash equivalents — net change from:
 
 
 
Operating, investing and financing activities
(1,614
)
 
(638
)
Effect of exchange rate changes on cash, cash equivalents, restricted cash and restricted cash equivalents
3

 
2

Cash, cash equivalents, restricted cash and restricted cash equivalents at beginning of period
1,787

 
911

Cash, cash equivalents, restricted cash and restricted cash equivalents at end of period
$
176

 
$
275

See Note 14 for supplemental cash flow information.
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

4


DR PEPPER SNAPPLE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
For the Three Months Ended March 31, 2017
(Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
Common Stock
 
Additional
 
 
 
Other
 
 
 
Issued
 
Paid-In
 
Retained
 
Comprehensive
 
Total
(in millions, except per share data)
Shares
 
Amount
 
Capital
 
Earnings
 
Loss
 
Equity
Balance as of January 1, 2017
183.1

 
$
2

 
$
95

 
$
2,266

 
$
(229
)
 
$
2,134

Shares issued under employee stock-based compensation plans and other
1.0

 

 

 

 

 

Net income

 

 

 
177

 

 
177

Other comprehensive income

 

 

 

 
23

 
23

Dividends declared, $0.58 per share

 

 

 
(107
)
 

 
(107
)
Stock options exercised and stock-based compensation

 

 
(6
)
 

 

 
(6
)
Common stock repurchases
(0.3
)
 

 
(28
)
 

 

 
(28
)
Balance as of March 31, 2017
183.8

 
$
2

 
$
61

 
$
2,336

 
$
(206
)
 
$
2,193

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 

5

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


1.
General
References in this Quarterly Report on Form 10-Q to "DPS" or "the Company" refer to Dr Pepper Snapple Group, Inc. and all entities included in the unaudited condensed consolidated financial statements.
This Quarterly Report on Form 10-Q refers to some of DPS' owned or licensed trademarks, trade names and service marks, which are referred to as the Company's brands. All of the product names included herein are either DPS' registered trademarks or those of the Company's licensors.
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete consolidated financial statements. In the opinion of management, all adjustments, consisting principally of normal recurring adjustments, considered necessary for a fair presentation have been included. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from these estimates. These unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements and the notes thereto in the Company's Annual Report on Form 10-K for the year ended December 31, 2016 ("Annual Report").
PRINCIPLES OF CONSOLIDATION
DPS consolidates all wholly owned subsidiaries. The Company uses the equity method to account for investments in companies if the investment provides the Company with the ability to exercise significant influence over operating and financial policies of the investee. Consolidated net income includes DPS' proportionate share of the net income or loss of these companies. Judgment regarding the level of influence over each equity method investment includes considering key factors such as ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions.
The Company is also required to consolidate entities that are variable interest entities (“VIEs”) of which DPS is the primary beneficiary. Judgments are made in assessing whether the Company is the primary beneficiary, including determination of the activities that most significantly impact the VIE’s economic performance.
The Company eliminates from its financial results all intercompany transactions between entities included in the unaudited condensed consolidated financial statements and the intercompany transactions with its equity method investees.
USE OF ESTIMATES
The process of preparing DPS' unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires the use of estimates and judgments that affect the reported amount of assets, liabilities, revenue and expenses. These estimates and judgments are based on historical experience, future expectations and other factors and assumptions the Company believes to be reasonable under the circumstances. These estimates and judgments are reviewed on an ongoing basis and are revised when necessary. Changes in estimates are recorded in the period of change. Actual amounts may differ from these estimates.
RECLASSIFICATIONS
Unrealized gains and losses on derivatives classified as economic hedges have been reclassified from other, net to the unrealized gains on economic hedges caption within the operating activities section in the unaudited Condensed Consolidated Statements of Cash Flows for the prior period to conform to the current year's presentation, with no impact to total cash provided by (used in) operating, investing or financing activities.
Excess tax benefit on stock-based compensation in the unaudited Condensed Consolidated Statement of Cash Flows has been reclassified from financing activities to other, net within operating activities for the prior period to conform to the current year's presentation as a result of the adoption of Accounting Standards Update ("ASU") 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share Based Payment Accounting ("ASU 2016-09"). See Recently Adopted Provisions of U.S. GAAP below for further details on the impact of the adoption of ASU 2016-09 on the Company's financial statements.

6

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


RECENTLY ISSUED ACCOUNTING STANDARDS

Effective in 2018
In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09"). The new guidance sets forth a new five-step revenue recognition model which replaces the prior revenue recognition guidance in its entirety and is intended to eliminate numerous industry-specific pieces of revenue recognition guidance that have historically existed in U.S. GAAP. The underlying principle of the new standard is that a business or other organization will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. The standard also requires more detailed disclosures and provides additional guidance for transactions that were not addressed completely in the prior accounting guidance. ASU 2014-09 provides alternative methods of initial adoption.
In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of ASU 2014-09 by one year to December 15, 2017 for interim and annual reporting periods beginning after that date and permitted early adoption of the standard, but not before the original effective date. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarifies the implementation guidance on principal versus agent considerations for the new model. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarifies the implementation guidance related to identifying performance obligations and licensing for the new model. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, which improves guidance on assessing collectibility, presentation of sales taxes, noncash consideration, and completed contracts and contract modifications at transition. These updates are effective concurrently with Topic 606 (ASU 2014-09).

At this point in time, the Company intends to adopt the above standards using the modified retrospective approach for the quarter ending March 31, 2018. In preparation for the Company's adoption of the new standard in the quarter ending March 31, 2018, management assembled a project management team, which has obtained representative samples of contracts and other forms of agreements with our customers and is evaluating the provisions contained within those documents based on the new guidance. While the Company does not expect this change to have a material impact on the Company's results of operations, financial position and cash flows once implemented on an annual basis, the Company does expect that it could have an impact on its net sales in interim periods due to timing. The Company is still evaluating the disclosure requirements under these standards. As the Company completes its overall evaluation, the Company is also identifying and preparing to implement changes to its accounting policies, practices and controls to support the new standards.

In March 2017, the FASB issued ASU 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost ("ASU 2017-07"). The ASU requires employers who offer defined benefit pension plans or other post-retirement benefit plans to report the service cost component within the same income statement caption as other compensation costs arising from services rendered by employees during the period. The ASU also requires the other components of net periodic benefit cost to be presented separately from the service cost component, in a caption outside of a subtotal of income from operations. Additionally, the ASU provides that only the service cost component is eligible for capitalization. ASU 2017-07 is effective for interim and annual reporting periods beginning after December 15, 2017, and early adoption is permitted. The standard requires retrospective adoption of the presentation of the components of net periodic benefit costs and prospective application of the capitalization of the service cost component in assets. The Company is currently evaluating the impact that ASU 2017-07 will have on the consolidated financial statements.

Effective in 2019
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) ("ASU 2016-02"). The ASU replaces the prior lease accounting guidance in its entirety. The underlying principle of the new standard is the recognition of lease assets and lease liabilities by lessees for substantially all leases, with an exception for leases with terms of less than twelve months. The standard also requires additional quantitative and qualitative disclosures. ASU 2016-02 is effective for interim and annual reporting periods beginning after December 15, 2018, and early adoption is permitted. The standard requires a modified retrospective approach, which includes several optional practical expedients. The Company does not intend to early adopt the standard. The Company has assembled a project management team and is in the early stages of evaluation. The Company anticipates the impact of the standard to be significant to its Consolidated Balance Sheet due to the amount of the Company's lease commitments. The Company is currently evaluating the other impacts that ASU 2016-02 will have on the consolidated financial statements.

7

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


RECENTLY ADOPTED PROVISIONS OF U.S. GAAP

As of January 1, 2017, the Company adopted ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory. This ASU requires inventories measured under any methods other than last-in, first-out ("LIFO") or the retail inventory method to be subsequently measured at the lower of cost or net realizable value, rather than at the lower of cost or market. Subsequent measurement of inventory using LIFO or the retail inventory method is unchanged by this ASU. The adoption of the ASU did not have a material impact on the Company's financial statements.

As of January 1, 2017, the Company adopted ASU 2016-09, which is part of the FASB's simplification initiative. The new standard provides for changes to accounting for stock compensation including 1) excess tax benefits and tax deficiencies related to share based payment awards will be recognized as income tax benefit or expense in the reporting period in which they occur; 2) excess tax benefits will be classified as an operating activity in the statement of cash flow; 3) the option to elect to estimate forfeitures or account for them when they occur; and 4) an increase in the tax withholding requirements threshold to qualify for equity classification. Beginning in 2017, the primary impact of adoption was the recognition of excess tax benefits for our stock awards in the provision for income taxes rather than additional paid-in capital. Additional amendments to the accounting for income taxes and minimum statutory withholding tax requirements had no impact to retained earnings. The Company elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period.

Adoption of the new standard resulted in the recognition of excess tax benefits in our provision for income taxes rather than paid-in capital of $18 million for the three months ended March 31, 2017. The presentation of excess tax benefits on stock-based compensation was adjusted retrospectively within the unaudited Condensed Consolidated Statements of Cash Flows, resulting in a $20 million increase in net cash provided by operating activities for the three months ended March 31, 2016 with a corresponding increase to net cash used in financing activities. The presentation requirements for cash flows related to employee taxes paid for withheld shares had no impact to any of the periods presented on the unaudited Condensed Consolidated Statements of Cash Flows as the Company has historically presented them as a financing activity.

As of January 1, 2017, the Company early adopted ASU No. 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash ("ASU 2016-18"), which requires amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning and ending amounts shown on the statement of cash flows. The Company elected to early adopt the provisions of ASU 2016-18 as of January 1, 2017 and has revised its unaudited Condensed Consolidated Statements of Cash Flows for the three-months ended March 31, 2017 and 2016 to reflect amounts described as restricted cash and restricted cash equivalents included with cash and cash equivalents in the reconciliation of beginning of period and end of period total amounts shown on the unaudited Condensed Consolidated Statements of Cash Flow. The adoption had no impact on amounts presented in the unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2016. Refer to Note 14 for the reconciliation of cash and cash equivalents and restricted cash as presented on the unaudited Condensed Consolidated Balance Sheets to the amounts as shown on the unaudited Condensed Consolidated Statements of Cash Flows.
2. Acquisitions
BAI BRANDS MERGER 
Description of the Transaction
On November 21, 2016, we entered into an Agreement and Plan of Merger (the "Merger Agreement") with Bai Brands LLC ("Bai Brands"), pursuant to which we agreed to acquire Bai Brands for a cash purchase price of $1.7 billion, subject to certain adjustments in the Merger Agreement (the "Bai Brands Merger"). The acquisition of Bai Brands will further enable the Company to meet growing consumer demand for better-for-you beverages, as Bai Brands is positioned for expanding growth in key beverage segments.
On January 31, 2017, the Company funded the Bai Brands Merger with the net proceeds from the senior unsecured notes issued in December 2016 and cash on hand. In order to complete the Bai Brands Merger, the Company paid $1,548 million, net of the Company's previous ownership interest, in exchange for the remaining ownership interests and seller transaction costs. Additionally, $103 million was held back and placed in escrow.


8


As a result of the Bai Brands Merger, our existing 2.63% equity interest in Bai Brands was remeasured to fair value of $43 million, which resulted in a gain of $28 million that was recognized in the first quarter of 2017 and included in other operating income, net.

Two transactions related to the merger were recognized separately from the acquisition of assets and assumptions of liabilities of Bai Brands:

The Company paid certain seller transaction costs, which included $2 million to reimburse Bai Brands for payments made on behalf of the Company for buyer acquisition-related costs, which were recorded as selling, general and administrative ("SG&A") expenses. The remainder of the seller transaction costs paid by the Company were accounted for by the Company as part of the consideration transferred.

Bai Brands had an executory contract as of January 31, 2017, which compensated certain counterparties with Profit Interest Units from Bai Brands (the “Predecessor PIUs”). The Predecessor PIUs were based upon the counterparties completing service requirements and various performance criteria. As a result of the Bai Brands Merger, these Predecessor PIUs have fully vested and were converted into cash as of January 31, 2017 based upon the consideration paid by the Company to acquire Bai Brands. The cash was placed in escrow and will be released from escrow to the counterparties on certain anniversary dates as long as the counterparties are not in breach of the executory contract. Although none of the costs of these benefits have been paid by the Company, DPSG will record SG&A expenses for the deferred compensation amounts payable to these counterparties by Bai Brands. As of March 31, 2017, the total unrecognized compensation cost is $13 million and the period over which these costs are expected to be recognized is 18 months.

The Company’s preliminary purchase price was $1,649 million, net of the Company's previous ownership interest. The components of the preliminary purchase price are presented below:
(in millions)
Preliminary Purchase Price
Cash paid to consummate Bai Brands Merger, net of the Company's previous ownership interest
$
1,548

Holdback placed in escrow
103

Less: Seller transaction costs reimbursed to Bai Brands for payments made on behalf of the Company for its acquisition-related costs
(2
)
Preliminary Purchase Price - Bai Brands(1)
$
1,649

___________________________
(1)
The preliminary purchase price excludes the impact of the Company's pre-existing ownership interest.

Acquisition and integration-related expenses of $19 million were recognized during the three months ended March 31, 2017 and included in SG&A expenses.
Escrow/Holdback Liability

The $103 million holdback placed in escrow is made up of two components:

$90 million, which will be held in escrow to secure indemnification obligations of the sellers relating to the accuracy of representations and warranties and a working capital adjustment to be settled 90 days after the acquisition date. As of January 31, 2018, $80 million less any working capital adjustment 90 days after the acquisition date will be released. The remaining $10 million will be released approximately 4 years after the acquisition date, subject to certain administrative conditions, and

$13 million of unrecognized compensation associated with the Predecessor PIUs related to the performance of certain counterparties, which will be held in escrow and released over the next 18 months.


9


The acquisition consideration held in escrow does not meet the definition of contingent consideration as provided under U.S. GAAP. The amount held in escrow was included in the preliminary purchase price as representations and warranties were expected to be valid as of the acquisition date. The escrow will be included in restricted cash along with a corresponding amount in the liability section of the unaudited Condensed Consolidated Balance Sheets, which will be allocated between other current liabilities and other non-current liabilities. Refer to Note 14 for additional information on location of the restricted cash on the unaudited Condensed Consolidated Balance Sheets.
Preliminary Purchase Price Allocation

The following table summarizes the preliminary allocation of the fair value of the assets acquired and liabilities assumed by major class for the Bai Brands Merger:
(in millions)
 
Fair Value
 
Useful Life
Property, plant & equipment
 
$
4

 
5 - 10 years
Customer relationships
 
30

 
7 years
Non-compete agreements
 
22

 
2 - 4 years
Brands
 
1,073

 
Indefinite
Goodwill
 
565

 
Indefinite
Assumed liabilities, net of acquired assets
 
(4
)
 
N/A
Total
 
$
1,690

 
 
The acquisition was accounted for as a business combination, and the identifiable assets acquired and liabilities assumed were recorded at their estimated fair values at the date of acquisition. We have completed our preliminary valuation to determine the fair value of the identifiable assets acquired and liabilities assumed. The fair values of the assets acquired were determined using various valuation techniques, including an income approach. The fair value measurements were primarily based on significant inputs that are not directly observable in the market and are considered Level 3 under the fair value measurements and disclosure framework. Key assumptions include cash flow projections of Bai Brands and the discount rate applied to those cash flows. The excess of the purchase price over the estimated fair values was recorded as goodwill.
In connection with this acquisition, the Company recorded goodwill of $565 million, which is deductible for tax purposes. The goodwill recognized was attributable to certain tax benefits the Company will realize over time, Bai Brands' management team and growth opportunities in a “better-for-you” beverage segment.
The Company recorded $34 million for the fair value of contingent liabilities assumed upon acquisition primarily related to existing manufacturing contracts. The fair value of the contingent liabilities was determined using discounted cash flows on expected future payments related to these contracts. The contingent liabilities will be evaluated each reporting period based on events and circumstances which may impact future payments under these contracts, and any changes in fair value will be recorded in the Company's unaudited Condensed Consolidated Statements of Income.
Pro Forma Information
The Company’s acquisition of Bai Brands is strategically significant to the future growth prospects of the Company; however at the time of the acquisition, the historical results of Bai Brands were immaterial to the Company’s consolidated financial results. Assuming the results of Bai Brands had been included in operations beginning on January 1, 2016, the estimated pro forma net operating revenues of the Company for the three months ended March 31, 2017 and 2016 would have been approximately $1,512 million and $1,496 million, respectively. The estimated pro forma net income, which includes the alignment of accounting policies, the effect of fair value adjustments related to the Merger, the associated tax effects and the impact of the additional debt to finance the Bai Brands Merger, for the three months ended March 31, 2017 and 2016 would have been approximately $166 million and $170 million, respectively. This estimated pro forma information is not necessarily indicative of the results that actually would have occurred had the Bai Brands Merger been completed on the date indicated or the future operating results.

10


Actual Results of Bai Brands
During the three months ended March 31, 2017, Bai Brands had net sales and net loss of $35 million and $5 million, respectively, since the acquisition date. These results do not reflect the consolidation impact of the Company's acquisition of Bai Brands.
The following table reconciles the net sales and net loss of Bai Brands since the acquisition date to the impact of Bai Brands to the Company's consolidated results of operations:
 
For the Three Months Ended March 31,
(in millions)
2017
Net sales - Bai Brands
$
35

Intercompany sales to Packaged Beverages Excluding Bai
(24
)
Incremental impact to consolidated net sales
$
11

    
 
For the Three Months Ended March 31,
(in millions)
2017
Net loss - Bai Brands
$
(5
)
Impact of intercompany activity with Packaged Beverages Excluding Bai(1)
(6
)
Incremental impact to consolidated net income
$
(11
)
___________________________
(1)
Impact of intercompany activity includes the elimination of intercompany net sales and the deferral of gross profit recognition on shipments of product still in Packaged Beverages Excluding Bai as of March 31, 2017, net of tax.


11

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


3.
Inventories
Inventories consisted of the following:
 
March 31,
 
December 31,
(in millions)
2017
 
2016
Raw materials
$
80

 
$
77

Spare parts
21

 
22

Work in process
6

 
5

Finished goods
171

 
130

Inventories at first in first out cost
278

 
234

Reduction to LIFO cost
(32
)
 
(32
)
Inventories
$
246

 
$
202


Approximately $197 million and $158 million of the Company's inventory was accounted for under the LIFO method of accounting as of March 31, 2017 and December 31, 2016, respectively. The reduction to LIFO cost reflects the excess of the current cost of LIFO inventories as of March 31, 2017 and December 31, 2016, over the amount at which these inventories were valued on the unaudited Condensed Consolidated Balance Sheets. For the three months ended March 31, 2017, there was no LIFO inventory liquidation. For the three months ended March 31, 2016, LIFO inventory liquidation increased the Company's gross profit by $1 million.
4.
Prepaid Expenses and Other Current Assets and Other Current Liabilities
The table below details the components of prepaid expenses and other current assets and other current liabilities:
 
March 31,
 
December 31,
(in millions)
2017
 
2016
Prepaid expenses and other current assets:
 
 
 
Customer incentive programs
$
82

 
$
24

Derivative instruments
17

 
19

Prepaid income taxes
4

 
18

Current assets held for sale
1


1

Other
76

 
39

Total prepaid expenses and other current assets
$
180

 
$
101

Other current liabilities:
 
 
 
Customer rebates and incentives
$
220

 
$
280

Accrued compensation
76

 
134

Insurance liability
39

 
36

Interest accrual
53

 
24

Dividends payable
107

 
97

Derivative instruments
8

 
2

Holdback liability to former Bai Brands shareholders(1)
87

 

Other
106

 
97

Total other current liabilities
$
696

 
$
670

____________________________
(1)
Refer to Note 2 for additional information on holdback liability to former Bai Brands shareholders as of March 31, 2017.

12

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


5.
Goodwill and Other Intangible Assets
GOODWILL
Changes in the carrying amount of goodwill by reporting unit are as follows:
(in millions)
Beverage Concentrates
 
WD Reporting Unit(1)
 
DSD Reporting Unit(1)
 
Bai
 
Latin America Beverages
 
Total
Balance as of January 1, 2016
 
 
 
 
 
 
 
 
 
 
 
Goodwill
$
1,733

 
$
1,222

 
$
189

 
$

 
$
24

 
$
3,168

Accumulated impairment losses

 

 
(180
)
 

 

 
(180
)
 
1,733

 
1,222

 
9



 
24

 
2,988

Foreign currency impact

 

 

 

 
(3
)
 
(3
)
Acquisition activity(2)

 

 

 

 
8

 
8

Balance as of December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Goodwill
1,733

 
1,222

 
189

 

 
29

 
3,173

Accumulated impairment losses

 

 
(180
)
 

 

 
(180
)
 
1,733

 
1,222

 
9

 

 
29

 
2,993

Foreign currency impact

 

 

 

 
2

 
2

Acquisition activity(3)

 

 

 
565

 

 
565

Balance as of March 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Goodwill
1,733

 
1,222

 
189

 
565

 
31

 
3,740

Accumulated impairment losses

 

 
(180
)
 

 

 
(180
)
 
$
1,733

 
$
1,222

 
$
9

 
$
565

 
$
31

 
$
3,560

____________________________
(1)
The Packaged Beverages Excluding Bai operating segment is comprised of two reporting units, the Direct Store Delivery ("DSD") system and the Warehouse Direct ("WD") system.
(2)
Goodwill was recorded to the Latin America Beverages reporting unit during 2016 as a result of the step acquisition of Industria Embotelladora de Bebidas Mexicanas and Embotelladora Mexicana de Agua, S.A. de C.V.
(3)
Goodwill was recorded to Bai during the quarter ended March 31, 2017 as a result of the Bai Brands Merger. Refer to Note 2 for additional information about the Bai Brands Merger.


13

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


INTANGIBLE ASSETS OTHER THAN GOODWILL
The net carrying amounts of intangible assets other than goodwill are as follows:
 
March 31, 2017
 
December 31, 2016
 
Gross
 
Accumulated
 
Net
 
Gross
 
Accumulated
 
Net
(in millions)
Amount
 
Amortization
 
Amount
 
Amount
 
Amortization
 
Amount
Intangible assets with indefinite lives:
 
 
 
 
 
 
 
 
 
 
 
Brands(1)
$
3,697

 
$

 
$
3,697

 
$
2,621

 
$

 
$
2,621

Distribution rights
28

 

 
28

 
27

 

 
27

Intangible assets with definite lives:
 
 
 
 
 
 
 
 
 
 
 
Customer relationships(1)
106

 
(77
)
 
29

 
76

 
(76
)
 

Non-compete agreements(1)
22

 

 
22

 

 

 

Distribution rights
17

 
(9
)
 
8

 
16

 
(8
)
 
8

Brands
29

 
(29
)
 

 
29

 
(29
)
 

Bottler agreements
19

 
(19
)
 

 
19

 
(19
)
 

Total
$
3,918

 
$
(134
)
 
$
3,784

 
$
2,788

 
$
(132
)
 
$
2,656

____________________________
(1)
As a result of the Bai Brands Merger, the Company recorded indefinite lived brand assets of $1,073 million and definite lived non-compete agreements and customer relationships of $22 million and $30 million, respectively. Refer to Note 2 for additional information. The remaining $3 million increase in brands with indefinite lives is due to foreign currency translation.
As of March 31, 2017, the weighted average useful life of intangible assets with finite lives was 7 years for customer relationships, 4 years for non-compete arrangements, 9 years for distribution rights and 6 years in total. Amortization expense for intangible assets was $2 million and $1 million for the three months ended March 31, 2017 and 2016, respectively.
Amortization expense of these intangible assets over the remainder of 2017 and the next four years is expected to be the following:
Year
Aggregate Amortization Expense
(in millions)
April 1, 2017 through December 31, 2017
$
4

2018
16

2019
13

2020
9

2021
6

IMPAIRMENT TESTING
The Company conducts impairment tests on goodwill and all indefinite-lived intangible assets annually or more frequently if circumstances indicate that the carrying amount of an asset may not be recoverable. DPS did not identify any circumstances that indicated that the carrying amount of any goodwill or any indefinite-lived intangible asset may not be recoverable as of March 31, 2017.

14

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


6.
Debt
The following table summarizes the Company's long-term obligations:
 
March 31,
 
December 31,
(in millions)
2017
 
2016
Senior unsecured notes
$
4,320

 
$
4,325

Capital lease obligations
157

 
153

Subtotal
4,477

 
4,478

Less - current portion
(10
)
 
(10
)
Long-term obligations
$
4,467

 
$
4,468

The following table summarizes the Company's short-term borrowings and current portion of long-term obligations:
 
March 31,
 
December 31,
(in millions)
2017
 
2016
Commercial paper
$

 
$

Current portion of long-term obligations:
 
 
 
Capital lease obligations
10

 
10

Short-term borrowings and current portion of long-term obligations
$
10

 
$
10

SENIOR UNSECURED NOTES 
The Company's senior unsecured notes consisted of the following:
(in millions)
 
 
 
 
 
Principal Amount
 
Carrying Amount
 
 
 
 
 
 
March 31,
 
March 31,
 
December 31,
Issuance
 
Maturity Date
 
Rate
 
2017
 
2017
 
2016
2018 Notes
 
May 1, 2018
 
6.82%
 
364

 
364

 
364

2019 Notes
 
January 15, 2019
 
2.60%
 
250

 
249

 
249

2020 Notes
 
January 15, 2020
 
2.00%
 
250

 
247

 
247

2021-A Notes
 
November 15, 2021
 
3.20%
 
250

 
249

 
249

2021-B Notes
 
November 15, 2021
 
2.53%
 
250

 
246

 
246

2022 Notes
 
November 15, 2022
 
2.70%
 
250

 
270

 
273

2023 Notes
 
December 15, 2023
 
3.13%
 
500

 
494

 
495

2025 Notes
 
November 15, 2025
 
3.40%
 
500

 
495

 
495

2026 Notes
 
September 15, 2026
 
2.55%
 
400

 
396

 
396

2027 Notes
 
June 15, 2027
 
3.43%
 
400

 
397

 
397

2038 Notes
 
May 1, 2038
 
7.45%
 
250

 
269

 
270

2045 Notes
 
November 15, 2045
 
4.50%
 
250

 
247

 
247

2046 Notes
 
December 15, 2046
 
4.42%
 
400

 
397

 
397

 
 
 
 
 
 
$
4,314

 
$
4,320

 
$
4,325


15

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


UNSECURED CREDIT AGREEMENT
In March 2017, the Company entered into a new five-year unsecured credit agreement (the "Credit Agreement"), which provides for a $500 million revolving line of credit (the "Revolver"). This Credit Agreement and Revolver fully replaced the Company's previous unsecured credit agreement and revolving line of credit, which was due to expire on September 25, 2017 and was terminated on March 16, 2017. There were no principal borrowings outstanding under the previous unsecured credit agreement upon termination. The Company incurred debt issuance costs of approximately $1 million in connection with the Credit Agreement during the three months ended March 31, 2017.
Borrowings under the Revolver bear interest at a floating rate per annum based upon the alternate base rate ("ABR") or the Eurodollar rate, in each case plus an applicable margin which varies based upon the Company's debt ratings. Rates range from 0.000% to 0.300% for the ABR loans and from 0.805% to 1.300% for Eurodollar loans. The ABR is defined as the greater of (a) JPMorgan Chase Bank's prime rate, (b) the Federal Reserve Bank of New York ("NYFRB") rate, as defined below, plus 0.500% and (c) the Adjusted LIBOR, as defined below, for a one month interest period plus 1.00%. The NYFRB rate is the greater of (a) the federal funds effective rate or (b) the overnight bank funding rate. The Adjusted LIBOR is the London interbank offered rate for dollars, adjusted for a statutory reserve rate set by the Board of Governors of the Federal Reserve System of the United States of America.
Additionally, the Revolver is available for the issuance of letters of credit, not to exceed $75 million. Letters of credit will reduce, on a dollar for dollar basis, the amount available under the Revolver.
The Credit Agreement further provides that we may request at any time, subject to the satisfaction of certain conditions, that the aggregate commitments under the facility be increased by a total amount not to exceed $250 million.

The Credit Agreement's representations, warranties, covenants and events of default are generally customary for investment grade credit and include a financial covenant that requires the Company to maintain a ratio as provided therein of Consolidated Total Debt to Consolidated EBITDA of no more than 3.50 to 1.00, tested quarterly. During the twelve month period following a Material Acquisition thereunder, the ratio may increase to no more than 4.00 to 1.00. Upon the occurrence of an event of default, among other things, amounts outstanding may be accelerated and the commitments may be terminated. The Company's obligations are guaranteed by certain of the Company's direct and indirect domestic subsidiaries. The Credit Agreement has a maturity date of March 16, 2022; however, with the consent of lenders holding more than 50% of the total commitments thereunder and subject to the satisfaction of certain conditions, the Company may extend the maturity date for up to two additional one-year terms.
The following table provides amounts utilized and available under our Revolver as of March 31, 2017:
(in millions)
Amount Utilized
 
Balances Available
Revolver
$

 
$
500

Letters of credit

 
75

As of March 31, 2017, the Company was in compliance with all financial covenant requirements relating to the Credit Agreement.
LETTERS OF CREDIT FACILITIES
In addition to the portion of the Revolver reserved for issuance of letters of credit, the Company has incremental letters of credit facilities. Under these facilities, $120 million is available for the issuance of letters of credit, $60 million of which was utilized as of March 31, 2017 and $60 million of which remains available for use.
BRIDGE FINANCING FOR BAI BRANDS MERGER
On November 21, 2016, the Company entered into a commitment letter for a 364-day bridge loan facility (the "Bridge Facility") in an aggregate principal amount of up to $1,700 million, in order to ensure that financing would be available for the Bai Brands Merger. On January 31, 2017, in accordance with its terms, the commitment under the Bridge Facility was automatically terminated upon the Company's funding of the Bai Brands Merger.

16

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


SHELF REGISTRATION STATEMENT
On August 10, 2016, the Company's Board of Directors ("the Board") authorized the Company to issue up to $2,000 million of securities from time to time. Subsequently, the Company filed a "well-known seasoned issuer" shelf registration statement (the "Shelf") with the SEC, effective September 2, 2016, which registered an indeterminate amount of securities for future sales. On September 16, 2016, the Company issued $400 million of 2026 Notes under the Shelf, leaving $1,600 million of securities authorized for issuance under the Shelf. On November 16, 2016, the Board replenished the authorized aggregate amount of securities available to be issued by an additional $400 million, which raised the full authorized amount to $2,000 million. On December 14, 2016, the Company issued an aggregate of $1,550 million of 2021, 2023, 2027 and 2046 Notes. As of March 31, 2017, $450 million remained authorized to be issued under the Shelf.
7. Derivatives
DPS is exposed to market risks arising from adverse changes in:
interest rates;
foreign exchange rates; and
commodity prices affecting the cost of raw materials and fuels, which are recorded in cost of sales and SG&A expenses, respectively.
The Company manages these risks through a variety of strategies, including the use of interest rate contracts, foreign exchange forward contracts, commodity forward and future contracts and supplier pricing agreements. DPS does not hold or issue derivative financial instruments for trading or speculative purposes.
The Company formally designates and accounts for certain interest rate contracts and foreign exchange forward contracts that meet established accounting criteria under U.S. GAAP as either fair value or cash flow hedges. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instruments is recorded, net of applicable taxes, in Accumulated Other Comprehensive Loss ("AOCL"), a component of Stockholders' Equity in the unaudited Condensed Consolidated Balance Sheets. When net income is affected by the variability of the underlying transaction, the applicable offsetting amount of the gain or loss from the derivative instrument deferred in AOCL is reclassified to net income and is reported as a component of the unaudited Condensed Consolidated Statements of Income. For derivative instruments that are designated and qualify as fair value hedges, the effective change in the fair value of the instrument, as well as the offsetting gain or loss on the hedged item attributable to the hedged risk, are recognized immediately in current-period earnings. For derivatives that are not designated or are de-designated as a hedging instrument, the gain or loss on the instrument is recognized in earnings in the period of change.
Certain interest rate contracts qualify for the "shortcut" method of accounting for hedges under U.S. GAAP. Under the shortcut method, the hedges are assumed to be perfectly effective and no ineffectiveness is recorded in earnings. For all other designated hedges, the Company assesses whether the derivative instrument is effective in offsetting the changes in fair value or variability of cash flows at the inception of the derivative contract. DPS measures hedge ineffectiveness on a quarterly basis throughout the designated period. Changes in the fair value of the derivative instrument that do not effectively offset changes in the fair value of the underlying hedged item throughout the designated hedge period are recorded in earnings each period.
If a fair value or cash flow hedge were to cease to qualify for hedge accounting, or were terminated, the derivatives would continue to be carried on the balance sheet at fair value until settled and hedge accounting would be discontinued prospectively. If the underlying hedged transaction ceases to exist, any associated amounts reported in AOCL would be reclassified to earnings at that time.

17

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


INTEREST RATES 
Fair Value Hedges
The Company is exposed to the risk of changes in the fair value of certain fixed-rate debt attributable to changes in interest rates and manages these risks through the use of receive-fixed, pay-variable interest rate swaps. Any ineffectiveness is recorded as interest during the period incurred. The following table presents information regarding these interest rate swaps and the associated hedging relationships:
 
 
 
 
 
 
 
 
Impact to the carrying value
($ in millions)
 
 
 
 
 
Method of
 
 
 
of long-term debt
 
 
Hedging
 
Number of
 
measuring
 
Notional
 
March 31,
 
December 31,
Period entered
 
relationship
 
instruments
 
effectiveness
 
value
 
2017
 
2016
November 2011
 
2019 Notes
 
2
 
Short cut method
 
$
100

 
$

 
$

November 2011
 
2021-A Notes
 
2
 
Short cut method
 
150

 

 

November 2012
 
2020 Notes
 
5
 
Short cut method
 
120

 
(2
)
 
(2
)
February 2015
 
2038 Notes
 
1
 
Regression
 
100

 
21

 
22

December 2016
 
2021-B Notes
 
2
 
Short cut method
 
250

 
(3
)
 
(2
)
December 2016
 
2023 Notes
 
2
 
Short cut method
 
150

 
(2
)
 
(1
)
January 2017
 
2022 Notes(1)
 
4
 
Regression
 
250

 
22

 
24

 
 
 
 
 
 
 
 
$
1,120

 
$
36

 
$
41

____________________________
(1)
In October 2016, the Company de-designated the hedging relationships between the four outstanding interest rate swaps and the 2022 Notes. The Company will amortize $25 million into earnings over the remaining term of the 2022 Notes which represents the increase to the carrying value of the debt upon de-designation consisting of changes in fair market value of the debt, pull to par adjustments and ineffectiveness recorded under the previous hedging relationship. The Company recorded the change in the fair value of the interest rate swaps after de-designation into interest expense.

In January 2017, the Company re-designated the hedging relationships between the four outstanding interest rate swaps and the 2022 Notes, which were de-designated in 2016. The Company uses regression analysis to assess the prospective and retrospective effectiveness of these hedging relationships.

FOREIGN EXCHANGE
Cash Flow Hedges
The Company's Canadian and Mexican businesses purchase inventory through transactions denominated and settled in United States ("U.S.") dollars, a currency different from the functional currency of the those businesses. These inventory purchases are subject to exposure from movements in exchange rates. During the three months ended March 31, 2017 and 2016, the Company utilized foreign exchange forward contracts designated as cash flow hedges to manage the exposures resulting from changes in these foreign currency exchange rates. The intent of these foreign exchange contracts is to provide predictability in the Company's overall cost structure. These foreign exchange contracts, carried at fair value, have maturities between one and nine months as of March 31, 2017. The Company had outstanding foreign exchange forward contracts with notional amounts of $69 million and $7 million as of March 31, 2017 and December 31, 2016, respectively.

18

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


COMMODITIES
Economic Hedges
DPS centrally manages the exposure to volatility in the prices of certain commodities used in its production process and transportation through forward and future contracts. The intent of these contracts is to provide a certain level of predictability in the Company's overall cost structure. During the three months ended March 31, 2017 and 2016, the Company held forward and future contracts that economically hedged certain of its risks. In these cases, a natural hedging relationship exists in which changes in the fair value of the instruments act as an economic offset to changes in the fair value of the underlying items. Changes in the fair value of these instruments are recorded in net income throughout the term of the derivative instrument and are reported in the same line item of the unaudited Condensed Consolidated Statements of Income as the hedged transaction. Unrealized gains and losses are recognized as a component of unallocated corporate costs until the Company's operating segments are affected by the completion of the underlying transaction, at which time the gain or loss is reflected as a component of the respective segment's operating profit ("SOP"). The total notional values of derivatives related to economic hedges of this type were $262 million and $296 million as of March 31, 2017 and December 31, 2016, respectively.
FAIR VALUE OF DERIVATIVE INSTRUMENTS
The following table summarizes the location of the fair value of the Company's derivative instruments within the unaudited Condensed Consolidated Balance Sheets:
(in millions)
Balance Sheet Location
 
March 31,
2017
 
December 31,
2016
Assets:
 
 
 
 
 
Derivative instruments designated as hedging instruments under U.S. GAAP:
 
 
 
 
 
Interest rate contracts
Prepaid expenses and other current assets
 
$
3

 
$
6

Interest rate contracts
Other non-current assets
 
30

 
21

Derivative instruments not designated as hedging instruments under U.S. GAAP:
 
 
 
 
 
Interest rate contracts
Prepaid expenses and other current assets
 

 
4

Commodity contracts
Prepaid expenses and other current assets
 
14

 
9

Interest rate contracts
Other non-current assets
 

 
8

Commodity contracts
Other non-current assets
 
14

 
12

Total assets
 
 
$
61

 
$
60

Liabilities:
 
 
 
 
 
Derivative instruments designated as hedging instruments under U.S. GAAP:
 
 
 
 
 
Interest rate contracts
Other current liabilities
 
$
2

 
$
1

Foreign exchange forward contracts
Other current liabilities
 
6

 

Interest rate contracts
Other non-current liabilities
 
6

 
7

Derivative instruments not designated as hedging instruments under U.S. GAAP:
 
 
 
 
 
Commodity contracts
Other current liabilities
 

 
1

Commodity contracts
Other non-current liabilities
 
2

 

Total liabilities
 
 
$
16

 
$
9


19

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


IMPACT OF CASH FLOW HEDGES
The following table presents the impact of derivative instruments designated as cash flow hedging instruments under U.S. GAAP to the unaudited Condensed Consolidated Statements of Income and Comprehensive Income:
 
Amount of Loss Recognized in
 
Amount of Loss Reclassified from AOCL into Income
 
Location of Loss Reclassified from AOCL into Income
(in millions)
Other Comprehensive Loss ("OCI")
 
 
 
 
 
 
 
 
For the three months ended March 31, 2017:
 
 
 
 
 
Interest rate contracts
$

 
$
(2
)
 
Interest expense
Foreign exchange forward contracts
(5
)
 

 
Cost of sales
Total
$
(5
)
 
$
(2
)
 
 
 
 
 
 
 
 
For the three months ended March 31, 2016:
 
 
 
 
 
Interest rate contracts
$

 
$
(2
)
 
Interest expense
Foreign exchange forward contracts
(2
)
 

 
Cost of sales
Total
$
(2
)
 
$
(2
)
 
 
There was no hedge ineffectiveness recognized in earnings for the three months ended March 31, 2017 and 2016 with respect to derivative instruments designated as cash flow hedges. During the next 12 months, the Company expects to reclassify pre-tax net losses of $2 million from AOCL into net income.
IMPACT OF FAIR VALUE HEDGES
The following table presents the impact of derivative instruments designated as fair value hedging instruments under U.S. GAAP to the unaudited Condensed Consolidated Statements of Income:
 
 
Amount of Gain
 
Location of Gain
(in millions)
 
Recognized in Income
 
Recognized in Income
For the three months ended March 31, 2017:
 
 
 
 
Interest rate contracts
 
$
4

 
Interest expense
Total
 
$
4

 
 
 
 
 
 
 
For the three months ended March 31, 2016:
 
 
 
 
Interest rate contracts
 
$
4

 
Interest expense
Total
 
$
4

 
 
For the three months ended March 31, 2017, no hedge ineffectiveness was recognized in earnings with respect to derivative instruments designated as fair value hedges. For the three months ended March 31, 2016, $1 million hedge ineffectiveness was recognized in earnings with respect to derivative instruments designated as fair value hedges.

20

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


IMPACT OF ECONOMIC HEDGES
The following table presents the impact of derivative instruments not designated as hedging instruments under U.S. GAAP to the unaudited Condensed Consolidated Statements of Income:
 
 
Amount of Gain (Loss)
 
Location of Gain (Loss)
(in millions)
 
Recognized in Income
 
Recognized in Income
For the three months ended March 31, 2017:
 
 
 
 
Commodity contracts(1)
 
$
21

 
Cost of sales
Commodity contracts(1)
 
(13
)
 
SG&A expenses
Interest rate contracts(2)
 
1

 
Interest expense
Total
 
$
9

 
 
 
 
 
 
 
For the three months ended March 31, 2016:
 
 
 
 
Commodity contracts(1)
 
$
(1
)
 
Cost of sales
Commodity contracts(1)
 

 
SG&A expenses
Total
 
$
(1
)
 
 
____________________________
(1)
Commodity contracts include both realized and unrealized gains and losses.
(2)
Represents gains on the interest rate contracts related to the 2022 Notes prior to re-designation of hedging relationship in January 2017.
Refer to Note 10 for additional information on the valuation of derivative instruments. The Company has exposure to credit losses from derivative instruments in an asset position in the event of nonperformance by the counterparties to the agreements. Historically, DPS has not experienced credit losses as a result of counterparty nonperformance. The Company selects and periodically reviews counterparties based on credit ratings, limits its exposure to a single counterparty under defined guidelines and monitors the market position of the programs upon execution of a hedging transaction and at least on a quarterly basis.

21

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


8. Other Non-Current Assets and Other Non-Current Liabilities
The table below details the components of other non-current assets and other non-current liabilities:
 
March 31,
 
December 31,
(in millions)
2017
 
2016
Other non-current assets:
 
 
 
Customer incentive programs
$
58

 
$
57

Marketable securities - trading
44

 
35

Derivative instruments
44

 
41

Cost method investments(1)
1

 
16

Non-current restricted cash and restricted cash equivalents(2)
16

 

Other
43

 
34

Total other non-current assets
$
206

 
$
183

Other non-current liabilities:
 
 
 
Long-term payables due to Mondelēz International, Inc.
$
21

 
$
21

Long-term pension and post-retirement liability
43

 
41

Insurance liability
66

 
67

Derivative instruments
8

 
7

Deferred compensation liability
44

 
35

Holdback liability to former Bai Brands shareholders(2)
16

 

Acquired contingent liabilities(2)
21

 

Other
39

 
38

Total other non-current liabilities
$
258

 
$
209

____________________________
(1)
Decrease in cost method investments resulted from our consummation of the Bai Brands Merger, as we had a cost method investment in Bai Brands as of December 31, 2016. Refer to Note 2 for additional information regarding the Bai Brands Merger and treatment of our previously held interest in Bai Brands.
(2)
Refer to Note 2 for additional information on non-current restricted cash and restricted cash equivalents, the corresponding holdback liability to former Bai Brands shareholders, and the acquired contingent liabilities, as of March 31, 2017.
9. Income Taxes
The effective tax rates for the three months ended March 31, 2017 and 2016 were 28.6% and 35.2%, respectively.
For the three months ended March 31, 2017, the provision for income taxes included an income tax benefit of $18 million due to the adoption of ASU 2016-09. Refer to Note 1 for additional information.

22

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


10. Fair Value
Under U.S. GAAP, 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 market participants at the measurement date under current market conditions. U.S. GAAP provides a framework for measuring fair value and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability. The three-level hierarchy for disclosure of fair value measurements is as follows:
Level 1 - Quoted market prices in active markets for identical assets or liabilities.
Level 2 - Observable inputs such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
Level 3 - Valuations with one or more unobservable significant inputs that reflect the reporting entity's own assumptions.
RECURRING FAIR VALUE MEASUREMENTS
The following table presents the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of March 31, 2017 and December 31, 2016:
 
March 31, 2017
 
Quoted Prices in Active Markets for Identical Assets
 
Significant Other Observable Inputs
 
Significant Unobservable Inputs
(in millions)
Level 1
 
Level 2
 
Level 3
Commodity contracts
$

 
$
28

 
$

Interest rate contracts

 
33

 

Marketable securities - trading
44

 

 

Total assets
$
44

 
$
61

 
$

 
 
 
 
 
 
Commodity contracts
$

 
$
2

 
$

Interest rate contracts

 
8

 

Foreign exchange forward contracts

 
6

 

Total liabilities
$

 
$
16

 
$


23

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


 
December 31, 2016
 
Quoted Prices in Active Markets for Identical Assets
 
Significant Other Observable Inputs
 
Significant Unobservable Inputs
(in millions)
Level 1
 
Level 2
 
Level 3
Commodity contracts
$

 
$
21

 
$

Interest rate contracts

 
39

 

Marketable securities - trading
35

 

 

Total assets
$
35

 
$
60

 
$

 
 
 
 
 
 
Commodity contracts
$

 
$
1

 
$

Interest rate contracts

 
8

 

Foreign exchange forward contracts

 

 

Total liabilities
$

 
$
9

 
$

The fair values of marketable securities are determined using quoted market prices from daily exchange traded markets based on the closing price as of the balance sheet date and are classified as Level 1. The fair values of commodity forward and future contracts, interest rate swap contracts and foreign currency forward contracts are determined based on inputs that are readily available in public markets or can be derived from information available in publicly quoted markets. The fair value of commodity forward and future contracts are valued using the market approach based on observable market transactions, primarily underlying commodities futures or physical index prices, at the balance sheet date. Interest rate swap contracts are valued using models based primarily on readily observable market parameters, such as London Interbank Offered Rate forward rates, for all substantial terms of the Company's contracts and credit risk of the counterparties. The fair value of foreign currency forward contracts are valued using quoted forward foreign exchange prices at the reporting date. Therefore, the Company has categorized these contracts as Level 2.
As of March 31, 2017 and December 31, 2016, the Company did not have any assets or liabilities measured on a recurring basis without observable market values that would require a high level of judgment to determine fair value (Level 3).
There were no transfers of financial instruments between the three levels of the fair value hierarchy during the three months ended March 31, 2017 and 2016.

24

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


ESTIMATED FAIR VALUE OF THE COMPANY'S FINANCIAL INSTRUMENTS
The carrying values and estimated fair values of the Company's financial instruments that are not required to be measured at fair value in the unaudited Condensed Consolidated Balance Sheet are as follows:
 
Fair Value Hierarchy Level
 
March 31, 2017
 
December 31, 2016
(in millions)
 
Carrying Amount
 
Fair Value
 
Carrying Amount
 
Fair Value
Assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents(1)
1
 
$
73

 
$
73

 
$
1,787

 
$
1,787

Restricted cash and restricted cash equivalents(1)
1
 
103

 
103

 

 

Liabilities:
 
 
 
 
 
 
 
 
 
Long-term debt – 2018 Notes(2)
2
 
364

 
384

 
364

 
389

Long-term debt – 2019 Notes(2)
2
 
249

 
253

 
249

 
254

Long-term debt – 2020 Notes(2)
2
 
247

 
249

 
247

 
248

Long-term debt – 2021-A Notes(2)
2
 
249

 
256

 
249

 
256

Long-term debt – 2021-B Notes(2)
2
 
246

 
249

 
246

 
248

Long-term debt – 2022 Notes(2)
2
 
270

 
247

 
273

 
247

Long-term debt – 2023 Notes(2)
2
 
494

 
502

 
495

 
500

Long-term debt – 2025 Notes(2)
2
 
495

 
502

 
495

 
498

Long-term debt – 2026 Notes(2)
2
 
396

 
373

 
396

 
370

Long-term debt – 2027 Notes(2)
2
 
397

 
399

 
397

 
398

Long-term debt – 2038 Notes(2)
2
 
269

 
343

 
270

 
347

Long-term debt – 2045 Notes(2)
2
 
247

 
250

 
247

 
253

Long-term debt – 2046 Notes(2)
2
 
397

 
403

 
397

 
407

____________________________
(1)
Cash equivalents and restricted cash equivalents are composed of certificates of deposit, time deposits and other interest-bearing investments with original maturity dates of three months or less. Cash equivalents and restricted cash equivalents are recorded at cost, which approximates fair value.
(2)
The fair value amounts of long term debt were based on current market rates available to the Company. The difference between the fair value and the carrying value represents the theoretical net premium or discount that would be paid or received to retire all debt and related unamortized costs to be incurred at such date. The carrying amount includes the unamortized discounts and issuance costs on the issuance of debt and impact of interest rate swaps designated as fair value hedges and other hedge related adjustments. Refer to Note 7 for additional information regarding the notes subject to fair value hedges.

25

DR PEPPER SNAPPLE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, Continued)


11. Stock-Based Compensation
The Company's Omnibus Stock Incentive Plan of 2009 ( "DPS Stock Plan") provides for various long-term incentive awards, including stock options, restricted stock units ("RSUs") and performance share units ("PSUs").
Stock-based compensation expense is recorded in SG&A expenses in the unaudited Condensed Consolidated Statements of Income. The components of stock-based compensation expense are presented below:
 
For the Three Months Ended March 31,
(in millions)
2017
 
2016
Total stock-based compensation expense
$
6

 
$
11

Income tax benefit recognized in the statement of income
(2
)
 
(4
)
Stock-based compensation expense, net of tax
$
4

 
$
7

STOCK OPTIONS
The table below summarizes stock option activity for the three months ended March 31, 2017:
 
Stock Options
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contractual Term (Years)
 
Aggregate Intrinsic Value (in millions)
Outstanding as of January 1, 2017
1,342,921

 
$
70.83

 
7.93
 
$
27

Granted
423,745

 
94.62

 
 
 
 
Exercised
(324,922
)
 
51.91

 
 
 
14

Forfeited or expired
(5,751
)
 
88.06

 
 
 
 
Outstanding as of March 31, 2017
1,435,993

 
82.06

 
8.56
 
23

Exercisable as of March 31, 2017
611,415

 
69.72

 
7.60
 
17

As of March 31, 2017, there was $8 million of unrecognized compensation cost related to unvested stock options granted under the DPS Stock Plan that is expected to be recognized over a weighted average period of 1.58 years.
RESTRICTED STOCK UNITS    
The table below summarizes RSU activity for the three months ended March 31, 2017. The fair value of RSUs is determined based on the number of units granted and the grant date price of the Company's common stock.
 
RSUs
 
Weighted Average Grant Date Fair Value
 
Weighted Average Remaining Contractual Term (Years)
 
Aggregate Intrinsic Value (in millions)
Outstanding as of January 1, 2017
1,218,244