R. Preferred and Common Stock

Preferred Stock. Alcoa has two classes of preferred stock: Class A Preferred Stock and Class B Serial Preferred Stock. Class A Preferred Stock has 660,000 shares authorized at a par value of $100 per share with an annual $3.75 cumulative dividend preference per share. There were 546,024 of such shares outstanding at December 31, 2015 and 2014. Class B Serial Preferred Stock has 10 million shares authorized at a par value of $1 per share. There were 2.5 million of such shares outstanding at December 31, 2015 and 2014 (see below).

In September 2014, Alcoa completed a public offering under its shelf registration statement for $1,250 of 25 million depositary shares, each of which represents a 1/10th interest in a share of Alcoa’s 5.375% Class B Mandatory Convertible Preferred Stock, Series 1, par value $1 per share, liquidation preference $500 per share (the “Mandatory Convertible Preferred Stock”). The 25 million depositary shares are equivalent to 2.5 million shares of Mandatory Convertible Preferred Stock. Each depositary share entitles the holder, through the depositary, to a proportional fractional interest in the rights and preferences of a share of Mandatory Convertible Preferred Stock, including conversion, dividend, liquidation, and voting rights, subject to terms of the deposit agreement. Alcoa received $1,213 in net proceeds from the public offering reflecting an underwriting discount. The net proceeds were used, together with the net proceeds of issued debt (see Note K), to finance the cash portion of the acquisition of Firth Rixson (see Note F). The underwriting discount was recorded as a decrease to Additional capital on the accompanying Consolidated Balance Sheet.

The Mandatory Convertible Preferred Stock constitutes a series of Alcoa’s Class B Serial Preferred Stock, which ranks senior to Alcoa’s common stock and junior to Alcoa’s Class A Preferred Stock and existing and future indebtedness. Dividends on the Mandatory Convertible Preferred Stock are cumulative in nature and are paid at the rate of $26.8750 per annum per share, which commenced January 1, 2015 (paid on December 30, 2014). Holders of the Mandatory Convertible Preferred Stock generally have no voting rights.

On the mandatory conversion date, October 1, 2017, all outstanding shares of Mandatory Convertible Preferred Stock will automatically convert into shares of Alcoa’s common stock. Based on the Applicable Market Value (as defined in the terms of the Mandatory Convertible Preferred Stock) of Alcoa’s common stock on the mandatory conversion date, each share of Mandatory Convertible Preferred Stock will be convertible into not more than 30.9406 shares of common stock and not less than 25.7838 shares of common stock, subject to certain anti-dilution and other adjustments as described in the terms of the Mandatory Convertible Preferred Stock. At any time prior to October 1, 2017, a holder may elect to convert shares of Mandatory Convertible Preferred Stock, in whole or in part (but in no event less than one share of Mandatory Convertible Preferred Stock), at the minimum conversion rate of 25.7838 shares of common stock, subject to certain anti-dilution and other adjustments as described in the terms of the Mandatory Convertible Preferred Stock. Alcoa does not have the right to redeem the Mandatory Convertible Preferred Stock.

If Alcoa undergoes a fundamental change, as defined in the terms of the Mandatory Convertible Preferred Stock, holders may elect to convert their Mandatory Convertible Preferred Stock, in whole or in part (but in no event less than one share of Mandatory Convertible Preferred Stock), into shares of Alcoa’s common stock. The per share conversion rate under a fundamental change is not less than 25.2994 shares of common stock and not more than 30.9406 shares of common stock. Holders who elect to convert will also receive any accumulated and unpaid dividends and a Fundamental Change Dividend Make-whole Amount (as defined in the terms of the Mandatory Convertible Preferred Stock) equal to the present value of all remaining dividend payments on the Mandatory Convertible Preferred Stock.

Common Stock. There are 1.8 billion shares authorized at a par value of $1 per share, and 1,391,211,244 and 1,303,813,830 shares, respectively, were issued at December 31, 2015 and 2014. The current dividend yield as authorized by Alcoa’s Board of Directors is $0.12 per annum or $0.03 per quarter.

In July 2015, Alcoa issued 87 million shares of common stock as consideration paid to acquire RTI (see Note F).

In early 2014, Alcoa issued 89 million shares of common stock under the terms of Alcoa’s 5.25% Convertible Notes due March 15, 2014 (see Note K). Also, in November 2014, Alcoa issued 37 million shares of common stock as part of the consideration paid to acquire an aerospace business, Firth Rixson (see Note F).

As of December 31, 2015, 77 million shares of common stock were reserved for issuance under Alcoa’s stock-based compensation plans, respectively. Alcoa issues shares from treasury stock to satisfy the exercise of stock options and the conversion of stock awards.

Share Activity (number of shares)


	Common stock
	Treasury			Outstanding
Balance at end of 2012		110,694,604			1,067,211,953
Conversion of convertible notes		-			310
Issued for stock-based compensation plans		(3,798,899	)		3,798,899
Balance at end of 2013		106,895,705			1,071,011,162
Conversion of convertible notes		-			89,383,953
Private placement		-			36,523,010
Issued for stock-based compensation plans		(19,745,536	)		19,745,536
Balance at end of 2014		87,150,169			1,216,663,661
Acquisition of RTI		-			87,397,414
Issued for stock-based compensation plans		(6,099,066	)		6,099,066
Balance at end of 2015		81,051,103			1,310,160,141

Stock-based Compensation

Alcoa has a stock-based compensation plan under which stock options and stock awards are granted in January each year to eligible employees. Most plan participants can choose whether to receive their award in the form of stock options, stock awards, or a combination of both. This choice is made before the grant is issued and is irrevocable. Stock options are granted at the closing market price of Alcoa’s common stock on the date of grant and vest over a three-year service period (1/3 each year) with a ten-year contractual term. Stock awards also vest over a three-year service period from the date of grant and certain of these awards also include performance conditions. In 2015, 2014, and 2013, the final number of performance stock awards earned will be based on Alcoa’s achievement of sales and profitability targets over the respective three-year period. One-third of the award will be earned each year based on the performance against the pre-established targets for that year. The performance stock awards earned over the three-year period vest at the end of the third year.

In 2015, 2014, and 2013, Alcoa recognized stock-based compensation expense of $92 ($61 after-tax), $87 ($58 after-tax), and $71 ($48 after-tax), respectively, of which approximately 80%, 80%, and 70%, respectively, related to stock awards (there was no stock-based compensation expense capitalized in 2015, 2014, or 2013). At December 31, 2015, there was $71 (pretax) of unrecognized compensation expense related to non-vested stock option grants and non-vested stock award grants. This expense is expected to be recognized over a weighted average period of 1.6 years. As part of Alcoa’s stock-based compensation plan design, individuals who are retirement-eligible have a six-month requisite service period in the year of grant. As a result, a larger portion of expense will be recognized in the first half of each year for these retirement-eligible employees. Of the total pretax compensation expense recognized in 2015, 2014, and 2013, $17, $15, and $14, respectively, pertains to the acceleration of expense related to retirement-eligible employees.

Stock-based compensation expense is based on the grant date fair value of the applicable equity grant. For stock awards, the fair value was equivalent to the closing market price of Alcoa’s common stock on the date of grant. For stock options, the fair value was estimated on the date of grant using a lattice-pricing model, which generated a result of $4.47, $2.84, and $2.24 per option in 2015, 2014, and 2013, respectively. The lattice-pricing model uses a number of assumptions to estimate the fair value of a stock option, including an average risk-free interest rate, dividend yield, volatility, exercise behavior, and contractual life. The following paragraph describes in detail the assumptions used to estimate the fair value of stock options granted in 2015 (the assumptions used to estimate the fair value of stock options granted in 2014 and 2013 were not materially different).

The range of average risk-free interest rates (0.07-1.83%) was based on a yield curve of interest rates at the time of the grant based on the contractual life of the option. The dividend yield (0.8%) was based on a one-year average. Volatility (32-41%) was based on historical and implied volatilities over the term of the option. Alcoa utilized historical option forfeiture data to estimate annual pre- and post-vesting forfeitures (7%). Exercise behavior (50%) was based on a weighted average exercise ratio (exercise patterns for grants issued over the number of years in the contractual option term) of an option’s intrinsic value resulting from historical employee exercise behavior. Based upon the other assumptions used in the determination of the fair value, the life of an option (5.9 years) was an output of the lattice-pricing model. The activity for stock options and stock awards during 2015 was as follows (options and awards in millions):


	Stock options					Stock awards
	Number of options			Weighted average exercise price		Number of awards			Weighted average FMV per award
Outstanding, January 1, 2015		32			11.26		19			9.98
Granted		3			15.55		7			14.85
Assumed at Acquisition		2			11.24		1			9.96
Exercised		(3	)		8.95		-			-
Converted		-			-		(5	)		10.08
Expired or forfeited		(1	)		13.39		(1	)		11.64
Performance share adjustment		-			-		(1	)		10.96
Outstanding, December 31, 2015		33			11.91		20			11.38

As of December 31, 2015, the number of stock options outstanding had a weighted average remaining contractual life of 6.08 years and a total intrinsic value of $8. Additionally, 23.3 million of the stock options outstanding were fully vested and exercisable and had a weighted average remaining contractual life of 5.25 years, a weighted average exercise price of $11.82, and a total intrinsic value of $5 as of December 31, 2015. In 2015, 2014, and 2013, the cash received from stock option exercises was $25, $150, and $13 and the total tax benefit realized from these exercises was $6, $28, and $1, respectively. The total intrinsic value of stock options exercised during 2015, 2014, and 2013 was $19, $84, and $2, respectively.