P. Preferred and Common Stock

Preferred Stock. Arconic 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, 2016 and 2015. 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, 2016 and 2015 (see below).

In September 2014, Arconic 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 Arconic’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. Arconic 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, to finance the cash portion of the acquisition of Firth Rixson. The underwriting discount was recorded as a decrease to Additional capital. The Mandatory Convertible Preferred Stock constitutes a series of Arconic’s Class B Serial Preferred Stock, which ranks senior to Arconic’s common stock and junior to Arconic’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 Arconic’s common stock. As a result of the Separation Transaction and the 1-for-3 Reverse Stock Split (see Note A), as defined in the terms of the Mandatory Convertible Preferred Stock, the conversion rate was adjusted and each share of Mandatory Convertible Preferred Stock is now convertible into not more than 15.6981 shares of common stock and not less than 13.0817 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 13.0817 shares of common stock, subject to certain anti-dilution and other adjustments as described in the terms of the Mandatory Convertible Preferred Stock. Arconic does not have the right to redeem the Mandatory Convertible Preferred Stock.

If Arconic 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 Arconic’s 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. As discussed in Note A, Arconic completed a 1-for-3 Reverse Stock Split on October 5, 2016. The Reverse Stock Split reduced the number of shares of common stock outstanding from approximately 1.3 billion shares to 0.4 billion shares. The par value of the common stock remained at $1.00 per share. Accordingly, Common stock and Additional capital in the accompanying Consolidated Balance Sheet at December 31, 2016 reflect a decrease and increase of $877, respectively. The number of authorized shares of common stock was also decreased from 1.8 billion shares to 0.6 billion shares.

In August 2016, Arconic retired its outstanding treasury stock consisting of approximately 25 million shares (76 million shares pre-reverse stock split). As a result, Common stock and Additional capital in the accompanying 2016 Consolidated Balance Sheet were decreased by $76 and $2,563, respectively, to reflect the retirement of the treasury shares.

At December 31, 2016, 438,519,780 shares were issued and outstanding. Dividends paid in each of 2016, 2015 and 2014 were $0.36 per annum or $0.09 per quarter. The current dividend yield as authorized by Arconic’s Board of Directors is $0.24 per annum or $0.06 per quarter.

In July 2015, Arconic issued 29 million shares (87 million shares—pre-Reverse Stock Split) of common stock as consideration paid to acquire RTI (see Note F).

In early 2014, Arconic issued 30 million shares (89 million shares—pre-Reverse Stock Split) of common stock under the terms of Arconic’s 5.25% Convertible Notes due March 15, 2014. Also, in November 2014, Arconic issued 12 million shares (37 million shares—pre-Reverse Stock Split) of common stock as part of the consideration paid to acquire Firth Rixson (see Note F).

As of December 31, 2016, 45 million shares of common stock were reserved for issuance under Arconic’s stock-based compensation plans. Arconic buys shares in the open market 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 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
Treasury stock retirement		(75,831,443	)		-
Reverse Stock Split (A)		-			(876,942,489	)
Issued for stock-based compensation plans		(5,219,660	)		5,302,128
Balance at end of 2016		-			438,519,780

Stock-based Compensation

Arconic 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, restricted stock unit 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 Arconic’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. Restricted stock unit awards also vest over a three-year service period from the date of grant and certain of these awards also include performance conditions. For the majority of performance stock awards issued in 2016, 2015, and 2014, the final number of shares earned will be based on Arconic’s achievement of sales and profitability targets over the respective three-year performance periods. 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 2016, 2015, and 2014, Arconic recognized stock-based compensation expense of $76 ($51 after-tax), $77 ($51 after-tax), and $70 ($47 after-tax), respectively. For each of 2016, 2015, and 2014, approximately 80% of the stock-based compensation expense recognized related to restricted stock unit awards and no stock-based compensation expense was capitalized in any of those years. At December 31, 2016, there was $45 (pretax) of unrecognized compensation expense related to non-vested stock option grants and non-vested restricted stock unit award grants. This expense is expected to be recognized over a weighted average period of 1.5 years. As part of Arconic’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 2016, 2015, and 2014, $19, $15, and $11, 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 restricted stock unit awards, the fair value was equivalent to the closing market price of Arconic’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 $4.78, $10.07, and $6.40 per option in 2016, 2015, and 2014, respectively. The lattice-pricing model uses a number of assumptions to estimate the fair value of a stock option, including a 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 2016 (the assumptions used to estimate the fair value of stock options granted in 2015 and 2014 were not materially different, except as noted below).

The risk-free interest rate (2.06%) 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 (1.1%) was based on a one-year average. Volatility (44.5% for 2016, 36.5% for 2015, and 35.0% in 2014) was based on historical and implied volatilities over the term of the option. Arconic utilized historical option forfeiture data to estimate annual pre- and post-vesting forfeitures (7%). Exercise behavior (60%) 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 (5.7 years) was an output of the lattice-pricing model. The activity for stock options and stock awards during 2016 was as follows (options and awards in millions):


	Stock options^(A)(D)					Stock awards^(A)(D)
	Number of options			Weighted average exercise price		Number of awards			Weighted average FMV per award
Outstanding, January 1, 2016		11		$	35.72		7		$	34.13
Granted		3		$	20.22		4		$	20.64
Exercised		-		$	26.89		-		$	-
Converted		-		$	-		(3	)	$	26.72
Expired or forfeited		-		$	36.75		-		$	31.90
Cancelled due to Separation Transaction^(B)		(4	)	$	32.70		(2	)	$	30.46
Adjustment due to Separation Transaction^(C)(D)		3		$	24.14		2		$	22.20
Performance share adjustment		-		$	-		-		$	20.87
Outstanding, December 31, 2016		13		$	24.14		8		$	22.26

^(A)	The number of stock options, stock awards and the weighted average exercise price has been adjusted to reflect the Reverse Stock Split (see Note A).

^(B)	As a result of the Separation Transaction, all stock options and stock awards relating to Alcoa Corporation employees were canceled.

^(C)	As a result of the Separation Transaction, all stock options and stock awards relating to Arconic employees were adjusted to reflect the Separation Transaction.

^(D)

Both the effect of the Reverse Stock Split and the effect of the Separation Transaction were considered modifications of the original stock options and awards and the modifications were designed such that the intrinsic values of the stock option or stock award were the same both previous to and after the adjustments.

As of December 31, 2016, the number of stock options outstanding had a weighted average remaining contractual life of 5.99 years and a total intrinsic value of $10. Additionally, 8.9 million of the stock options outstanding were fully vested and exercisable and had a weighted average remaining contractual life of 4.75 years, a weighted average exercise price of $26.23, and a total intrinsic value of $0.2 as of December 31, 2016. In 2016, 2015, and 2014, the cash received from stock option exercises was $4, $25, and $150 and the total tax benefit realized from these exercises was $0, $6, and $28, respectively. The total intrinsic value of stock options exercised during 2016, 2015, and 2014 was $1, $19, and $84, respectively.