UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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COMMISSION FILE NUMBER 1-9750 |
SOTHEBYS
(Exact name of registrant as specified in its charter)
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Delaware |
38-2478409 |
(212) 606-7000
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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Title of each class |
Name of each exchange |
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Common Stock, |
New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Act. Yes R No £
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes £ No R
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Act during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Act). Large accelerated filer R
Accelerated filer £ Non-accelerated filer £
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes £ No R
As of June 30, 2006, the aggregate market value of the 60,612,960 shares of Common Stock held by non-affiliates of the registrant was $1,591,090,200, based upon the closing price ($26.25) on the New York Stock Exchange composite tape on such date for the Common Stock.
As of February 20, 2007, there were outstanding 65,739,549 shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrants proxy statement for the 2007 annual meeting of shareholders are incorporated by reference into Part III of this Form 10-K.
TABLE OF CONTENTS
Page
PART I Description of Business
1 Risk Factors
7 Unresolved Staff Comments
9 Properties
9 Legal Proceedings
10 Submission of Matters to a Vote of Security Holders
10
PART II Market for the Registrants Common Equity and Related Shareholder Matters
11 Selected Financial Data
14 Managements Discussion and Analysis of Financial Condition and Results of Operations
15 Quantitative and Qualitative Disclosures About Market Risk
49 Financial Statements and Supplementary Data
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50
51
52
53
54
55 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
98 Control and Procedures
98
PART III Directors and Executive Officers of Registrant
101 Executive Compensation
101 Security Ownership of Certain Beneficial Owners and Management and
101 Certain Relationships and Related Transactions
101 Principal Accountant Fees and Services
101
PART IV Exhibits, Financial Statement Schedules and Reports on Form 8-K
102
106
107
108
Related Stockholder Matters
PART I ITEM 1: DESCRIPTION OF BUSINESS Company Overview Sothebys (formerly Sothebys Holdings, Inc. and together with its subsidiaries, unless the context otherwise requires, the Company) is one of the worlds two largest auctioneers of
authenticated fine art, antiques and decorative art, jewelry and collectibles. In addition to auctioneering, the Companys Auction segment is engaged in a number of related activities, including the
brokering of private purchases and sales of fine art, jewelry and collectibles. The Company also operates as a dealer in works of art through its Dealer segment, conducts art-related financing
activities through its Finance segment and is engaged, to a lesser extent, in licensing activities. A detailed explanation of the activities of each of the Companys segments, as well as its licensing
activities is provided below. The Company was initially incorporated in Michigan in August 1983. In October 1983, the Company acquired Sotheby Parke Bernet Group Limited, which was then a publicly held company
listed on the International Stock Exchange of the United Kingdom and which, through its predecessors, had been engaged in the auction business since 1744. In 1988, the Company issued shares of
Class A Limited Voting Common Stock, par value $0.10 per share (the Class A Stock), to the public, which were listed on the New York Stock Exchange (the NYSE). In June 2006, the Company (then named Sothebys Holdings, Inc.) reincorporated into the State of Delaware (the Reincorporation). The Reincorporation and related proposals were approved
by the shareholders of Sothebys Holdings, Inc. at the annual meeting of shareholders on May 8, 2006. The Reincorporation was completed by means of a merger of Sothebys Holdings, Inc. with and
into Sothebys Delaware, Inc., a Delaware corporation (Sothebys Delaware) and a wholly-owned subsidiary of Sothebys Holdings, Inc. incorporated for the purpose of effecting the
Reincorporation, with Sothebys Delaware being the surviving corporation. Sothebys Delaware was renamed Sothebys upon completion of the merger. In the merger, each outstanding share of Class A Stock was converted into one share of Common Stock of Sothebys Delaware (Sothebys Delaware Stock). As a result, holders of Class A
Stock became holders of Sothebys Delaware Stock, and their rights as holders thereof are now governed by the General Corporation Law of the State of Delaware and the Certificate of
Incorporation and By-Laws of Sothebys Delaware. The Reincorporation was accounted for as a reverse merger, whereby, for accounting purposes, Sothebys Holdings, Inc. is considered the acquiror and the surviving corporation is treated as the
successor to the historical operations of Sothebys Holdings, Inc. Accordingly, the historical financial statements of Sothebys Holdings, Inc. which were previously reported to the SEC on Forms 10-K
and 10-Q, among other forms, are treated as the financial statements of the surviving corporation. The Reincorporation did not result in any change in the business or principal facilities of Sothebys Holdings, Inc. Additionally, Sothebys Holdings, Inc. management and board of directors
continued as the management and board of directors of Sothebys Delaware and Sothebys Delaware stock continued to trade on the NYSE under the symbol BID. Auction Segment Description of Business The purchase and sale of works of art in the international art market are primarily effected through numerous dealers, the major auction houses, smaller auction houses and also directly between
collectors. Although dealers and smaller auction houses generally do not report sales figures publicly, the Company believes that dealers account for the majority of the volume of transactions in the
international art market. 1
The Company and Christies International, PLC (Christies), a privately held auction house, are the two largest art auction houses in the world. The Company auctions a wide variety of property, including fine art, antiques and decorative art, jewelry and collectibles. Most of the objects auctioned by the Company are unique items, and
their value, therefore, can only be estimated prior to sale. The Companys principal role as an auctioneer is to identify, evaluate and appraise works of art through its international staff of specialists;
to stimulate purchaser interest through professional marketing techniques; and to match sellers and buyers through the auction process. In its role as auctioneer, the Company functions as an agent accepting property on consignment from its selling clients. The Company sells property as agent of the consignor, billing the buyer for
property purchased, receiving payment from the buyer and remitting to the consignor the consignors portion of the buyers payment after deducting the Companys commissions, expenses and
applicable taxes and royalties. The Companys auction commission revenues include those earned from the buyer (buyers premium revenue) and those earned from the consignor (sellers
commission revenue), both of which are calculated as a percentage of the hammer price of property sold at auction. For the years ended December 31, 2006, 2005 and 2004, auction commission
revenues accounted for 83%, 86% and 77%, respectively, of the Companys consolidated revenues. In certain situations, under negotiated contractual arrangements or when the buyer takes possession of the property purchased at auction before payment is made, the Company is liable to the
consignor for the net sale proceeds. (See Note E of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) From time to time in the ordinary course of business, the Company will guarantee to consignors a minimum price in connection with the sale of property at auction (an auction guarantee). The
Company must perform under its auction guarantee in the event that the property sells for less than the minimum price, in which event the Company must fund the difference between the sale price
at auction and the amount of the auction guarantee. If the property does not sell, the amount of the guarantee must be paid, but the Company has the right to recover such amount through the
future sale of the property. In certain instances, the sale proceeds ultimately realized by the Company exceed the amount of any prior losses recognized on the auction guarantee. Additionally, the
Company is generally entitled to a share of a negotiated amount of excess proceeds if the property under the auction guarantee sells above a minimum price. In addition, the Company is obligated
under the terms of certain auction guarantees to advance a portion of the guaranteed amount prior to the auction. In certain situations, the Company reduces its financial exposure under auction
guarantees through auction commission sharing arrangements with partners. Partners may also assist the Company in valuing and marketing the property to be sold at auction. (See Note P of Notes
to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) In addition to auctioneering, the Auction segment is engaged in a number of related activities, including the brokering of private purchases and sales of fine art, jewelry and collectibles. The worldwide art auction market has two principal selling seasons, spring and autumn. The Auction segments business is seasonal, with peak revenues and operating income generally occurring
in the second and fourth quarters of each year. Consequently, first and third quarter results of the Auction segment historically reflect lower Net Auction Sales (as defined below in Item 6, Selected
Financial Data) when compared to the second and fourth quarters and a loss from continuing operations due to the fixed nature of many of the Companys operating expenses. (See Item 7,
Managements Discussion and Analysis of Financial Condition and Results of Operations, and Note Y of Notes to Consolidated Financial Statements under Item 8, Financial Statements and
Supplementary Data.) (See Strategic Initiatives under Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations.) 2
The Auction Market and Competition Competition in the international art market is intense. A fundamental challenge facing any auctioneer or dealer is to obtain high quality and valuable property for sale either as agent or as
principal. The Companys primary auction competitor is Christies and the Company also faces competition from a variety of dealers across all collecting categories. The owner of a work of art wishing to sell it has four principal options: (1) sale or consignment to, or private sale by, an art dealer; (2) consignment to, or private sale by, an auction house;
(3) private sale to a collector or museum without the use of an intermediary; or (4) for certain categories of property (in particular, collectibles) consignment to, or private sale through, an internet-
based service. The more valuable the property, the more likely it is that the owner will consider more than one option and will solicit proposals from more than one potential purchaser or agent,
particularly if the seller is a fiduciary representing an estate or trust. A complex array of factors may influence the sellers decision. These factors, which are not ranked in any particular order,
include:
The level and breadth of expertise of the dealer or auction house with respect to the property; The extent of the prior relationship, if any, between the dealer or auction house and its staff and the seller; The reputation and historic level of achievement by the dealer or auction house in attaining high sale prices in the propertys specialized category; The desire for privacy on the part of clients; The amount of cash offered by a dealer, auction house or other purchaser to purchase the property outright, which is greatly influenced by the amount and cost of capital resources available to
such parties; The level of auction guarantees or the terms of other financial options offered by auction houses; The level of pre-sale estimates offered by auction houses; The desirability of a public auction in order to achieve the maximum possible price (a particular concern for fiduciary sellers, such as trustees and executors); The amount of commission charged by dealers or auction houses to sell a work on consignment; The cost, style and extent of presale marketing and promotion to be undertaken by a dealer or auction house; Recommendations by third parties consulted by the seller; The desire of clients to conduct business with a publicly traded company; and The availability and extent of related services, such as tax or insurance appraisals and short-term financing. It is not possible to measure with any particular accuracy the entire international art market or to reach any conclusions regarding overall competition because dealers and auction firms
frequently do not publicly report annual totals for auction sales, revenues or profits, and the amounts reported may not be verifiable. Auction Regulation Regulation
of the auction business varies from jurisdiction to jurisdiction. In many jurisdictions,
the Company is subject to laws and regulations that are not directed solely
toward the auction business, including, but not limited to, import and export
regulations, antitrust laws, cultural property ownership laws, data protection
and privacy laws, anti-money laundering laws and value added sales taxes. In
addition, the Company is subject to local auction regulations, such as New York
City Auction Regulations Subchapter M of Title 6 §§ 2-1212-125,
et. seq. Such regulations do 3
not impose a material impediment to the worldwide business of the Company but do affect the market generally, and a material adverse change in such regulations could affect the business. In
addition, the failure to comply with such local laws and regulations could subject the Company to civil and/or criminal penalties in such jurisdictions. The Company has a Compliance Department
which, amongst other activities, develops and updates compliance policies and audits, monitors, and provides training to Company employees on compliance with many of these laws and regulations. Finance Segment Description of Business The Companys Finance segment provides certain collectors and dealers with financing, generally secured by works of art that the Company either has in its possession or permits the borrower to
possess. Clients who borrow from the Finance segment are often unable to borrow on conventional terms from traditional lenders and are typically not highly interest rate sensitive. The Companys
financing activities are conducted through its wholly-owned subsidiaries. The majority of the Companys secured loans are made at loan to value ratios (principal loan amount divided by the low auction estimate of the collateral) of 50% or lower. However, the
Company will also lend at loan to value ratios higher than 50%. The Finance segments loans are predominantly variable interest rate loans. The Company generally makes two types of secured loans: (1) advances secured by consigned property to borrowers who are contractually committed, in the near term, to sell the property at
auction (a consignor advance); and (2) general purpose term loans to collectors or dealers secured by property not presently intended for sale (a term loan). The consignor advance allows a
consignor to receive funds shortly after consignment for an auction that will occur several weeks or months in the future, while preserving for the benefit of the consignor the potential of the auction
process. Term loans allow the Company to establish or enhance mutually beneficial relationships with dealers and collectors and sometimes result in auction consignments. Secured loans are generally
made with full recourse against the borrower. In certain instances, however, secured loans are made with recourse limited to the works of art pledged as security for the loan. To the extent that the
Company is looking wholly or partially to the collateral for repayment of its loans, repayment can be adversely impacted by a decline in the art market in general or in the value of the particular
collateral. In addition, in situations where the borrower becomes subject to bankruptcy or insolvency laws, the Companys ability to realize on its collateral may be limited or delayed by the
application of such laws. Under certain circumstances, the Company also makes unsecured loans to collectors and dealers. In certain of these situations, the Company finances the purchase of works of art by certain art
dealers through unsecured loans. The property purchased pursuant to such unsecured loans is sold privately or at auction with any profit or loss shared by the Company and the dealer. Interest
income related to such unsecured loans is reflected in the results of the Finance segment, while the Companys share of any profit or loss is reflected in the results of the Dealer segment. (See Notes B and E of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) The Company funds its financing activities generally through operating cash flows supplemented by credit facility borrowings. (See Item 7, Managements Discussion and Analysis of Financial
Condition and Results of OperationsLiquidity and Capital Resources, and Note J of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) The Finance Market and Competition A considerable number of traditional lending sources offer conventional loans at a lower cost to borrowers than the average cost of those offered by the Company. Additionally, many traditional
lenders offer borrowers a variety of integrated financial services such as wealth management services, which are not offered by the Company. Few lenders, however, are willing to accept works 4
of art as sole collateral as they do not possess the ability both to appraise and to sell works of art within a vertically integrated organization. The Company believes that through a combination of its
art expertise and skills in international law and finance, it has the ability to tailor attractive financing packages for clients who wish to obtain liquidity from their art assets. Dealer Segment Description of Business On June 7, 2006, the Company and Arcimboldo S.A., a private limited liability company incorporated under the laws of Luxembourg, entered into a sale and purchase agreement, pursuant to
which the Company acquired all the issued and outstanding shares of capital stock of Noortman Master Paintings B.V. (or NMP), a company incorporated under the laws of the Netherlands and
one of the worlds leading art dealers specializing in Dutch and Flemish Old Master Paintings, as well as French Impressionist and Post-Impressionist paintings. NMP is based in Maastricht, the
Netherlands. As an art dealer, NMP sells works of art directly to private collectors and museums and, from time-to-time, acts as a broker in private purchases and sales of art. NMPs results are
included in the Companys Consolidated Income Statements beginning on June 1, 2006 and are not material to the periods covered by this report. In the fourth quarter of 2006, due to the acquisition of NMP and the resulting increase in the Companys Dealer activities, certain activities which were previously managed and reported as part
of the Auction segment were realigned with NMP and aggregated into a newly established Dealer segment under the oversight of an executive committee responsible for managing the Companys
portfolio of Dealer activities. Such activities principally include:
The investment in and resale of art and other collectibles directly by the Company. The investment in art through unsecured loans made by the Company to unaffiliated art dealers. (See Note E of Notes to Consolidated Financial Statements under Item 8, Financial
Statements and Supplementary Data.) The activities of certain equity investees, including Acquavella Modern Art (AMA). (See Note F of Notes to Consolidated Financial Statements under Item 8, Financial Statements and
Supplementary Data.) The purchase and resale of art through an art dealer whose results are required to be consolidated with the Companys results under generally accepted accounting principles. The Company has
no equity investment in this entity. (See Note R of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) Robert Noortman, Managing Director of NMP, died unexpectedly on January 14, 2007. NMP is continuing under the leadership of Mr. Noortmans son, William. (See Acquisition below and
Note C of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for more discussion of the acquisition and the impact of Mr. Noortmans death.) The Dealer Market and Competition The Dealer segment operates in the same market as the Auction segment and is impacted to varying degrees by many of the same competitive factors (as discussed above under The Auction
Market and Competition). The most prominent competitive factors impacting the Dealer segment, which are not ranked in any particular order, include: (i) relationships and personal interaction
between the buyer or seller and the dealer; (ii) the level of specialized expertise of the dealer; and (iii) the ability of the dealer to finance purchases of art. 5
Discontinued
Operations In
the fourth quarter of 2003, the Company committed to a plan to sell its domestic
real estate brokerage business, Sothebys International Realty, Inc. (SIR),
as well as most of its real estate brokerage offices outside
of the U.S. As a result, such operations qualified for treatment as discontinued
operations in the fourth quarter of 2003. On February 17, 2004, the Company consummated the sale of SIR to a subsidiary of Realogy Corporation (Realogy), formerly Cendant Corporation. In conjunction with the sale, the Company
entered into an agreement with Realogy to license the Sothebys International Realty trademark and certain related trademarks for an initial 50-year term with a 50-year renewal option (the Realogy
License Agreement). Initially, the Realogy License Agreement was applicable to the U.S., Canada, Israel, Mexico and certain Caribbean countries. Also in conjunction with the sale, Realogy received options to acquire most of the other non-U.S. offices of the Companys real estate brokerage business and to expand the Realogy License
Agreement to cover the related trademarks in other countries outside the U.S., excluding Australia and New Zealand (the International Options). The International Options were exercised by
Realogy and the Realogy License Agreement was amended to cover New Zealand during 2004. As a result, such operations qualified for treatment as discontinued operations in 2004. In the fourth quarter of 2004, the Company committed to a plan to discontinue its real estate brokerage business in Australia and license the Sothebys International Realty trademark and certain
related trademarks in Australia. The Company had expected to consummate a license agreement related to such trademarks some time in 2006, but such an agreement could not be reached on terms
acceptable to the Company. As a result, in the second quarter of 2006, management decided to continue operating the Companys real estate brokerage business in Australia. Accordingly, the
operating results of this business, which had previously been reported as discontinued operations in the Consolidated Income Statements since the fourth quarter of 2004, have been reclassified into
the Companys results from continuing operations for all periods presented. The Australia real estate brokerage business, which is the only remaining component of the Companys former Real Estate
segment, is not material to the Companys results of operations, financial condition or liquidity. (See Note T of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for additional information on Discontinued Operations.) Licensing As discussed under Discontinued Operations above, in conjunction with the sale of SIR, the Company entered into an agreement with Realogy to license the SIR trademark and certain related
trademarks. The Realogy License Agreement provides for an ongoing license fee during its term based on the volume of commerce transacted under the licensed trademarks. In 2006 and 2005, the
Company earned $2.6 million and $1.3 million, respectively, in license fee revenue related to the Realogy License Agreement. The Company continues to consider additional opportunities to license
the Sothebys brand in businesses where appropriate. Financial and Geographical Information about Segments See Note D of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for financial and geographical information about the Companys
segments. Personnel As of December 31, 2006, the Company had 1,497 employees with 551 located in North America; 567 in the U.K.; 279 in Continental Europe and 100 in Asia. The Company regards its relations
with its employees as good. The table below provides a breakdown of the Companys employees as of December 31, 2006 and 2005. 6
December 31
2006
2005 Auction segment
1,351
1,315 Finance segment
7
7 Dealer segment
8
1 All Other
131
120 Total
1,497
1,443 Employees classified within All Other principally relate to the Companys central corporate and information technology departments. (See Strategic Initiatives under Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations.) Technology Over the past several years, the Company has made substantial investments in information technology designed to improve client service. A new portfolio of enterprise systems anchored by SAP
has been deployed across the organization, which has enhanced the quality of information and processing of sales and inventory tracking, as well as data management. A number of new web site
developments are underway that are targeted at providing clients with real-time access to their account data and balances, as well as information on current and historical transactions, auction tracking
services and enhanced media content. The Companys goal is to enhance the services provided to its clients in order to maximize the value from these investments. (See Strategic Initiatives under Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations.) Website Address The Company makes available free of charge its annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K through a hyperlink from its website,
www.sothebys.com, to www.shareholder.com/bid/edgar.cfm, a website maintained by an unaffiliated third-party service. Such reports are made available on the same day that they are electronically
filed with or furnished to the Securities and Exchange Commission (the SEC). Operating results for the Company, as well as the Companys liquidity, are significantly influenced by a number of risk factors, many of which are not within the Companys control. These
factors, which are not ranked in any particular order, include: The overall strength of the international economy and financial markets The art market in which the Company operates is influenced over time by the overall strength of the international economy and financial markets, although this correlation may not be
immediately evident in the short-term. The Companys business can be particularly influenced by the economies of the U.S., the U.K., and the major countries or territories of Continental Europe
and Asia (principally China and Japan). Interest rates Fluctuations in interest rates influence the Companys cost of funds for borrowings under its credit facility that may be required to finance working capital needs and, in particular, the Finance
segments client loan portfolio. 7
Government laws and regulations Many
of the Companys activities are subject to laws and regulations including,
but not limited to, import and export regulations, cultural property ownership
laws, data protection and privacy laws, anti-money laundering laws, antitrust
laws and value added sales taxes. In addition, the Company is subject to local
auction regulations, such as New York City Auction Regulations Subchapter M
of Title 6 §§ 2-1212-125, et. seq. Such regulations do
not impose a material impediment to the worldwide business of the Company but
do affect the market generally, and a material adverse change in such regulations
could affect the business. Additionally, export and import laws and cultural
property ownership laws could affect the availability of certain kinds of property
for sale at the Companys principal auction locations or could increase
the cost of moving property to such locations. Political conditions and world events Global political conditions and world events may affect the Companys business through their effect on the economies of various countries, as well as on the decision of buyers and sellers to
purchase and sell art in the wake of economic uncertainty. Global political conditions may also influence the enactment of legislation that could adversely affect the Companys business. Foreign currency exchange rate movements The Company has operations throughout the world, with approximately 53% of its revenues coming from outside of the U.S. in 2006. Accordingly, fluctuations in exchange rates can have a
significant impact on the Companys results of operations. Seasonality of the Companys auction business The worldwide art auction market has two principal selling seasons, spring and autumn. The Companys revenues and operating income may be affected as described under Seasonality in
Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations. Competition Competition in the art market is intense, including competition both with other auctioneers and with art dealers. See Auction SegmentThe Art Market and Competition under Item 1,
Description of Business, for a discussion of the factors that may affect the Companys ability to compete successfully in its business. The amount and quality of property being consigned to art auction houses The amount and quality of property being consigned to art auction houses is influenced by a number of factors not within the Companys control. Many major consignments, and specifically
single-owner sale consignments, often become available as a result of the death or financial or marital difficulties of the owner, all of which are unpredictable. This, plus the ability of the Company to
sell such property, can cause auction and related revenues to be highly variable from period to period. The demand for fine arts, decorative arts, and collectibles The demand for fine arts, decorative arts, and collectibles is influenced not only by overall economic conditions, but also by changing trends in the art market as to which kinds of property and
the works of which artists are most sought after and by the collecting preferences of individual collectors, all of which can be unpredictable. 8
Qualified personnel The Companys business is largely a service business in which the ability of its employees to develop and maintain relationships with potential sellers and buyers of works of art is essential to the
Companys success. Moreover, the Companys business is both complex and unique, making it important to retain key specialists and members of management. Accordingly, the Companys business is
highly dependent upon its success in attracting and retaining qualified personnel. Demand for art-related financing The Companys Finance segment is dependent on the demand for art-related financing, which can be significantly influenced by overall economic conditions and by the often unpredictable
financial requirements of owners of major art collections. Strategic Initiatives As discussed in more detail below within Strategic Initiatives under Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations, management is
undertaking certain strategic initiatives designed to refocus the Companys business portfolio. The Companys future operating results are dependent in part on the success of management in
implementing the Companys strategic plans. Value of artworks The art market is not a highly liquid trading market, as a result of which the valuation of artworks is inherently subjective and the realizable value of artworks often varies over time.
Accordingly, the Company is at risk both as to the value of art held as inventory and as to the value of artworks pledged as collateral for Finance segment loans. U.K. Pension Plan Future costs related to the Companys U.K. defined benefit pension plan are heavily influenced by changes in interest rates and investment performance in the debt and equity markets, both of
which are unpredictable. (See Salaries and Related CostsEmployee Benefits under Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations.) Income taxes The Company operates in many tax jurisdictions throughout the world. Variations in taxable income in the various jurisdictions in which the Company does business can have a significant impact
on its effective tax rate. ITEM 1B: UNRESOLVED STAFF COMMENTS None. The Companys North American Auction, Dealer and Finance operations, as well as its corporate offices, are headquartered at 1334 York Avenue, New York, New York (the York Property).
The York Property is home to the Companys sole North American salesroom and its principal North American exhibition space. The Company completed the construction of the six-story addition to
and renovation of the York Property in 2001, which expanded the Companys auction, warehouse and office space in New York City and enabled the Company to consolidate many of its New York
City operations. On February 7, 2003, the Company sold the York Property and entered into an agreement to lease it back from the buyer for an initial 20-year term, with options to extend the lease
for two additional 10-year terms. According to the terms of the lease, if the landlord desires to sell the York Property, notice shall be given to the Company by the landlord 9
of such proposed sale and a statement of the proposed purchase price and the proposed closing date for the transaction (the Landlords Offer). Upon receipt of such notice, the Company has thirty
days to accept or reject the Landlords Offer. If accepted, the Company would purchase the York Property at the proposed purchase price. In February 2007, the Company was advised that the
landlord of the York Property intends to market and sell the York Property. Management is currently assessing its rights and options with respect to the York Property. The Company also leases
office and exhibition space in several other major cities throughout the U.S. The Companys U.K. operations (primarily Auction) are centered at New Bond Street, London, where the main salesrooms, exhibition space and administrative offices of Sothebys U.K. are
located. The Company owns a portion of the New Bond Street premises (approximately 35%), and the remaining portion is leased under short and long-term leases (approximately 65%). The lease
related to a small portion of the New Bond Street complex is due to expire in September 2007 and, as a result, the Company will lose exhibition and office space. To partially compensate for this
loss of space, the Company has begun a refurbishment of the New Bond Street premises. This refurbishment is expected to cost approximately $11 million, of which approximately $4 million has been
spent through December 31, 2006. The refurbishment of the New Bond Street premises is expected to be completed in September 2007. In the U.K., the Company also leases space for its specially dedicated middle market auction salesroom at Olympia, a building located in Kensington, West London. In addition, the Company
leases warehouse space at Kings House in West London and owns land and a building at Billingshurst, West Sussex (the Sussex Property), which previously housed an auction salesroom. The
Company has entered into an agreement for the sale of vacated parts of the Sussex Property. The Company has received planning permission for redevelopment of the land for sale; however,
consummation of the sale is conditional upon the completion of a statutory review period. Management anticipates that the sale of the Sussex Property will be completed in March 2007. (See Note O
of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) The Company also leases space primarily for Auction operations in various locations throughout Continental Europe, including salesrooms in Amsterdam, The Netherlands; Geneva and Zurich,
Switzerland; Milan, Italy; and Paris, France; in Asia, including Hong Kong and Singapore; and in Australia. Additionally, the Company owns land and a building in Maastricht, The Netherlands, which
houses Noortman Master Paintings, an art dealer acquired by the Company in June 2006 (see Acquisition under Item 7, Managements Discussion and Analysis of Financial Condition and Results
of Operations and Note C of Notes to Consolidated Financial Statements under Items 8, Financial Statements and Supplementary Data). In managements opinion, the Companys worldwide premises are adequate for the current conduct of its business. However, management continually analyzes its worldwide premises for both its
current and future business needs as part of its ongoing efforts to manage infrastructure and other overhead costs. Where appropriate, management will continue to make any necessary changes to
address the Companys premises requirements. (See Strategic Initiatives under Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations.) The Company becomes involved, from time to time, in various claims and lawsuits incidental to the ordinary course of its business. Management does not believe that the outcome of any of
these pending claims or proceedings will have a material adverse effect on the Companys business, results of operations, financial condition and/or liquidity. (See statement on Forward Looking
Statements.) ITEM 4: SUBMISSION TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Companys shareholders during the fourth quarter of 2006. 10
PART II
MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED SHAREHOLDER MATTERS Market Information The principal U.S. market for the Companys common stock is the NYSE (symbol: BID). The number of holders of record of the Companys common stock as of February 20, 2007 was 2,014.
The quarterly price ranges on the NYSE of the Companys common stock for 2006 and 2005 are as follows:
Quarter Ended
2006
High
Low March 31
$
29.30
$
18.18 June 30
$
33.84
$
22.78 September 30
$
32.95
$
25.08 December 31
$
38.64
$
29.81
Quarter Ended
2005
High
Low March 31
$
18.63
$
15.33 June 30
$
17.85
$
13.52 September 30
$
18.30
$
13.93 December 31
$
19.43
$
15.08 Pursuant to the Companys senior secured credit agreement, dividend payments, if any, must be paid solely out of 40% of the Companys net income arising after June 30, 2005 and computed on
a cumulative basis (see Item 7, Managements Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources). The Company did not pay any dividends
during 2005. On each of August 2 and November 2, 2006, the Companys Board of Directors declared quarterly dividends on its common stock of $0.10 per share totaling approximately $6.4 million
and $6.5 million, respectively. The dividend declared on August 2, 2006 was paid on September 15, 2006. The dividend declared on November 2, 2006 was paid on December 15, 2006. On February
27, 2007, the Companys Board of Directors declared a quarterly dividend on its common stock of $0.10 per share (approximately $6.5 million), to be paid on March 15, 2007 to shareholders of
record on February 28, 2007. It is the intention of the Company to continue to pay quarterly dividends at this rate (an annual rate of $0.40 per share), subject to Board approval and depending on
economic, financial, market and other conditions at the time. (See statement on Forward Looking Statements.) 11
Equity Compensation Plans The following table provides information as of December 31, 2006 with respect to shares of the Companys common stock that may be issued under its existing equity compensation plans,
including the Sothebys 1997 Stock Option Plan (the 1997 Stock Option Plan), the Sothebys Amended and Restated Restricted Stock Plan (the Restricted Stock Plan) and the Sothebys Stock
Compensation Plan for Non-Employee Directors (the Directors Stock Plan):
(A)
(B)
(C) Plan Category (1)
Number of
Weighted Average
Number of Securities
(In thousands, except per share data) Equity compensation plans approved by shareholders
4,300
$
15.65
4,389 Equity compensation plans not approved by shareholders
Total
4,300
$
15.65
4,389
(1)
See Note M of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for a description of the material features of and additional information
related to the equity compensation plans. (2) Includes 2,080,782 shares of common stock awarded under the Restricted Stock Plan on which the restrictions have not yet lapsed. (3) The weighted-average exercise price does not take into account 2,080,782 shares of common stock awarded under the Restricted Stock Plan, which have no exercise price. (4) Includes 3,879,805 shares of common stock available for future issuance under the Restricted Stock Plan. Issuance of Unregistered Securities On August 4, 2006, September 15, 2006, November 6, 2006 and December 15, 2006, the Company issued 1,325, 210, 1,666 and 195 shares of its common stock or deferred stock units, respectively,
to certain directors pursuant to the Companys stock compensation plan for its non-employee directors as partial compensation for Board service. Upon terminating Board service, a deferred stock
unit holder will receive one share of Company common stock in exchange for each unit held. The Company issued these securities pursuant to a registration exemption under Section 4(2) of the
Securities Act of 1933, as amended, relying on the directors control person and accredited investor status by virtue of their being directors. 12
Securities to be
Issued Upon
Exercise of
Outstanding
Options,
Warrants and
Rights (2)
Exercise Price of
Outstanding
Options, Warrants
and Rights (3)
Remaining Avaliable for
Future Issuance Under
Equity Compensation
Plans (4)
Performance Graph The following graph compares the Companys cumulative total shareholder return on its common stock (for the five year period from December 31, 2001 to December 31, 2006) with the
cumulative return of the Standard & Poors MidCap 400 Stock Index (S&P MidCap 400) and the Companys Peer Group (the Peer Group). The Peer Group consists of Nordstrom, Inc., Saks
Holdings, Inc., Tiffany & Co. and Movado, Inc. The Company believes the members of this Peer Group to be purveyors of luxury goods appealing to a segment of the population consistent with the Companys own clientele as no other
auction house of comparable market share or capitalization is publicly traded. The graph reflects an investment of $100 in the Companys common stock, the S&P MidCap 400, which includes the Company, and the Companys Peer Group, respectively, on December 31, 2001,
and a reinvestment of dividends at the average of the closing stock prices at the beginning and end of each quarter. Comparison of Five-Year Cumulative Total Return Among
12/31/2001
12/31/2002
12/31/2003
12/31/2004
12/31/2005
12/31/2006 Sothebys
$
100.00
$
54.18
$
82.24
$
109.33
$
110.54
$
187.99 Peer Group
$
100.00
$
131.66
$
214.82
$
228.70
$
238.96
$
319.64 S&P MidCap 400
$
100.00
$
85.49
$
115.65
$
134.43
$
151.07
$
166.65 13
Sothebys, the Peer Group Index and the S&P MidCap 400
as of December 31, 2006
ITEM 6: SELECTED FINANCIAL DATA The following table provides selected financial data for the Company (in thousands of dollars, except per share data). Year Ended December 31
2006
2005
2004
2003
2002 Net Auction Sales (1)
$
3,234,526
$
2,361,830
$
2,334,937
$
1,455,970
$
1,552,703 Income statement data: Auction and related revenues
$
631,344
$
496,899
$
439,526
$
307,608
$
293,565 Finance revenues
15,864
8,302
5,907
5,310
5,997 Dealer revenues
12,776
5,131
3,604
1,382
3,179 License fee revenues
2,922
1,404
45,745
Other revenues
1,903
2,117
2,274
3,288
5,126 Total revenues
$
664,809
$
513,853
$
497,056
$
317,588
$
307,867 Net interest expense
$
(27,148
)
$
(27,738
)
$
(30,267
)
$
(30,333
)
$
(20,174
) Income (loss) from continuing operations
$
107,359
$
63,217
(2)
$
62,397
(3)
$
(26,260
)(4)(6)
$
(59,582
)(5)(6) Net income (loss)
$
107,049
$
61,602
(2)
$
86,679
(3)
$
(20,848
)(4)(6)
$
(55,252
)(5)(6) Basic income (loss) per share from continuing operations
$
1.78
$
1.04
(2)
$
1.01
(3)
$
(0.43
)(4)(6)
$
(0.97
)(5)(6) Basic earnings (loss) per share
$
1.77
$
1.01
(2)
$
1.40
(3)
$
(0.34
)(4)(6)
$
(0.90
)(5)(6) Diluted income (loss) per share from continuing operations
$
1.73
$
1.02
(2)
$
1.00
(3)
$
(0.43
)(4)(6)
$
(0.97
)(5)(6) Diluted earnings (loss) per share
$
1.72
$
1.00
(2)
$
1.38
(3)
$
(0.34
)(4)(6)
$
(0.90
)(5)(6) Cash dividends declared per share
$
0.20
$
$
$
$
Balance sheet data: Working capital
$
258,636
$
141,711
$
212,318
$
82,404
$
9,544 Total assets
$
1,477,165
$
1,060,752
$
1,224,812
$
903,346
$
869,812 Credit facility borrowings
$
$
34,542
$
$
20,000
$
100,000 Long-term debt (net)
$
99,791
$
99,701
$
99,617
$
99,539
$
99,466 York Property capital lease obligation
$
170,605
$
172,044
$
172,169
$
172,282
$
Shareholders equity
$
301,687
$
126,276
(7)
$
235,385
$
124,654
$
134,475
(1)
Represents the hammer (sale) price of property sold at auction. (2) Amounts for the year ended December 31, 2005 include (on a pre-tax basis) $3.1 million in credit facility termination costs and antitrust related charges of $1.1 million. (3) Amounts for the year ended December 31, 2004 include (on a pre-tax basis) one-time License Fee Revenues of $45.6 million, Retention Costs of $0.3 million, Net Restructuring Charges of $0.1
million and antitrust related charges of $1.9 million. (4) Amounts for the year ended December 31, 2003 include (on a pre-tax basis) Retention Costs of $8.5 million, Net Restructuring Charges of $5 million and antitrust related charges of $3.1 million. (5) Amounts for the year ended December 31, 2002 include (on a pre-tax basis) Retention Costs of $22.6 million, Net Restructuring Charges of $2 million and antitrust related charges of $41 million. (6) As restated, see Review of Stock Option Granting Practices under Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations. (7) The significant decrease in shareholders equity between 2004 and 2005 is principally due to the impact of the recapitalization transaction discussed in Note U of Notes to Consolidated Financial
Statements under Item 8, Financial Statements and Supplementary Data. 14
ITEM 7: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Seasonality The worldwide art auction market has two principal selling seasons, spring and autumn. The Companys auction business is seasonal, with peak revenues and operating income generally occurring
in the second and fourth quarters of each year. Consequently, first and third quarter results of the Auction segment historically reflect lower Net Auction Sales (as defined below under Key
Performance Indicators) when compared to the second and fourth quarters and a loss from continuing operations due to the fixed nature of many of the Companys operating expenses. (See Note Y
of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for information on the Companys quarterly results for the years ended December 31,
2006 and 2005.) Critical Accounting Estimates The preparation of financial statements and related disclosures in conformity with GAAP (as defined below under Use of Non-GAAP Financial Measures) requires management to make
judgments, assumptions and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Actual results may ultimately differ from managements
original estimates as future events and circumstances sometimes do not develop as expected. Note B of Notes to Consolidated Financial Statements describes the significant accounting policies and
methods used in the preparation of the Consolidated Financial Statements. In addition, management believes that the following are the most critical accounting estimates, which are not ranked in any
particular order, which may affect the Companys financial condition and/or results of operations.
(1)
Value of artworksThe art market is not a highly liquid trading market. As a result, the valuation of artworks is inherently subjective and the realizable value of artworks often varies over time.
Accordingly, the Company is at risk as to the value of art held as inventory by its Dealer and Auction segments, the value of its investment in AMA and as to the value of artworks pledged as
collateral for Finance segment loans.
If there was a decline in the estimated realizable value of the artworks held in inventory by the Company or the inventory held by AMA, management would be required to evaluate whether to
record losses in the Auction and/or Dealer segments to reduce the carrying values of its inventory and/or investment in AMA. Additionally, to the extent that the Company is looking wholly or partially to the artworks pledged as collateral for repayment of Finance segment loans, repayment can be adversely impacted
by a decline in the estimated realizable value of the collateral. Management reevaluates the value of the collateral for specific loans when it becomes aware of a situation where the estimated
realizable value of the collateral may be less than the loan balance, and with respect to which the under-collateralized amount may not be collectible from the borrower. In the event that the
estimated realizable value of the artworks pledged as collateral declines and becomes less than the corresponding loan balances, the Company would be required to assess whether it is necessary
to record losses in the Finance segment to reduce the carrying value of specific loans, after taking into account the ability of borrowers to repay the loans. Due to the inherent subjectivity involved in estimating the value of artworks, managements judgments about the estimated realizable value of art held by its Dealer and Auction segments, the
value of its investment in AMA and the value of artworks pledged as collateral for Finance segment loans may prove, with the benefit of hindsight, to be inaccurate. (See Notes B and E of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) (2) Pension BenefitsThe pension obligations related to the Companys U.K. defined benefit pension plan (the U.K. Pension Plan) are developed from an actuarial valuation. Inherent in 15
The discount rate assumption represents the approximate weighted average rate at which the Companys pension obligations could be effectively settled and is based on a hypothetical portfolio
of high-quality corporate bonds with maturity dates approximating the length of time remaining until individual benefit payment dates. The discount rate used to calculate the $6.7 million in net
annual pension cost related to the U.K. Pension Plan for the year ended December 31, 2006 was 4.9%. A hypothetical increase or decrease of 0.1% in this assumption (i.e., from 4.9% to 5% or
from 4.9% to 4.8%) would result in a decrease or increase in net pension cost of approximately $0.6 million. As of the date of the most recent plan actuarial valuation, the discount rate used to
calculate the $344 million projected benefit obligation related to the U.K. Pension Plan was 4.8%. A hypothetical increase or decrease of 0.1% in this assumption (i.e., from 4.8% to 4.9% or
from 4.8% to 4.7%) would result in a decrease or increase in the projected benefit obligation of approximately $8 million. The assumption for the expected long-term return on plan assets is based on expected future appreciation, as well as dividend and interest yields available in equity and bond markets as of the
plans measurement date and weighted according to the composition of invested plan assets. The long-term return on plan assets used to calculate the $6.7 million in net pension cost related to
the U.K. Pension Plan for the year ended December 31, 2006 was 7.25% per year. A hypothetical increase or decrease of 0.25% in this assumption (i.e., from 7.25% to 7.5% or from 7.25% to
7%) would result in a decrease or increase in net annual pension cost of approximately $0.6 million. The assumption for future compensation increases is established after considering historical salary data for U.K. employees and current economic data for inflation, as well as managements
expectations for future salary growth. The assumption for future compensation increases used to calculate the $6.7 million in net annual pension cost related to the U.K. Pension Plan for the
year ended December 31, 2006 was 4.5% per annum. A hypothetical increase or decrease of 0.25% in this assumption (i.e., from 4.5% to 4.75% or from 4.5% to 4.25%) would result in an
increase or decrease in net pension cost of approximately $0.6 million. As of the date of the most recent plan actuarial valuation, the assumption for future compensation increases used to
calculate the $344 million projected benefit obligation related to the U.K. Pension Plan was 4.75% per year. A hypothetical increase or decrease of 0.25% in this assumption (i.e., from 4.75% to
5% or from 4.75% to 4.5%) would result in an increase or decrease in the projected benefit obligation of approximately $2.9 million. As
of the date of the most recent plan actuarial valuation, pre-tax actuarial
losses related to the U.K. Pension Plan totaled approximately $91 million
($63.7 million, after tax). These losses accumulated over several years
as a result of differences in actual experience compared to projected
experience, and were specifically influenced by a general trend of lower
discount rates, driven by the U.K. interest rate environment, as well
as the adoption of updated mortality tables reflecting more recent data
on longer life expectancies. These losses, which are reflected in the
Consolidated Balance Sheets on an after-tax basis within accumulated other
comprehensive loss and not yet recognized in net annual pension cost,
are being systematically recognized as an increase in future net pension
cost in accordance with Statement of Financial Accounting Standards (SFAS)
No. 87, Employers Accounting for Pensions, and SFAS
No. 158, Employers Accounting for Defined Benefit Pension
and Other Postretirement Plans, an amendment of FASB Statements No. 87,
88, 106, and 132(R). Such pre-tax losses in excess of 10% of the
greater of the market-related value of plan assets or the plans
projected benefit obligation are recognized over a period of approximately
14 years, which represents the average remaining service period of active
employees expected to receive benefits under the plan. Management projects
that, in 2007, the amortization of such pre-tax losses will increase by
approximately $2.6 million when compared to 2006 (from $3.4 million to
$6 million), significantly contributing to the $4 million expected overall
increase in costs related to the U.K. 16
this valuation are key assumptions and estimates, including the discount rate, expected long-term return on plan assets, future compensation increases, and other factors, which are updated on an
annual basis. In determining these assumptions and estimates, management considers current market conditions, market indices and other relevant data.
Pension
Plan. In accordance with SFAS No. 87, the market-related value of plan
assets was derived using a method that adjusts for 20% of the last five
years actual gains and losses. (See
Note N of Notes to Consolidated Financial Statements under Item 8, Financial
Statements and Supplementary Data, for additional information related
to the U.K. Pension Plan, as well as the Companys other material
pension arrangements.) (3) Settlement
LiabilitiesIn conjunction with the settlement of certain civil
litigation related to the investigation by the Antitrust Division of the
U.S. Department of Justice (the DOJ), in May 2003 the Company
issued to the class of plaintiffs vendors commission discount certificates
(Discount Certificates) with a face value of $62.5 million.
The Discount Certificates are fully redeemable in connection with any
auction conducted by the Company or Christies in the U.S. or in
the U.K. and may be used to satisfy consignment charges involving vendors
commission, risk of loss and/or catalogue illustration. The court determined
that the $62.5 million face value of the Discount Certificates had a fair
market value of not less than $50 million, which represents the amount
recorded by the Company as settlement liabilities in the third quarter
of 2000. The Discount Certificates will expire on May 14, 2008 and cannot
be redeemed subsequent to that date; however, any unused Discount Certificates
may be redeemed for cash at their face value at any time between May 15,
2007 and May 14, 2008. As
of December 31, 2006, the outstanding face value of unused Discount Certificates
that the Company could be required to redeem was $46.7 million and the
carrying value of such Discount Certificates reflected within Current
Liabilities in the Consolidated Balance Sheets was approximately $45.8
million. The classification of the remaining liability for the Discount
Certificates within Current Liabilities is based on managements
estimate of future Discount Certificate redemptions and reflects the fact
that unused Discount Certificates may be redeemed for cash starting on
May 15, 2007. However, due to the unpredictability of Discount Certificate
redemption activity, actual future redemptions could be materially less
than managements estimate, which would result in the reversal of
any remaining liability prior to or upon the expiration of the Discount
Certificates on May 14, 2008. (See
Note Q of Notes to Consolidated Financial Statements under Item 8, Financial
Statements and Supplementary Data.) (4) Income
TaxesAt December 31, 2006, the Company had net deferred tax
assets of $74.8 million primarily resulting from net operating loss and
credit carryforwards and deductible temporary differences, which will
reduce taxable income in future periods over a number of years. Included
in this net deferred tax asset is a valuation allowance of $29.1 million
to reduce the Companys deferred tax assets to the amount that is
more likely than not to be realized. In assessing the need for the valuation
allowance management considers, among other things, its projections of
future taxable income and ongoing prudent and feasible tax planning strategies.
If the Companys projections of future taxable income and other positive
evidence considered in evaluating the need for a valuation allowance prove,
with the benefit of hindsight, to be inaccurate, it will be more difficult
to support the realization of these deferred tax assets. As a result,
an additional valuation allowance may be required, which would have an
adverse impact on the Companys results. Conversely, should management
determine that it would be able to realize its deferred tax assets in
the future in excess of its net recorded amount, an adjustment to the
deferred tax asset would have a favorable impact on the Companys
results in the period such determination was made. Additionally,
tax contingencies are recorded to address potential exposures involving
tax positions that the Company has taken that could be challenged by taxing
authorities. These potential exposures result from the varying applications
of statutes, rules, regulations and interpretations. The Companys
tax contingencies contain assumptions based on past experiences and judgments
about potential actions by taxing jurisdictions. The cost of the ultimate
resolution of these matters may be greater or less than the amount that
the Company has provided. (See
Note K of Notes to Consolidated Financial Statements under Item 8, Financial
Statements and Supplementary Data.) 17
(5) Goodwill and Intangible AssetsGoodwill is not amortized, but is tested for impairment at the reporting unit level annually (October 31 for the Company) and between annual tests if indicators of
impairment exist. These indicators could include a significant change in the outlook for the business, legal factors, lower than expected operating results, increased competition, or the sale or
disposition of a significant portion of a reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and
liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated using a
discounted cash flow methodology. This requires significant judgments including the estimation of future cash flows, which is dependent on internal forecasts. Changes in the estimates and
assumptions used could materially affect the determination of fair value and/or goodwill impairment for each reporting unit. Intangible assets other than goodwill are amortized over their estimated useful lives unless such lives are deemed indefinite. If indicators of potential impairment exist, intangible assets with
defined useful lives are tested for impairment based on undiscounted cash flows and, if impaired, written down to fair value based on either discounted cash flows or appraised values. Intangible
assets with indefinite lives are tested annually (October 31 for the Company) for impairment and written down to fair value as required. Changes in the estimated fair values of the Companys
intangible assets could materially affect the determination of impairment. (See Notes C, H and I of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) Use of Non-GAAP Financial Measures GAAP refers to generally accepted accounting principles in the United States of America. Included in Managements Discussion and Analysis of Financial Condition and Results of Operations
(MD&A) are financial measures presented in accordance with GAAP and also on a non-GAAP basis. Specifically, in MD&A, the Company makes reference to Adjusted EBITDA, which is defined as income from continuing operations excluding income tax expense, net interest expense and
depreciation and amortization expense, as well as costs associated with the termination of the Companys previous senior secured credit facility in 2005 and certain one-time license fee revenues and
transaction costs recognized in 2004. Management believes that Adjusted EBITDA provides a useful supplemental performance measure of the Companys operations and financial performance.
Management also believes that Adjusted EBITDA-based measures are used by many investors, equity analysts and rating agencies as a measure of the Companys financial performance. It is
important to note that Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies and should not be considered as an alternative to income from continuing
operations determined in accordance with GAAP. Additionally, when material, the Company excludes the impact of changes in foreign currency exchange rates when comparing current year results to the prior year. Consequently, such period-to-
period comparisons are provided on a constant dollar basis by eliminating the impact of changes in foreign currency exchange rates from the prior year. Management also utilizes these non-GAAP financial measures in analyzing its operating results. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP
measures is presented in the Overview and Impact of Foreign Currency Translations sections under Results of Operations below. 18
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005 Note D (Segment Reporting) of Notes to Consolidated Financial Statements should be read in conjunction with this discussion. Overview The Companys income from continuing operations before taxes for the year ended December 31, 2006 increased $74.8 million, or 82%, to $165.8 million, reflecting the continuing strength of the
international art market, as Net Auction Sales and Private Sales (both defined below under Key Performance Indicators) increased significantly from the prior year. The higher levels of sale activity
resulted in an increase in auction and related revenues of $134.4 million, or 27%. The higher level of revenues during the period was partially offset by an increase in operating expenses of $77.1
million, or 20%. Management currently anticipates a continuation of the strong international art market and is encouraged by the Companys sales results to date in the first quarter of 2007. (See
statement on Forward Looking Statements.) The Companys results from continuing operations for the years ended December 31, 2006 and 2005 are summarized below (in thousands of dollars):
Year Ended December 31
2006
2005
Favorable/(Unfavorable)
$ Change
% Change Revenues: Auction and related revenues
$
631,344
$
496,899
$
134,445
27.1
% Finance revenues
15,864
8,302
7,562
91.1
% Dealer revenues
12,776
5,131
7,645
* License fee revenues
2,922
1,404
1,518
* Other revenues
1,903
2,117
(214
)
(10.1
%) Total revenues
664,809
513,853
150,956
29.4
% Expenses
467,651
390,590
(77,061
)
(19.7
%) Operating income
197,158
123,263
73,895
59.9
% Net interest expense
(27,148
)
(27,738
)
590
2.1
% Credit facility termination costs
(3,069
)
3,069
100.0
% Other expense
(4,227
)
(1,474
)
(2,753
)
* Income from continuing operations before taxes
165,783
90,982
74,801
82.2
% Equity in earnings of investees, net of taxes
1,626
829
797
96.1
% Income tax expense
60,050
28,594
(31,456
)
* Income from continuing operations
$
107,359
$
63,217
$
44,142
69.8
% Key performance indicators: Aggregate Auction Sales (a)
$
3,747,854
$
2,752,185
$
995,669
36.2
% Net Auction Sales (b)
$
3,234,526
$
2,361,830
$
872,696
36.9
% Private Sales (c)
$
327,884
$
271,936
$
55,948
20.6
% Auction commission margin (d)
17.0%
18.7%
N/A
(8.8
%) Average loan portfolio (e)
$
158,021
$
102,605
$
55,416
54.0
% Adjusted EBITDA (f)
$
218,383
$
145,145
$
73,238
50.5
% Legend:
*
Represents a change in excess of 100%. (a) Represents the hammer (sale) price of property sold at auction plus buyers premium. (b) Represents the hammer (sale) price of property sold at auction. (c) Represents the total purchase price of property sold in private sales brokered by the Company. (d) Represents total auction commission revenues as a percentage of Net Auction Sales. (e) Represents the average loan portfolio of the Companys Finance segment. (f) See Use of Non-GAAP Financial Measures above. 19
Please see below for a more detailed discussion of the significant factors impacting the Companys results from continuing operations for the year ended December 31, 2006. The following is a reconciliation of Adjusted EBITDA (see Use of Non-GAAP Financial Measures above) to income from continuing operations for the years ended December 31, 2006 and
2005 (in thousands of dollars):
Year Ended December 31
2006
2005 Adjusted EBITDA
$
218,383
$
145,145 Income tax expense related to continuing operations
(60,050
)
(28,594
) Income tax expense related to earnings from equity investees
(1,043
)
(446
) Net interest expense
(27,148
)
(27,738
) Depreciation and amortization expense
(22,783
)
(22,081
) Credit facility termination costs
(3,069
) Income from continuing operations
$
107,359
$
63,217 Impact of Foreign Currency Translations For the year ended December 31, 2006, income from continuing operations before taxes increased $74.8 million, or 82%, to $165.8 million, when compared to the prior year. During 2006, the
favorable impact of foreign currency translations on income from continuing operations before taxes was approximately $3.1 million. Excluding the favorable impact of foreign currency translations,
income from continuing operations before taxes increased $71.7 million, or 79%, to $162.7 million for the year ended December 31, 2006 (see Use of Non-GAAP Financial Measures above). In
2006, the favorable impact of foreign currency translations on income from continuing operations before taxes consists of the following (in thousands of dollars):
For the Year Ended December 31, 2006
Favorable/ Total revenues
$
7,237 Total expenses
(4,006
) Operating income
3,231 Net interest expense and other
(85
) Income from continuing operations before taxes
$
3,146 Revenues For the years ended December 31, 2006 and 2005, revenues from continuing operations consist of the following (in thousands of dollars):
Year Ended December 31
2006
2005
Favorable/(Unfavorable)
$ Change
% Change Auction and related revenues: Auction commission revenues
$
551,230
$
441,301
$
109,929
24.9
% Auction expense recoveries
17,467
19,312
(1,845
)
(9.6
%) Private sale commissions
25,790
20,600
5,190
25.2
% Principal activities **
13,640
(1,305
)
14,945
* Catalogue subscription revenues
8,753
9,690
(937
)
(9.7
%) Other
14,464
7,301
7,163
98.1
% Total auction and related revenues
631,344
496,899
134,445
27.1
% Other revenues: Finance revenues
15,864
8,302
7,562
91.1
% Dealer revenues **
12,776
5,131
7,645
* License fee revenues
2,922
1,404
1,518
* Other
1,903
2,117
(214
)
(10.1
%) Total other revenues
33,465
16,954
16,511
97.4
% Total revenues
$
664,809
$
513,853
$
150,956
29.4
% 20
(Unfavorable)
Legend:
*
Represents a change in excess of 100%. ** In the fourth quarter of 2006, due to the acquisition of NMP (see Acquisition below) and the resulting increase in the Companys Dealer activities, certain activities which were previously
managed and reported as part of the Auction segment were realigned with NMP and aggregated into a newly established Dealer segment under the oversight of an executive committee
responsible for managing the Companys portfolio of Dealer activities. Such activities principally include:
The investment in and resale of art and other collectibles directly by the Company. The investment in art through unsecured loans made by the Company to unaffiliated art dealers. (See Note E of Notes to Consolidated Financial Statements under Item 8, Financial
Statements and Supplementary Data.) The activities of certain equity investees, including AMA. (See Note F of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) The purchase and resale of art through an art dealer whose results are required to be consolidated with the Companys results under generally accepted accounting principles. The
Company has no equity investment in this entity. (See Note R of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) Accordingly, revenues related to such activities, which prior to this Form 10-K were classified as Auction and Related Revenues, are now reported as Dealer Revenues for all periods
presented. Auction and Related Revenues For the year ended December 31, 2006, auction and related revenues increased $134.4 million, or 27%, to $631.3 million, when compared to the prior year, primarily due to a $110 million, or
25%, increase in auction commission revenues. To a much lesser extent, the increase in auction and related revenues is attributable to a higher level of principal activities and private sale
commissions, as well as a $3 million fee earned during the fourth quarter of 2006 for facilitating a private sale transaction in which the Company was not the primary broker and for which there was
no comparable event in 2005. This fee is reflected in the table above within other auction and related revenues. The significant factors impacting the increase in auction and related revenues for the
year ended December 31, 2006 are explained in more detail below. Auction Commission RevenuesFor the year ended December 31, 2006, the higher level of auction commission revenues is primarily attributable to a 37% increase in Net Auction Sales, partially
offset by a 9% decrease in auction commission margin (from 18.7% to 17%). See Net Auction Sales and Auction Commission Margin below for a detailed discussion of these key performance
indicators. Net Auction SalesFor the year ended December 31, 2006, Net Auction Sales increased $872.7 million, or 37%, to $3.2 billion, when compared to the prior year primarily due to a $558.6 million,
or 72%, increase in Impressionist and Contemporary art sales in the Companys New York and London salesrooms. These results are indicative of the continued strength of these markets, which
greatly contributed to an increase in the average selling price of lots sold. The spring sales in New York were highlighted by the sale of Picassos Dora Maar with Cat for $85 million (hammer price),
for which there was no comparably priced painting sold in the prior year. Also contributing to the improvement versus the prior year is the broad strength of the art market, which yielded increases
across several other collecting categories including:
A $48.4 million increase in sales of 19th Century Paintings, most notably in London, with smaller improvements in Zurich and Amsterdam.
21
A $46.5 million, or 125%, increase in Asian art sales in New York, reflecting market growth in the areas of Chinese Contemporary art and Indian and Southeast Asian art. A $44 million increase in Net Auction Sales attributable to Sothebys Asia (which includes auction salesrooms in Hong Kong, Singapore and Australia), primarily due to a 166% improvement
in sales of Chinese Contemporary art and a 37% increase in sales of jewelry and watches in Hong Kong. A $41.4 million, or 47%, increase in sales of Russian art in New York and London, reflecting the continued growth of this market. A $34.9 million, or 36%, increase in sales of American Paintings due, in part, to the November 2006 sale of Edward Hoppers Hotel Window for $26.9 million. There was no comparable
painting sold at auction in the prior year in this collecting category. A $28.7 million, or 17%, increase in sales of Old Master Paintings and Drawings, with favorable sales results in New York ($43.3 million increase) and Milan ($9.8 million increase) partially
offset by lower results from sales in London ($26.4 million decrease). In 2005, the July Old Master Paintings sale in London included the sale of Canalettos Venice, The Grand Canal, Looking
Northeast From Palazzo Balbi To The Rialto Bridge for approximately $29 million. There was no comparably priced painting offered in the July 2006 sales. Auction Commission MarginAuction commission margin represents total auction commission revenues as a percentage of Net Auction Sales. Typically, auction commission margins are higher for
lower value works of art or collections, while higher valued property earns lower margins. Auction commission margins are adversely impacted by arrangements whereby, in certain limited situations,
auction commissions are shared with the consignor or with the Companys partners in auction guarantees. In certain of these instances, the Company may share auction commissions with the
consignor as part of an auction guarantee in exchange for a portion of the hammer price in excess of a negotiated amount. Auction commissions shared with auction guarantee partners are the result
of managements decision to reduce auction risk through sharing arrangements with such partners, whereby the Company reduces its financial exposure under an auction guarantee in exchange for
sharing the auction commission. For the year ended December 31, 2006, auction commission margin decreased 9% (from 18.7% to 17%) primarily due to a change in sales mix as a more significant portion of Net Auction Sales
in 2006 were at the high-end of the Companys business where auction commission margins are traditionally lower. Also contributing to the deterioration in auction commission margin were certain
significant consignments in the second and fourth quarters of 2006 that were sold subject to commission sharing arrangements, whereby the Company shared the auction commissions in exchange for a
portion of the hammer price in excess of a negotiated amount (see discussion of Principal Activities below). Effective January 12, 2007, the Company increased its buyers premium charged on certain auction sales. In salesrooms in the U.S., the buyers premium is now 20% on the first $500,000 of the
hammer (sale) price and 12% of any remaining amount over $500,000. In foreign salesrooms, these U.S. dollar thresholds are translated into an appropriate fixed local currency amount. Previously,
the buyers premium charged on auction sales was generally 20% of the hammer price on the first $200,000 and 12% of any remaining amount over $200,000. It is expected that while this increase
will impact only a very small percentage of lots the Company sells worldwide, it will further strengthen the Companys ability to compete in the marketplace. (See statement on Forward Looking
Statements.) Principal ActivitiesAuction segment principal activities consist mainly of income or loss related to auction guarantees and gains or losses related to the sale of Auction segment inventory, as well
as any decreases in the carrying value of its inventory. Auction segment inventory consists principally of objects obtained as a result of the failure of guaranteed property to sell at auction, and to a
much lesser extent, objects obtained incidental to the auction process, primarily as a result of defaults by purchasers after the consignor has been paid, and the honoring of purchasers claims. 22
For the year ended December 31, 2006, principal activities increased $14.9 million when compared to the prior year, primarily due to significantly favorable guarantee experience in the second
quarter of 2006 (see discussion of Auction Commission Margin above). As discussed above, in certain limited situations the Company may share auction commissions with the consignor as part of an
auction guarantee in exchange for a portion of the hammer price in excess of the guaranteed amount. As a result, in periods impacted by such arrangements, such as in this period, auction
commission revenues are best reviewed in the aggregate with principal activities to fully understand auction and related revenues for the period. Also contributing to the increase in principal activities in 2006 is a $6.3 million gain recognized on the sale of a painting that failed to sell at auction in 2004 and was acquired as a result of a
guarantee, for which there was no comparable gain in 2005. As discussed in more detail below under Off-Balance Sheet Arrangements, when guaranteed property fails to sell at auction, the amount
of the auction guarantee must be paid, but the Company has the right to recover such amount through future sale of the property. In certain instances such as the sale described above, the sale
proceeds ultimately realized by the Company exceed the amount of any prior losses recognized on the auction guarantee. Private Sale CommissionsThe level of private sale commissions earned by the Company in any period is typically highly variable. For the year ended December 31, 2006, private sale commissions
increased $5.2 million, or 25%, when compared to prior year. Most notably, 2006 results include revenue associated with the private sale of the Collection of Dr. Martin Luther King, Jr. and private
sales conducted at the Chatsworth House, for which there were no comparable sales in the prior year. The overall increase in private sale commissions reflects managements continued commitment
to pursue private sales opportunities in the strong international art market. Finance Revenues For the year ended December 31, 2006, Finance revenues increased $7.6 million, or 91%, when compared to the prior year. This substantial increase principally results from a 54% increase in the
average loan portfolio balance during the year (from $102.6 million to $158 million). Also favorably impacting the comparison to the prior year are higher interest rates earned on the loan portfolio
primarily resulting from an increase in the Prime Rate. A significant portion of the increase in the average loan portfolio balance is the result of three term loans issued to the same borrower in the
second and fourth quarters of 2005 and in the third quarter of 2006 totaling approximately $59 million. These loans are due to be repaid in May 2007 (approximately $51 million) and February 2008
(approximately $8 million). For the year ended December 31, 2006, these three loans contributed approximately $3.4 million to the increase in Finance revenues for the period and, in the aggregate,
comprise approximately 34% of the client loan portfolio at December 31, 2006. The growth in the Finance segments client loan portfolio reflects the availability of capital to fund new loans and
managements marketing efforts in this area. Dealer Revenues Dealer Revenues consist of revenues earned from the sale of Dealer segment inventory and the Companys share of gains resulting from the sale of property purchased by art dealers through
unsecured loans from the Company. Dealer inventory consists principally of property held by Noortman Master Paintings B.V. and objects purchased for investment purposes. Dealer revenues increased $7.6 million in 2006 when compared to the prior year mostly due to incremental revenues contributed by NMP, which was acquired by the Company in June 2006.
These revenues are partially offset by $6.1 million in related cost of sales. Robert Noortman, Managing Director of NMP, died unexpectedly on January 14, 2007. NMP is continuing under the
leadership of Mr. Noortmans son, William. (See Acquisition below and Note C of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for
more discussion of the acquisition and the impact of Mr. Noortmans death.) 23
License Fee Revenues For the year ended December 31, 2006, license fee revenues increased $1.5 million when compared to the prior year. License fee revenues consist principally of fees earned in conjunction with a
license agreement with Realogy Corporation (Realogy), formerly Cendant Corporation. Under this agreement, Realogy licenses the Sothebys International Realty trademark and certain related
trademarks in exchange for an ongoing license fee based upon a percentage of the volume of commerce transacted under licensed trademarks. Expenses For the years ended December 31, 2006 and 2005, expenses from continuing operations consist of the following (in thousands of dollars):
Year Ended December 31
2006
2005
Favorable/(Unfavorable)
$ Change
% Change Direct costs of services
$
74,120
$
65,782
($8,338
)
(12.7
%) Dealer cost of sales
6,060
(6,060
)
* Salaries and related costs
226,410
187,753
(38,657
)
(20.6
%) General and administrative expenses
138,278
114,974
(23,304
)
(20.3
%) Depreciation and amortization expense
22,783
22,081
(702
)
(3.2
%) Total expenses
$
467,651
$
390,590
($77,061
)
(19.7
%) Legend:
*
Represents a change in excess of 100%.
Direct Costs of Services Direct costs of services consists largely of catalogue production and distribution costs, as well as sale marketing costs and corporate marketing expenses. The level of direct costs incurred in any
period is generally dependent upon the volume and composition of the Companys auction offerings. For example, direct costs attributable to single-owner or other high-value collections are typically
higher than those associated with standard various-owner sales, mainly due to higher promotional costs for catalogues, special events and traveling exhibitions, as well as higher shipping expenses. For the year ended December 31, 2006, direct costs of services increased $8.3 million, or 13%, when compared to the prior year. The increase in direct costs is consistent with the volume and
type of property offered and sold at auction during 2006. In particular, the increase reflects higher sale promotion and shipping costs related to the successful Impressionist and Contemporary art sales
in New York and London, in addition to $1 million of costs to promote a private sale exhibition at the Chatsworth House in the U.K. Also contributing to the increase in direct costs are $1.5 million
in corporate marketing expenses attributable to increased spending for client service programs, $0.9 million attributable to the unfavorable impact of foreign currency translations and a $0.8 million
increase in venue preparation costs for sales conducted at a new location in Hong Kong. The overall increase in direct costs for the period is partially offset by costs incurred in 2005 related to significant off-premises single-owner sales, for which there were no comparable events in
2006. Specifically, in 2005, direct costs included approximately $4.8 million in costs related to the off-premises single-owner auction sale of property from the Royal House of Hanover in Germany in
October 2005 and $1.5 million in costs related to the sale of cars and memorabilia at Ferrari headquarters in Maranello, Italy. 24
Salaries and Related Costs For the years ended December 31, 2006 and 2005, salaries and related costs consisted of the following (in thousands of dollars):
Year Ended December 31
2006
2005
Favorable/(Unfavorable)
$ Change
% Change Full-time salaries
$
110,882
$
101,287
($9,595
)
(9.5
%) Employee benefits
25,641
20,929
(4,712
)
(22.5
%) Payroll taxes
17,883
14,102
(3,781
)
(26.8
%) Incentive bonus costs
41,970
30,479
(11,491
)
(37.7
%) Stock compensation expense
13,335
3,716
(9,619
)
* Option Exchange
2,484
4,553
2,069
45.4
% Other **
14,215
12,687
(1,528
)
(12.0
%) Total salaries and related costs
$
226,410
$
187,753
($38,657
)
(20.6
%) Key Performance Indicator: Salaries and related costs as a % of total revenues
34.1
%
36.5
%
N/A
6.8
% Legend:
*
Represents a change in excess of 100%. ** Principally includes the cost of temporary labor and overtime. In recent years, the Companys overall compensation strategy has evolved towards having greater variability in pay, dependent upon the Companys profitability. Also, the Companys equity
compensation strategy has evolved towards a preference for restricted stock as opposed to stock options. These strategic shifts are reflected in the $38.7 million, or 21%, increase in salaries and
related costs during 2006, as the significant drivers of this increase include higher levels of incentive bonus costs and restricted stock compensation expense due to the significant profitability of the
Company. In 2006, the level of salaries and related costs was also impacted by strategic headcount additions in certain departments, as discussed in more detail below, which contributed to the 10%
increase in full-time salaries. The comparison to the prior year is also unfavorably impacted by higher employee benefits and payroll taxes. See discussion below for a more detailed explanation of
each of these factors. Incentive Bonus CostsFor the year ended December 31, 2006, incentive bonus costs increased $11.5 million, or 38%, when compared to the prior year, due to the Companys strong financial
performance in 2006. Stock Compensation ExpenseFor the year ended December 31, 2006, stock compensation expense (excluding costs related to the Exchange Offer described below) increased $9.6 million when
compared to the prior year. This increase is attributable to stock compensation costs resulting from compensation arrangements with certain senior executives consummated in 2006 totaling $5.5
million for the year ended December 31, 2006, as well as incremental costs from other restricted stock awarded during 2006. Included in the stock compensation expense associated with these
executive compensation arrangements is $3.5 million related to shares of restricted stock granted in 2006 that will only vest and create value for the recipients at the end of a minimum employment
period, and only if certain objective performance or market-based criteria are satisfied. Additionally, for the year ended December 31, 2006, the Company recognized $1.4 million in stock
compensation expense for stock options resulting from the adoption of SFAS No. 123R, Share-Based Payment, on January 1, 2006. For the year ending December 31, 2007, stock compensation
expense for stock options is expected to total $0.2 million, a decrease of $1.2 million when compared to 2006. (See Note M of Notes to Consolidated Financial Statements under Item 8, Financial
Statements and Supplementary Data, for detailed information related to the adoption of SFAS No. 123R.) For the year ending December 31, 2007, stock compensation expense (excluding costs related to the Exchange Offer discussed below) is expected to increase approximately $11.1 million when
compared to 2006, principally due to restricted stock grants made in February 2007, as well the 2006 restricted stock grants discussed above. A portion of this increase ($1.2 million) reflects the full-
year impact of shares of restricted stock granted in 2006 to certain senior executives that will only vest 25
and create value for the recipients at the end of a minimum employment period, and only if certain objective performance or market-based criteria are satisfied. (See statement on Forward Looking
Statements.) The chart below details the stock compensation for the years ended December 31, 2006 (actual), 2007 (projected) and 2008 (projected) based upon restricted stock grants and employment
arrangements signed as of February 26, 2007. Type of Grant
2006
2007
2008
(Thousands of dollars) 2006 Executive Bonus Plan Grant *
$
2,289
$
1,249
$
511 2007 Executive Bonus Plan Grant *
3,270
1,783 2006 Employment Arrangements
5,456
6,951
6,868 All other grants and contractually committed stock compensation
4,200
12,724
7,786 Stock Option Expense
1,390
192
25 Total Stock Compensation Expense
$
13,335
$
24,386
$
16,973 Legend:
*
Executive Bonus Plan grants are based on the Companys financial performance in the year prior to the date of grant. (See Note M of Notes to Consolidated Financial Statements under Item
8, Financial Statements and Supplementary Data, for additional information on the Executive Bonus Plan.)
Note: The chart above does not include the potential issuance of performance-based restricted stock under the Companys Executive Bonus Plan in 2008 or any additional discretionary restricted stock
grants in 2007 or 2008. Any such awards of restricted stock would generate higher total stock compensation expense than shown in the chart above. (See statement on Forward Looking Statements.) Full-Time SalariesFor the year ended December 31, 2006, full-time salaries increased $9.6 million, or 10%, when compared to the prior year. This increase is principally due to strategic headcount
additions in certain departments within the Auction segment which have experienced market growth, including Contemporary Paintings, Impressionist Paintings, Russian Art and Asian Art, as well as
limited salary increases throughout the Company. The overall increase in full-time salaries is partially offset by $0.8 million of savings achieved in the second half of 2006 as a result of the outsourcing
of the Companys catalogue production operations in the U.K. in the first half of 2006. Payroll TaxesFor the year ended December 31, 2006, payroll taxes increased $3.8 million, or 27%, when compared to the prior year, principally due to incremental taxes associated with a
significantly higher level of employee stock option exercises and the vesting of restricted stock shares during 2006. To a lesser extent, the increase in payroll taxes is also attributable to the increases
in full-time salaries and incentive bonus costs discussed above. Employee Benefit CostsEmployee benefit expenses include costs of the Companys retirement plans, the costs of its health and welfare programs and, to a much lesser extent, severance costs. The
Companys material retirement plans include a defined benefit pension plan, covering most employees in the U.K., and defined contribution and deferred compensation plans for employees in the
U.S. The U.S. plans provide for a Company matching contribution of up to 6% of each participants eligible compensation, as well as a discretionary annual Company contribution that varies
depending on the Companys profitability. Generally, the level of employee benefit costs is dependent upon movements in headcount and compensation levels, as well as the Companys financial
performance. Additionally, expenses related to the Companys U.K. defined benefit pension plan are significantly influenced by interest rates and investment performance in the debt and equity
markets (see Part I, Item 1A, Risk Factors). For the year ended December 31, 2006, employee benefit costs increased $4.7 million, or 23%, when compared to the prior year. The higher level of employee benefit costs is attributable to the 26
Actual
Projected
Projected
headcount, salary and incentive bonus cost increases discussed above in addition to the following factors:
A $2.8 million increase in the cost of benefits for the Companys U.K. employees. Included in this amount is a $2.2 million, or 50%, increase in costs related to the U.K. Pension Plan (see
Note N of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data). A $0.9 million increase in severance costs, principally in Europe. A $0.7 million, or 41%, increase in profit sharing costs related to the Companys U.S. defined contribution and deferred compensation plans as a result of the Companys strong financial
performance. The overall increase in employee benefit costs in 2006 is partially offset by a $0.9 million one-time charge recognized in 2005 for retirement benefits in Germany, for which there is no
comparable expense in the current period. As discussed above under Critical Accounting Estimates, actuarial losses related to the U.K. Pension Plan were approximately $91 million ($63.7 million, after tax) as of the date of the most
recent plan actuarial valuation (September 30, 2006). These losses accumulated over several years as a result of differences in actual experience compared to projected experience and were specifically
influenced by a general trend of lower discount rates, driven by the U.K. interest rate environment, as well as the adoption of updated mortality tables reflecting more recent data on longer life
expectancies. These losses, which are reflected in the Consolidated Balance Sheets on an after-tax basis within accumulated other comprehensive loss and not yet recognized in net pension cost, are
being systematically recognized as an increase in future net periodic pension cost in accordance with SFAS No. 87, Employers Accounting for Pensions and SFAS No. 158, Employers Accounting
for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R). In 2007, management projects an increase of approximately $4 million
in costs related to the U.K. Pension Plan, principally due to higher amortization of such unrecognized losses, as well as higher interest costs resulting from an increase in the projected benefit
obligation. (See statement on Forward Looking Statements.) Option Exchange ProgramIn February 2003, the Compensation Committee approved an exchange offer of cash or restricted stock for certain stock options held by eligible employees under the
1997 Stock Option Plan (the Exchange Offer). The Exchange Offer was tendered during the first half of 2004. For the year ended December 31, 2006, compensation expense related to the Exchange Offer decreased $2.1 million, or 45%, when compared to the prior year as a result of lower stock
compensation expense related to the issuance of 1.1 million restricted shares in the Exchange Offer, which is being amortized over a graded four-year vesting period. The amortization of stock
compensation expense related to the Exchange Offer is expected to be approximately $1.2 million and $0.2 million for the years ended December 31, 2007 and 2008, respectively. (See statement on
Forward Looking Statements.) General and Administrative Expenses For the year ended December 31, 2006, general and administrative expenses increased $23.3 million, or 20%, when compared to the prior year. This increase is largely attributable to the
following factors:
A $9.8 million, or 33%, increase in professional fees, which is partially attributable to $3.3 million in costs associated with outsourcing the Companys catalogue production operations in the
U.K. Also contributing to the increase are approximately $2.2 million in consulting fees related to strategic corporate initiatives, including several client service and marketing initiatives; as well
as $1.7 million in tax staffing fees. A $4.5 million, or 24%, increase in travel and entertainment costs principally due to the higher level of travel for pursuing business opportunities during the period. Also contributing to the
increase in travel and entertainment costs during the period are price increases for airfares and other travel costs. 27
A $2.9 million benefit recorded in the fourth quarter of 2005 related to the reversal of certain sales tax estimates that were no longer necessary, for which there was no comparable event in the
current period. A $2.3 million, or 8%, increase in premises related costs principally due to increased rental costs in Europe ($0.9 million), moving expenses related to the refurbishment of the Companys New
Bond Street building in London ($0.6 million) and increased cost for building repairs and maintenance in the U.K. ($0.4 million). A $2.3 million increase in authenticity claims, goodwill gestures and other litigation-related charges. $1.1 million in general and administrative costs related to Noortman Master Paintings, which was acquired in June 2006 and for which there are no comparable costs in the prior year. $1 million contingency reserve recorded in the fourth quarter of 2006 related to certain state and local tax issues. (See Note O of Notes to Consolidated Financial Statements under Item 8,
Financial Statements and Supplementary Data.) A $0.7 million charge related to the final settlement of the Canadian Competition Bureau investigation. (See Note Q of Notes to Consolidated Financial Statements under Item 8, Financial
Statements and Supplementary Data.) Various smaller increases in other general and administrative expenses totaling approximately $2 million. For the year ended December 31, 2006, the overall increase in general and administrative expenses was partially offset by the one-time benefit associated with the recovery of $2.4 million in
administrative expenses related to the settlement of the International Antitrust Litigation (see Note Q of Notes to Consolidated Financial Statements under Item 8, Financial Statements and
Supplementary Data, for information related to the original income statement classification of such expenses) and a $1 million reduction in insurance costs, reflecting managements cost reduction
efforts and lower overall premiums available in the insurance market. Depreciation and Amortization Expense For the year ended December 31, 2006, depreciation and amortization expense increased $0.7 million, or 3%, to $22.8 million when compared to the prior year principally due to $1.7 million of
amortization expense related to intangible assets acquired in the acquisition of Noortman Master Paintings (see Acquisition below and Notes C and I of Notes to Consolidated Financial Statements
under Item 8, Financial Statements and Supplementary Financial Data), partially offset by lower depreciation expense as a result of the timing and rate of capital spending on depreciable fixed
assets. Net Interest Expense Due to funding requirements for new client loans, as well as decreased cash balances resulting from funding the Transaction described under Recapitalization below, the Company had
significantly lower average cash balances and short-term investments and a higher level of average outstanding revolving credit facility borrowings during the nine months ended September 30, 2006,
when compared to the same period in the prior year. As a result of these factors, for the nine months ended September 30, 2006, net interest expense increased $2.3 million, when compared to the
same period in 2005. However, during the fourth quarter of 2006, average cash balances and short-term investments increased significantly and average outstanding credit facility borrowings decreased
as a result of the strength of the Companys auction sales, causing a $2.9 million decrease in net interest expense for the quarter. Overall, for the year ended December 31, 2006, net interest expense
decreased $0.6 million, or 2%, when compared to the prior year. (See Note J of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for
additional information related to interest expense.) 28
Credit Facility Termination Costs As discussed in more detail in Liquidity and Capital Resources below, on September 7, 2005, in connection with the Transaction described under Recapitalization below, the Company
terminated its senior secured credit agreement with General Electric Capital Corporation (the GE Capital Credit Agreement). As a result of the termination of the GE Capital Credit Agreement,
the Company incurred a $1 million termination fee and wrote off approximately $2.1 million in arrangement fees and other direct costs related to the GE Capital Credit Agreement, which were
previously being amortized over the term of the agreement. These charges are combined and reflected as a separate caption in the Consolidated Income Statement for the year ended December 31,
2005. There was no comparable event or charges impacting the Companys results for the year ended December 31, 2006. (See Liquidity and Capital Resources below and Note J of Notes to
Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for information related to the Companys credit arrangements.) Other Expense For the year ended December 31, 2006, other expense increased $2.8 million to $4.2 million principally due to net losses relating to the revaluation and settlement of certain forward exchange
contracts during the year. Such forward exchange contracts were principally used as cash flow hedges of the Companys exposure to foreign currency denominated future guarantee obligations. These
contracts are not designated as hedging instruments under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, and are recorded in the Consolidated Balance
Sheets at fair value, which is based on referenced market rates. (See Note B of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for more
information.) Provision for Income Taxes The effective tax rate related to continuing operations was approximately 36.2% in 2006, compared to approximately 31.4% in 2005. This increase is primarily the result of the benefit recorded in
2005 related to the reversal of the valuation allowance associated with certain federal and foreign net operating loss carryforwards, higher income tax reserves related to certain U.S. and international
issues (see Note O of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data) and increased deemed income from overseas subsidiaries. These
increases were partially offset by the utilization of foreign tax credits. At December 31, 2006, the Company has deferred tax assets related to state tax loss carryforwards totaling $20.4 million that begin to expire in 2008. The Company has provided a full valuation
allowance related to these deferred tax assets. In assessing the need for this valuation allowance management considers, among other things, its projections of future taxable income and ongoing
prudent and feasible tax planning strategies. In the event that the Company continues its strong performance and substantially exceeds its current financial projections of future taxable income, a
portion of, or the entire, valuation allowance related to state loss carryforwards may be reversed some time in 2007. (See Critical Accounting Estimates above and statement on Forward Looking
Statements below.) On November 7, 2005, the Companys Chief Executive Officer and Board of Directors approved a domestic reinvestment plan to repatriate up to $72.4 million of foreign earnings under the
American Jobs Creation Act of 2004 during 2005. These foreign earnings were previously considered to be indefinitely reinvested outside of the U.S. The Company repatriated approximately $72.4
million during 2005 and recorded income tax expense of $3.8 million. As of December 31, 2006, approximately $60.6 million of the repatriated funds have been used, primarily for capital asset costs
and leased asset investments. (See Item 1A, Risk Factors and Note K of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) Discontinued Operations For information related to Discontinued Operations, see Note T of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data. 29
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004 Note D (Segment Reporting) of Notes to Consolidated Financial Statements should be read in conjunction with this discussion. Overview The Companys results for the year ended December 31, 2005 reflected the continued strength of the international art market as Net Auction Sales and Private Sales (both defined below)
remained strong. In 2005, income from continuing operations increased 1% to $63.2 million even though 2004 results included one-time license fee revenues of $45.6 million earned in conjunction with
the consummation of the Realogy License Agreement (see License Fee Revenues below). The Companys strong financial performance in 2005 was largely the result of a significant improvement in
auction commission margins. The Companys results from continuing operations for the years ended December 31, 2005 and 2004 are summarized below (in thousands of dollars):
Favorable/(Unfavorable)
Year Ended December 31
2005
2004
$ Change
% Change Revenues: Auction and related revenues
$
496,899
$
439,526
$
57,373
13.1
% Finance revenues
8,302
5,907
2,395
40.5
% Dealer revenues
5,131
3,604
1,527
42.4
% License fee revenues
1,404
45,745
(44,341
)
(96.9
%) Other revenues
2,117
2,274
(157
)
(6.9
%) Total revenues
513,853
497,056
16,797
3.4
% Expenses
390,590
370,399
(20,191
)
(5.5
%) Operating income
123,263
126,657
(3,394
)
(2.7
%) Net interest expense
(27,738
)
(30,267
)
2,529
8.4
% Credit facility termination costs
(3,069
)
(3,069
)
* Other (expense) income
(1,474
)
267
(1,741
)
* Income from continuing operations before taxes
90,982
96,657
(5,675
)
(5.9
%) Equity in earnings of investees, net of taxes
829
740
89
12.0
% Income tax expense
28,594
35,000
6,406
18.3
% Income from continuing operations
$
63,217
$
62,397
$
820
1.3
% Key performance indicators: Aggregate Auction Sales (a)
$
2,752,185
$
2,694,544
$
57,641
2.1
% Net Auction Sales (b)
$
2,361,830
$
2,334,937
$
26,893
1.2
% Private Sales (c)
$
271,936
$
262,891
$
9,045
3.4
% Auction commission margin (d)
18.7
%
16.4
%
N/A
14.0
% Average loan portfolio (e)
$
102,605
$
82,519
$
20,086
24.3
% Adjusted EBITDA (f)
$
145,145
$
108,410
$
36,735
33.9
% Legend:
*
Represents a change in excess of 100%. (a) Represents the hammer (sale) price of property sold at auction plus buyers premium. (b) Represents the hammer (sale) price of property sold at auction. (c) Represents the total purchase price of property sold in private sales brokered by the Company. (d) Represents total auction commission revenues as a percentage of Net Auction Sales. (e) Represents the average loan portfolio of the Companys Finance segment. (f) See Use of Non-GAAP Financial Measures above and reconciliation to corresponding GAAP amount below. 30
Please see below for a more detailed discussion of the significant factors impacting the Companys results from continuing operations for the year ended December 31, 2005. The following is a reconciliation of Adjusted EBITDA (see Use of Non-GAAP Financial Measures above) to income from continuing operations for the years ended December 31, 2005 and
2004 (in thousands of dollars):
Year Ended December 31
2005
2004 Adjusted EBITDA
$
145,145
$
108,410 Income tax expense related to continuing operations
(28,594
)
(35,000
) Income tax expense related to earnings from equity investees
(446
)
(398
) Net interest expense
(27,738
)
(30,267
) Depreciation and amortization expense
(22,081
)
(23,837
) Credit facility termination costs
(3,069
)
One-time Cendant license fee revenue
45,650 Realogy License Agreement transaction costs
(2,161
) Income from continuing operations
$
63,217
$
62,397 Impact of Foreign Currency Translations For the year ended December 31, 2005, income from continuing operations before taxes decreased $5.7 million, or 6%, to $91 million, when compared to the prior year. During 2005, the
unfavorable impact of foreign currency translations on income from continuing operations before taxes was approximately $2.4 million. Excluding the unfavorable impact of foreign currency
translations, income from continuing operations before taxes decreased $3.3 million, or 3%, to $93.4 million for the year ended December 31, 2005 (see Use of Non-GAAP Financial Measures
above). In 2005, the unfavorable impact of foreign currency translations on income from continuing operations before taxes consisted of the following (in thousands of dollars):
Year Ended December 31, 2005
Favorable/ Total revenues
$
(5,075
) Total expenses
2,633 Operating income
(2,442
) Net interest expense and other
16 Income from continuing operations before taxes
$
(2,426
) 31
(Unfavorable)
Revenues For
the years ended December 31, 2005 and 2004, revenues from continuing operations
consisted of the following (in thousands of dollars):
Favorable/(Unfavorable)
Year Ended December 31
2005
2004
$ Change
% Change Auction and related revenues: Auction commission revenues
$
441,301
$
383,142
$
58,159
15.2
% Auction expense recoveries
19,312
17,633
1,679
9.5
% Private sale commissions
20,600
21,492
(892
)
(4.2
%) Principal activities *
(1,305
)
(1,001
)
(304
)
(30.4
%) Catalogue subscription revenues
9,690
9,700
(10
)
(0.1
%) Other
7,301
8,560
(1,259
)
(14.7
%) Total auction and related revenues
496,899
439,526
57,373
13.1
% Other revenues: Finance revenues
8,302
5,907
2,395
40.5
% Dealer revenues *
5,131
3,604
1,527
42.4
% License fee revenues
1,404
45,745
(44,341
)
(96.9
%) Other
2,117
2,274
(157
)
(6.9
%) Total other revenues
16,954
57,530
(40,576
)
(70.5
%) Total revenues
$
513,853
$
497,056
$
16,797
3.4
% Legend:
*
In the fourth quarter of 2006, due to the acquisition of NMP (see Acquisition below) and the resulting increase in the Companys Dealer activities, certain activities which were previously
managed and reported as part of the Auction segment were realigned with NMP and aggregated into a newly established Dealer segment under the oversight of an executive committee
responsible for managing the Companys portfolio of Dealer activities. Such activities principally include:
The investment in and resale of art and other collectibles directly by the Company. The investment in art through unsecured loans made by the Company to unaffiliated art dealers. (See Note E of Notes to Consolidated Financial Statements under Item 8, Financial
Statements and Supplementary Data.) The activities of certain equity investees including AMA. (See Note F of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) The purchase and resale of art through an art dealer whose results are required to be consolidated with the Companys results under generally accepted accounting principles. The
Company has no equity investment in this entity. (See Note R of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) Accordingly, revenues related to such activities, which prior to this Form 10-K were classified as Auction and Related Revenues, are now reported as Dealer Revenues for all periods
presented. Auction and Related Revenues For the year ended December 31, 2005, auction and related revenues increased $57.4 million, or 13%, to $496.9 million, when compared to the prior year. This improvement was almost entirely
due to a $58.2 million, or 15%, increase in auction commission revenues. The significant factors contributing to the improvement in auction commission revenues are explained in more detail below. Auction Commission RevenuesThe higher level of auction commission revenues during 2005 was principally due to a 14% improvement in auction commission margin (from 16.4% to 18.7%) and,
to a much lesser extent, a slight increase in Net Auction Sales. See Auction Commission Margin and Net Auction Sales below for a detailed discussion of these key performance indicators. The
overall increase in auction commission revenues was partially offset by the unfavorable impact of foreign currency translations, which decreased auction commission revenues by approximately $5
million during the year. 32
Auction Commission MarginAuction commission margin represents total auction commission revenues as a percentage of Net Auction Sales. Typically, auction commission margins are higher for
lower value works of art or collections, while higher valued property earns lower margins. Effective January 1, 2005, the Company increased its buyers premium charged on certain auction sales. In salesrooms in the U.S., the buyers premium was increased to 20% of the hammer
(sale) price on the first $200,000 and 12% of any remaining amount over $200,000. In foreign salesrooms, these U.S. dollar thresholds were translated into an appropriate fixed local currency amount
upon the effective date of the change. Previously, the buyers premium charged on auction sales was generally 20% of the hammer (sale) price on the first $100,000 and 12% of any remaining amount
over $100,000. As discussed above, for the year ended December 31, 2005, auction commission margin increased 14% (from 16.4% to 18.7%) when compared to the prior year principally due to the following
factors:
A $19.6 million decrease in shared auction commissions as certain significant consignments for property sold in 2004 were subject to commission sharing arrangements with third parties. These
arrangements were primarily the result of the competitive environment for such consignments, as well as the Companys decision to reduce its auction guarantee risk through sharing
arrangements with partners, whereby the Company reduced its financial exposure under the auction guarantee in exchange for sharing the auction commission with the partner. A favorable change in sales mix as a more significant portion of Net Auction Sales in 2004 were at the high-end of the Companys business where auction commission margins are traditionally
lower. The increase in the buyers premium rate structure discussed above. Net Auction SalesFor the year ended December 31, 2005, Net Auction Sales increased $26.9 million, or 1%, to $2.4 billion, when compared to the prior year. This increase was attributable to the
following factors:
A $57.3 million increase in various-owner sales of Contemporary art, reflecting the strength of this market. A $51.2 million, or 36%, increase in Net Auction Sales conducted by Sothebys Asia (which includes auction salerooms in Hong Kong, Singapore and Australia) primarily due to a higher level
of Chinese Ceramics and Paintings sales, in addition to a $20 million improvement in Asian art sales in New York and London, both which reflect the continued growth of the Chinese art
market. A $42.4 million increase in Russian art sales, reflecting the rapid growth of that market. Net Auction Sales attributable to the November 2005 sale of property from the single-owner decorative arts collection of Lilly and Edmond J. Safra in New York ($41.9 million) and the
October 2005 off-premises single-owner sale of property from the Royal House of Hanover in Germany ($41.4 million). Except for the historic May 2004 sale of property from the Greentree
Foundation discussed below, there were no comparable single-owner sales in the prior year. Several increases in Net Auction Sales related to recurring sales, such as those for 19th Century Paintings ($23 million improvement) and Jewelry in the U.S. and Europe ($20 million
improvement). These increases in Net Auction Sales in 2005 were largely offset as prior year results include the May 2004 sale of property from the Greentree Foundation, which totaled $189.4 million and for
which there was no comparable event in 2005. To a lesser extent, the comparison to the prior year was unfavorably influenced by a $46.7 million decrease in various-owner sales of Impressionist art
primarily due to several high-value works sold in the November 2004 Impressionist sale in New York for which there were no comparable works sold in the same sale in 2005. Also partially offsetting
the overall increase in Net Auction Sales versus the prior year was a $30 million decrease in various-owner American Paintings sales, which, in 2004, included the sale of John Singer Sargents
Group of Parasols (A Siesta) for $21 million. There was no comparable picture sold at auction in the 2005 American Paintings sales. 33
Private Sales CommissionsThe level of private sales commissions earned by the Company in any period is typically variable. In 2005, private sales commissions remained at a historically high level
totaling $20.6 million, representing a slight decrease compared to the prior year even though 2004 results included private sales commissions related to the landmark private sale of the Forbes
Collection of Faberge. Finance Revenues For the year ended December 31, 2005, Finance revenues increased $2.4 million, or 41%, when compared to the prior year. This increase was principally due to a 24% increase in the average
loan portfolio balance (from $82.5 million to $102.6 million), including two loans made to the same borrower in the second and fourth quarters of 2005. This increase was due in part to the
availability of capital to fund new loans and marketing efforts to increase client loan activity. The comparison of 2005 Finance segment revenues to the prior year was unfavorably influenced by $1
million in interest income recognized in the second quarter of 2004 as a result of the collection of a disputed client loan, for which there was no comparable event in 2005. License Fee Revenues For the year ended December 31, 2005, license fee revenues decreased $44.3 million to $1.4 million, when compared to the prior year as 2004 results include $45.6 million in one-time license fee
revenues earned in conjunction with the consummation of the Realogy License Agreement (see Note T of Notes to Consolidated Financial Statements under Item 8, Financial Statements and
Supplementary Data). In 2005, license fee revenues included $1.3 million in ongoing license fees earned as a result of Realogys continued use of the Companys licensed trademarks. Expenses For the years ended December 31, 2005 and 2004, expenses from continuing operations consisted of the following (in thousands of dollars):
Favorable/(Unfavorable)
Year Ended December 31
2005
2004
$ Change
% Change Direct costs of services
$
65,782
$
55,551
($10,231
)
(18.4
%) Salaries and related costs
187,753
177,717
(10,036
)
(5.6
%) General and administrative expenses
114,974
112,863
(2,111
)
(1.9
%) Depreciation and amortization expense
22,081
23,837
1,756
7.4
% Retention costs
285
285
100.0
% Net restructuring charges
146
146
100.0
% Total expenses
$
390,590
$
370,399
($20,191
)
(5.5
%) Direct Costs of Services Direct costs of services consisted largely of catalogue production and distribution costs, as well as sale marketing costs and corporate marketing expenses. The level of direct costs incurred in any
period is generally dependent upon the volume and composition of the Companys auction offerings. For example, direct costs attributable to single-owner collections are typically higher than those
associated with various-owner sales, mainly due to higher promotional costs for catalogues, special events and traveling exhibitions. For the year ended December 31, 2005, direct costs of services increased $10.2 million, or 18%, to $65.8 million when compared to the prior year, principally due to the higher number and type
of single-owner sales during the period. Specifically, in 2005, direct costs included expenses related to significant off-premises single-owner sales for which there were no comparable events in the prior
period, including the sale of property from the Royal House of Hanover in Germany ($4.8 million); the sale of cars and memorabilia at Ferrari headquarters in Maranello, Italy ($1.5 million) and the
Easton Neston house sale in Northamptonshire, U.K. ($0.8 million). Also contributing to the higher level of direct costs in 2005 were increases of $2 million and $1.9 million related to sales
conducted 34
during the period in Asia and the U.K. (excluding the Easton Neston sale discussed above), respectively. These increases were generally consistent with the higher level of Net Auction Sales achieved
in those regions. The overall increase in direct costs was partially offset by the favorable impact of foreign currency translations, which decreased direct costs by approximately $0.8 million during the
year. Salaries and Related Costs For the years ended December 31, 2005 and 2004, salaries and related costs consisted of the following (in thousands of dollars):
Favorable/(Unfavorable)
Year Ended December 31
2005
2004
$ Change
% Change Full-time salaries
$
101,287
$
98,424
($2,863
)
(2.9
%) Employee benefits
20,929
19,339
(1,590
)
(8.2
%) Payroll taxes
14,102
13,355
(747
)
(5.6
%) Incentive bonus costs
30,479
25,909
(4,570
)
(17.6
%) Stock compensation expense
3,716
1,098
(2,618
)
* Option Exchange
4,553
7,688
3,135
40.8
% Other **
12,687
11,904
(783
)
(6.6
%) Total salaries and related costs
$
187,753
$
177,717
($10,036
)
(5.6
%) Key Performance Indicator: Salaries and related costs as a % of total revenues
36.5
%
35.8
%
N/A
2.0
% Legend:
*
Represents a change in excess of 100%. ** Principally includes the cost of temporary labor and overtime. In recent years, the Companys compensation strategy evolved towards having greater variability in pay, dependent upon the Companys profitability. Also, the Companys equity compensation
strategy evolved towards a preference for restricted stock as opposed to stock options. The $10 million, or 6%, increase in salaries and related costs during 2005 reflected this change in strategy as the
significant drivers of this increase were higher levels of incentive bonus costs and restricted stock compensation expense. Also contributing to the increase versus the prior year was a 3% increase in
full-time salaries, principally due to limited salary and headcount increases in 2005, and increased employee benefit costs. The overall increase in salaries and related costs for the period was partially
offset by lower Option Exchange costs, as well as the favorable impact of foreign currency translations, which decreased salaries and related costs by approximately $1.3 million during the year. See
discussion below for a more detailed explanation of certain of these factors. Incentive Bonus CostsFor the year ended December 31, 2005, incentive bonus costs increased $4.6 million, or 18%, to $30.5 million, when compared to the prior year. This increase was
attributable to the Companys strong financial performance during 2005, even when compared to the prior years results from continuing operations which included one-time license fee revenues of
$45.6 million earned in conjunction with the consummation of the Realogy License Agreement (see License Fee Revenues above). Stock Compensation ExpenseFor the year ended December 31, 2005, stock compensation expense related to restricted stock shares granted pursuant to the Restricted Stock Plan (excluding shares
issued in conjunction with the Exchange Offer discussed below) increased $2.6 million when compared to the prior year. This increase was primarily due to the amortization of stock compensation
expense associated with restricted stock shares granted in 2005. (See Note M of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for information related to the Restricted Stock Plan.) Employee BenefitsFor the year ended December 31, 2005, employee benefits increased $1.6 million, or 8%, to $20.9 million, when compared to the prior year. The higher level of employee benefits for
the period was primarily due to a $1.7 million, or 61%, increase in costs related to the U.K. 35
Pension Plan (see Note N of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data). To a lesser extent, the increase in employee benefits was
attributable to incremental profit-sharing costs of $0.8 million related to the Companys U.S. pension plans, reflecting the Companys strong financial performance for 2005 (see Incentive Bonus Costs
above), as well as increased other benefit costs attributable to limited salary and headcount increases and market inflation for such costs. In the prior year, certain contributions to the Companys U.S.
pension plans were determined as a fixed percentage of an employees eligible compensation rather than via a profit-sharing formula. Also unfavorably impacting the comparison to the prior year was a $0.9
million one-time charge for retirement benefits in Germany. The overall increase in employee benefit costs in 2005 was largely offset by a $2.8 million decrease in severance costs. Option Exchange ProgramIn February 2003, the Compensation Committee approved an exchange offer of cash or restricted stock for certain stock options held by eligible employees under the
1997 Stock Option Plan. The Exchange Offer was tendered during the first half of 2004. In 2005, compensation expense related to the Exchange Offer decreased $3.1 million, or 41%, to $4.6 million,
as prior year results include $2.2 million of expense recognized in the first quarter of 2004 representing the one-time cash payment made to employees upon acceptance of the Exchange Offer on
March 31, 2004. The comparison to the prior period was also favorably influenced by lower amortization of stock compensation related to the issuance of 1.1 million restricted shares as a result of the
Exchange Offer, the expense relating to which is being amortized over a graded four-year vesting period. General and Administrative Expenses For the year ended December 31, 2005, general and administrative expenses increased $2.1 million, or 2%, to $115 million, when compared to the prior year. This increase was largely attributable
to the following factors:
An insurance recovery of approximately $4 million, which reduced general and administrative expenses in the second quarter of 2004, for which there was no comparable event in 2005. A $2.7 million increase in travel and entertainment costs, principally due to the higher level of travel for pursuing business opportunities during 2005, reflecting the strength of the art market. A $1.4 million increase in professional fees, primarily due to $1.1 million in incremental fees incurred as a result of outsourcing management of the Companys catalogue production operations
in the U.S. Outsourcing allowed the Company to achieve improved quality along with cost efficiencies and headcount reductions in this area. A $1.4 million increase in facility related expenses primarily as a result of higher costs for utilities and security. A $1.2 million increase in property taxes related to the Companys headquarters building at 1334 York Avenue in New York as a result of a tax reassessment that became effective on July 1,
2004. The recovery of $1 million in previously paid real estate taxes in the U.K. recorded in the third quarter of 2004, for which there was no comparable event in 2005. $0.9 million in lease abandonment costs in the U.K. incurred in the fourth quarter of 2005, for which there was no comparable event in 2004. The overall increase in general and administrative expenses for the year ended December 31, 2005 was partially offset by the following factors:
A $2.9 million benefit recorded in the fourth quarter of 2005 due to the reversal of certain sales tax estimates that were no longer necessary, for which there was no comparable event in the
prior year. A $2.4 million decrease in client goodwill gestures, authenticity claims and litigation settlements primarily as a result of fewer and less costly occurrences of such matters in 2005. $2.2 million in transaction costs incurred in 2004 related to the consummation of the Companys agreement with Realogy to license the Sothebys International Realty trademark, for which
there were no comparable fees incurred in 2005. 36
A $1 million reduction in insurance costs, reflecting managements cost reduction efforts and lower overall premiums available in the market. A $0.8 million decrease in settlement administration costs and legal fees associated with certain civil antitrust litigation (see Note Q of Notes to Consolidated Financial Statements under Item 8,
Financial Statements and Supplementary Data). The reversal of a $0.7 million legal accrual in the fourth quarter of 2005 as a result of favorable changes in circumstances, for which there was no comparable event in 2004. A $0.6 million decrease in computer costs principally as a result of the favorable renegotiation of a maintenance outsourcing agreement. Depreciation and Amortization Expense For the year ended December 31, 2005, depreciation and amortization expense decreased $1.8 million, or 7%, to $22.1 million when compared to the prior year principally due to the timing and
rate of capital spending on depreciable assets, as well as $0.3 million in accelerated depreciation expense recognized in the third quarter of 2004 for assets retired as a result of the consolidation of
the Companys New York warehouse space into its headquarters building at 1334 York Avenue in New York. Net Interest Expense For the year ended December 31, 2005, net interest expense decreased $2.5 million, or 8%, to $27.7 million, when compared to the prior year. This decrease was largely attributable to a $2.4
million improvement in interest income resulting from higher average balances of cash and short-term investments, as well as higher interest rates due in part to a change in investment composition
during the first nine months of the year. To a lesser extent, the decrease in net interest expense versus the prior year was attributable to lower amortization of the discount associated with the DOJ
antitrust fine, which was being paid over a five-year period. The final payment of $15 million owed under the fine was paid by the Company on February 6, 2006 and the liability to the DOJ was
extinguished (see Note Q of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data). The overall improvement in net interest expense in 2005 was
partially offset by an increase of $0.9 million in credit facility borrowing costs primarily as a result of higher average borrowings outstanding during the period largely due to the funding requirements
for new client loans, as well as decreased cash balances resulting from the Transaction described under Recapitalization below. (See Liquidity and Capital Resources below and Note J of Notes
to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data for information on the Companys credit arrangements.) Termination of GE Capital Credit Agreement On September 7, 2005, in connection with the Transaction described below under Recapitalization, the Company terminated the GE Capital Credit Agreement. As a result of the termination
of the GE Capital Credit Agreement, the Company incurred a $1 million termination fee and wrote off approximately $2.1 million in related arrangement fees, which were previously being amortized
over the term of the agreement. These charges were combined and reflected as a separate caption in the Consolidated Income Statement for the year ended December 31, 2005. (See Liquidity and
Capital Resources below and Note J of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for information related to the Companys credit
arrangements.) Cumulative Effect of a Change in Accounting Principle In March 2005, the FASB issued FIN No. 47, Accounting for Conditional Asset Retirement Obligationsan interpretation of FASB Statement No. 143. FIN No. 47 requires an entity to
recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated. FIN No. 47 states that a conditional asset retirement obligation is a
legal obligation to perform an asset retirement activity in which the timing or method of settlement are conditional upon a future event that may or may not be within the control of the entity. The
Company adopted FIN No. 47 effective December 2005 and accordingly recorded an after-tax charge 37
of approximately $1.1 million ($1.6 million, pre-tax), or $0.02 per diluted share, as a cumulative effect of a change in accounting principle in the Consolidated Income Statement for the year ended
December 31, 2005. This charge relates primarily to those lease agreements that require the Company to restore the underlying facilities to their original condition at the end of the leases. The
Company was uncertain of the timing of payment for these asset retirement obligations; therefore a liability was not previously recognized in the financial statements under GAAP. On a prospective
basis, this accounting change requires recognition of these costs ratably over the lease term. The adoption of FIN No. 47 initially resulted in a non-cash addition to fixed assets of $1 million with a
corresponding increase in long-term liabilities. The assets as of December 31, 2005 were $0.2 million, consisting of gross assets of $1 million less accumulated depreciation of $0.8 million. The asset
retirement obligation as of December 31, 2005 was $1.8 million, consisting of a liability of $1 million and accretion expense of $0.8 million. Provision for Income Taxes The effective tax rate related to continuing operations was approximately 31.4% in 2005, compared to approximately 36.2% in 2004. The overall decrease in the effective tax rate in 2005 from
2004 was primarily the result of a $7.1 million benefit arising from the release of valuation allowances in 2005 related to the Companys U.S. Federal and certain foreign tax operating loss carryovers,
as well as the tax rate differential between U.S. and foreign jurisdictions as more of the Companys earnings in 2005 arose overseas in jurisdictions with tax rates lower than in the U.S. These items
were partially offset by the impact of the Companys repatriation of earnings accumulated outside the U.S. under its domestic reinvestment plan as discussed in more detail below, as well as increased
passive income arising overseas. In October 2004, the President signed the American Jobs Creation Act of 2004 (the AJCA). The AJCA creates a temporary incentive for companies to repatriate earnings accumulated outside
the U.S. by allowing them to reduce taxable income by 85% of certain eligible dividends received from non-U.S. subsidiaries by the end of 2005 at an effective tax rate of 5.25%. On November 7, 2005, the Companys Chief Executive Officer and Board of Directors approved a domestic reinvestment plan to repatriate up to $72.4 million of foreign earnings under the
AJCA during the fourth quarter of 2005. These foreign earnings were previously considered to be indefinitely reinvested outside of the U.S. The Company repatriated approximately $72.4 during the
fourth quarter of 2005 and accordingly, the Company recorded income tax expense of $3.8 million. (See Item 1A, Risk Factors, and Note K of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) Discontinued Operations For information related to Discontinued Operations, see Note T of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data. 38
FINANCIAL CONDITION AS OF DECEMBER 31, 2006 This discussion should be read in conjunction with the Companys Consolidated Statements of Cash Flows (see Item 8, Financial Statements and Supplementary Data). For the year ended
December 31, 2006, total cash and cash equivalents increased $96.1 million primarily due to the factors discussed below. Net cash provided by operations was $270.4 million for the year ended December 31, 2006 largely due to a $148.8 million net increase in amounts owed to clients principally due to the timing
and settlement of auction sales conducted in the fourth quarter of 2005 and throughout 2006. As a result of this increase, the December 31, 2006 due to consignors balance is unusually high; however,
a substantial portion of this balance will be paid out in the first quarter of 2007. Also contributing significantly to net cash provided by operations is net income of $107 million earned in 2006. Net cash used by investing activities was $197.9 million for the year ended December 31, 2006 largely due to a $126 million net increase in short-term investments and a $61.5 million net increase
in client loans. Net cash provided by financing activities was $21.2 million for the year ended December 31, 2006 principally due to $67 million in proceeds received from the exercise of stock options and $14.9
million in excess tax benefits resulting from such stock option exercises. These financing cash inflows are partially offset by a $36.5 million net decrease in credit facility borrowings, $12.9 million of
dividend payments (see Liquidity and Capital Resources below) and the $9.5 million repayment of acquiree bank debt (see Note C of Notes to Consolidated Financial Statements under Item 8,
Financial Statements and Supplementary Data). ADOPTION OF SFAS NO. 158 In September 2006, the Financial Accounting Standards Board (the FASB) issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plansan
amendment of FASB Statements No. 87, 88, 106, and 132(R). Generally, SFAS No. 158 requires an employer to recognize the over-funded or under-funded status of a defined benefit postretirement
plan as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS No. 158 also requires the
measurement of defined benefit plan assets and obligations as of the date of the employers fiscal year-end balance sheet (with limited exceptions). The requirement to recognize the funded status of
a defined benefit postretirement plan and the related disclosure requirements were effective for the Company as of December 31, 2006 and, as a result, the Company adopted the recognition
provisions of SFAS No. 158 in the fourth quarter of 2006. The requirement to measure the plan assets and benefit obligations as of the date of the balance sheet is effective for the Company as of
December 31, 2008. (See Note N of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for detailed information on the impact of adopting SFAS No. 158.) STAFF ACCOUNTING BULLETIN NO. 108 In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements. SAB No. 108 requires that registrants quantify errors using both a balance sheet and income statement approach and evaluate whether either approach results in a misstated amount that,
when all relevant quantitative and qualitative factors are considered, is material. The Company adopted SAB No. 108 in the fourth quarter of 2006. 39
REVIEW OF STOCK OPTION GRANTING PRACTICES In June through November 2006, at the request of the Companys Chief Executive Officer, outside legal counsel conducted a review of the Companys stock option granting practices from 1995
through the present to determine whether any backdating of stock options had occurred. This request was not made because of any knowledge or belief that there were any improprieties in the
Companys stock option granting practices, but because of the publicity that had been given to this subject in relation to other companies. Counsel concluded and management concurred that there
was no evidence of intentional wrongdoing by any of the Companys Named Executive Officers (as defined by the SEC) or by any other director or employee of the Company. However, it was
concluded that, in a number of instances in 2002 and in prior years, the Company had used an incorrect measurement date under Accounting Principles Board Opinion No. 25, Accounting for Stock
Options (Opinion 25), in accounting for certain of its stock option grants because on the date of such grants, the number of shares that particular individuals were entitled to receive was not
finalized or the number of options allocated to certain recipients was changed after the award approval date. Based on the results of counsels review, management concluded that the measurement
dates for these awards should be revised. The
Company has determined that from the first quarter of 1996 through 2004, it
had certain unrecorded non-cash stock compensation charges associated with its
stock option plans. The amount of aggregate unrecorded non-cash stock compensation
expense, which the Company should have recorded in prior periods as a component
of Salaries and Related Costs, is approximately $6 million pre-tax and approximately
$4 million after-tax. The Company determined, however, that the charges from
1996 through 2004 were not material to its consolidated financial statements
in any of the periods to which such charges related. Management has, however, concluded that the aggregate amount of unrecorded stock compensation expense related to these stock options would be material, if recorded, to the fourth quarter of
2006. As a result, the Company has restated its financial statements for prior periods and recorded an adjustment of approximately $3.8 million to Retained Earnings and Additional Paid-in Capital as
of January 1, 2004, which is reflected in the accompanying Consolidated Statements of Changes in Shareholders Equity. This adjustment represents the cumulative effect on an after tax basis of the
adjustment relating to the non-cash stock compensation charges discussed above related to years 1999 to 2003. The impact of these unrecorded amounts is presented in the chart below. The impact of
the adjustments related to 2004 and years prior to 1999 is inconsequential. In addition, there was no impact on total cash flows from operating, investing or financing activities within the Consolidated
Statements of Cash Flows for any of the years presented nor was there any impact on any interim periods within 2005 or 2006.
Year Ended December 31
1999
2000
2001
2002
2003
Total
(Thousands of dollars) Stock compensation adjustment, pre-tax
$
1,584
$
1,924
$
1,376
$
776
$
282
$
5,942 Tax effect
586
608
590
279
90
2,153 Stock compensation adjustment, net of tax effect
$
998
$
1,316
$
786
$
497
$
192
$
3,789
*
*
Adjustment to December 31, 2004 beginning retained earnings. RECAPITALIZATION On September 7, 2005, the Company entered into a Transaction Agreement (the Agreement), with various affiliates of A. Alfred Taubman and his family (the Shareholders). Prior to
completion of the transactions contemplated by the Agreement, the Shareholders were the Companys largest shareholders, holding in the aggregate 14,034,158 shares of the Companys Class B Stock,
representing approximately 62.4% of the aggregate voting power of the Companys capital stock. Robert S. Taubman, A. Alfred Taubmans son, is a director of the Company. 40
Pursuant to the Agreement, the Company agreed to an exchange of all 14,034,158 shares of Class B Stock owned by the Shareholders for $168,409,896 in cash and 7.1 million shares of the
Companys Class A Stock, (such exchange, the Transaction). (See Mechanics of Effecting the Transaction; Funding below.) Completion of the Transaction was not subject to any conditions and it
was completed on September 7, 2005. Because the outstanding shares of Class B Stock constituted less than fifty percent of the aggregate voting power of the Companys outstanding common stock
following completion of the Transaction, pursuant to the Companys Third Amended and Restated Articles of Incorporation (the Articles), following completion of the Transaction each remaining
outstanding share of Class B Stock held by shareholders not a party to the Transaction was automatically converted into one share of Class A Stock without any action on the part of the holder
thereof. Therefore, immediately following completion of the Transaction and such conversion, the Company had approximately 57.3 million shares of Class A Stock outstanding (of which the
Shareholders owned 7.1 million, or approximately 12.4%) and no shares of Class B Stock outstanding. The Companys Board of Directors appointed a Special Committee to carefully examine all details of the Transaction. The Special Committee consisted of four disinterested Directors who, after
careful deliberation and negotiation, and based on the advice of independent legal and financial advisors retained by the Special Committee, unanimously recommended that the Companys Board of
Directors approve the Transaction. As a result of the Transaction, the dual class super-voting share structure that had been in place since the Companys initial public offering in 1988 was eliminated; allowing for a corporate
governance structure that is more consistent with the best practices of public companies. Mechanics of Effecting the Transaction; FundingUnder the terms of the Agreement, the Transaction was effected by means of: (1) the Shareholders voluntarily converting, on a one-for-one basis
pursuant to the Articles, 7.1 million shares of Class B Stock into shares of Class A Stock, and (2) the Company acquiring the remaining shares of Class B Stock owned by the Shareholders for
aggregate cash consideration of $168,409,896. The Company funded the cash portion of the consideration plus direct transaction and financing costs with then existing cash balances and $100 million
in borrowings under a new credit facility (see Liquidity and Capital Resources below and Note J of Notes to Consolidated Financial Statements under Item 8, Financial Statements and
Supplementary Data, for information related to the Companys credit arrangements). The total cost to acquire the Class B Stock owned by the Shareholders of $177.2 million (including $8.8 million in direct transaction costs) was accounted for as a treasury stock transaction in the
third quarter of 2005, with common stock and additional paid-in capital being reduced by $177.1 million. Additionally, the Company ascribed $100,000 of the cost to the Standstill and the Restrictions
on Transfer (as described below) based on their fair value as determined by an independent valuation expert. Such amount was expensed as incurred within other expense in the period of the
Transaction. Direct financing costs of $3.7 million attributable to the new credit facility are being amortized on a straight-line basis over the term of the facility (see Note J of Notes to Consolidated Financial
Statements under Item 8, Financial Statements and Supplementary Data). StandstillIn the Agreement, each Shareholder agreed to a customary standstill lasting until the earlier of (1) the fourth anniversary of the Transaction or (2) 30 days after the date on which (a)
the Shareholders, together with their affiliates, own, in the aggregate, securities representing less than ten percent of the Companys total outstanding voting power and (b) no affiliate of any
Shareholder is a member of the Board of Directors of the Company (however, if such 30th day would otherwise occur on or before the second anniversary of the Transaction, such 30th day would
not be deemed to occur until such second anniversary). The terms of the Standstill generally state that, each Shareholder shall not (unless requested by the Company): (1) acquire or propose to
acquire ownership of or the ability to vote any securities or other property of the Company or any of its subsidiaries or (2) act to seek to control or influence the management, Board of Directors,
shareholders, business, operations or policies of the Company. 41
Restrictions on TransferIn the Agreement, each Shareholder agreed that, prior to the second anniversary of the Transaction, such Shareholder would not transfer any shares of Class A Stock or
any economic interest therein, except to an affiliate of such Shareholder in connection with tax or estate-planning transactions, or, to the extent permitted by law, for sales of shares of Class A Stock
in any three month period, that when aggregated with sales by all other Shareholders in such period, would not exceed the greater of one percent of the outstanding shares of Class A Stock or the
average weekly trading volume of the Class A Stock during the four weeks preceding such sale. Registration RightsIn the Agreement, the Company agreed that, following the second anniversary of the Transaction and on not more than two occasions, the Shareholders would have the right to
require the Company to file a registration statement under the federal securities laws registering the sale of all or a portion of the shares of Class A Stock owned by the Shareholders that are not
otherwise freely tradable, provided that the market value of the securities proposed to be sold exceeds specified thresholds. The Company has the right to defer the filing of such registration
statement under certain circumstances. The Company also agreed to allow the Shareholders to participate in any registration statement proposed to be effected by the Company following the second
anniversary of the Transaction, subject to certain restrictions. The Company agreed to pay all expenses incurred in connection with such registration, other than any underwriting discounts or commissions, and also agreed to indemnify each Shareholder from
losses incurred as a result of material misstatements or omissions in such registration statement (other than those that are the responsibility of the Shareholders, losses incurred by the Company as a
result of which would be subject to indemnification from the Shareholders). REINCORPORATION On June 30, 2006, Sothebys Holdings, Inc., a Michigan corporation (Sothebys Michigan), completed its reincorporation into the State of Delaware (the Reincorporation). The
Reincorporation and related proposals were approved by the shareholders of Sothebys Michigan at the annual meeting of shareholders on May 8, 2006. The Reincorporation was completed by means
of a merger of Sothebys Michigan with and into Sothebys Delaware, Inc., a Delaware corporation (Sothebys Delaware) and a wholly-owned subsidiary of Sothebys Michigan incorporated for the
purpose of effecting the Reincorporation, with Sothebys Delaware being the surviving corporation. Sothebys Delaware was renamed Sothebys upon completion of the merger. In the merger, each outstanding share of Sothebys Michigan Class A Limited Voting Common Stock (Sothebys Michigan Stock) was converted into one share of Common Stock of Sothebys
Delaware (Sothebys Delaware Stock). As a result, holders of Sothebys Michigan Stock are now holders of Sothebys Delaware Stock, and their rights as holders thereof are governed by the
General Corporation Law of the State of Delaware and the Certificate of Incorporation and By-Laws of Sothebys Delaware. The Reincorporation was accounted for as a reverse merger whereby, for accounting purposes, Sothebys Michigan is considered the acquiror and the surviving corporation is treated as the
successor to the historical operations of Sothebys Michigan. Accordingly, the historical financial statements of Sothebys Michigan, which Sothebys Michigan previously reported to the SEC on Forms
10-K and 10-Q, among other forms, are treated as the financial statements of the surviving corporation. The Reincorporation did not result in any change in the business or principal facilities of Sothebys Michigan. Upon completion of the merger, the address of Sothebys principal executive offices
is 1334 York Avenue, New York, NY 10021. Sothebys Michigans management and board of directors continue as the management and board of directors of Sothebys Delaware. Sothebys Delaware
Stock will continue to trade on the New York Stock Exchange under the symbol BID. Shareholders are not required to exchange their existing stock certificates, which now represent an equivalent
number of shares of Sothebys Delaware Stock. 42
ACQUISITION On June 7, 2006, the Company and Arcimboldo S.A. (Arcimboldo), a private limited liability company incorporated under the laws of Luxembourg, entered into a sale and purchase agreement
(the Purchase Agreement), pursuant to which the Company acquired all the issued and outstanding shares of capital stock of Noortman Master Paintings B.V. (previously defined as NMP), a
company incorporated under the laws of the Netherlands and a pre-eminent art dealer. The acquisition of NMP provides the Company with the opportunity to expand its dealer activities. NMP is
based in Maastricht, the Netherlands. Robert C. Noortman, who was the Managing Director of NMP and sole shareholder of Arcimboldo and also guaranteed the obligations of Arcimboldo under the
Purchase Agreement, died unexpectedly on January 14, 2007. Following Mr. Noortmans death, his guarantee under the Purchase Agreement remains binding on his estate. NMP is continuing under
the leadership of Mr. Noortmans son, William. NMPs results are included in the Companys Consolidated Income Statements beginning on June 1, 2006. Pursuant to the Purchase Agreement, the Company paid initial consideration (the Initial Consideration) in the form of 1,946,849 shares of Sothebys Class A Common Stock (Sothebys
Shares), which had a fair value of approximately $41.4 million. The fair value of the Sothebys Shares issued as Initial Consideration is based on the actual number of shares issued using the closing
price of Sothebys Shares on the New York Stock Exchange of $25.30 per share on June 6, 2006 reduced by $7.9 million to reflect the fair value of certain restrictions on the future transfer of the
Initial Consideration, as discussed in more detail below. The fair value of these restrictions was determined by an independent valuation expert. In addition to the Initial Consideration, the Company
acquired NMP subject to approximately $25.6 million of indebtedness, consisting of a 12.5 million ($16.1 million) long-term non-interest bearing note payable to Arcimboldo over a period of three
years (as discussed in more detail below) and $9.5 million of bank debt that was repaid upon the closing of the transaction, as well as the settlement of an $11.7 million payable to Sothebys. As of
the date of acquisition, the present value of the note payable to Arcimboldo was approximately 11.3 million ($14.6 million). The 1.2 million ($1.5 million) discount on the note payable is being
amortized to interest expense over the three-year term. The first payment of 2.1 million ($2.6 million) under the note payable was made on July 26, 2006. The remaining payments under the note
payable are due according to the following schedule: 2 million ($2.7 million) on June 7, 2007, 4.2 million ($5.5 million) on June 7, 2008 and 4.2 million ($5.5 million) on June 7, 2009. If NMP fails to achieve a minimum level of financial performance during the five years following the closing of the transaction, up to 20% of the Initial Consideration will be transferred back to
the Company. An additional 486,712 Sothebys Shares (the Additional Consideration) have been issued and placed in escrow, to be released only if NMP achieves certain targeted performance criteria
specified in the Purchase Agreement during the five years following the closing of the transaction and if NMP achieves certain service criteria. Based on the closing price of Sothebys Shares on the
New York Stock Exchange of $38.99 per share on February 20, 2007, the Additional Consideration has a fair value of approximately $19 million. The Additional Consideration is being held in escrow
pursuant to an escrow agreement dated June 7, 2006, among the parties to the Purchase Agreement and LaSalle Bank N.A. The Purchase Agreement also provides for certain restrictions on the transfer of Sothebys Shares received by Arcimboldo, as discussed above. Subject to certain limited exclusions, Arcimboldo
may not transfer any of the Sothebys Shares that it received as Initial Consideration for a period of two years after the closing, and may not transfer 20% of the Sothebys Shares that it received as
Initial Consideration for a period of five years after the closing. The Company, Arcimboldo and Mr. Noortman also made customary warranties and covenants in the Purchase Agreement, including certain post-closing business covenants of the Company and
certain non-competition and non-solicitation covenants of Arcimboldo and Mr. Noortman for a period of five years following closing. Mr. Noortman also entered into a seven-year employment
agreement with NMP, which ceased upon Mr. Noortmans death. 43
In addition, the Company also has in place a key man life insurance policy of $20 million covering Mr. Noortman. The Company has filed the necessary claim forms to establish its rights under
this policy. As a result of Mr. Noortmans death in January 2007, goodwill and intangible assets related to NMP are being tested for impairment. The Company anticipates that it will record an impairment
charge in the first quarter of 2007 to reduce the carrying values of NMPs goodwill and intangible assets. The amount of such a charge could potentially be material depending on the outcome of the
Companys assessment. (See Note C of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for additional information related to the acquisition of NMP.) CONTRACTUAL OBLIGATIONS AND COMMITMENTS The following table summarizes the Companys material contractual obligations and commitments as of December 31, 2006:
Payments Due by Period
Total
2007
2008 to
2010 to
After
(Thousands of dollars) Long-term debt (1): Principal payments
$
100,000
$
$
100,000
$
$
Interest payments
16,615
6,875
9,740
Sub-total
116,615
6,875
109,740
Other commitments: York Property capital lease (2)
369,670
19,287
39,900
41,274
269,209 Operating lease obligations (3)
83,001
15,718
23,791
10,226
33,266 Discount Certificates (4)
46,731
46,731
Note payable to Arcimboldo (5)
13,705
2,741
10,964
Employment arrangements (6)
25,247
6,678
10,571
7,084
914 Sub-total
538,354
91,155
85,226
58,584
303,389 Total
$
654,969
$
98,030
$
194,966
$
58,584
$
303,389
(1)
Represents the aggregate outstanding principal and semi-annual interest payments due on the Companys long-term debt. (See Liquidity and Capital Resources below and Note J of Notes to
Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, for information related to the Companys credit arrangements.) (2) Represents the rental payments due under the capital lease obligation for the York Property, as discussed in Notes G and L of Notes to Consolidated Financial Statements under Item 8,
Financial Statements and Supplementary Data. (3) Represents rental payments due under the Companys operating lease obligations. (See Note L of Notes to Consolidated Financial Statements under Item 8, Financial Statements and
Supplementary Data.) (4) Represents the remaining outstanding face value of the Discount Certificates that were distributed in conjunction with the settlement of certain civil litigation related to the antitrust investigation
by the U.S. Department of Justice, which are fully redeemable in connection with any auction that is conducted by the Company or Christies in the U.S. or in the U.K. The Discount Certificates
may be used to satisfy consignment charges involving vendors commission, risk of loss and/or catalogue illustration. The Discount Certificates will expire on May 14, 2008 and cannot be
redeemed subsequent to that date; however, any unused Discount Certificates may be redeemed for cash at their face value at any time between May 15, 2007 and May 14, 2008. (See Note Q of
Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) (5) See Note C of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data. 44
2009
2011
2011
(6) Represents the remaining commitment for future salaries as of December 31, 2006 related to employment arrangements with eight employees, excluding incentive bonuses, any participation in the
Companys Executive Bonus Plan and equity grants. (See Note O of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data.) OFF-BALANCE SHEET ARRANGEMENTS Auction Guarantees From time to time in the ordinary course of business, the Company will guarantee to consignors a minimum price in connection with the sale of property at auction. The Company must perform
under its auction guarantee in the event the property sells for less than the minimum price, in which event the Company must fund the difference between the sale price at auction and the amount of
the auction guarantee. If the property does not sell, the amount of the auction guarantee must be paid, but the Company has the right to recover such amount through future sale of the property. In
certain instances, the sale proceeds ultimately realized by the Company exceed the amount of any prior losses recognized on the auction guarantee. Additionally, the Company is generally entitled to
a share of the excess proceeds if the property under the auction guarantee sells above a minimum price. In addition, the Company is obligated under the terms of certain auction guarantees to
advance a portion of the guaranteed amount prior to the auction. In certain situations, the Company reduces its financial exposure under auction guarantees through auction commission sharing
arrangements with partners. Partners may also assist the Company in valuing and marketing the property to be sold at auction. As of December 31, 2006, the Company had outstanding auction guarantees totaling $116.5 million, the property relating to which had a mid-estimate sales price (1) of $132.3 million. The
Companys financial exposure under these auction guarantees is reduced by $0.5 million as a result of sharing arrangements with partners. Substantially all of the property related to such auction
guarantees is being offered at auctions in the first half of 2007. As of December 31, 2006, $36 million of the guaranteed amount had been advanced by the Company and is recorded within notes
receivable and consignor advances in the Consolidated Balance Sheet (see Note E of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data). As
of December 31, 2006 and December 31, 2005, the carrying amount of the liability related to the Companys auction guarantees was approximately $1.5 million and $0.3 million, respectively, and was
reflected in the Consolidated Balance Sheets within accounts payable and accrued liabilities. As of February 20, 2007, the Company had outstanding auction guarantees totaling $83.2 million, the property relating to which had a mid-estimate sales price (1) of $90.6 million. Substantially
all of the property related to such auction guarantees is being offered at auctions in the first nine months of 2007. As of February 20, 2007, $15.7 million of the guaranteed amount had been advanced
by the Company and will be recorded within notes receivable and consignor advances.
(1)
The mid-estimate sales price is calculated as the average of the low and high pre-sale auction estimates for the property under the auction guarantee. Pre-sale estimates are not always
accurate predictions of auction sale results.
Lending Commitments In certain situations, the Company enters into legally binding arrangements to lend, primarily on a collateralized basis and subject to certain limitations and conditions, to potential consignors and
other individuals who have collections of fine art or other objects. Unfunded commitments to extend additional credit were $15 million and $16.7 million at December 31, 2006 and February 20, 2007,
respectively. 45
DERIVATIVE FINANCIAL INSTRUMENTS The Company utilizes forward exchange contracts to manage exposures related to foreign currency risks, which primarily arise from short-term foreign currency denominated intercompany
balances and, to a lesser extent, foreign currency denominated client receivable and payable balances, as well as foreign currency denominated future guarantee obligations. Generally, exposures
related to such foreign currency risks are centrally managed by the Companys global treasury function. The Companys objective for holding derivative instruments is to minimize foreign currency
risks using the most effective methods to eliminate or reduce the impacts of these exposures. The forward exchange contracts entered into by the Company are used mostly as cash flow hedges of the Companys exposure to short-term foreign currency denominated intercompany balances
and, to a lesser extent, foreign currency denominated client receivable and payable balances, as well as foreign currency denominated future guarantee obligations. Such forward exchange contracts
are typically short-term with settlement dates less than one year from their inception. These contracts are not designated as hedging instruments under SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended, and are recorded in the Consolidated Balance Sheets at fair value, which is based on referenced market rates. Changes in the fair value of the
Companys forward exchange contracts are recognized currently in earnings. At December 31, 2006, the Company had $140.8 million of notional value forward exchange contracts outstanding. Notional amounts do not quantify risk or represent assets or liabilities of the
Company, but are used in the calculation of cash settlements under such contracts. The Company is exposed to credit-related losses in the event of nonperformance by the two counterparties to its
forward exchange contracts, but the Company does not expect any counterparties to fail to meet their obligations given their high credit ratings. As of December 31, 2006, the Consolidated Balance Sheets included a liability of $1.1 million recorded within accounts payable and accrued liabilities reflecting the fair value of the Companys
outstanding forward exchange contracts on that date. As of December 31, 2005, the Consolidated Balance Sheets included an asset of $0.1 million recorded within prepaid expenses and other current
assets reflecting the fair value of the Companys outstanding forward exchange contracts on that date. CONTINGENCIES For information related to Contingencies, see Note O of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data. LIQUIDITY AND CAPITAL RESOURCES On September 7, 2005, in connection with the Transaction discussed above under Recapitalization above, the Company terminated its previous senior secured credit agreement and entered into
a new senior secured credit agreement with an international syndicate of lenders arranged by Banc of America Securities LLC (BofA) and LaSalle Bank N.A. (the BofA Credit Agreement). The
BofA Credit Agreement originally provided for borrowings of up to $250 million through a revolving credit facility. On May 18, 2006, the Company amended the BofA Credit Agreement to provide
for $50 million in additional commitments from its existing lenders, thereby increasing the total borrowing capacity to $300 million. The amendment also permits the amount of available borrowings to
be increased by an additional $50 million to $350 million. The amount of borrowings available at any time under the BofA Credit Agreement is limited to a borrowing base, which is generally equal to 100% of eligible loans made by the Company in
the U.S. and the U.K. (i.e., notes receivable and consignor advances) plus 15% of the Companys net tangible assets (calculated as total assets less current liabilities, goodwill, intangible assets,
unamortized debt discount and eligible loans). As of December 31, 2006, there were no outstanding borrowings under the BofA Credit Agreement and the amount of unused borrowing capacity
available and borrowing base under the BofA Credit Agreement was $275.2 million. As of February 20, 2007, there were no outstanding borrowings under the BofA Credit Agreement and the amount
of unused borrowing capacity available under the BofA Credit Agreement was $282.6 million. The BofA Credit Agreement is available through September 7, 2010; provided that in the event that any of the $100 million in long-term debt securities (the Notes) issued by the Company in 46
February 1999 are still outstanding on July 1, 2008, then either: (a) the Company shall deposit cash in an amount equal to the aggregate outstanding principal amount of the Notes on such date into
an account in the sole control and dominion of BofA for the benefit of the lenders and the holders of the Notes or (b) the Company shall have otherwise demonstrated its ability to redeem and pay
in full the Notes; otherwise, the BofA Credit Agreement shall terminate and all amounts outstanding thereunder shall be due and payable in full on July 1, 2008. Management expects to be able to
demonstrate its ability to redeem and repay the Notes in full on the required date. (See Note J of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary
Data, for more information related to the Notes.) Borrowings under the BofA Credit Agreement were used to finance in part the Transaction and related expenses and are also available to provide ongoing working capital and for other general
corporate purposes of the Company. The Companys obligations under the BofA Credit Agreement are secured by substantially all of the non-real estate assets of the Company, as well as the non-
real estate assets of its subsidiaries in the U.S. and the U.K. The BofA Credit Agreement contains financial covenants requiring the Company not to exceed a maximum level of capital expenditures and dividend payments (as discussed in more detail
below) and to have a quarterly interest coverage ratio of not less than 2.0 and a quarterly leverage ratio of not more than: (i) 3.5 for quarters ending December 31, 2006 to September 30, 2007 and
(ii) 3.0 for quarters ending December 31, 2007 and thereafter. The maximum level of annual capital expenditures permitted under the BofA Credit Agreement is $15 million through 2007 and $20
million thereafter with any unused amounts carried forward to the following year. Dividend payments, if any, must be paid solely out of 40% of the Companys net income arising after June 30, 2005
and computed on a cumulative basis. The BofA Credit Agreement also has certain non-financial covenants and restrictions. The Company is in compliance with its covenants. On each of August 2 and November 2, 2006, the Companys Board of Directors declared quarterly dividends on its common stock of $0.10 per share totaling approximately $6.4 million and $6.5
million, respectively. The dividend declared on August 2, 2006 was paid on September 15, 2006. The dividend declared on November 2, 2006 was paid on December 15, 2006. On February 27, 2007,
the Companys Board of Directors declared a quarterly dividend on its common stock of $0.10 per share (approximately $6.5 million), to be paid on March 15, 2007 to shareholders of record on
February 28, 2007. It is the intention of the Company to continue to pay quarterly dividends at this rate (an annual rate of $0.40 per share), subject to Board approval and depending on economic,
financial, market and other conditions at the time. (See statement on Forward Looking Statements.) At the option of the Company, any borrowings under the BofA Credit Agreement generally bear interest at a rate equal to: (i) LIBOR plus 1.75%, or (ii) 0.5% plus the higher of the Prime
Rate or the Federal Funds Rate plus 0.5%. For the years ended December 31, 2006 and 2005, the weighted average interest rates incurred by the Company on outstanding borrowings under the
BofA Credit Agreement were approximately 7% and 6.3%, respectively. The Company paid underwriting, structuring and amendment fees of $2.8 million related to the BofA Credit Agreement, which are being amortized on a straight-line basis to interest expense
over the term of the facility. The Company generally relies on operating cash flows supplemented by borrowings to meet its liquidity requirements. The Company currently believes that operating cash flows, current cash
balances and borrowings available under the BofA Credit Agreement will be adequate to meet its presently contemplated or anticipated short-term and long-term commitments, operating needs and
capital requirements through September 7, 2010. The Companys short-term operating needs and capital requirements include peak seasonal working capital requirements, other short-term commitments to consignors, the funding of notes
receivable and consignor advances, the funding of capital expenditures and the payment of the quarterly dividend discussed above, as well as the short-term commitments to be funded prior to
December 31, 2007 included in the table of contractual obligations above. The Companys long-term operating needs and capital requirements include peak seasonal working capital requirements, the funding of notes receivable and consignor advances and the funding
of capital expenditures, as well as the funding of the Companys presently anticipated long-term contractual obligations and commitments included in the table of contractual obligations above through
September 7, 2010. 47
On December 7, 2006, the Company adopted the Sothebys Deferred Compensation Plan (the Deferred Compensation Plan), effective January 1, 2007. The Deferred Compensation Plan
replaced the Sothebys, Inc. 2005 Benefit Equalization Plan (the 2005 BEP), which superseded an existing Benefit Equalization Plan (the BEP), with a plan that incorporates best practice features
of contemporary non-qualified plans. Employee deferrals and Company contributions to the Deferred Compensation Plan are informally funded into a rabbi trust which provides additional benefit
security by sheltering assets in the event of a change-in-control of the Company and certain other situations. Plan liabilities are financed through the trust using Company-owned variable life
insurance, as well as other investments. The combined unfunded liability for the 2005 BEP and the BEP, which totaled $24.2 million as of December 31, 2006, was transferred into the Deferred
Compensation Plan on January 1, 2007. The Company funded this amount into the rabbi trust on February 8, 2007. (See Note N of Notes to Consolidated Financial Statements under Item 8,
Financial Statements and Supplementary Data, for additional information related to the Deferred Compensation Plan.) QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company continually evaluates its market risk associated with its financial instruments and forward exchange contracts during the course of its business. The Companys financial instruments
include cash and cash equivalents, restricted cash, short-term investments, notes receivable and consignor advances, credit facility borrowings, long-term debt, the note payable to Arcimboldo (see
Note C of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data) and the liability for the Discount Certificates issued in connection with the
settlement of certain civil antitrust litigation (see Note Q of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data). The Company believes that its interest rate risk is minimal as a hypothetical 10% increase or decrease in interest rates is immaterial to the Companys cash flow, earnings and fair value related
to financial instruments. (See statement on Forward Looking Statements.) The Company utilizes forward exchange contracts to manage exposures related to foreign currency risks, which primarily arise from short-term foreign currency denominated intercompany
balances and, to a lesser extent, foreign currency denominated client receivable and payable balances, as well as foreign currency denominated future guarantee obligations. At December 31, 2006, the
Company had $140.8 million of notional value forward exchange contracts outstanding. Notional amounts do not quantify risk or represent assets or liabilities of the Company, but are used in the
calculation of cash settlements under such contracts. The Company is exposed to credit-related losses in the event of nonperformance by the two counterparties to its forward exchange contracts, but
the Company does not expect any counterparties to fail to meet their obligations given their high credit ratings. (See Derivative Financial Instruments above and Note B of Notes to Consolidated
Financial Statements under Item 8, Financial Statements and Supplementary Data.) At December 31, 2006, a hypothetical 10% strengthening or weakening of the U.S. dollar relative to all other currencies would result in a decrease or increase in cash flow of approximately $19.9
million. FUTURE IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In July, 2006, the FASB issued FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109., which requires that realization
of an uncertain income tax position must be more likely than not (i.e., greater than 50% likelihood of receiving a benefit) before it can be recognized in the financial statements. Further, this
interpretation prescribes the benefit to be recorded in the financial statements as the amount most likely to be realized assuming a review by tax authorities having all relevant information and
applying current conventions; clarifies the financial statement classification of tax-related penalties and interest and sets forth new disclosures regarding unrecognized tax benefits. FIN No. 48 is
effective for the Company in the first quarter of 2007. Management is evaluating the Companys tax positions and assessing the impact of adopting FIN No. 48. 48
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value, and expands disclosures
about fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements. The provisions of SFAS No. 157 are effective for
financial statements issued by the Company starting in 2008. Management is evaluating the impact of adopting SFAS No. 157, if any, on the Companys financial statements. In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an amendment of FASB Statement No. 115. SFAS No. 159
permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be
recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for the Company as of January 1, 2008. Management is evaluating the impact of adopting SFAS No. 159, if any,
on the Companys financial statements. STRATEGIC INITIATIVES In
recent years, the Companys focus on the high end of the art market has
been an important contributor to its success. Accordingly, management is initiating
significant organizational changes, globally reorganizing its management of
client relationships and investing in those areas most valued by its major clients.
For example, a major corporate web site enhancement will provide clients with
real-time access to their account data and balances, as well as information
on current and historical transactions, auction tracking services and enhanced
media content. In line with the Companys strategy, in February 2007, management decided to refocus its business portfolio. Accordingly, the Company will discontinue auctions at Olympia in London, which
traditionally has processed sales at a much lower price point than the rest of the Company. In addition, there will be staff reductions in lower end sales categories in New York, Amsterdam and
Milan. The Company expects these decisions, which will be guided by local statutory consultation guidelines, to reduce headcount by approximately five percent globally and to result in first quarter
severance charges in the range of $2 million. In addition, this strategic initiative will significantly reduce the quantity of lots offered for sale at auction, which will result in cost savings and operating
efficiencies. However, the Company will invest a portion of these savings in new staff, in order to better focus on client relationships and grow revenues, which management expects will more than
offset the lost revenue on lower end sales categories. The Company anticipates implementing many of these strategic changes during the first half of 2007, with the benefits beginning to be realized in
the second half of 2007 and increasingly in future years. Accordingly, there could be an unfavorable impact on short-term operating results. (See statement on Forward Looking Statements.) FORWARD LOOKING STATEMENTS This Form 10-K contains certain forward looking statements; as such term is defined in Section 21E of the Securities Exchange Act of 1934, as amended, relating to future events and the
financial performance of the Company. Such statements are only predictions and involve risks and uncertainties, resulting in the possibility that the actual events or performance will differ materially
from such predictions. Major factors which the Company believes could cause the actual results to differ materially from the predicted results in the forward looking statements include, but are not
limited to, the factors listed below under Part I, Item 1A, Risk Factors, which are not ranked in any particular order.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See the discussion under this caption contained in Item 7. 49
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of We have audited the accompanying consolidated balance sheets of Sothebys and subsidiaries (the Company) as of December 31, 2006 and 2005, and the related consolidated statements of
income, cash flows, and changes in shareholders equity for each of the three years in the period ended December 31, 2006. Our audits also included the financial statement schedule listed in the
Index at Item 15(d). These financial statements and financial statement schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on the financial
statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Sothebys and subsidiaries as of December 31, 2006 and 2005, and the results
of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects,
the information set forth therein. As discussed in Notes M and N to the consolidated financial statements, in 2006 the Company adopted Statement of Financial Accounting Standards No. 123 (R), Share-Based Payment, as
revised effective January 1, 2006 and the recognition and disclosure provisions of Statement of Financial Accounting Standards No. 158, Employers Accounting for Defined Benefit Pension and
Other Postretirement Plansan amendment of FASB Statements No. 87, 88, 106 and 132(R), effective December 31, 2006. In addition, as discussed in Note B to the consolidated financial statements,
in 2005 the Company adopted FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligationsan interpretation of FASB Statement No. 143, effective December 31, 2005. We
have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Companys internal
control over financial reporting as of December 31, 2006, based on the criteria
established in Internal ControlIntegrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 1, 2007 expressed an unqualified opinion on managements assessment
of the effectiveness of the Companys internal control over financial reporting
and an unqualified opinion on the effectiveness of the Companys internal
control over financial reporting. 50
SOTHEBYS
New York, New York
/s/ DELOITTE
&
TOUCHE
LLP
Deloitte & Touche
LLP
New York, New York
March 1, 2007
SOTHEBYS
Year Ended December 31
2006
2005
2004 Revenues: Auction and related revenues
$
631,344
$
496,899
$
439,526 Finance revenues
15,864
8,302
5,907 Dealer revenues
12,776
5,131
3,604 License fee revenues
2,922
1,404
45,745 Other revenues
1,903
2,117
2,274 Total revenues
664,809
513,853
497,056 Expenses: Direct costs of services
74,120
65,782
55,551 Dealer cost of sales
6,060
Salaries and related costs
226,410
187,753
177,717 General and administrative expenses
138,278
114,974
112,863 Depreciation and amortization expense
22,783
22,081
23,837 Retention costs
285 Net restructuring charges
146 Total expenses
467,651
390,590
370,399 Operating income
197,158
123,263
126,657 Interest income
5,891
5,683
3,284 Interest expense
(33,039
)
(33,421
)
(33,551
) Credit facility termination costs
(3,069
)
Other (expense) income
(4,227
)
(1,474
)
267 Income from continuing operations before taxes
165,783
90,982
96,657 Equity in earnings of investees, net of taxes
1,626
829
740 Income tax expense
60,050
28,594
35,000 Income from continuing operations
107,359
63,217
62,397 Discontinued operations: (Loss) income from discontinued operations before taxes
(504
)
(854
)
38,798 Income tax (benefit) expense
(194
)
(369
)
14,516 (Loss) income from discontinued operations
(310
)
(485
)
24,282 Cumulative effect of a change in accounting principle, net of taxes
(1,130
)
Net income
$
107,049
$
61,602
$
86,679 Basic earnings per share: Earnings from continuing operations
$
1.78
$
1.04
$
1.01 (Loss) earnings from discontinued operations
(0.01
)
(0.01
)
0.39 Cumulative effect of a change in accounting principle, net of taxes
(0.02
)
Basic earnings per share
$
1.77
$
1.01
$
1.40 Diluted earnings per share: Earnings from continuing operations
$
1.73
$
1.02
$
1.00 (Loss) earnings from discontinued operations
(0.00
)
(0.01
)
0.39 Cumulative effect of a change in accounting principle, net of taxes
(0.02
)
Diluted earnings per share
$
1.72
$
1.00
$
1.38 Dividends per share
$
0.20
$
$
See accompanying Notes to Consolidated Financial Statements 51
CONSOLIDATED INCOME STATEMENTS
(Thousands of dollars, except per share data)
SOTHEBYS
December 31
2006
2005 ASSETS Current Assets: Cash and cash equivalents
$
221,094
$
124,956 Restricted cash
11,356
7,679 Short-term investments
126,042
Accounts receivable, net of allowance for doubtful accounts of $5,935 and $5,345
390,061
354,741 Notes receivable and consignor advances, net of allowance for credit losses of $1,154 and $792
152,070
85,272 Inventory (see Note C)
115,955
45,087 Deferred income taxes
6,984
15,055 Prepaid expenses and other current assets
24,265
54,166 Total Current Assets
1,047,827
686,956 Non-Current Assets: Notes receivable
56,474
56,678 Fixed assets, net of accumulated depreciation and amortization of $158,718 and $135,651
226,522
225,434 Goodwill (see Notes C and H)
34,709
13,447 Intangible assets (see Notes C and I)
12,780
Investments
23,107
25,871 Deferred income taxes
67,784
46,033 Other assets
7,962
6,333 Total Assets
$
1,477,165
$
1,060,752 LIABILITIES AND SHAREHOLDERS EQUITY Current Liabilities: Due to consignors
$
558,250
$
376,079 Accounts payable and accrued liabilities
152,685
131,354 Deferred revenues
7,601
5,186 Accrued income taxes
19,856
8,918 Deferred income taxes
2,286
42 York Property capital lease obligation
1,619
1,438 Deferred gain on sale of York Property
1,129
1,129 Settlement liabilities
45,765
21,099 Total Current Liabilities
789,191
545,245 Long-Term Liabilities: Long-term debt, net of unamortized discount of $209 and $299
99,791
99,701 Credit facility borrowings
34,542 Settlement liabilities
40,794 York Property capital lease obligation
168,986
170,606 Deferred gain on sale of York Property
17,117
18,245 Pension liabilities
55,273
Deferred income taxes
4,345
Other liabilities
40,775
25,343 Total Liabilities
1,175,478
934,476 Commitments and contingencies (see Note O) Shareholders Equity: Common Stock, $0.10 par value (see Notes U and V)
6,473
5,777 Authorized shares at December 31, 2006200,000,000 Additional paid-in capital
197,047
73,597
* Retained earnings
160,055
65,952
* Deferred compensation expense
(7,876
) Accumulated other comprehensive loss
(61,888
)
(11,174
) Total Shareholders Equity
301,687
126,276 Total Liabilities and Shareholders Equity
$
1,477,165
$
1,060,752
*
As restated, see note M.
See accompanying Notes to Consolidated Financial Statements 52
CONSOLIDATED BALANCE SHEETS
(Thousands of dollars)
Issued and outstanding shares at December 31, 200664,795,100
Issued and outstanding shares at December 31, 200557,847,878 of Class A
SOTHEBYS
Year Ended December 31
2006
2005
2004 Operating Activities: Net income*
$
107,049
$
61,602
$
86,679 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization expense
22,783
22,081
23,837 Gain on sale of discontinued operations
(32,005
) Equity in earnings of investees
(1,626
)
(829
)
(740
) Deferred income tax expense
23,347
8,757
23,215 Stock compensation expense
15,830
8,269
6,646 Defined benefit pension expense
6,897
5,332
2,757 Cumulative effect of a change in accounting principle
1,130
Asset provisions
4,320
3,667
4,033 Write-off of fees and direct costs related to terminated credit agreement
2,069
Amortization of discount related to antitrust matters
2,679
3,988
4,885 Excess tax benefits from stock-based compensation
(14,871
)
Other
658
1,285
1,602 Changes in assets and liabilities (net of effects from acquisitionsee Note C): (Increase) decrease in accounts receivable
(21,653
)
34,833
(172,482
) Increase in inventory
(17,177
)
(14,526
)
(19,312
) Increase in prepaid expenses and other current assets
(8,896
)
(6,122
)
(17,518
) Increase in other long-term assets
(904
)
(2,863
)
(372
) Funding of settlement liabilities
(19,009
)
(18,214
)
(10,822
) Increase (decrease) in due to consignors
170,458
(79,899
)
208,655 Decrease (increase) in income tax receivable and deferred income tax assets
5,105
865
(677
) Increase (decrease) in accrued income taxes and deferred income tax liabilities
8,507
(3,297
)
6,191 (Decrease) increase in accounts payable and accrued liabilities and other liabilities
(13,084
)
30,658
28,218 Adjustments related to discontinued operations
3,461 Net cash provided by operating activities
270,413
58,786
146,251 Investing Activities: Funding of notes receivable and consignor advances
(280,735
)
(214,918
)
(145,663
) Collections of notes receivable and consignor advances
219,266
164,856
160,940 Purchases of short-term investments
(312,183
)
(323,163
)
(288,414
) Proceeds from maturities of short-term investments
186,141
433,163
178,414 Capital expenditures
(12,719
)
(14,862
)
(13,468
) Distributions from equity investees
5,434
3,748
2,900 (Increase) decrease in restricted cash
(3,061
)
4,032
(4,489
) Proceeds from sale of discontinued operations
53,863 Investing activities related to discontinued operations
561 Net cash (used) provided by investing activities
(197,857
)
52,856
(55,356
) Financing Activities: Proceeds from revolving credit facility borrowings
398,673
174,542
65,000 Repayments of revolving credit facility borrowings
(435,158
)
(140,000
)
(85,000
) Repurchase of common stock
(212
)
(177,215
)
Dividends paid
(12,946
)
Repayment of acquiree bank debt (see Note C)
(9,531
)
Decrease in York Property capital lease obligation
(1,437
)
(125
)
(113
) Proceeds from exercise of employee stock options
66,987
9,322
9,945 Excess tax benefits from stock-based compensation
14,871
Net cash provided (used) by financing activities
21,247
(133,476
)
(10,168
) Effect of exchange rate changes on cash and cash equivalents
2,335
(233
)
893 Increase (decrease) in cash and cash equivalents
96,138
(22,067
)
81,620 Cash and cash equivalents at beginning of period
124,956
147,023
65,403 Cash and cash equivalents at end of period
$
221,094
$
124,956
$
147,023 * Net (loss) income from discontinued operations
($310
)
($485
)
$
24,282 Supplemental information on noncash investing and financing activities: On June 7, 2006, the Company acquired Noortman Master Paintings B.V. for initial consideration See accompanying Notes to Consolidated Financial Statements 53
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands of dollars)
(see Note J)
of 1,946,849 shares of Sothebys Stock (see Note C)
SOTHEBYS
Comprehensive
Common
Additional
Retained
Deferred
Accumulated Balance at January 1, 2004, as reported
$
6,173
$
204,567
$
(78,540
)
$
(1,507
)
$
(6,039
) Adjustment, net of taxes (see Note M)
3,789
(3,789
) Balance at January 1, 2004, as restated
208,356*
(82,329
)* Comprehensive income: Net income
$
86,679
86,679 Other comprehensive incomeforeign currency translation
7,128
7,128 Comprehensive income
$
93,807 Stock options exercised
84
10,141 Restricted stock shares issued
117
15,286
(15,643
) Restricted stock shares forfeited
(1
)
(162
)
163 Amortization of restricted stock compensation expense
6,646 Shares issued to directors
1
292 Balance at December 31, 2004
6,374
233,913
4,350
(10,341
)
1,089 Comprehensive income: Net income
$
61,602
61,602 Other comprehensive lossforeign currency translation
(12,263
)
(12,263
) Comprehensive income
$
49,339 Repurchase of common stock
(694
)
(176,422
) Adjustment to deferred tax asset
1,719 Stock options exercised
76
9,342 Tax benefit associated with stock option exercises
1,069 Restricted stock shares issued
34
5,919
(5,956
) Restricted shares withheld to satisfy employee tax obligations
(13
)
(2,190
) Restricted stock shares forfeited
(1
)
(110
) Amortization of restricted stock compensation expense
8,421 Shares issued to directors
1
357 Balance at December 31, 2005
5,777
73,597
65,952
(7,876
)
(11,174
) Comprehensive income: Net income
$
107,049
107,049 Other comprehensive lossforeign currency translation
12,841
12,841 Comprehensive income
$
119,890 SFAS No. 158 transition adjustment (see Notes B and N)
(63,555
) Repurchase of common stock
(212
) Issuance of common stock in acquisition (see Note C)
195
41,180 Stock options exercised
395
66,592 Amortization of stock option expense
1,389 Elimination of deferred compensation expense upon adoption of SFAS No. 123R (see Note M)
(7,876
)
7,876 Restricted stock shares issued
127
(127
) Restricted shares withheld to satisfy employee tax obligations
(22
)
(5,852
) Restricted stock shares forfeited
(1
)
1 Amortization of restricted stock compensation expense
13,226 Tax benefit associated with stock option exercises and the vesting of restricted stock shares
14,871 Shares issued to directors
2
258 Cash dividends declared
(12,946
) Balance at December 31, 2006
$
6,473
$
197,047
$
160,055
$
$
(61,888
) * As restated, see Note M. See accompanying Notes to Consolidated Financial Statements 54
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
(Thousands of dollars)
Income (Loss)
Stock
Paid-In
Capital
Earnings
(Accumulated
Deficit)
Compensation
Expense
Other
Comprehensive
Income (Loss)
valuation allowance related
to stock option exercises
SOTHEBYS Note AOrganization and Business Sothebys (formerly Sothebys Holdings, Inc. and together with its subsidiaries, unless the context otherwise requires, the Company) is one of the worlds two largest auctioneers of
authenticated fine art, antiques and decorative art, jewelry and collectibles. In addition to auctioneering, the Auction segment is engaged in a number of related activities, including the brokering of
private purchases and sales of fine art, jewelry and collectibles. The Company also operates as a dealer in works of art through its Dealer segment, conducts art-related financing activities through its
Finance segment and is engaged, to a lesser extent, in licensing activities. (See Note D for additional information related to the composition of the Companys segments.) (See Note U for information related to a recapitalization transaction consummated by the Company in September 2005. See Note V for information related to the Companys June 2006
reincorporation in the State of Delaware.) Note BSummary of Significant Accounting Policies Principles of ConsolidationThe Consolidated Financial Statements include the accounts of Sothebys and its wholly-owned subsidiaries, as well as those of an entity for which the Company is the
primary beneficiary in accordance with Financial Accounting Standards Board (FASB) Interpretation (FIN) No. 46, Consolidation of Variable Interest Entities (FIN 46), as revised (see Note
R). Intercompany transactions and balances have been eliminated. Equity investments in which the Company has significant influence over the investee but does not have control and is not the
primary beneficiary are accounted for using the equity method (see Note F). ReclassificationsIn the fourth quarter of 2006, due to the acquisition of Noortman Master Paintings B.V. (or NMP) (see Note C) and the resulting increase in the Companys Dealer activities,
certain activities which were previously managed and reported as part of the Auction segment were realigned with NMP and aggregated into a newly established Dealer segment under the oversight
of an executive committee responsible for managing the Companys portfolio of Dealer activities (see Note D). Accordingly, revenues related to such activities, which prior to this Form 10-K were
classified as Auction and Related Revenues, are now reported as Dealer Revenues for all periods presented. Prior to 2005, amounts related to the investigation by the DOJ, other governmental investigations and the related civil litigation were classified as Special Charges in the Consolidated Income
Statements. The majority of such expenses was incurred prior to the first quarter of 2005. Beginning in 2005, such amounts, relating principally to settlement administration costs and legal fees, are
classified within General and Administrative Expenses for all periods presented as they are no longer significant to the Companys results. For the year ended December 31, 2006, the Company
recorded a net benefit of $0.8 million in General and Administrative Expenses associated with antitrust related matters, which includes a $2.4 million benefit for the recovery of settlement
administration costs related to the International Antitrust Litigation. For the years ended December 31, 2005 and 2004, antitrust related expenses were $1.1 million and $1.9 million, respectively. See
Note Q for additional information on antitrust related matters. Foreign Currency TranslationAssets and liabilities of foreign subsidiaries are translated at year-end exchange rates. Income statement amounts are translated using weighted average monthly
exchange rates during the year. Gains and losses resulting from translating foreign currency financial statements are recorded in Accumulated Other Comprehensive Income (Loss) until the subsidiary
is sold or liquidated. Revenue Recognition (Auction and Related Revenues)The principal components of Auction and Related Revenues are: (1) auction commission revenues, (2) private sale commissions, (3) principal
activities, (4) auction expense recoveries and (5) catalogue subscription revenues. The revenue recognition policy for each of these is described below. 55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Auction Commission RevenuesIn its role as auctioneer, the Company functions as an agent accepting property on consignment from its selling clients. The Company sells property as agent of
the consignor, billing the buyer for property purchased, receiving payment from the buyer and remitting to the consignor the consignors portion of the buyers payment after deducting the Companys
commissions, expenses and applicable taxes. The Companys commissions include those earned from the buyer (buyers premium revenue) and those earned from the consignor (sellers commission
revenue), both of which are calculated as a percentage of the hammer price of property sold at auction. Buyers premium and sellers commission revenues are recognized at the time of the auction
sale (i.e., when the auctioneers hammer falls) and are recorded net of commissions owed to third parties. Commissions owed to third parties are typically the result of the competitive environment or
as a result of risk sharing arrangements, whereby the Company reduces its financial exposure under certain auction guarantees in exchange for sharing in the auction commissions with a partner. Also,
in certain situations, an auction guarantee partner will assist the Company in valuing and marketing the property to be sold at auction. (2) Private Sale CommissionsPrivate sale commissions are earned through the brokering of art and collectible purchases and sales and are recognized when an agreement with the purchaser is
finalized and the Company has fulfilled its obligations with respect to the transaction. (3) Principal ActivitiesAuction segment principal activities consist mainly of income or loss related to auction guarantees and gains or losses related to the sale of Auction segment inventory, as
well as any decreases in the carrying value of its inventory. Auction segment inventory consists principally of objects obtained as a result of the failure of guaranteed property to sell at auction, and
to a much lesser extent, objects obtained incidental to the auction process, primarily as a result of defaults by purchasers after the consignor has been paid, and the honoring of purchasers claims.
(See Note P for additional information on auction guarantees.) From time to time in the ordinary course of business, the Company will guarantee to consignors a minimum price in connection with the sale of property at auction. The Company must perform
under its auction guarantee in the event the property does not sell, or sells for less than the minimum price, in which event the Company must fund the difference between the sale price at auction
and the amount of the auction guarantee. If the property does not sell, the amount of the auction guarantee must be paid, but the Company has the right to recover such amount through future sale
of the property. In certain instances, the sale proceeds ultimately realized by the Company exceed the amount of any prior losses recognized on the auction guarantee. Additionally, the Company is
generally entitled to a share of the excess proceeds if the property under the auction guarantee sells above a minimum price. The Companys share of any excess proceeds, as well as any shortfall
between the sale price at auction and the amount of the auction guarantee, are recognized as principal income or loss in the period of the related auction sale. Gains or losses on the sale of Auction inventory and loan collateral are recognized when the sale is completed, title to the property has passed to the purchaser and the Company has fulfilled its
obligations with respect to the transaction. The recognition of a loss is accelerated if and when management determines that an impairment of the inventorys value has occurred. (4) Auction Expense RecoveriesAccording to the terms of certain consignment agreements, the Company has the right to recover certain direct costs of its auction services from the consignor.
Such auction expense recoveries are recognized in the period of the related sale. (5) Catalogue Subscription RevenuesCatalogue subscription revenues are earned from the sale of auction catalogues and are recognized ratably over the period of the related subscription. Revenue Recognition (Finance Revenues)Finance revenues consist principally of interest income earned on Notes Receivable and Consignor Advances. Such interest income is recognized when
earned based on the amount of the outstanding loan and the length of time the loan was outstanding during the period. Where there is doubt regarding the ultimate collectibility of principal for
impaired loans, interest income is no longer recognized and any cash receipts subsequently received are thereafter directly applied to reduce the recorded investment in the loan. 56
Revenue Recognition (Dealer Revenues)Dealer Revenues consist of revenues earned from the sale of Dealer segment inventory and the Companys share of gains resulting from the sale of
property purchased by art dealers through unsecured loans from the Company. Dealer inventory consists principally of property held by NMP and objects purchased for investment purposes. Revenues earned from the sale of Dealer inventory are recognized when title to the property has passed to the purchaser and the Company has fulfilled its obligations with respect to the
transaction. The recognition of a loss is accelerated if and when management determines that an impairment of the inventorys value has occurred. The Companys share of gains resulting from the sale of property purchased by art dealers through unsecured loans from the Company is recognized when the sale is completed and title to the
underlying property passes to the purchaser. Sales, Use and Value Added TaxesSales, use and value added taxes assessed by governmental authorities that are both imposed on and concurrent with revenue-producing transactions between
the Company and its customers are reported on a net basis (i.e., no impact on revenues). Direct Costs of ServicesDirect Costs of Services consists largely of catalogue production and distribution costs and sale marketing costs, which are expensed at the time of sale, as well as
corporate marketing expenses, which are expensed as incurred. Stock-Based CompensationIn December 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment. SFAS No. 123R is a revision of SFAS
No. 123, as amended, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees. SFAS No.
123R eliminates the alternative to use the intrinsic value method of accounting that was provided in SFAS No. 123, which generally resulted in no compensation expense recorded in the financial
statements for stock options awarded to employees with an exercise price equal to the stocks fair value on the date of grant. SFAS No. 123R requires that the cost resulting from all share-based
payment transactions be recognized in the financial statements. SFAS No. 123R establishes fair value as the measurement objective in accounting for share-based payment arrangements and generally
requires all companies to apply a fair-value-based measurement method in accounting for all share-based payment transactions with employees. On January 1, 2006, the Company adopted SFAS No. 123R using the modified prospective method. Accordingly, prior period amounts have not been restated. Under this method, the Company
is required to record compensation expense for all share-based awards granted after the date of adoption and for the unvested portion of previously granted awards that remained outstanding at the
date of adoption. Prior to the adoption of SFAS No. 123R, the Company applied APB No. 25 to account for its stock-based awards. The Company historically has treated its stock options as having
been granted at the stocks fair market value on the date of grant. Consequently, under the provisions of APB No. 25, the Company did not recognize compensation expense for the cost of stock
options issued to employees under its stock option plans. However, see Review of Stock Option Granting Practices under Note M for a discussion of a review conducted by outside legal counsel
which resulted in, among other things, the use of new measurement dates for certain stock option grants. The Company has elected to adopt the alternative transition method provided in SFAS No. 123R-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards,
for calculating the tax effects of stock-based compensation pursuant to SFAS No. 123R. The alternative transition method includes simplified methods to establish the beginning balance of the
additional paid-in capital pool (the APIC pool) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated
Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS No. 123R. Stock-based compensation expense related to restricted stock shares issued pursuant to the Amended and Restated Restricted Stock Plan is determined based on the closing fair value of the 57
shares issued on the business day before the date of grant. Such compensation expense is subsequently amortized to Salaries and Related Costs over the corresponding graded vesting period. Stock compensation expense is also recognized for the value of future restricted stock grants that are contractually guaranteed according to the terms of certain employment arrangements. The
guaranteed value of such future restricted stock grants is amortized over a period beginning on the effective date of the respective employment arrangement and through the final legal vesting date of
the grant. (See Note M for additional information on the Companys employee stock option plans and the Restricted Stock Plan.) Earnings Per ShareBasic earnings per share is calculated by dividing net income by the weighted average number of outstanding shares of common stock. The weighted average number of shares
used for calculating basic and diluted earnings per share, which excludes shares issued as contingent consideration in the acquisition of Noortman Master Paintings B.V. (see Note C), is as follows:
Year Ended December 31
2006
2005
2004
(In millions) Basic weighted average shares outstanding
60.3
60.7
61.9 Dilutive effect of stock options and unvested restricted stock
1.8
1.2
0.8 Diluted weighted average shares outstanding
62.1
61.9
62.7 (See Note M for information on stock options and restricted stock outstanding.) For the years ended December 31, 2006, 2005 and 2004, there were no reconciling items between the net income used in calculating basic and diluted earnings per share. Comprehensive Income (Loss)SFAS No. 130, Reporting Comprehensive Income, requires certain transactions to be included as adjustments to net income (loss) in order to report
comprehensive income (loss). The Companys Comprehensive Income includes the Net Income for the period, as well as Other Comprehensive Income (Loss), and is reported in the Consolidated
Statements of Changes in Shareholders Equity. Other Comprehensive Income (Loss) includes principally gains and losses related to the Companys defined benefit plans that arise during the period
but are not recognized as components of net periodic pension cost pursuant to SFAS No. 87, Employers Accounting for Pensions (see Note N), as well as the change in the foreign currency
translation adjustment during the period. Such amounts are included on a cumulative basis in Accumulated Other Comprehensive Income (Loss) in the Consolidated Balance Sheets. Amounts
recognized in Accumulated Other Comprehensive Income (Loss) related to the Companys defined benefit plans are adjusted as they are subsequently recognized as components of net periodic
pension cost pursuant to the recognition and amortization provisions of SFAS No. 87. Cash and Cash EquivalentsCash equivalents are liquid investments comprised primarily of bank and time deposits and other short-term investments with maturities of three months or less when
purchased. These investments are carried at cost, which approximates fair value. Restricted CashRestricted Cash principally consists of amounts or deposits whose use is restricted by either law or contract and primarily includes deposits supporting rental obligations in the
United States (the U.S.) and Europe and net auction proceeds owed to consignors in certain non-U.S. jurisdictions. Short-Term InvestmentsFrom time-to-time, the Company invests in money-market instruments with maturities of more than three months when purchased. These investments are classified as
available-for-sale and are reflected in the Consolidated Balance Sheets at fair value, which is the equivalent of their par value. Allowance for Doubtful AccountsManagement evaluates its allowance for doubtful accounts regularly and also evaluates specific accounts receivable balances when it becomes aware of a situation
where a client may not be able to meet its financial obligations to the Company. The amount of the required allowance is based on the facts available to management and is reevaluated 58
and adjusted as additional information is received. Allowances are also established for probable losses inherent in the remainder of the accounts receivable balance. Allowance for Credit LossesManagement evaluates its allowance for credit losses regularly and also evaluates specific loans when it becomes aware of a situation where a borrower may not be
able to repay the loan. The amount of the required allowance is based on the facts available to management and is reevaluated and adjusted as additional information is received. Secured loans that
may not be collectible are analyzed based on the current estimated realizable value of the collateral securing each loan, as well as the ability of the borrower to repay the loan. Reserves are
established for secured loans that management believes are under-collateralized, and with respect to which the under-collateralized amount may not be collectible from the borrower. Unsecured loans
are analyzed based on managements estimate of the current collectibility of each loan, taking into account the ability of the borrower to repay the loan. A reserve is also established for probable
losses inherent in the remainder of the loan portfolio based on historical data related to loan write-offs. (See Note E.) InventoryInventory consists of property held by the Dealer and Auction segments. Dealer inventory consists principally of property held by NMP and objects purchased for investment purposes.
Auction inventory consists principally of objects obtained as a result of the failure of guaranteed property to sell at auction, and to a lesser extent, objects obtained incidental to the auction process,
as a result of defaults by purchasers after the consignor has been paid, and the honoring of purchasers claims. In situations where guaranteed property fails to sell at auction, the Company has the
right to recover the minimum guaranteed amount through the future sale of the property (see Note P). Inventory is valued on a specific identification basis at the lower of cost or managements
estimate of net realizable value. Fixed AssetsFixed Assets are stated at cost less accumulated depreciation and amortization. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets.
Leaseholds and leasehold improvements are amortized using the straight-line method over the lesser of the life of the lease or the estimated useful life of the improvement. Computer software
consists of the capitalized cost of purchased computer software, as well as direct external and internal computer software development costs incurred in the acquisition or development of software for
internal use. These costs are amortized on a straight-line basis over the estimated useful life of the software. (See Note G.) GoodwillGoodwill represents the excess of the purchase price paid over the fair value of net assets acquired in business acquisitions. Goodwill is not amortized, but it is tested for impairment at
the reporting unit level annually (October 31 for the Company) and between annual tests if indicators of potential impairment exist. An impairment loss is recognized for any amount by which the
carrying amount of a reporting units goodwill exceeds its fair value. Fair values are established using discounted cash flows. (See Note H.) Intangible AssetsIntangible assets are amortized over their estimated useful lives unless such lives are deemed indefinite. If indicators of potential impairment exist, amortizable intangible assets
are tested for impairment based on undiscounted cash flows and, if impaired, written down to fair value based on either discounted cash flows or appraised values. Intangible assets with indefinite
lives are tested annually for impairment (October 31 for the Company) and written down to fair value as required. (See Note I.) Impairment of Long-Lived AssetsLong-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be
recoverable. In such situations, long-lived assets are considered impaired when estimated future cash flows (undiscounted and without interest charges) resulting from the use of the asset and its
eventual disposition are less than the assets carrying amount. In such situations, the asset is written down to the present value of the estimated future cash flows. Valuation Allowance for Deferred Tax AssetsThe Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. In assessing
the need for the valuation allowance, management considers, among other things, its projections of future taxable income and ongoing prudent and feasible tax planning strategies. (See Note K.) 59
Auction GuaranteesThe liability related to the Companys outstanding auction guarantees is recorded within Accounts Payable and Accrued Liabilities in the Consolidated Balance Sheets at fair
value, which is estimated based on an analysis of historical loss experience related to auction guarantees. (See Note P.) Defined Benefit Pension PlanThe Company sponsors defined benefit pension plans for certain of its employees. As of December 31, 2006, the Company adopted the recognition and disclosure
provisions of SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plansan amendment of FASB Statements No. 87, 88, 106, and 132(R). See Note N for
detailed information on the adoption of SFAS No. 158. Asset Retirement ObligationsIn March 2005, the FASB issued FIN No. 47, Accounting for Conditional Asset Retirement Obligationsan interpretation of FASB Statement No. 143. FIN No. 47
requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated. FIN No. 47 states that a conditional asset
retirement obligation is a legal obligation to perform an asset retirement activity in which the timing or method of settlement are conditional upon a future event that may or may not be within the
control of the entity. The Company adopted FIN No. 47 effective December 2005 and accordingly recorded an after-tax charge of approximately $1.1 million ($1.6 million, pre-tax), or $0.02 per diluted share, as a
cumulative effect of a change in accounting principle in the Consolidated Income Statement for the year ended December 31, 2005. This charge relates primarily to those lease agreements that
require the Company to restore the underlying facilities to their original condition at the end of the leases. The Company was uncertain of the timing of payment for these asset retirement
obligations; therefore a liability was not previously recognized in the financial statements under generally accepted accounting principles. On a prospective basis, this accounting change requires
recognition of these costs ratably over the lease term. The adoption of FIN No. 47 initially resulted in a non-cash addition to Fixed Assets of $1 million with a corresponding increase in long-term
liabilities. As of December 31, 2006 and 2005, assets recorded on the Consolidated Balance Sheet related to FIN No. 47 were $0.2 million, consisting of gross assets of $1 million less accumulated
depreciation of $0.8 million, and the asset retirement obligation as of those dates was $1.8 million. In future periods, when cash is paid upon the settlement of the asset retirement obligation, the
payments will be classified as a component of operating cash flow in the Consolidated Statements of Cash Flows. If the provisions of FIN No. 47 would have been applied during the periods prior to
adoption, the asset retirement obligation as of December 31, 2004 would have been $1.7 million. For the year ended December 31, 2006, changes in the Companys asset retirement obligations were
as follows (in thousands of dollars): Balance as of January 1, 2006
$
1,864 Liabilities incurred
Liabilities settled
(140
) Accretion expense
90 Foreign currency exchange rate changes
35 Balance as of December 31, 2006
$
1,849 Financial InstrumentsThe Companys financial instruments include Cash and Cash Equivalents, Restricted Cash, Short-Term Investments, Notes Receivable and Consignor Advances (see Note E),
Credit Facility Borrowings, Long-Term Debt, the liability for the Discount Certificates issued in connection with the settlement of certain civil litigation related to the investigation by the United
States Department of Justice (the DOJ) and the note payable to Arcimboldo S.A. (Arcimboldo). The carrying amounts of Cash and Cash Equivalents, Restricted Cash, Short-Term Investments, Notes Receivable and Consignor Advances (see Note E) and Credit Facility Borrowings (see
Note J) do not materially differ from their estimated fair values due to their nature and the variable interest rates associated with each of these financial instruments. 60
The fair value of the Companys long-term debt was approximately $98 million as of December 31, 2006. This amount is based on quoted market prices. (See Note J.) The carrying amounts of the Discount Certificate liability (see Note Q) and the note payable to Arcimboldo (see Note C) approximate their fair values. Derivative Financial InstrumentsThe Company utilizes forward exchange contracts to manage exposures related to foreign currency risks, which primarily arise from short-term foreign currency
denominated intercompany balances and, to a lesser extent, foreign currency denominated client receivable and payable balances as well as foreign currency denominated future guarantee obligations.
Generally, exposures related to such foreign currency risks are centrally managed by the Companys global treasury function. The Companys objective for holding derivative instruments is to
minimize foreign currency risks using the most effective methods to eliminate or reduce the impacts of these exposures. The forward exchange contracts entered into by the Company are used mostly as cash flow hedges of the Companys exposure to short-term foreign currency denominated intercompany balances
and, to a lesser extent, foreign currency denominated client receivable and payable balances as well as foreign currency denominated future guarantee obligations. Such forward exchange contracts are
typically short-term with settlement dates less than one year from their inception. These contracts are not designated as hedging instruments under SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended, and are recorded in the Consolidated Balance Sheets at fair value, which is based on referenced market rates. Changes in the fair value of the
Companys forward exchange contracts are recognized currently in earnings. At December 31, 2006, the Company had $140.8 million of notional value forward exchange contracts outstanding. Notional amounts do not quantify risk or represent assets or liabilities of the
Company, but are used in the calculation of cash settlements under such contracts. The Company is exposed to credit-related losses in the event of nonperformance by the two counterparties to its
forward exchange contracts, but the Company does not expect any counterparties to fail to meet their obligations given their high credit ratings. As of December 31, 2006, the Consolidated Balance Sheets included a liability of $1.1 million recorded within Accounts Payable and Accrued Liabilities reflecting the fair value of the Companys
outstanding forward exchange contracts on that date. As of December 31, 2005, the Consolidated Balance Sheets included an asset of $0.1 million recorded within Prepaid Expenses and Other
Current Assets reflecting the fair value of the Companys outstanding forward exchange contracts on that date. Use of EstimatesThe preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ materially from those estimates and could change in the short-term. Staff Accounting Bulletin No. 108In September 2006, the Securities and Exchange Commission (the SEC) issued Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB No. 108 requires that registrants quantify errors using both a balance sheet and income statement
approach and evaluate whether either approach results in a misstated amount that, when all relevant quantitative and qualitative factors are considered, is material. The Company adopted SAB No.
108 in the fourth quarter of 2006. Recently Issued Accounting StandardsIn July, 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109, which requires that
realization of an uncertain income tax position must be more likely than not (i.e., greater than 50% likelihood of receiving a benefit) before it can be recognized in the financial statements.
Further, this interpretation prescribes the benefit to be recorded in the financial statements as the amount most likely to be realized assuming a review by tax authorities having all relevant 61
information and applying current conventions; clarifies the financial statement classification of tax-related penalties and interest and sets forth new disclosures regarding unrecognized tax benefits. FIN
No. 48 is effective for the Company in the first quarter of 2007. Management is evaluating the Companys tax positions and assessing the impact of adopting FIN No. 48. In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value, and expands disclosures
about fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements. The provisions of SFAS No. 157 are effective for
financial statements issued by the Company starting in 2008. Management is evaluating the impact of adopting SFAS No. 157, if any, on the Companys financial statements. In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an amendment of FASB Statement No. 115. SFAS No. 159
permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be
recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for the Company as of January 1, 2008. Management is evaluating the impact of adopting SFAS No. 159, if any,
on the Companys financial statements. Note CAcquisition On June 7, 2006, the Company and Arcimboldo S.A. (Arcimboldo), a private limited liability company incorporated under the laws of Luxembourg, entered into a sale and purchase agreement
(the Purchase Agreement), pursuant to which the Company acquired all the issued and outstanding shares of capital stock of Noortman Master Paintings B.V., a company incorporated under the
laws of the Netherlands and a pre-eminent art dealer. The acquisition of NMP provides the Company with the opportunity to expand its dealer activities. NMP is based in Maastricht, the
Netherlands. Robert C. Noortman, who was the Managing Director of NMP and sole shareholder of Arcimboldo and also guaranteed the obligations of Arcimboldo under the Purchase Agreement,
died unexpectedly on January 14, 2007. Following Mr. Noortmans death, his guarantee under the Purchase Agreement remains binding on his estate. NMP is continuing under the leadership of Mr.
Noortmans son, William. NMPs results are included in the Companys Consolidated Income Statements beginning on June 1, 2006. Pursuant to the Purchase Agreement, the Company paid initial consideration (the Initial Consideration) in the form of 1,946,849 shares of Sothebys Class A Common Stock (Sothebys
Shares), which had a fair value of approximately $41.4 million. The fair value of the Sothebys Shares issued as Initial Consideration is based on the actual number of shares issued using the closing
price of Sothebys Shares on the New York Stock Exchange of $25.30 per share on June 6, 2006 reduced by $7.9 million to reflect the fair value of certain restrictions on the future transfer of the
Initial Consideration, as discussed in more detail below. The fair value of these restrictions was determined by an independent valuation expert. In addition to the Initial Consideration, the Company
acquired NMP subject to approximately $25.6 million of indebtedness, consisting of a 12.5 million ($16.1 million) long-term non-interest bearing note payable to Arcimboldo over a period of three
years (as discussed in more detail below) and $9.5 million of bank debt that was repaid upon the closing of the transaction, as well as the settlement of an $11.7 million payable to Sothebys. As of
the date of acquisition, the present value of the note payable to Arcimboldo was approximately 11.3 million ($14.6 million). The 1.2 million ($1.5 million) discount on the note payable is being
amortized to interest expense over the three-year term. The first payment of 2.1 million ($2.6 million) under the note payable was made on July 26, 2006. The remaining payments under the note
payable are due according to the following schedule: 2 million ($2.7 million) on June 7, 2007, 4.2 million ($5.5 million) on June 7, 2008 and 4.2 million ($5.5 million) on June 7, 2009. As of December
31, 2006, the carrying value of the note payable was $12.6 million. The current portion of the note payable ($2.1 million) is recorded in the December 31, 2006 Consolidated Balance Sheet within
Accounts Payable and Accrued Liabilities. The non-current portion of the note payable 62
($10.5 million) is recorded in the December 31, 2006 Consolidated Balance Sheet within Other Liabilities. If NMP fails to achieve a minimum level of financial performance during the five years following the closing of the transaction, up to 20% of the Initial Consideration will be transferred back to
the Company. An additional 486,712 Sothebys Shares (the Additional Consideration) have been issued and placed in escrow, to be released only if NMP achieves certain targeted performance criteria
specified in the Purchase Agreement during the five years following the closing of the transaction and if NMP achieves certain service criteria. Based on the closing price of Sothebys Shares on the
New York Stock Exchange of $38.99 per share on February 20, 2007, the Additional Consideration has a fair value of approximately $19 million. The Additional Consideration is being held in escrow
pursuant to an escrow agreement dated June 7, 2006, among the parties to the Purchase Agreement and LaSalle Bank N.A. The Purchase Agreement also provides for certain restrictions on the transfer of Sothebys Shares received by Arcimboldo, as discussed above. Subject to certain limited exclusions, Arcimboldo
may not transfer any of the Sothebys Shares that it received as Initial Consideration for a period of two years after the closing, and may not transfer 20% of the Sothebys Shares that it received as
Initial Consideration for a period of five years after the closing. The Company, Arcimboldo and Mr. Noortman also made customary warranties and covenants in the Purchase Agreement, including certain post-closing business covenants of the Company and
certain non-competition and non-solicitation covenants of Arcimboldo and Mr. Noortman for a period of five years following closing. Mr. Noortman also entered into a seven-year employment
agreement with NMP, which ceased upon Mr. Noortmans death. In addition, the Company also has in place a key man life insurance policy of $20 million covering Mr. Noortman. The Company has filed the necessary claim forms to establish its rights under
this policy. In the fourth quarter of 2006, the Company substantially completed its valuation of the NMP assets acquired (including intangible assets) and liabilities assumed and will finalize the valuation in
the first quarter of 2007. The fair value of the art-related assets acquired was estimated by a team of qualified art experts. The fair value of all other NMP assets and liabilities were estimated
utilizing a number of techniques, including independent appraisals. The table below, which is presented in thousands of dollars, summarizes the allocation of the purchase price to the NMP assets
acquired and liabilities assumed. The initial allocation provided in the Companys June 30, 2006 Form 10-Q has been updated to reallocate amounts from Goodwill to Intangible Assets ($14.2 million),
Inventory ($9.2 million), Fixed Assets ($2.7 million) and Other Long-Term Assets ($0.4 million) based on the completed appraisals. Additionally, in the third and fourth quarters of 2006, Deferred
Tax Liabilities of $1.5 million and $5.9 million were recorded to reflect the impact of taxable temporary differences between the book and tax bases of certain acquired assets and liabilities, resulting
in a corresponding increase to Goodwill. The Goodwill related to NMP is not tax deductible. 63
Purchase price: Fair value of Initial Consideration
$
41,374 Settlement of payable due to Sothebys
11,745
* Direct acquisition costs
1,527 Total purchase price
$
54,646 Allocation of purchase price: Accounts receivable
$
13,424 Inventory
56,412 Fixed assets
3,330 Prepaid expenses and other current assets
293 Other long-term assets
518 Goodwill
20,583
** Intangible assets
14,162
*** Accounts payable and accrued liabilities
(20,395
) Other current liabilities
(1,309
) Note payable to Arcimboldo
(14,590
) Bank debt
(9,531
) Deferred tax liabilities
(7,419
) Other non-current liabilities
(832
) Total purchase price
$
54,646
*
Reflects amounts due to Sothebys for property purchased by NMP at auction prior to the date of acquisition. ** As a result of Mr. Noortmans death in January 2007, Goodwill related to NMP is being tested for impairment. The Company anticipates that it will record an impairment charge in the first
quarter of 2007 to reduce the carrying value of NMPs Goodwill. The amount of such a charge could potentially be material depending on the outcome of the Companys assessment. See
Note H for additional information related to Goodwill. *** The amount allocated to Intangible Assets relates to customer relationships ($11.1 million), trade name ($2.5 million) and a non-compete agreement ($0.6 million). As a result of Mr.
Noortmans death in January 2007, Intangible Assets related to NMP are being tested for impairment. The Company anticipates that it will record an impairment charge in the first quarter
of 2007 to reduce the carrying value of NMPs Intangible Assets. The amount of such a charge could potentially be material depending on the outcome of the Companys assessment. See
Note I for additional information related to Intangible Assets. Note DSegment Reporting The Companys continuing operations are organized under three business segmentsAuction, Finance and Dealer. The Companys discontinued real estate brokerage business, which almost entirely
comprised its former Real Estate segment, is not included in this presentation. In the second quarter of 2006, management decided to continue to operate the Companys real estate brokerage
business in Australia, which had previously been reported in discontinued operations since the fourth quarter of 2004. Consequently, beginning in the second quarter of 2006, results for this business,
which are not material to the Companys Consolidated Income Statements, have been reclassified into continuing operations and are included in this presentation in All Other for all periods
presented. (See Note T for further information on discontinued operations.) The Companys segments are strategic business units that offer different services. They are managed separately because each business requires different resources and strategies. The Companys
chief operating decision making group, which is comprised of the Chief Executive Officer, the Chief Financial Officer and the senior executives of each segment, regularly evaluates financial
information about each segment in deciding how to allocate resources and in assessing 64
performance. The performance of each segment is measured based on its profit or loss from operations before taxes and excluding the unallocated items highlighted below in the reconciliation of
segment income (loss) to income (loss) from continuing operations before taxes. The Auction segment is an aggregation of Auction operations in North America, Europe and Asia as they have similar economic characteristics and they are similar in service, customers and the
way in which the services are provided. The Auction segment conducts auctions of fine arts, decorative arts, jewelry and collectibles in which the Company generally functions as an agent accepting
property on consignment from its selling clients. In addition to auctioneering, the Auction segment is engaged in a number of related activities including the brokering of private purchases and sales
of art, jewelry and other collectibles. The Finance segment provides art-related financing generally secured by works of art that the Company either has in its possession or that the Company permits
the borrower to possess (see Note E). All Other primarily includes amounts related to the Companys licensing activities and other ancillary businesses. In the fourth quarter of 2006, due to the acquisition of NMP (see Note C) and the resulting increase in the Companys Dealer activities, certain activities which were previously managed as part
of the Auction segment were realigned with NMP and aggregated into a newly established Dealer segment under the oversight of an executive committee responsible for managing the Companys
portfolio of Dealer activities. Such activities include:
The investment in and resale of art and other collectibles directly by the Company. The investment in art through unsecured loans made by the Company to unaffiliated art dealers (see Note E). The activities of certain equity investees including Acquavella Modern Art (see Note F). The purchase and resale of art through an art dealer whose results are required to be consolidated with the Companys results under generally accepted accounting principles. The Company has
no equity investment in this entity. (See Note R.) In periods prior to the fourth quarter of 2006, NMPs results were not material and were reported as part of All Other. All prior period segment information has been revised for comparability
to reflect this change. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (see Note B). Auction and Dealer segment revenues are attributed to
geographic areas based on the location of the actual sale. Finance segment revenues are attributed to geographic areas based on the location of the entity that originated the loan. 65
The following tables present the Companys segment information for the years ended December 31, 2006, 2005 and 2004:
Year Ended December 31, 2006
Auction
Finance
Dealer
All Other
Reconciling
Total
(Thousands of dollars) Revenues
$
631,344
$
16,974
$
12,776
$
4,825
$
(1,110
)
$
664,809 Interest income
$
16,309
$
1
$
17
$
7
$
$
16,334 Interest expense
$
29,828
$
$
422
$
110
$
$
30,360 Depreciation and amortization
$
20,927
$
62
$
1,779
$
15
$
$
22,783 Segment income
$
164,962
$
1,622
$
1,681
$
2,061
$
$
170,326 Year Ended December 31, 2005 Revenues
$
496,899
$
8,949
$
5,131
$
3,521
$
(647
)
$
513,853 Interest income
$
9,793
$
$
$
4
$
$
9,797 Interest expense
$
29,356
$
$
$
77
$
$
29,433 Depreciation and amortization
$
21,988
$
62
$
4
$
27
$
$
22,081 Segment income (loss)
$
95,342
$
(274
)
$
4,425
$
949
$
$
100,442 Year Ended December 31, 2004 Revenues
$
439,526
$
6,305
$
3,604
$
2,369
$
(398
)
$
451,406 Interest income
$
7,611
$
$
$
13
$
$
7,624 Interest expense
$
28,682
$
(87
)
$
$
71
$
$
28,666 Depreciation and amortization
$
23,797
$
$
3
$
37
$
$
23,837 Segment income
$
55,398
$
(634
)
$
7,250
$
(464
)
$
$
61,550
*
Represents charges between the Finance segment and the Auction segment for certain client loans. Such intercompany charges were immaterial to the Finance segment prior to the second quarter
of 2006 and, therefore, were not included in Finance segment revenues. Beginning in the second quarter of 2006, such charges are being included in Finance segment revenues for all periods
presented.
For the year ended December 31, 2004, the presentation of segment revenues above excludes $45.6 million in one-time license fee revenues earned in conjunction with the consummation of the
Realogy License Agreement (see Note T). Ongoing license fees earned during the term of the Realogy License Agreement are reflected in All Other. The table below presents a reconciliation of segment income before taxes to income from continuing operations before taxes for years ended December 31, 2006, 2005 and 2004:
Year Ended December 31
2006
2005
2004
(Thousands of dollars) Auction
$
164,962
$
95,342
$
55,398 Finance
1,622
(274
)
(634
) Dealer
1,681
4,425
7,250 All Other
2,061
949
(464
) Segment income before taxes
$
170,326
$
100,442
$
61,550 Unallocated amounts and reconciling items: Credit facility termination costs (a)
(3,069
)
One-time license fee revenue and related costs (b)
43,489 Antitrust related benefit (expense) (c)
806
(1,127
)
(1,928
) Amortization of interest related to Antitrust matters (d)
(2,679
)
(3,988
)
(4,885
) Retention costs
(285
) Net restructuring charges
(146
) Equity in earnings of investees (e)
(2,670
)
(1,276
)
(1,138
) Income from continuing operations before taxes
$
165,783
$
90,982
$
96,657
(a)
Represents a $1 million termination fee and the write-off of approximately $2.1 million in arrangement fees and other direct costs related to the termination of the Companys senior secured
credit agreement with General Electric Capital Corporation (see Note J).
66
Item*
(b) Represents one-time license fee revenues earned in conjunction with the consummation of the Realogy License Agreement (approximately $45.6 million) and the related transaction costs ($2.2
million), which are not allocated to the Companys operating segments (see Note T). (c) Represents amounts related to antitrust matters consisting principally of settlement administration costs and legal fees, which are classified within General and Administrative Expenses. For the
year ended December 31, 2006, the amount reflected in this caption includes a $2.4 million benefit for the recovery of settlement administration expenses related to the International Antitrust
Litigation (see Note Q). (d) Represents the amortization of interest charges related to the DOJ antitrust fine and certain related civil litigation (see Note Q). (e) Represents the Companys pre-tax share of earnings related to its equity investees. Such amounts are included in the table above in income before taxes for the Dealer segment, but are presented
net of taxes below Income from Continuing Operations Before Taxes in the Consolidated Income Statements. The table below presents other reconciling items related to the Companys segment information for the years ended December 31, 2006, 2005 and 2004:
Year Ended December 31, 2006
Segment
Reconciling
Consolidated
(Thousands of dollars) Interest income
$
16,334
$
(10,443
)(a)
$
5,891 Interest expense
$
30,360
$
2,679
(b)
$
33,039 Year Ended December 31, 2005 Interest income
$
9,797
$
(4,114
)(a)
$
5,683 Interest expense
$
29,433
$
3,988
(b)
$
33,421 Year Ended December 31, 2004 Interest income
$
7,624
$
(4,340
)(a)
$
3,284 Interest expense
$
28,666
$
4,885
(b)
$
33,551
(a)
Represents the elimination of interest charged by Auction to Finance for funding Finances loan portfolio. (b) Represents the amortization of interest charges related to the DOJ antitrust fine and certain related civil litigation (see Note Q). 67
Totals
Items
Total
The table below presents information concerning revenues from continuing operations for geographical areas for the years ended December 31, 2006, 2005 and 2004:
Year Ended December 31
2006
2005
2004
(Thousands of dollars) United States: Auction
$
294,042
$
201,430
$
190,641 Finance
8,211
4,650
3,953 Dealer
7,118
5,131
3,604 All Other
3,124
2,140
878 Sub-total
312,495
213,351
199,076 United Kingdom: Auction
222,088
189,606
167,379 Finance
8,505
4,113
2,191 All Other
869
541
700 Sub-total
231,462
194,260
170,270 China: Auction
40,268
32,793
23,306 Finance
230
98
39 Sub-total
40,498
32,891
23,345 Other Countries: Auction (a)
74,946
73,070
58,200 Finance
28
88
122 Dealer
5,658
All Other
832
840
791 Sub-total
81,464
73,998
59,113 One-time License fee revenue (b)
45,650 Reconciling item: Intercompany revenue earned by Finance from Auction
(1,110
)
(647
)
(398
) Total
$
664,809
$
513,853
$
497,056
(a)
No other individual country exceeds 5% of total revenues for any of the periods presented. (b) Represents one-time license fee revenues earned in conjunction with the consummation of the Realogy License Agreement, which are not allocated to the Companys operating segments (see
Note T). The table below presents assets for the Companys segments, as well as a reconciliation of segment assets to consolidated assets as of December 31, 2006 and 2005:
December 31
2006
2005
(Thousands of dollars) Auction
$
1,066,089
$
815,352 Finance
178,548
148,576 Dealer
156,710
35,626 All Other
1,050
110 Total segment assets
1,402,397
999,664 Unallocated amounts: Deferred tax assets
74,768
61,088 Consolidated assets
$
1,477,165
$
1,060,752 68
Note EReceivables Accounts ReceivableIn its role as auctioneer, the Company generally functions as an agent accepting property on consignment from its selling clients. The Company sells property as agent of the
consignor, billing the buyer for property purchased, receiving payment from the buyer and remitting to the consignor the consignors portion of the buyers payment after deducting the Companys
commissions, expenses and applicable taxes. The amounts billed to buyers are recorded as Accounts Receivable in the Consolidated Balance Sheets. Under the standard terms and conditions of the
Companys auction sales, the Company is not obligated to pay consignors for items that have not been paid for by the purchaser. If the purchaser defaults on payment, the Company has the right to
cancel the sale and return the property to the owner, re-offer the property at a future auction or negotiate a private sale. In certain situations, under negotiated contractual arrangements or when the buyer takes possession of the property before payment is made, the Company is liable to the consignor for the net
sale proceeds whether or not the buyer makes payment. As of December 31, 2006 and 2005, Accounts Receivable included approximately $103.1 million and $180.1 million, respectively, of such
amounts due from buyers. As of December 31, 2006, substantially the entire amount outstanding at December 31, 2005 had been collected. As of February 16, 2007, approximately $59.5 million of the
amount outstanding at December 31, 2006 had been collected. Management believes that adequate allowances have been established to provide for potential losses on any uncollected amounts. Notes Receivable and Consignor AdvancesThe Company provides certain collectors and dealers with financing, generally secured by works of art that the Company either has in its possession or
permits the borrower to possess. The majority of the Companys secured loans are made at loan to value ratios (principal loan amount divided by the low auction estimate of the collateral) of 50% or
lower. However, the Company will also lend at loan to value ratios higher than 50%. As of December 31, 2006, such loans totaled $90.9 million and represented 44% of net Notes Receivable and
Consignor Advances. The property related to such loans had a low auction estimate of approximately $149.5 million. The Companys loans are predominantly variable interest rate loans. The Company generally makes two types of secured loans: (1) advances secured by consigned property to borrowers who are contractually committed, in the near term, to sell the property at
auction (a consignor advance); and (2) general purpose term loans to collectors or dealers secured by property not presently intended for sale (a term loan). The consignor advance allows a
consignor to receive funds shortly after consignment for an auction that will occur several weeks or months in the future, while preserving for the benefit of the consignor the potential of the auction
process. Term loans allow the Company to establish or enhance mutually beneficial relationships with dealers and collectors and sometimes result in auction consignments. Secured loans are generally
made with full recourse against the borrower. In certain instances, however, secured loans are made with recourse limited to the works of art pledged as security for the loan. To the extent that the
Company is looking wholly or partially to the collateral for repayment of its loans, repayment can be adversely impacted by a decline in the art market in general or in the value of the particular
collateral. In addition, in situations where the borrower becomes subject to bankruptcy or insolvency laws, the Companys ability to realize on its collateral may be limited or delayed by the
application of such laws. Under certain circumstances, the Company also makes unsecured loans to collectors and dealers. Included in gross Notes Receivable and Consignor Advances are unsecured
loans totaling $2.1 million and $0.6 million at December 31, 2006 and 2005, respectively. In certain situations, the Company also finances the purchase of works of art by certain art dealers through unsecured loans. The property purchased pursuant to such unsecured loans is sold
privately or at auction with any profit or loss shared by the Company and the dealer. The total of all such unsecured loans was $1.9 million and $0.3 million at December 31, 2006 and 2005,
respectively. These amounts are included in the total unsecured loan balances provided in the previous paragraph. 69
At December 31, 2006, three term loans issued to the same borrower, totaling $58.9 million, comprised in the aggregate approximately 28% of the net Notes Receivable and Consignor Advances
balance. As of December 31, 2006 and 2005, Notes Receivable and Consignor Advances consists of the following:
2006
2005
(Thousands of dollars) Current: Consignor advances
$
47,974
$
21,596 Term loans
105,250
64,468 Sub-total
153,224
86,064 Non-current: Consignor advances
5,400
1,925 Term loans
51,074
54,753 Sub-total
56,474
56,678 Notes receivable and consignor advances
209,698
142,742 Allowance for credit losses
(1,154
)
(792
) Notes receivables and consignor advances (net)
$
208,544
$
141,950 The weighted average interest rates charged on Notes Receivable and Consignor Advances were 8.2%, 6.8% and 5.9% for the years ended December 31, 2006, 2005 and 2004, respectively. As of December 31, 2006 and 2005, Notes Receivable and Consignor Advances includes employee loans of $0.6 million and $0.4 million, respectively. For the years ended December 31, 2006 and
2005, the weighted average interest rates charged on these loans were 9.7% and 8.1%, respectively. Changes in the Allowance for Credit Losses relating to Notes Receivable and Consignor Advances during 2006 and 2005 were as follows:
2006
2005
(Thousands of
dollars) Allowance for credit losses at January 1
$
792
$
1,759 Change in loan loss provision
423
(935
) Write-offs
(99
)
Foreign currency exchange rate changes
38
(32
) Allowance for credit losses at December 31
$
1,154
$
792 Note FInvestments On May 23, 1990, the Company purchased the common stock of the Pierre Matisse Gallery Corporation (Matisse) for approximately $153 million. The assets of Matisse consisted of a collection
of fine art (the Matisse Inventory). Upon consummation of the purchase, the Company entered into an agreement with Acquavella Contemporary Art, Inc. (ACA) to form Acquavella Modern
Art (AMA), a partnership through which the Matisse Inventory would be sold. The Company contributed the Matisse Inventory to AMA in exchange for a 50% interest in the partnership.
Although the original term of the AMA partnership agreement was for ten years and was due to expire in 2000, it has been renewed on an annual basis since then. The Company does not control AMA and is not its primary beneficiary; consequently, the Company uses the equity method to account for its investment in AMA and records its share of
AMAs earnings or losses, net of taxes, within Equity in Earnings of Investees in the Consolidated Income Statements. The Companys 50% interest in the net assets of AMA is included in
Investments in the Consolidated Balance Sheets. The carrying value of the Companys investment in AMA totaled $20.3 million and $23.5 million as of December 31, 2006 and 2005, respectively. For 70
the years ended December 31, 2006, 2005 and 2004, the Companys share of AMAs earnings, net of taxes, was $1.4 million, $0.5 million and $0.5 million, respectively. Pursuant to the AMA partnership agreement, upon the death of the majority shareholder of ACA, the successors-in-interest to ACA have the right, but not the obligation, to require the
Company to purchase their interest in AMA at a price equal to the fair market value of such interest. The fair market value shall be determined pursuant to a process and a formula set forth in the
partnership agreement that includes an appraisal of the works of art held by AMA at such time. The net assets of AMA consist almost entirely of the Matisse Inventory. At December 31, 2006, the
carrying value of this inventory was $64.2 million. To the extent that AMA requires working capital, the Company has agreed to lend the same to AMA. As of December 31, 2006 and 2005, no such amounts were outstanding. Additionally, from
time-to-time, the Company transacts with the principal shareholder of ACA in the normal course of its business. As of December 31, 2006 and 2005, the carrying value of the Companys investment in another affiliate was $2.8 million and $2.4 million, respectively. The Company does not control this affiliate
and is not its primary beneficiary; consequently, the Company uses the equity method to account for its investment. For the years ended December 31, 2006, 2005 and 2004, the Companys share of
this affiliates earnings, net of taxes, was $0.2 million, $0.3 million and $0.2 million, respectively. Note GFixed Assets As of December 31, 2006 and 2005, Fixed Assets consisted of the following:
December 31
2006
2005
(Thousands of dollars) Land
$
7,776
$
6,340 York Property capital lease
173,866
173,866 Buildings and building improvements
8,040
4,914 Leasehold improvements
72,352
64,222 Computer hardware and software
60,612
59,438 Furniture, fixtures and equipment
54,679
49,299 Construction in progress
6,157
1,293 Other
1,758
1,713
385,240
361,085 Less: accumulated depreciation and amortization
(158,718
)
(135,651
) Total
$
226,522
$
225,434 On February 7, 2003, the Company completed the sale of its headquarters building at 1334 York Avenue in New York, New York (the York Property) and leased it back from the buyer for
an initial 20-year term, with options for the Company to extend the lease for two additional 10-year terms. The resulting lease is being accounted for as a capital lease, with the related asset being
amortized over the initial 20-year lease term. According to the terms of the lease, if the landlord desires to sell the York Property, notice shall be given to the Company by the landlord of such
proposed sale and a statement of the proposed purchase price and the proposed closing date for the transaction (the Landlords Offer). Upon receipt of such notice, the Company has thirty days to
accept or reject the Landlords Offer. If accepted, the Company would purchase the York Property at the proposed purchase price. In February 2007, the Company was advised that the landlord of
the York Property intends to market and sell the York Property. Management is currently assessing its rights and options with respect to the York Property. Included in Accumulated Depreciation and Amortization above is $33.9 million and $25.3 million as of December 31, 2006 and 2005, respectively, related to the York Property capital lease. The
sale of the York Property resulted in a deferred gain of approximately $23 million, which is being amortized on a straight-line basis against Depreciation and Amortization Expense over the initial 20-
year lease term (see Note L). 71
Note HGoodwill The Company has Goodwill in its Auction and Dealer segments. The Goodwill in the Dealer segment is solely attributable to NMP, which was acquired on June 7, 2006 (see Note C). The
Company completed its annual impairment test and concluded that its Goodwill was not impaired as of October 31, 2006. For the years ended December 31, 2006 and 2005, changes in the carrying
value of Goodwill were as follows (in thousands of dollars):
2006
2005
Auction
Dealer
Total
Auction
Dealer
Total Balance as of January 1
$
13,447
$
$
13,447
$
13,753
$
$
13,753 Goodwill acquired (see Note C)
20,583
20,583
Foreign currency exchangerate changes
213
466
679
(306
)
(306
) Balance as of December 31
$
13,660
$
21,049
$
34,709
$
13,447
$
$
13,447 Robert C. Noortman, who was the Managing Director of NMP, died unexpectedly on January 14, 2007. NMP is continuing under the leadership of Mr. Noortmans son, William. As a result of
Mr. Noortmans death, Goodwill related to NMP is being tested for impairment. The Company anticipates that it will record an impairment charge in the first quarter of 2007 to reduce the carrying
value of NMPs Goodwill. The amount of such a charge could potentially be material depending on the outcome of the Companys assessment. Note IIntangible Assets As discussed in Note C, on June 7, 2006, the Company acquired NMP. In conjunction with the purchase price allocation, management assigned approximately $14.2 million to acquired intangible
assets. As of December 31, 2006, Intangible Assets consisted of the following:
Gross
Accumulated
Net
(Thousands of dollars) Indefinite lived intangible assets: Trade name
$
2,502 Amortizable intangible assets: Customer relationships (a)
$
11,376
$
1,658
$
9,718 Non-compete agreement (b)
605
45
560 Total
$
11,981
$
1,703
$
10,278
(a)
Amortized over a useful life of four years. (b) Amortized over a useful life of eight years. Amortization expense related to Intangible Assets for the year ended December 31, 2006, which is included in Depreciation and Amortization Expense in the Companys Consolidated Income
Statement, totaled $1.7 million. As of December 31, 2006, the remaining $10.3 million of acquired intangible assets have a weighted-average useful life of approximately 3.6 years. Based on the
December 31, 2006 carrying values and subject to the impairment test discussed below, amortization expense related to the customer relationships is expected to be approximately $2.8 million in each
of 2007, 2008, and 2009 and $1.3 million in 2010. Robert Noortman, Managing Director of NMP, died unexpectedly on January 14, 2007. As a result, the remaining unamortized intangible asset of $0.6 million relating to Mr. Noortmans non-
compete agreement will be expensed in the first quarter of 2007, while the intangible assets relating to the trade name and customer relationships of $2.5 million and $9.7 million, respectively, are
being tested for impairment. The Company anticipates that it will record an impairment charge in the first quarter of 2007 to reduce the carrying value of NMPs Intangible Assets. The amount of
such a 72
Carrying
Amount
Amortization
Carrying
Amount
charge could potentially be material depending on the outcome of the Companys assessment. (See Note C.) Note JCredit Arrangements Bank Credit FacilitiesOn September 7, 2005, in connection with the Transaction discussed in Note U, the Company terminated its previous senior secured credit agreement and entered into a new
senior secured credit agreement with an international syndicate of lenders arranged by Banc of America Securities LLC (BofA) and LaSalle Bank N.A. (the BofA Credit Agreement). The BofA
Credit Agreement originally provided for borrowings of up to $250 million through a revolving credit facility. On May 18, 2006, the Company amended the BofA Credit Agreement to provide for $50
million in additional commitments from its existing lenders, thereby increasing the total borrowing capacity to $300 million. The amendment also permits the amount of available borrowings to be
increased by an additional $50 million to $350 million. The amount of borrowings available at any time under the BofA Credit Agreement is limited to a borrowing base, which is generally equal to 100% of eligible loans made by the Company in
the U.S. and the U.K. (i.e., notes receivable and consignor advances) plus 15% of the Companys net tangible assets (calculated as total assets less current liabilities, goodwill, intangible assets,
unamortized debt discount and eligible loans). As of December 31, 2006, there were no outstanding borrowings under the BofA Credit Agreement and the amount of unused borrowing capacity
available and borrowing base under the BofA Credit Agreement was $275.2 million. The BofA Credit Agreement is available through September 7, 2010; provided that in the event that any of the $100 million in long-term debt securities (the Notes) issued by the Company in
February 1999 are still outstanding on July 1, 2008, then either: (a) the Company shall deposit cash in an amount equal to the aggregate outstanding principal amount of the Notes on such date into
an account in the sole control and dominion of BofA for the benefit of the lenders and the holders of the Notes or (b) the Company shall have otherwise demonstrated its ability to redeem and pay
in full the Notes; otherwise, the BofA Credit Agreement shall terminate and all amounts outstanding thereunder shall be due and payable in full on July 1, 2008. Borrowings under the BofA Credit Agreement were used to finance in part the Transaction and related expenses (see Note U) and are also available to provide ongoing working capital and for
other general corporate purposes of the Company. The Companys obligations under the BofA Credit Agreement are secured by substantially all of the non-real estate assets of the Company, as well
as the non-real estate assets of its subsidiaries in the U.S. and the U.K. The BofA Credit Agreement contains financial covenants requiring the Company not to exceed a maximum level of capital expenditures and dividend payments (as discussed in more detail
below) and to have a quarterly interest coverage ratio of not less than 2.0 and a quarterly leverage ratio of not more than: (i) 3.5 for quarters ending December 31, 2006 to September 30, 2007 and
(ii) 3.0 for quarters ending December 31, 2007 and thereafter. The maximum level of annual capital expenditures permitted under the BofA Credit Agreement is $15 million through 2007 and $20
million thereafter with any unused amounts carried forward to the following year. Dividend payments, if any, must be paid solely out of 40% of the Companys net income arising after June 30, 2005
and computed on a cumulative basis (see Note M). The BofA Credit Agreement also has certain non-financial covenants and restrictions. The Company is in compliance with its covenants. At the option of the Company, any borrowings under the BofA Credit Agreement generally bear interest at a rate equal to: (i) LIBOR plus 1.75%, or (ii) 0.5% plus the higher of the Prime
Rate or the Federal Funds Rate plus 0.5%. For the years ended December 31, 2006 and 2005, the weighted average interest rates incurred by the Company on outstanding borrowings under the
BofA Credit Agreement were approximately 7% and 6.3%, respectively. For the year ended December 31, 2004, the weighted average interest rate incurred by the Company on outstanding
borrowings under its previous credit facility was approximately 6.3%. 73
The Company paid underwriting, structuring and amendment fees of $2.8 million related to the BofA Credit Agreement, which are being amortized on a straight-line basis to interest expense
over the term of the facility. As a result of the termination of its previous senior secured credit agreement, in the third quarter of 2005, the Company incurred a $1 million termination fee and wrote off approximately $2.1
million in arrangement fees and other direct costs related to the GE Capital Credit Agreement, which were previously being amortized over the term of the agreement. These charges are combined
and reflected as a separate caption in the Consolidated Income Statement for the year ended December 31, 2005. Senior Unsecured DebtIn February 1999, the Company issued a tranche of long-term debt securities (defined above as the Notes), pursuant to the Companys $200 million shelf registration with
the SEC, for an aggregate offering price of $100 million. The ten-year Notes have an effective interest rate of 6.98% with interest payments due semi-annually in February and August. The Notes
have covenants that impose limitations on the Company from placing liens on certain property and entering into certain sale-leaseback transactions. The Company is in compliance with these
covenants. As of December 31, 2006, aggregate principal and interest payments due under the Notes are as follows (in thousands): 2007
$
6,875 2008
6,875 2009
102,865 Total future principal and interest payments
$
116,615 Interest ExpenseFor the years ended December 31, 2006, 2005 and 2004, interest expense consisted of the following:
Year Ended December 31
2006
2005
2004
(Thousands of dollars) Senior secured credit facility: Interest expense on outstanding borrowings
$
1,787
$
1,513
$
298 Amortization of amendment and arrangement fees
568
844
1,114 Commitment fees
707
851
869 Sub-total
3,062
3,208
2,281 Interest expense on York Property capital lease obligation (see Note L)
17,826
17,899
17,911 Interest expense on long-term debt
6,965
6,959
6,952 Amortization of discount related to antitrust matters (see Note Q)
2,679
3,988
4,885 Other interest expense
2,507
1,367
1,522 Total
$
33,039
$
33,421
$
33,551 Other interest expense principally relates to interest accrued on the obligations under the Sothebys, Inc. Benefit Equalization Plan and its successor, the Sothebys, Inc. 2005 Benefit Equalization
Plan, which were unfunded deferred compensation plans available to certain U.S. officers of the Company through December 31, 2006 (see Note N). Interest PaidFor the years ended December 31, 2006, 2005 and 2004, interest paid totaled $28.1 million, $29.2 million and $29 million, respectively. Interest paid consists of cash payments related
to the Companys credit facility borrowings (including interest and fees) and long-term debt securities, as well as the portion of lease payments for the York Property capital lease obligation related to
interest. 74
Note KIncome Taxes For the years ended December 31, 2006, 2005 and 2004, the significant components of income tax expense (benefit) from continuing operations consist of the following:
Year Ended December 31
2006
2005
2004
(Thousands of dollars) Income (loss) from continuing operations before taxes: Domestic
$
32,456
$
(13,217
)
$
27,763 Foreign
133,327
104,199
68,894 Total
$
165,783
$
90,982
$
96,657 Income tax expensecurrent: Federal and state
$
4,043
$
4,505
$
1,515 Foreign
32,660
15,332
10,270 Sub-total
36,703
19,837
11,785 Income tax expense (benefit)deferred: Federal and state
22,341
(2,375
)
9,216 Foreign
1,006
11,132
13,999 Sub-total
23,347
8,757
23,215 Total
$
60,050
$
28,594
$
35,000 For the years ended December 31, 2006, 2005 and 2004, income tax expense related to the Companys equity in earnings of investees was approximately $1 million, $0.4 million and $0.4 million,
respectively. The components of deferred income tax assets and liabilities are disclosed below:
December 31
2006
2005
(Thousands of dollars) Deferred Tax Assets: Asset provisions and accrued liabilities
$
41,285
$
33,847 Pension obligations
18,249
Capital lease obligation
73,079
73,076 Tax loss and credit carryforwards
30,347
49,412 Difference between book and tax basis of depreciable and amortizable assets
1,683
Sub-total
164,643
156,335 Valuation allowance
(29,147
)
(24,885
) Total deferred tax assets
135,496
131,450 Deferred Tax Liabilities: Difference between book and tax basis of depreciable and amortizable assets
56,382
52,522 Step up of acquired assets
2,586
Pension obligations
8,095 Basis difference in equity method investments
8,391
9,787 Total deferred tax liabilities
67,359
70,404 Total
$
68,137
$
61,046 The Company has deferred tax assets related to various foreign and state loss and tax credit carryforwards totaling $28.4 million that begin to expire in 2008. In addition, at December 31, 2006
the Company has alternative minimum tax credits of $1.9 million being carried forward indefinitely. The Company provided a valuation allowance for certain deferred tax assets primarily related to state, federal and foreign losses of $29.1 million and $24.9 million at December 31, 2006 and
2005, respectively. In 2005, the valuation allowance decreased from 2004 by $8.9 million, primarily due to the reversal of allowances related to federal and foreign net operating loss carryforwards.
During 75
2006, the valuation allowance increased by $4.2 million due to changes in the state deferred tax assets. The changes in the valuation allowance resulted from managements evaluation of the utilization
of state, federal and foreign operating losses. In assessing the need for the valuation allowance management considers, among other things, its projections of future taxable income and ongoing
prudent and feasible tax planning strategies. During 2006, the Company recorded excess tax benefits associated with the exercise of stock options and the vesting of restricted stock of $14.9 million to Additional Paid-in Capital. In 2005, the
equivalent was $1.3 million. The effective rate from continuing operations varied from the statutory rate as follows:
Year Ended December 31
2006
2005
2004 Statutory federal income tax rate
35.00
%
35.00
%
35.00
% State and local taxes, net of federal tax benefit
0.03
%
0.57
%
(2.42
%) Foreign taxes at rates different from U.S. rates
(8.85
%)
(8.48
%)
(2.11
%) Deemed income from foreign subsidiaries, net
8.08
%
5.42
%
Valuation allowance
(7.88
%)
3.26
% Foreign earnings repatriation
4.35
%
Other
1.96
%
2.45
%
2.48
% Effective income tax rate
36.22
%
31.43
%
36.21
% The Companys consolidated financial statements do not provide U.S. taxes on undistributed earnings of certain foreign subsidiaries that are intended to be indefinitely reinvested in operations
outside the U.S. Income taxes have not been provided on a cumulative total of $119.9 million and $91.6 million of such earnings at December 31, 2006 and 2005, respectively. It is not practicable to
determine the income tax liability that might be incurred if these earnings were to be distributed. On November 7, 2005, after approval by the Companys Chief Executive Officer, the Board of Directors approved a plan to repatriate foreign earnings in accordance with the temporary
repatriation incentive under the American Jobs Creation Act of 2004 (the AJCA). The amount repatriated was $72.4 million. The Company recorded a tax charge and related tax liability of $3.8
million in 2005. Repatriated funds have been used for capital and leased asset investments. Total net income tax payments related to the Companys continuing operations during 2006, 2005 and 2004 were $24.3 million, $20.4 million and $7.8 million, respectively. (See Notes C, N and O.) Note LLease Commitments Capital LeaseOn February 7, 2003, the Company sold the York Property (see Note G) and leased it back from the buyer for an initial 20-year term, with options for the Company to extend the
lease for two additional 10-year terms. The resulting lease is being accounted for as a capital lease. Under the lease agreement, rental payments escalate 7% every three years during the initial term. The following is a schedule, by year, of the future minimum lease payments due under the York Property capital lease, together with the present value of the future minimum lease payments as
of December 31, 2006 (in thousands of dollars): 2007
$
19,287 2008
19,287 2009
20,613 2010
20,637 2011
20,637 Thereafter
269,209 Total future minimum lease payments
369,670 Less: amount representing interest
199,065 Present value of future minimum lease payments
$
170,605 76
In addition to the lease payments above, under the terms of the York Property capital lease, the Company is required to pay real estate taxes and operating costs related to the premises. Operating LeasesThe Company also conducts business on premises leased in various locations under long-term operating leases expiring through 2060. For the years ended December 31, 2006,
2005 and 2004, net rental expense under operating leases was as follows:
Year Ended December 31
2006
2005
2004
(Thousands of dollars) Continuing operations
$
13,655
$
13,611
$
13,090 Discontinued operations (see Note T)
827 Total
$
13,655
$
13,611
$
13,917 Future minimum lease payments under non-cancelable operating leases in effect at December 31, 2006 are as follows (in thousands of dollars): 2007
$
15,718 2008
13,440 2009
10,351 2010
6,098 2011
4,128 Thereafter
33,266 Total future minimum lease payments
$
83,001 Future minimum lease payments exclude minimum sublease rental receipts of $6 million owed to the Company in the future under non-cancelable subleases. In addition to the lease payments above, under the terms of certain leases, the Company is required to pay real estate taxes and utility costs and may be subject to escalations in the amount of
future minimum lease payments based on certain contractual provisions. Note MShareholders Equity and Share-Based Payments Common StockThe principal U.S. market for the Companys common stock is the New York Stock Exchange (the NYSE). Each share of common stock is entitled to one vote. (See Note U
for information related to a recapitalization transaction consummated by the Company in September, 2005. See Note V for information related to the Companys June 2006 reincorporation in the
State of Delaware.) Preferred StockIn addition to the common stock outstanding, the Company has the authority to issue 50 million shares of no par value Preferred Stock. No such shares were issued and
outstanding as of December 31, 2006 and 2005. DividendsOn each of August 2 and November 2, 2006, the Companys Board of Directors declared quarterly dividends on its common stock of $0.10 per share totaling approximately $6.4 million
and $6.5 million, respectively. The dividend declared on August 2, 2006 was paid on September 15, 2006. The dividend declared on November 2, 2006 was paid on December 15, 2006. On February
27, 2007, the Companys Board of Directors declared a quarterly dividend on its common stock of $0.10 per share (approximately $6.5 million), to be paid on March 15, 2007 to shareholders of
record on February 28, 2007. (See Note J for information on financial covenants contained in the BofA Credit Agreement related to dividend payments.) Share-Based PaymentsIn December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. SFAS No. 123R is a revision of SFAS No. 123, as amended, Accounting for Stock-Based
Compensation, and supersedes APB No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R eliminates the alternative to use the intrinsic value method of accounting that was
provided in SFAS No. 123, which resulted in no compensation expense recorded in the financial statements related to the issuance of stock option awards to employees with an exercise price equal to
the stocks fair value on the date of grant. SFAS No. 123R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. SFAS No. 123R 77
establishes fair value as the measurement objective in accounting for share-based payment arrangements and generally requires all companies to apply a fair-value-based measurement method in
accounting for all share-based payment transactions with employees. On January 1, 2006, the Company adopted SFAS No. 123R using the modified prospective method. Accordingly, prior period amounts have not been restated. Under this method, the Company
is required to record compensation expense for all share-based awards granted after the date of adoption and for the unvested portion of previously granted awards that remained outstanding at the
date of adoption. Prior to the adoption of SFAS No. 123R, the Company applied APB No. 25 to account for its stock-based awards. The Company historically has treated its stock options as having
been granted at the stocks fair market value on the date of grant. Consequently, under the provisions of APB No. 25, the Company did not recognize compensation expense for the cost of stock
options issued to employees under its stock option plans. However, see Review of Stock Option Granting Practices below for a discussion of a review conducted by outside legal counsel which
resulted in, among other things, the use of new measurement dates for certain stock option grants. The Company has elected to adopt the alternative transition method provided in SFAS No. 123R-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Award,
for calculating the tax effects of stock-based compensation pursuant to SFAS No. 123R. The alternative transition method includes simplified methods to establish the beginning balance of the
additional paid-in capital pool (the APIC pool) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated
Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS No. 123R. For the years ended December 31, 2005 and 2004, the Company only recorded stock-based compensation expense for restricted stock, totaling $8.3 million and $6.6 million, respectively, for those
periods. Subsequent to the adoption of SFAS No. 123R, for the year ended December 31, 2006, the Company recorded stock compensation expense for the cost of stock options and restricted stock
of $15.8 million ($10.7 million after tax or $0.17 per diluted share). In recent years, the Companys equity compensation strategy has evolved towards a preference for restricted stock as opposed to
stock options. The following table details the effect on net income and earnings per share had compensation expense for all employee share-based awards been recorded for the years ended December 31, 2005
and 2004 based on the fair value method under SFAS No. 123. The reported and pro forma net income and earnings per share for the year ended December 31, 2006 are the same since stock-based
compensation expense is calculated under the provisions of SFAS No. 123R. The amounts for the year ended December 31, 2006 are included in the table below only to provide the detail for a
comparative presentation to the comparable periods in 2005 and 2004.
Year Ended December 31
2006
2005
2004
(Thousands of dollars, Net income, as reported
$
107,049
$
61,602
$
86,679 Add: Stock-based employee compensation expenseincluded in reported net income, net of tax effects
10,652
5,701
4,240 Deduct: Total stock-based employee compensationexpense determined under fair value based method for all awards, net of tax effects
(10,652
)
(7,288
)
(6,158
) Pro forma net income
$
107,049
$
60,015
$
84,761 Earnings per share: Basic earnings per share, as reported
$
1.77
$
1.01
$
1.40 Basic earnings per share, pro forma
$
1.77
$
0.99
$
1.37 Diluted earnings per share, as reported
$
1.72
$
1.00
$
1.38 Diluted earnings per share, pro forma
$
1.72
$
0.97
$
1.35 78
except per share data)
For the year ended December 31, 2006, the adoption of SFAS No. 123R resulted in incremental stock-based compensation expense of $1.4 million ($0.9 million after tax or $0.01 per diluted
share), for the cost of stock options related to the Sothebys 1997 Stock Option Plan (the 1997 Stock Option Plan) that otherwise would not have been recognized. For the year ended December
31, 2006, stock-based compensation expense for restricted stock of $14.4 million ($9.7 million after tax or $0.16 per diluted share), would have been recognized in 2006 regardless of the adoption of
SFAS No. 123R. In addition, in connection with the adoption of SFAS No. 123R, for the year ended December 31, 2006, net cash provided by operating activities decreased and net cash provided by
financing activities increased by approximately $14.9 million related to the classification of excess tax benefits from stock-based payment arrangements. Stock OptionsStock options issued pursuant to the 1997 Stock Option Plan are exercisable into authorized but unissued shares of the Companys common stock. Stock options generally expire ten
years after the date of grant. Stock options granted pursuant to the 1997 Stock Option Plan generally vest and become exercisable ratably after each of the first, second, third, fourth and fifth years
following the date of grant (except in the U.K. where certain options vest three-fifths after the third year and one-fifth after each of the fourth and fifth years following the date of grant). Stock
options granted on or after April 29, 1997 vest immediately upon a change in control of the Company (as defined in the plan document for the 1997 Stock Option Plan, as amended). In March 2006,
the Compensation Committee of the Board of Directors (the Compensation Committee) approved an amendment to the 1997 Stock Option Plan whereby the maximum amount of shares reserved
for issuance under this plan was reduced by approximately 7 million shares to 7.9 million shares. This amendment is consistent with the evolution of the Companys equity compensation strategy
towards a preference for restricted stock as opposed to stock options and was made in conjunction with shareholder approval of a 4.5 million increase in the number of shares of common stock
authorized for issuance under the Sothebys Amended and Restated Restricted Stock Plan (the Restricted Stock Plan). On May 8, 2006, the Restricted Stock Plan was approved. As of December 31,
2006, the number of shares of common stock authorized for issuance under the 1997 Stock Option Plan was 7.9 million shares, of which 0.5 million shares were available for issuance. (See Restricted
Stock for a more detailed discussion of the Restricted Stock Plan.) In January 2002, the Company granted 1.6 million stock options pursuant to the 1997 Stock Option Plan which were due to vest on the earlier of one year from the date of grant or on the day
after the market price of the common stock closed at or above $30 per share for ten consecutive trading days. These stock options vested in January 2003 as the market price of the common stock
did not close at or above $30 per share for ten consecutive trading days during the one-year period after the date of grant. Such options expired on January 30, 2007. In 2003, the Company granted 940,000 stock options pursuant to the 1997 Stock Option Plan. Such stock options, which were granted at an exercise price equal to the fair market value of the
common stock at the date of grant, generally vest and become exercisable ratably after each of the first, second, third and fourth years following the date of grant and expire ten years after the date
of grant. In June 2004 and August 2004, the Company granted 140,000 and 100,000 stock options, respectively, pursuant to the 1997 Stock Option Plan. These stock options were granted at an exercise
price equal to the fair market value of the common stock at the date of grant and expire ten years after the date of grant. The stock options granted in June 2004 vested and became exercisable
ratably after each of the first and second years following the date of grant pursuant to the terms of an employment agreement. The stock options granted in August 2004 vest and become exercisable
ratably after each of the first, second, third and fourth years following the date of grant. In 2005, the Company granted 136,500 stock options pursuant to the 1997 Stock Option Plan. These stock options, which were granted at an exercise price equal to the fair market value of the
common stock at the date of grant, vested on June 30, 2006 pursuant to the terms of an employment agreement and expire ten years after the date of grant. Included in the Companys stock compensation expense for the year ended December 31, 2006 is the cost related to the unvested portion of stock options granted in 2001 and from 2003 to 2005. 79
The stock options granted before 2001 and those granted in 2002 were fully vested as of the beginning of 2006. No stock options were granted in 2006. Changes in the number of stock options outstanding during the year ended December 31, 2006 were as follows (shares in thousands):
Options Outstanding
Weighted Average Balance at January 1, 2006
6,172
$
16.51 Options canceled
(4
)
$
25.84 Options expired
(2
)
$
14.75 Options exercised
(3,947
)
$
17.01 Balance at December 31, 2006
2,219
$
15.65 Options Exercisable at December 31, 2006
1,968
$
16.36 The total intrinsic value for stock options exercised during 2006, 2005 and 2004 was approximately $38.4 million, $4.2 million and $4.1 million, respectively. The weighted-average grant date fair
value for the stock options granted in 2005 and 2004 was $6.03 and $6.84, respectively. The Company expects its remaining unvested stock options to vest. The fair value of stock options granted in 2005 and 2004 was estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table.
The risk-free rate is based on the comparable U.S. Treasury yield curve in effect at the time of grant. The expected life (estimated period of time outstanding) of the 2005 and 2004 grants was
estimated using historical exercise behavior taking into consideration the shorter-than-normal vesting period. Expected volatility was based on historical volatility for a period approximately equal to
the stock options expected life. No dividend yield was factored into the Black-Scholes valuation for the stock options granted in 2005 and 2004 due to the fact that the Company had not declared a
dividend during the period 1999 to August 1, 2006.
2005
2004 Dividend yield
Expected volatility
44.0%
47.9% Risk-free rate of return
3.9%
3.8% Expected life
4.5 years
4.5 years The following table summarizes additional information about stock options outstanding as of December 31, 2006 (shares and aggregate intrinsic value in thousands):
Number of
Weighted Average
Aggregate Options Outstanding
2,219
4.5 years
$
34,077 Options Exercisable
1,968
4.3 years
$
28,850 For the year ended December 31, 2006, the amount of cash received from the exercise of stock options was approximately $67 million and the related tax benefit was $12 million. Review of Stock Option Granting PracticesIn June through November 2006, at the request of the Companys Chief Executive Officer, outside legal counsel conducted a review of the Companys
stock option granting practices from 1995 through the present to determine whether any backdating of stock options had occurred. This request was not made because of any knowledge or belief that
there were any improprieties in the Companys stock option granting practices, but because of the publicity that had been given to this subject in relation to other companies. Counsel concluded and
management concurred that there was no evidence of intentional wrongdoing by any of the Companys Named Executive Officers (as defined by the SEC) or by any other director or employee of
the Company. However, it was concluded that, in a number of instances in 2002 and in prior years, the Company had used an incorrect measurement date under Accounting Principles Board Opinion
No. 25, Accounting for Stock Options (Opinion 25), in accounting for certain of its stock option grants because on the date of such grants, the number of shares that particular 80
Exercise Price
Options
Remaining
Contractual Term
Intrinsic Value
individuals were entitled to receive was not finalized or the number of options allocated to certain recipients was changed after the award approval date. Based on the results of counsels review,
management concluded that the measurement dates for these awards should be revised. The
Company has determined that from the first quarter of 1996 through 2004, it
had certain unrecorded non-cash stock compensation charges associated with its
stock option plans. The amount of aggregate unrecorded non-cash stock compensation
expense, which the Company should have recorded in prior periods as a component
of Salaries and Related Costs, is approximately $6 million pre-tax and approximately
$4 million after-tax. The Company determined, however, that the charges from
1996 through 2004 were not material to its consolidated financial statements
in any of the periods to which such charges related. Management has, however, concluded that the aggregate amount of unrecorded stock compensation expense related to these stock options would be material, if recorded, to the fourth quarter of
2006. As a result, the Company has restated its financial statements for prior periods and recorded an adjustment of approximately $3.8 million to Retained Earnings and Additional Paid-in Capital as
of January 1, 2004, which is reflected in the accompanying Consolidated Statements of Changes in Shareholders Equity. This adjustment represents the cumulative effect on an after tax basis of the
adjustment relating to the non-cash stock compensation charges discussed above related to years 1999 to 2003. The impact of these unrecorded amounts is presented in the chart below. The impact of
the adjustments related to 2004 and years prior to 1999 is inconsequential. In addition, there was no impact on total cash flows from operating, investing or financing activities within the Consolidated
Statements of Cash Flows for any of the years presented nor was there any impact on any interim periods within 2005 or 2006.
Year Ended December 31
1999
2000
2001
2002
2003
Total
(Thousands of dollars) Stock compensation adjustment, pre-tax
$
1,584
$
1,924
$
1,376
$
776
$
282
$
5,942 Tax effect
586
608
590
279
90
2,153 Stock compensation adjustment,
$
998
$
1,316
$
786
$
497
$
192
$
3,789*
*
Adjustment to December 31, 2004 beginning retained earnings.
Restricted StockIn February 2003, the Compensation Committee approved the adoption of the Restricted Stock Plan, effective May 1, 2003. The Restricted Stock Plan was approved by a vote of
shareholders on April 29, 2003. The Restricted Stock Plan was amended on November 7, 2005 to conform the plan to the Companys capital structure following completion of the recapitalization
transaction described in Note U. The purpose of the Restricted Stock Plan is to enable the Company to retain valued employees and to continue to attract the finest executives. The Restricted Stock Plan provides for the issuance of restricted shares of common stock to eligible employees, as determined by the Compensation Committee. In making such selections, the
Compensation Committee may take into account the nature of the services rendered by such employees, their present and potential contributions to the Companys success, and such other factors as
the Compensation Committee in its discretion shall deem relevant. Restricted stock shares granted pursuant to the Restricted Stock Plan generally vest ratably after each of the first, second, third and fourth years following the date of grant; however, shares
issued in connection with the Sothebys Holdings, Inc. Executive Bonus Plan (the EBP) vest ratably over a three-year period and restricted shares issued pursuant to certain employment
arrangements vest over three and five-year periods, subject to the satisfaction of certain performance or market-based criteria (as discussed in more detail below), as well as continued employment
during the vesting periods. Prior to vesting, participants have voting rights and receive dividends, if any, but the shares may not be sold, assigned, transferred, pledged or otherwise encumbered. On
May 8, 2006, the Companys shareholders approved an amendment and restatement of the Restricted Stock Plan whereby the maximum amount of restricted stock that may be issued under the
Restricted Stock Plan was increased by 4.5 million shares to 6.5 million shares. As of December 31, 2006, the maximum amount of restricted stock which may be issued from the 81
net of tax effect
Companys authorized but unissued or reacquired shares of common stock was 6.5 million shares, of which 3.9 million shares remained available for future grants. Also, in February 2003, the Compensation Committee approved an exchange offer of cash or restricted stock for certain stock options held by eligible employees under the 1997 Stock Option
Plan (the Exchange Offer). The Exchange Offer was tendered during the first half of 2004. As a result of the Exchange Offer, approximately 5.6 million stock options were cancelled and 1.1 million
shares of restricted stock were issued. The restricted shares were issued upon acceptance of the Exchange Offer at the closing market price of the Companys common stock on the dates of grant. For
the years ended December 31, 2006, 2005 and 2004, the Company recognized stock compensation expense of $2.5 million, $4.6 million and $5.5 million related to the Exchange Offer, respectively.
The cash payment made in conjunction with the Exchange Offer was approximately $2.2 million and was expensed in full upon acceptance of the offer on March 31, 2004. In addition to restricted stock issued in conjunction with the Exchange Offer, the Company issued 375,697 shares and 120,000 shares of restricted stock with fair values of $6.2 million and $1.6
million during 2005 and 2004, respectively. For the years ended December 31, 2006, 2005 and 2004, the Company recognized compensation expense of $2.5 million, $3.7 million and $1.1 million,
respectively, related to these restricted stock grants. A small portion of these restricted shares were granted pursuant to a three-year employment agreement and vested on June 30, 2006. In February 2005, the Compensation Committee approved the adoption of the EBP, effective retroactively to January 1, 2005. The EBP was approved by a vote of shareholders on May 4, 2005.
The EBP provides for the issuance of restricted stock, generally governed by the Restricted Stock Plan, and cash awards based on satisfaction of objective performance criteria set by the
Compensation Committee. Restricted shares issued pursuant to the EBP vest ratably after each of the first, second and third years following the date of grant. In February 2006, the Compensation
Committee approved the issuance of 201,621 shares of restricted stock with a fair value of $4.1 million pursuant to the EBP. For the year ended December 31, 2006, the Company recognized
compensation expense of $2.3 million related to this restricted stock grant. On April 1, 2006, in conjunction with his employment arrangement and in an effort to encourage and reward the growth of shareholder value, the Company agreed to grant William F. Ruprecht,
the Companys President and Chief Executive Officer, a one time award of 300,000 shares of restricted stock that will only vest and create value for Mr. Ruprecht at the end of the third and fifth
years of his employment arrangement, and only if certain objective performance or market-based criteria are satisfied. These criteria are based on either a specified compound increase in shareholder
value as measured by stock price and dividends, if any, or a specified compound cumulative increase in the Companys net income. Additionally, as he had in the past three years under his previous
employment agreement, Mr. Ruprecht received a 2006 equity award of restricted stock. This award of 78,785 restricted shares, which was received on March 31, 2006, had a fair market value equal to
$2.1 million on the date of grant and will vest in equal annual installments over four years. Mr. Ruprecht is no longer eligible to participate in the EBP, but instead, beginning in 2007, will be entitled
to a restricted stock award in each year, subject to agreed annual minimum ($1.4 million) and maximum ($2.2 million) levels, the value of which will be determined largely based on the extent to
which the performance criteria for the EBP have been satisfied. The Company recognized stock compensation expense of $3.8 million in 2006 related to Mr. Ruprechts employment arrangement. Pursuant to certain employment arrangements agreed to in the third quarter of 2006 with certain senior executives, the Company granted 427,531 shares of restricted stock that will only vest and
create value for the grantees at the end of the third and fifth years of the employment arrangements, and only if certain objective performance or market-based criteria are satisfied. These criteria are
based on either a specified compound increase in shareholder value as measured by stock price and dividends, if any, or a specified compound cumulative increase in the Companys net income. The
Company recognized compensation expense of $1.6 million in 2006 related to this grant of Restricted Stock. 82
In addition to the grants discussed above, the Company also issued 258,818 shares of restricted stock in 2006 with a fair value of $6.6 million that will vest ratably after each of the first, second,
third and fourth years following the date of grant. The Company recognized compensation expense of $1.7 million in 2006 related to these grants. In February 2007, the Compensation Committee approved the issuance of the following restricted stock grants:
151,955 shares with a fair value of $5.8 million pursuant to the EBP. Such shares will vest ratably after each of the first, second and third years following the date of grant. 57,277 shares with a fair value of $2.2 million to Mr. Ruprecht as part of his employment arrangement and 19,135 shares with a fair value of $0.7 million related to other executive employment
arrangements. Such shares will vest ratably after each of the first, second, third and fourth years following the date of grant. 469,711 shares awarded at the discretion of the Compensation Committee with a fair value of $18.2 million. These shares generally will vest ratably after each of the first, second, third and,
fourth years following the date of grant. Changes in the number of outstanding restricted stock shares during the year ended December 31, 2006 were as follows (shares in thousands):
Restricted
Weighted Average Balance at January 1, 2006
1,356
$
13.73 Restricted shares granted
1,267
$
27.20 Restricted shares vested
(529
)
$
12.97 Restricted shares canceled
(13
)
$
20.21 Balance at December 31, 2006
2,081
$
21.96 The total fair value of restricted stock shares that vested during 2006, 2005 and 2004 was $14.3 million, $5.6 million and $0.6 million, respectively, based on the closing stock price on the dates
the shares vested. The Company expects its remaining unvested shares of restricted stock to vest. Under the provisions of SFAS No. 123R, the recognition of deferred compensation, a contra-equity account representing the amount of unrecognized restricted stock expense that is reduced as
stock compensation expense is recognized at the date restricted stock is granted, is no longer required. Therefore, in the first quarter of 2006, the amount that had been in Deferred Compensation
was eliminated against Additional Paid-in Capital in the Companys Consolidated Balance Sheets. As of December 31, 2006, unrecognized compensation expense related to the unvested portion of the
Companys stock-based compensation was approximately $29.1 million and is expected to be recognized over a weighted-average period of approximately 3.1 years. Note NPension Arrangements Retirement Savings PlanThe Company has a defined contribution plan for U.S. employees who have completed three consecutive months of employment (the Retirement Savings Plan). Prior to
January 1, 2005, the Company contributed a standard amount equal to 2% of each participants eligible compensation to the Retirement Savings Plan. Effective January 1, 2005, the Retirement
Savings Plan was amended to replace the standard 2% contribution with a discretionary annual Company contribution that varies as a percentage of each participants eligible compensation depending
on the Companys profitability and subject to the maximum amount allowable under Internal Revenue Service (IRS) regulations. For the years ended December 31, 2006 and 2005, the Companys
discretionary contribution to the Retirement Savings Plan was 4% and 3% of each participants eligible compensation, respectively. Additionally, prior to January 1, 2005, participants could elect to contribute between 2% and 12% of their eligible compensation, up to the maximum amount allowable under IRS regulations, on 83
Shares
Grant Date
Fair Value
a pre-tax basis. Effective January 1, 2005, participants may elect to contribute between 2% and 20% of their eligible compensation, up to the maximum amount allowable under IRS regulations, on a
pre-tax basis. Employee savings have been and will continue to be matched by a Company contribution of up to an additional 6% of each participants eligible compensation. Effective January 1, 2006, newly hired employees who have completed three consecutive months of employment are automatically enrolled in the Retirement Savings Plan at an amount equal to
3% of eligible compensation. An employee who is automatically enrolled is permitted to op-out of the automatic enrollment or to change the level of employee contributions according to the
provisions described above. For the years ended December 31, 2006, 2005 and 2004, pension expense recorded within Salaries and Related Costs for the Retirement Savings Plan, net of the impact of forfeitures, was as
follows:
Year Ended December 31
2006
2005
2004
(Thousands of dollars) Continuing operations
$
4,596
$
3,459
$
2,808 Discontinued operations (see Note T)
56 Total
$
4,596
$
3,459
$
2,864 Benefit Equalization PlanThrough December 31, 2006, the Company had an unfunded deferred compensation plan, the Sothebys, Inc. 2005 Benefit Equalization Plan (the 2005 BEP), which
was available to certain officers of the Company for whom contributions to the Retirement Savings Plan were limited by IRS regulations. Such officers could enter into agreements pursuant to which
their salaries would be reduced and the Company would maintain accounts on their behalf in the amount of the difference between the deferral election made in the participants salary reduction
agreement and the aggregate amount of contributions actually made by the participant under the Retirement Savings Plan. Employees could elect to defer up to 12% of their eligible compensation
and employee deferrals were matched by a Company contribution of up to 6% of the participants eligible compensation. Additionally, there was a discretionary annual Company contribution for
those participants for whom discretionary contributions to the Retirement Savings Plan were limited by IRS regulations. Contributions to the 2005 BEP earned interest at a rate equal to 3.3% above
the 10-year U.S. Treasury Bond rate. The establishment of the 2005 BEP was approved by the Companys Compensation Committee in December 2004. The 2005 BEP, which superseded an existing Benefit Equalization Plan (the
BEP) on January 1, 2005, was established solely to comply with provisions of the AJCA, which placed new restrictions on deferred compensation arrangements, including limiting the ability of both
companies and individuals to revise deferral elections or to accelerate distributions from a deferred compensation plan. With the exception of these changes, the 2005 BEP remained the same as the
previously existing BEP, which was deemed frozen with no deferrals or employer contributions permitted after December 31, 2004. The total combined unfunded liability of the 2005 BEP and the BEP was $24.2 million and $18.6 million as of December 31, 2006 and 2005, respectively, and is included within Other Liabilities
in the Consolidated Balance Sheets. For the years ended December 31, 2006, 2005 and 2004, compensation expense recorded within Salaries and Related Costs for the 2005 BEP and the BEP (for 2004) was $1.4 million, $1.1 million
and $0.6 million, respectively. On December 7, 2006, the Company adopted the Sothebys Deferred Compensation Plan (the Deferred Compensation Plan), effective January 1, 2007. The Deferred Compensation Plan
replaced the Companys 2005 BEP with a plan that incorporates best practice features of contemporary non-qualified plans. Participants in the Plan are able to defer a greater proportion of eligible
compensation as compared to the 2005 BEP and are provided with more flexible distribution options. Specifically, the Deferred Compensation Plan allows eligible employees to defer up to 80% of
base salary and up to 100% of incentive compensation; non-employee Directors may defer up to 100% of the cash portion of Directors fees. As with the 2005 BEP, the Company matching and 84
profit sharing contribution rates are identical to those in the Retirement Savings Plan. The Deferred Compensation Plan provides a broad menu of investment crediting options which track a portfolio
of various deemed investment funds; where as discussed above, the 2005 BEP balances were credited at a fixed rate of 3.3% above the 10-year U.S. Treasury rate. Employee deferrals and Company contributions are informally funded into a rabbi trust which provides additional benefit security by sheltering assets in the event of a change-in-control of the
Company and certain other situations. Plan liabilities are financed through the trust using Company-owned variable life insurance, as well as other investments. The combined unfunded liability for
the 2005 BEP and the BEP, which totaled $24.2 million as of December 31, 2006, was transferred into the Deferred Compensation Plan on January 1, 2007. The Company funded this amount into
the rabbi trust on February 8, 2007. Adoption of SFAS No. 158In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plansan amendment of FASB
Statements No. 87, 88, 106, and 132(R). Generally, SFAS No. 158 requires an employer to recognize the over-funded or under-funded status of a defined benefit postretirement plan as an asset or
liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS No. 158 also requires the measurement of
defined benefit plan assets and obligations as of the date of the employers fiscal year-end balance sheet (with limited exceptions). The requirement to recognize the funded status of a defined benefit
postretirement plan and the related disclosure requirements were effective for the Company as of December 31, 2006 and, as a result, the Company adopted the recognition provisions of SFAS No.
158 in the fourth quarter of 2006. The requirement to measure the plan assets and benefit obligations as of the date of the balance sheet is effective for the Company as of December 31, 2008. The following table shows the incremental effect of applying SFAS No. 158 on individual line items in the Companys December 31, 2006 Consolidated Balance Sheet (in thousands of dollars):
Before Application of
Adjustments
After Application of Prepaid expenses and other current assets
$
62,496
($38,231
)
$
24,265 Deferred income tax assetscurrent
5,149
1,835
6,984 Deferred income tax assetsnon-current
42,300
25,484
67,784 Total assets
1,488,078
(10,913
)
1,477,165 Pension liability
2,750
52,523
55,273 Deferred income tax liabilitieslong-term
4,225
120
4,345 Total liabilities
1,122,835
52,643
1,175,478 Accumulated other comprehensive income (loss)
1,667
(63,555
)
(61,888
) Total shareholders equity
365,242
(63,555
)
301,687 Defined Benefit Plan (U.K.)The Company sponsors a defined benefit pension plan covering most U.K. employees (the U.K. Pension Plan). Effective April 1, 2004, the U.K. Pension Plan was
closed to new employees. From that date, a defined contribution plan was made available to new employees in the U.K. The Company uses a September 30 measurement date for the U.K. Pension
Plan. 85
SFAS No. 158
SFAS No. 158
Benefit Obligation The table below details the change in the benefit obligation, the change in the fair value of plan assets, the funded status and the amounts recognized in the Consolidated Balance Sheets as of
December 31, 2006 and 2005 related to the U.K. Pension Plan:
December 31
2006
2005
(Thousands of dollars) Reconciliation of benefit obligation Benefit obligation at beginning of year
$
248,864
$
247,937 Service cost
6,720
6,275 Interest cost
12,866
12,525 Contributions by plan participants
998
1,101 Actuarial loss
41,202
11,917 Benefits paid
(4,384
)
(3,810
) Special termination benefits
7 Foreign currency exchange rate changes
37,738
(27,088
) Benefit obligation at end of year
344,004
248,864 Reconciliation of plan assets Fair value of plan assets at beginning of year
231,882
197,960 Actual return on plan assets
26,484
42,809 Employer contributions
2,851
17,699 Contributions by plan participants
998
1,101 Benefits paid
(4,384
)
(3,810
) Foreign currency exchange rate changes
33,343
(23,877
) Fair value of plan assets at end of year
291,174
231,882 Funded Status Funded status at end of year
(52,830
)
(16,982
) Unrecognized prior service cost
N/A*
373 Unrecognized net actuarial loss
N/A*
54,048 Net pension (liability) asset recognized
$
(52,830
)
$
37,439
*
As discussed above, the Company adopted SFAS No. 158 in the fourth quarter of 2006. In conjunction with the adoption of SFAS No. 158, the December 31, 2006 Consolidated Balance Sheet
was adjusted so that unrecognized actuarial losses and unrecognized prior service costs were recognized as an adjustment to the ending balance of accumulated comprehensive income, net of
taxes.
The valuation of the funded status includes an allowance for discretionary benefit increases to the extent that these are expected to be awarded in the future. The accumulated benefit obligation for the U.K. Pension Plan was $252.4 million and $188.4 million as of December 31, 2006 and 2005, respectively. 86
Components of Net Pension Cost For the years ended December 31, 2006, 2005 and 2004, the components of net pension cost related to the U.K. Pension Plan were:
Year Ended December 31
2006
2005
2004
(Thousands of dollars) Service cost
$
6,720
$
6,275
$
6,705 Interest cost
12,866
12,525
11,240 Expected return on plan assets
(16,587
)
(16,719
)
(16,559
) Amortization of prior service cost
269
266
267 Amortization of net loss
3,417
2,084
1,055 Sub-total
6,685
4,431
2,708 Special termination benefits
7
49 Net pension cost
$
6,685
$
4,438
$
2,757 Amounts Recognized in Accumulated Other Comprehensive Loss The table below details the amounts recognized in accumulated other comprehensive loss, net of taxes, related to the U.K. Pension Plan for the year ended December 31, 2006:
Year Ended December 31
2006
2005
(Thousands of dollars) Net loss for period **
($21,968
)
N/A Amortization of prior service cost
188
N/A Amortization of net loss
2,392
N/A Total
($19,388
)
N/A
**
Net loss is the change in the value of either the benefit obligation or plan assets resulting from experience different from that assumed or from a change in an actuarial assumption.
Amounts Included in Accumulated Other Comprehensive Loss The table below details the amounts included in accumulated other comprehensive loss, net of taxes, related to the U.K. Pension Plan that have not yet been recognized as components of net
pension cost as of December 31, 2006:
December 31
2006
2005
(Thousands of dollars) Net loss
$
63,647
N/A Prior service cost
96
N/A Total
$
63,743
N/A The net loss and prior service costs are being recognized over the expected remaining service lives of the active employees in the U.K. Pension Plan. As of September 30, 2006, this was
estimated to be approximately 14 years. The table below details the amounts in accumulated other comprehensive loss expected to be recognized as components of net pension cost, net of taxes, for the year ended December 31, 2007
(in thousands of dollars): Net loss
$
4,221 Prior service cost
62 Total
$
4,283 87
Assumptions The following assumptions were used in determining the benefit obligation and net pension cost related to the U.K. Pension Plan:
Benefit Obligation
2006
2005 Weighted average discount rate
4.80
%
4.90
% Weighted average rate of compensation increase
4.75
%
4.50
%
Net Pension Cost
2006
2005
2004 Weighted average discount rate
4.90
%
5.40
%
5.20
% Weighted average rate of compensation increase
4.50
%
4.75
%
4.25
% Weighted average expected long-term rate of return on plan assets
7.25
%
7.75
%
8.00
% The expected long-term rate of return on plan assets is based on expected future appreciation, as well as dividend and interest yields currently available on equity and bond markets as of the
measurement date and weighted according to the composition of invested assets as of that date. Plan Assets As of September 30, 2006 and 2005, the weighted average asset allocations for the U.K. Pension Plan, by category, were as follows:
September 30
2006
2005 Equity securities
66
%
67
% Debt securities
28
%
27
% Real estate
3
%
3
% Other
3
%
3
% The investment policy for the U.K. Pension Plan is established by its trustees (the Trustees) in consultation with the management of the Company. The Trustees investment objective is to
maximize the return on assets while controlling the level of risk so as to ensure that sufficient assets are available to pay participants benefits as and when they arise. The Trustees have agreed that a
diversified portfolio of assets with a relatively high concentration of equity securities is appropriate. In order to avoid an undue concentration of risk, a diverse spread of assets is held. The
diversification is both within and across asset categories. In setting specific asset allocation targets, the Trustees take expert advice as required from professional investment advisors. Additionally, the
Trustees require that the majority of the assets be realizable at short notice. The Trustees current investment strategy includes target allocation percentages of approximately 68% for equity securities
and approximately 32% for debt securities and other assets. These target allocation percentages are spread across different categories within each asset class and permit actual allocation percentages
to fall within a reasonable range of these targets. The investment managers for the U.K. Pension Plan have full discretion in making investment decisions, subject to broad guidelines established by the Trustees. It is the Trustees policy not to
invest in shares of the Company or any of its subsidiaries. The performance of the investment managers is benchmarked against suitable indices. Estimated Future Benefit Payments The following benefit payments related to the U.K. Pension Plan, which reflect expected future service, as appropriate, are expected to be paid as follows (in thousands of dollars):
Benefit Payments October 1, 2006 to September 30, 2007
$
4,911 October 1, 2007 to September 30, 2008
$
5,996 October 1, 2008 to September 30, 2009
$
7,207 October 1, 2009 to September 30, 2010
$
7,134 October 1, 2010 to September 30, 2011
$
9,233 October 1, 2011 to September 30, 2016
$
52,987 88
Contributions In 2006, the Company contributed $2.9 million to the U.K. Pension Plan, and expects to contribute approximately $3.1 million in 2007. Defined Benefit Plan (Germany)The Company sponsors a defined benefit pension plan for its employees in Germany (the German Pension Plan). The Company uses a December 31st
measurement date for the German Pension Plan. In the fourth quarter of 2006, the Company adopted the recognition provisions of SFAS No. 158 for the German Pension Plan and, as a result,
recognized net gains of $0.2 million in Other Comprehensive Income. These are the only amounts related to the German Pension Plan included in Accumulated Other Comprehensive Loss as of
December 31, 2006. As of December 31, 2006 and 2005, the pension liability related to the German Pension Plan recorded in the Consolidated Balance Sheets was approximately $2.4 million and $2.3 million,
respectively. For the years ended December 31, 2006 and 2005, net pension cost for the German Pension Plan was $0.2 million and $0.9 million, respectively. Future benefit payments to the German
Pension Plan are expected to be approximately $50,000 annually for the years 2007 to 2011 and approximately $0.5 million in the aggregate during the five years thereafter. Note OCommitments and Contingencies Employment ArrangementsAs of December 31, 2006, the Company had employment arrangements with 8 employees, which expire at various points between August 2008 and June 2013. Such
arrangements provide, among other benefits, for minimum salary levels and incentive bonuses which are payable only if specified Company and individual goals are attained. Additionally, certain of
these arrangements provide for participation in the Companys Executive Bonus Plan, annual equity grants, severance payments and continuation of benefits upon termination of employment under
certain circumstances. The aggregate remaining commitment for salaries related to these employment arrangements, excluding incentive bonuses, any participation in the Companys Executive Bonus
Plan and equity grants, was approximately $25.2 million as of December 31, 2006. Lending CommitmentsIn certain situations, the Company enters into legally binding arrangements to lend, primarily on a collateralized basis and subject to certain limitations and conditions, to
potential consignors and other individuals who have collections of fine art or other objects. Unfunded commitments to extend additional credit were $15 million at December 31, 2006. Legal ActionsThe Company also becomes involved, from time to time, in various claims and lawsuits incidental to the ordinary course of its business. Management does not believe that the
outcome of any of these pending claims or proceedings will have a material adverse effect on the Companys business, results of operations, financial condition and/or liquidity. Tax ContingenciesThe Company is routinely under examination by taxing authorities in certain countries and states in which the Company has significant business operations. Such examinations
challenge certain deductions and credits reported by the Company on its income tax returns, as well as other tax matters. The major territories where the Company is undergoing such examinations
are the U.S., the U.K. and France. In accordance with SFAS No. 109, Accounting for Income Taxes, and SFAS No. 5, Accounting for Contingencies, the Company establishes reserves for tax
contingencies that reflect managements best estimate given the Companys history with similar matters and interpretation of current tax laws and regulations. As of December 31, 2006, total income
tax contingencies reserved are approximately $7.8 million; of this amount, approximately $6.8 million was recorded in the fourth quarter of 2006 and is primarily related to certain U.S. and
international issues. Additionally the Company has a contingency reserve of approximately $2.2 million related to certain other state and local issues, of which approximately $1 million was recorded in
the fourth quarter of 2006. (See Note B.) Gain ContingenciesThe Company owns land and a building at Billingshurst, West Sussex (the Sussex Property), which previously housed an auction salesroom. The Company has entered into
an agreement for the sale of vacated parts of the Sussex Property. The Company has received planning permission for redevelopment of the land for sale; however, consummation of the sale is 89
conditional upon the completion of a statutory review period. If completed, the sale of the Sussex Property would result in a pre-tax gain in the range of approximately $4 million to $5 million.
Management anticipates that the sale of the Sussex Property will be completed in March 2007. (See Notes C, J, L and P for other commitments. See Notes C, P and Q for other contingencies.) Note PAuction Guarantees From time to time in the ordinary course of business, the Company will guarantee to consignors a minimum price in connection with the sale of property at auction. The Company must perform
under its auction guarantee in the event the property sells for less than the minimum price, in which event the Company must fund the difference between the sale price at auction and the amount of
the auction guarantee. If the property does not sell, the amount of the auction guarantee must be paid, but the Company has the right to recover such amount through future sale of the property. In
certain instances, the sale proceeds ultimately realized by the Company exceed the amount of any prior losses recognized on the auction guarantee. Additionally, the Company is generally entitled to
a share of the excess proceeds if the property under the auction guarantee sells above a minimum price. In addition, the Company is obligated under the terms of certain auction guarantees to
advance a portion of the guaranteed amount prior to the auction. In certain situations, the Company reduces its financial exposure under auction guarantees through auction commission sharing
arrangements with partners. Partners may also assist the Company in valuing and marketing the property to be sold at auction. As of December 31, 2006, the Company had outstanding auction guarantees totaling $116.5 million, the property relating to which had a mid-estimate sales price (1) of $132.3 million. The
Companys financial exposure under these auction guarantees is reduced by $0.5 million as a result of sharing arrangements with partners. Substantially all of the property related to such auction
guarantees is being offered at auctions in the first half of 2007. As of December 31, 2006, $36 million of the guaranteed amount had been advanced by the Company and is recorded within Notes
Receivable and Consignor Advances in the Consolidated Balance Sheet (see Note E). As of December 31, 2006 and December 31, 2005, the carrying amount of the liability related to the Companys
auction guarantees was approximately $1.5 million and $0.3 million, respectively, and was reflected in the Consolidated Balance Sheets within Accounts Payable and Accrued Liabilities.
(1)
The mid-estimate sales price is calculated as the average of the low and high pre-sale auction estimates for the property under the auction guarantee. Pre-sale estimates are not always
accurate predictions of auction sale results.
Note QAntitrust Related Matters In April 1997, the DOJ began an investigation of certain art dealers and major auction houses, including the Company and its principal competitor, Christies International, PLC (Christies).
The Company pled guilty to a violation of U.S. antitrust laws in connection with a conspiracy to fix auction commission rates charged to sellers in the U.S. and elsewhere. In February 2001, the U.S.
District Court for the Southern District of New York imposed on the Company a fine of $45 million payable to the DOJ without interest over a period of five years. As a result, in the third quarter
of 2000, the Company recorded Settlement Liabilities of $34.1 million representing the present value of the fine payable. The $10.9 million discount on the fine payable was amortized to interest
expense over the five-year period during which the fine was paid. The final payment of $15 million owed under the fine was paid by the Company on February 6, 2006 and the liability to the DOJ
was extinguished. In conjunction with the settlement of certain civil litigation related to the investigation by the DOJ, in May 2003, the Company issued to the class of plaintiffs vendors commission discount
certificates (Discount Certificates) with a face value of $62.5 million. The Discount Certificates are fully redeemable in connection with any auction conducted by the Company or Christies in the
U.S. or in the U.K. and may be used to satisfy consignment charges involving vendors commission, risk of loss and/or catalogue illustration. The court determined that the $62.5 million face value of
the 90
Discount Certificates had a fair market value of not less than $50 million, which represents the amount recorded by the Company as Settlement Liabilities in the third quarter of 2000. The Discount
Certificates will expire on May 14, 2008 and cannot be redeemed subsequent to that date; however, any unused Discount Certificates may be redeemed for cash at their face value at any time
between May 15, 2007 and May 14, 2008. The $12.5 million discount on the face value of the Discount Certificates is being amortized to interest expense over the four-year period prior to May 15,
2007, the first date at which the Discount Certificates are redeemable for cash. As of December 31, 2006, the outstanding face value of unused Discount Certificates that the Company could be
required to redeem was $46.7 million and the carrying value of such Discount Certificates reflected in the Consolidated Balance Sheet was approximately $45.8 million. As of December 31, 2006 and December 31, 2005, Settlement Liabilities related to these matters consisted of the following:
December 31,
December 31,
(Thousands of dollars) Current: Discount Certificates (net)
$
45,765
$
6,200 DOJ antitrust fine (net)
14,899 Sub-total
45,765
21,099 Long-term: Discount Certificates (net)
40,794 Total
$
45,765
$
61,893 As of December 31, 2006, the classification of the remaining liability for the Discount Certificates within Current Liabilities is based on managements estimate of future Discount Certificate
redemptions and reflects the fact that unused Discount Certificates may be redeemed for cash starting on May 15, 2007. During the period January 1, 2004 to December 31, 2006, amounts charged to and cash payments made against Settlement Liabilities with respect to the Discount Certificates and the DOJ
antitrust fine were as follows:
Discount
DOJ
Total
(Thousands of dollars) Balance at January 1, 2004
$
51,175
$
29,604
$
80,779 Cash payment to DOJ
(6,000
)
(6,000
) Redemption of Discount Certificates
(4,823
)
(4,823
) Amortization of discount
2,836
2,049
4,885 Loss on redemption of Discount Certificates
698
698 Balance at December 31, 2004
49,886
25,653
75,539 Cash payment to DOJ
(12,000
)
(12,000
) Redemption of Discount Certificates
(6,214
)
(6,214
) Amortization of discount
2,742
1,246
3,988 Loss on redemption of Discount Certificates
580
580 Balance at December 31, 2005
46,994
14,899
61,893 Cash payment to DOJ
(15,000
)
(15,000
) Redemption of Discount Certificates
(4,009
)
(4,009
) Amortization of discount
2,578
101
2,679 Loss on redemption of Discount Certificates
202
202 Balance at December 31, 2006
$
45,765
$
$
45,765 On March 10, 2003, the Company and Christies agreed to each pay $20 million to settle litigation that alleged violations of U.S. antitrust laws and international law impacting purchasers and
sellers in auctions conducted outside the U.S. (the International Antitrust Litigation), and thereafter, the Company deposited $20 million into an escrow account for the benefit of the members of
the class of plaintiffs. The settlement agreement for the International Antitrust Litigation provides that if, as of June 7, 2006, there were any remaining settlement funds following the payment of all
submitted claims, the Company and Christies would be reimbursed for third 91
2006
2005
Certificates
(net)
Antitrust Fine
(net)
party administration costs incurred in distributing the settlement funds. In June 2006, it was determined that sufficient settlement funds remained following the payment of all submitted claims to
reimburse the Company and Christies for third party administration costs incurred in distributing the settlement funds. As a result, for the year ended December 31, 2006, the Company has recorded
a $2.4 million benefit to General and Administrative Expenses, reflecting the recovery of such third party administration costs incurred through December 31, 2006. The Company received this
reimbursement on January 29, 2007. (See Note B for information related to the original income statement classification of such expenses.) In August 2006, a Canadian court approved the final settlement of the Canadian Competition Bureaus investigation regarding anticompetitive practices relating to vendors commissions charged
by the Company and Christies for auction services during the period 1993 to 2000. Under the civil settlement, the Company and its Canadian subsidiary entered into a civil Consent Prohibition Order
requiring them to: (i) comply with Canadian antitrust laws and continue antitrust compliance training for five years, (ii) post a copy of the Order on the Companys website for 120 days and notify
Canadian consignors about the Order and (iii) pay $0.7 million in reimbursement of the costs of the investigation. In the first half of 2006, the Company recorded a $0.7 million charge related to the
settlement of this matter within General and Administrative Expenses, which was paid in the third quarter of 2006. Note RVariable Interest Entity The Company has concluded that an entity with whom its Finance segment has outstanding loans of approximately $3.5 million and to whom the Company provides management consulting
services meets the definition of a variable interest entity (VIE) under FIN 46, Consolidation of Variable Interest Entities, as revised. As primary beneficiary of the VIE, the Company is required
to consolidate the entity as part of the Dealer segment (see Note D). The entity is an art gallery which is engaged in business as a broker/dealer in works of art. The Company provides management consulting services to the entity in exchange for a management
fee, which is equal to 50% of the entitys net income (excluding the management fee and certain other specified revenues and expenses). Included in the Companys consolidated assets as of
December 31, 2006 is inventory with a carrying value of approximately $2.8 million. Such inventory consists entirely of artwork and is the collateral for the $3.5 million in outstanding loans discussed
above, which are eliminated in consolidation. The Company has no equity investment in the entity. The Company accounts for its interest in the entity on a quarter lag applied on a consistent basis. As of September 30, 2006, the entity had total assets of $7.1 million, total liabilities of $5.4
million and capital of $1.7 million. Note SEmployee Loans Prior to December 1995, the Company had two bank loan programs available to certain employees whereby a bank would directly lend money to certain officers and staff at favorable interest
rates. The Company guaranteed all repayment obligations under these bank loan programs, and all loans were immediately repayable in the event an employee left the Company. Effective March 8,
2004, the entire $0.6 million of outstanding loans under these programs was sold and assigned to the Company. The amount of outstanding loans under this program was $0.1 million and $0.2 million
at December 31, 2006 and December 31, 2005, respectively. The Company does not intend to grant any new loans to employees under this program in the future. (See Note E for the disclosure of employee loans made by the Companys Finance segment. Such loans are secured by works of art owned by the employees.) 92
Note TDiscontinued Operations In the fourth quarter of 2003, the Company committed to a plan to sell its domestic real estate brokerage business, Sothebys International Realty, Inc. (SIR), as well as most of its real estate
brokerage offices outside of the U.S. As a result, such operations qualified for treatment as discontinued operations in the fourth quarter of 2003. On February 17, 2004, the Company consummated the sale of SIR to a subsidiary of Realogy Corporation (Realogy), formerly Cendant Corporation. In conjunction with the sale, the Company
entered into an agreement with Realogy to license the Sothebys International Realty trademark and certain related trademarks for an initial 50-year term with a 50-year renewal option (the Realogy
License Agreement). Initially, the Realogy License Agreement was applicable to the U.S., Canada, Israel, Mexico and certain Caribbean countries. Also in conjunction with the sale, Realogy received options to acquire most of the other non-U.S. offices of the Companys real estate brokerage business and to expand the Realogy License
Agreement to cover the related trademarks in other countries outside the U.S., excluding Australia and New Zealand (the International Options). The International Options were exercised by
Realogy and the Realogy License Agreement was amended to cover New Zealand during 2004. As a result, such operations qualified for treatment as discontinued operations in 2004. In the fourth quarter of 2004, the Company committed to a plan to discontinue its real estate brokerage business in Australia and license the Sothebys International Realty trademark and certain
related trademarks in Australia. The Company had expected to consummate a license agreement related to such trademarks some time in 2006, but such an agreement could not be reached on terms
acceptable to the Company. As a result, in the second quarter of 2006, management decided to continue operating the Companys real estate brokerage business in Australia. Accordingly, the
operating results of this business, which had previously been reported as discontinued operations in the Consolidated Income Statements since the fourth quarter of 2004, have been reclassified into
the Companys results from continuing operations for all periods presented. The Australia real estate brokerage business, which is the only remaining component of the Companys former Real Estate
segment, is not material to the Companys results of operations, financial condition or liquidity. The following is a summary of the results of the Companys discontinued operations for the years ended December 31, 2006, 2005 and 2004:
Year Ended December 31
2006
2005
2004
(Thousands of dollars) Revenues
$
$
534
$
17,380 Expenses
489
1,066
10,605 Operating (loss) income
(489
)
(532
)
6,775 Gain on sale of discontinued operations
32,005 Other (expense) income
(15
)
(322
)
18 (Loss) income from discontinued operations before taxes
(504
)
(854
)
38,798 Income tax (benefit) expense
(194
)
(369
)
14,516 (Loss) income from discontinued operations
$
(310
)
$
(485
)
$
24,282 According to the terms of the Stock Purchase Agreement related to the sale of SIR, the Company is due to receive amounts collected by Realogy for the closing of real estate transactions
subsequent to February 17, 2004 that were under contract prior to that date. For the years ended December 31, 2005 and 2004, revenues from discontinued operations included $0.5 million and $9.5
million, respectively, of such amounts. Additionally, included in the Companys results from discontinued operations for the year ended December 31, 2006 are litigation accruals (net of recoveries)
related to events that occurred prior to sale of SIR on February 17, 2004. 93
Note URecapitalization On September 7, 2005, the Company entered into a Transaction Agreement (the Agreement), with various affiliates of A. Alfred Taubman and his family (the Shareholders). Prior to
completion of the transactions contemplated by the Agreement, the Shareholders were the Companys largest shareholders, holding in the aggregate 14,034,158 shares of the Companys Class B
Common Stock, par value $0.10 per share (the Class B Stock), representing approximately 62.4% of the aggregate voting power of the Companys capital stock. Robert S. Taubman, A. Alfred
Taubmans son, is a director of the Company. Pursuant to the Agreement, the Company agreed to an exchange of all 14,034,158 shares of Class B Stock owned by the Shareholders for $168,409,896 in cash and 7.1 million shares of the
Companys Class A Limited Voting Common Stock, par value $0.10 per share (the Class A Stock), (such exchange, the Transaction). (See Mechanics of Effecting the Transaction; Funding
below.) Completion of the Transaction was not subject to any conditions and it was completed on September 7, 2005. Because the outstanding shares of Class B Stock constituted less than fifty
percent of the aggregate voting power of the Companys outstanding common stock following completion of the Transaction, pursuant to the Companys Third Amended and Restated Articles of
Incorporation (the Articles), following completion of the Transaction each remaining outstanding share of Class B Stock held by shareholders not a party to the Transaction was automatically
converted into one share of Class A Stock without any action on the part of the holder thereof. Therefore, immediately following completion of the Transaction and such conversion, the Company
had approximately 57.3 million shares of Class A Stock outstanding (of which the Shareholders owned 7.1 million, or approximately 12.4%) and no shares of Class B Stock outstanding. The Companys Board of Directors appointed a Special Committee to carefully examine all details of the Transaction. The Special Committee consisted of four disinterested Directors who, after
careful deliberation and negotiation, and based on the advice of independent legal and financial advisors retained by the Special Committee, unanimously recommended that the Companys Board of
Directors approve the Transaction. As a result of the Transaction, the dual class super-voting share structure that had been in place since the Companys initial public offering in 1988 was eliminated; allowing for a corporate
governance structure that is more consistent with the best practices of public companies. Mechanics of Effecting the Transaction; FundingUnder the terms of the Agreement, the Transaction was effected by means of: (1) the Shareholders voluntarily converting, on a one-for-one basis
pursuant to the Articles, 7.1 million shares of Class B Stock into shares of Class A Stock, and (2) the Company acquiring the remaining shares of Class B Stock owned by the Shareholders for
aggregate cash consideration of $168,409,896. The Company funded the cash portion of the consideration plus direct transaction and financing costs with then existing cash balances and $100 million
in borrowings under a new credit facility (see Note J). The total cost to acquire the Class B Stock owned by the Shareholders of $177.2 million (including $8.8 million in direct transaction costs) was accounted for as a treasury stock transaction in the
third quarter of 2005, with Common Stock and Additional Paid-In Capital being reduced by $177.1 million. Additionally, the Company ascribed $100,000 of the cost to the Standstill and the
Restrictions on Transfer (as described below) based on their fair value as determined by an independent valuation expert. Such amount was expensed as incurred within Other Expense in the period
of the Transaction. Direct financing costs of $3.7 million attributable to the new credit facility are being amortized on a straight-line basis over the term of the facility (see Note J). StandstillIn the Agreement, each Shareholder agreed to a customary standstill lasting until the earlier of (1) the fourth anniversary of the Transaction or (2) 30 days after the date on which (a)
the Shareholders, together with their affiliates, own, in the aggregate, securities representing less than ten percent of the Companys total outstanding voting power and (b) no affiliate of any
Shareholder is a member of the Board of Directors of the Company (however, if such 30th day would otherwise occur on or before the second anniversary of the Transaction, such 30th day would 94
not be deemed to occur until such second anniversary). The terms of the Standstill generally state that, each Shareholder shall not (unless requested by the Company): (1) acquire or propose to
acquire ownership of or the ability to vote any securities or other property of the Company or any of its subsidiaries or (2) act to seek to control or influence the management, Board of Directors,
shareholders, business, operations or policies of the Company. Restrictions on TransferIn the Agreement, each Shareholder agreed that, prior to the second anniversary of the Transaction, such Shareholder would not transfer any shares of Class A Stock or
any economic interest therein, except to an affiliate of such Shareholder in connection with tax or estate-planning transactions, or, to the extent permitted by law, for sales of shares of Class A Stock
in any three month period, that when aggregated with sales by all other Shareholders in such period, would not exceed the greater of one percent of the outstanding shares of Class A Stock or the
average weekly trading volume of the Class A Stock during the four weeks preceding such sale. Registration RightsIn the Agreement, the Company agreed that, following the second anniversary of the Transaction and on not more than two occasions, the Shareholders would have the right to
require the Company to file a registration statement under the federal securities laws registering the sale of all or a portion of the shares of Class A Stock owned by the Shareholders that are not
otherwise freely tradable, provided that the market value of the securities proposed to be sold exceeds specified thresholds. The Company has the right to defer the filing of such registration
statement under certain circumstances. The Company also agreed to allow the Shareholders to participate in any registration statement proposed to be effected by the Company following the second
anniversary of the Transaction, subject to certain restrictions. The Company agreed to pay all expenses incurred in connection with such registration, other than any underwriting discounts or
commissions, and also agreed to indemnify each Shareholder from losses incurred as a result of material misstatements or omissions in such registration statement (other than those that are the
responsibility of the Shareholders, losses incurred by the Company as a result of which would be subject to indemnification from the Shareholders). Note VReincorporation On June 30, 2006, the Company (then named Sothebys Holdings, Inc.) reincorporated into the State of Delaware (the Reincorporation). The Reincorporation and related proposals were
approved by the shareholders of Sothebys Holdings, Inc. at the annual meeting of shareholders on May 8, 2006. The Reincorporation was completed by means of a merger of Sothebys Holdings, Inc.
with and into Sothebys Delaware, Inc., a Delaware corporation (Sothebys Delaware) and a wholly-owned subsidiary of Sothebys Holdings, Inc. incorporated for the purpose of effecting the
Reincorporation, with Sothebys Delaware being the surviving corporation. Sothebys Delaware was renamed Sothebys upon completion of the merger. In the merger, each outstanding share of Sothebys Holdings, Inc. Class A Limited Voting Common Stock (Sothebys Holdings, Inc. Stock) was converted into one share of Common Stock of
Sothebys Delaware (Sothebys Delaware Stock). As a result, holders of Sothebys Holdings, Inc. Stock are now holders of Sothebys Delaware Stock, and their rights as holders thereof are
governed by the General Corporation Law of the State of Delaware and the Certificate of Incorporation and By-Laws of Sothebys Delaware. The Reincorporation was accounted for as a reverse merger whereby, for accounting purposes, Sothebys Holdings, Inc. is considered the acquiror and the surviving corporation is treated as the
successor to the historical operations of Sothebys Holdings, Inc. Accordingly, the historical financial statements of Sothebys Holdings, Inc., which Sothebys Holdings, Inc. previously reported to the
SEC on Forms 10-K and 10-Q, among other forms, are treated as the financial statements of the surviving corporation. The Reincorporation did not result in any change in the business or principal facilities of Sothebys Holdings, Inc. Upon completion of the merger, the address of Sothebys principal executive
offices is 1334 York Avenue, New York, NY 10021. Sothebys Holdings, Inc.s management and board of directors continued as the management and board of directors of 95
Sothebys Delaware and Sothebys Delaware Stock continued to trade on the NYSE under the symbol BID. Note WRetention Costs In 2001 and 2002, the Company implemented retention programs that provided cash awards payable to certain key employees upon the fulfillment of full-time employment through certain dates.
All amounts related to the retention programs were amortized over the corresponding contractual service periods. For the year ended December 31, 2004, the Company recognized Retention Costs of
$0.3 million. The final cash payment of $0.4 million due under the retention programs was made in January 2004 and, as a result, the retention programs concluded. Note XRestructuring Plans In the fourth quarter of 2002, management approved a restructuring plan impacting the Auction segment, as well as certain corporate departments (the 2002 Restructuring Plan). For the year
ended December 31, 2004, Net Restructuring Charges related to the 2002 Restructuring Plan totaled $0.1 million, principally relating to severance benefit costs. During 2004, all remaining amounts
due under the 2002 Restructuring Plan were paid out and the related restructuring liability was extinguished. Note YQuarterly Results The worldwide art auction market has two principal selling seasons, spring and autumn. Accordingly, the Auction segments business is seasonal, with peak revenues and operating income
generally occurring in the second and fourth quarters of each year. Consequently, first and third quarter results of the Auction segment historically reflect lower Net Auction Sales (as defined below)
when compared to the second and fourth quarters and a loss from continuing operations due to the fixed nature of many of the Companys operating expenses. 96
See Note D for information regarding prior period reclassifications relating to the Companys newly established Dealer segment, as well as the reclassification of results from the Companys real
estate brokerage business in Australia to continuing operations.
First
Second
Third
Fourth
(Thousands of dollars, except per share data) Year Ended December 31, 2006 Net Auction Sales (a)
$
443,024
$
1,281,559
$
195,462
$
1,314,481 Income Statement Data: Auction and related revenues
$
89,493
$
242,877
$
50,830
$
248,144 Finance revenues
3,432
3,550
4,347
4,535 Dealer revenues
2,231
634
920
8,991 License fee revenues
470
722
961
769 Other revenues
389
516
322
676 Total revenues
$
96,015
$
248,299
$
57,380
$
263,115 (Loss) income from continuing operations
$
(3,939
)
$
72,379
$
(30,425
)
$
69,344 Net (loss) income
$
(3,977
)
$
71,448
$
(30,727
)
$
70,305 Basic and Diluted Earnings (Loss) Per Share: Basic (loss) earnings from continuing operations
$
(0.07
)
$
1.21
$
(0.49
)
$
1.11 Basic (loss) earnings per share
$
(0.07
)
$
1.20
$
(0.50
)
$
1.12 Diluted (loss) earnings from continuing operations
$
(0.07
)
$
1.17
$
(0.49
)
$
1.08 Diluted (loss) earnings per share
$
(0.07
)
$
1.16
$
(0.50
)
$
1.09 Year Ended December 31, 2005 Net Auction Sales (a)
$
305,052
$
838,747
$
228,133
$
989,898 Income Statement Data: Auction and related revenues
$
71,731
$
173,200
$
52,914
$
199,054 Finance revenues
1,208
1,768
2,112
3,214 Dealer revenues
444
2,358
779
1,550 License fee revenues
176
448
385
395 Other revenues
556
578
279
704 Total revenues
$
74,115
$
178,352
$
56,469
$
204,917 (Loss) income from continuing operations
$
(9,739
)
$
42,494
$
(21,204
)
$
51,666 Net (loss) income (b)
$
(9,721
)
$
41,977
$
(20,961
)
$
50,307 Basic and Diluted Earnings (Loss) Per Share: Basic (loss) earnings from continuing operations
$
(0.16
)
$
0.68
$
(0.35
)
$
0.92 Basic (loss) earnings per share (b)
$
(0.16
)
$
0.67
$
(0.34
)
$
0.89 Diluted (loss) earnings from continuing operations
$
(0.16
)
$
0.67
$
(0.35
)
$
0.90 Diluted (loss) earnings per share (b)
$
(0.16
)
$
0.66
$
(0.34
)
$
0.87 Legend:
(a)
Net Auction Sales represents the hammer (sale) price of property sold at auction. (b) In the fourth quarter of 2005, the Company recorded the cumulative effect of a change in accounting principle of $1.1 million (net of taxes) related to the adoption of FIN No. 47. 97
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON Not applicable.
ITEM 9A. CONTROLS AND
PROCEDURES
Disclosure
Controls and Procedures As of December 31, 2006, the Company has carried out an evaluation, under the supervision and with the participation of the Companys management, including the Companys Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the Companys disclosure controls and procedures. Based upon that evaluation, the Companys Chief Executive Officer and Chief Financial
Officer have concluded that the Companys disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) were effective as of December 31, 2006. Managements Report on Internal Control over Financial Reporting The Companys management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f).
Management evaluates the effectiveness of the Companys internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) in Internal ControlIntegrated Framework. Management, under the supervision and with the participation of the Companys Chief Executive Officer and Chief Financial
Officer, assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2006 and concluded that it is effective. The Companys independent registered public accounting firm, Deloitte & Touche LLP, has audited the effectiveness of the Companys internal control over financial reporting and managements
assessment of the effectiveness of the Companys internal control over financial reporting as of December 31, 2006, and has expressed unqualified opinions in their report which is included herein. Changes in Internal Control over Financial Reporting There was no change in the Companys internal control over financial reporting that occurred during the Companys most recent fiscal quarter that has materially affected, or is reasonably likely
to materially affect, the Companys internal control over financial reporting. 98
ACCOUNTING AND FINANCIAL DISCLOSURE
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of We have audited managements assessment, included in the accompanying Managements Report on Internal Control Over Financial Reporting, that Sothebys and subsidiaries (the Company)
maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the Companys internal control over financial
reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control
over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A companys internal control over financial reporting is a process designed by, or under the supervision of, the companys principal executive and principal financial officers, or persons
performing similar functions, and effected by the companys board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies
and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to
error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject
to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, managements assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based
on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained,
in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement
schedule as of and for the year ended December 31, 2006 of the Company and our report dated March 1, 2007 expressed an unqualified opinion and includes an explanatory paragraph referring to 99
SOTHEBYS
New York, New York
the Companys adoption of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, as revised, effective January 1, 2006 and the recognition and disclosure provisions of
Statement of Financial Accounting Standards No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plansan amendment of FASB Statements No. 87, 88, 106 and
132(R), effective December 31, 2006, on those financial statements and financial statement schedule.
/s/ DELOITTE & TOUCHE LLP
100
Deloitte & Touche LLP
New York, New York
March 1, 2007
PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE Information required by this item is incorporated herein by reference to the Companys definitive proxy statement for the annual meeting of shareholders to be held in 2007 (the Proxy
Statement) under the captions Election of Directors, Corporate Governance and Section 16(a) Beneficial Ownership Compliance. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated herein by reference to the material appearing in the Proxy Statement under the captions Compensation of Executive Officers and
Compensation of Directors. Notwithstanding anything to the contrary herein, the Audit Committee Report and the Compensation Committee Report in the Proxy Statement are not incorporated by
reference herein. The information required by this item is incorporated herein by reference to the table and related text and footnotes appearing in the Proxy Statement under the caption Security Ownership of
Certain Beneficial Owners and Management. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE The information required by this item is incorporated herein by reference to the material appearing in the Proxy Statement under the captions Certain Relationships and Related Transactions
and Corporate Governance. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES The information required by this item is incorporated herein by reference to the material appearing in the Proxy Statement under the caption Ratification of the Appointment of Independent
Auditors. 101
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
15(a)(1) The following consolidated financial statements and the related notes thereto of Sothebys Holdings, Inc. and subsidiaries are contained in Item 8, Financial Statements and Supplementary
Data: Consolidated Income StatementsYears ended December 31, 2006, 2005 and 2004; Consolidated Balance SheetsDecember 31, 2006 and 2005; Consolidated Statements of Cash
FlowsYears ended December 31, 2006, 2005 and 2004; Consolidated Statements of Changes in Shareholders EquityYears ended December 31, 2006, 2005 and 2004.
15(a)(2) The following is the consolidated financial statement schedule of Sothebys Holdings, Inc. and subsidiaries required by Item 15(d): Schedule IIValuation and Qualifying Accounts for the
years ended December 31, 2006, 2005 and 2004.
15(a)(3)
2.1 Agreement and Plan of Merger between Sothebys Holdings, Inc., a Michigan corporation and Sothebys Delaware, Inc., a Delaware corporation, dated March 31, 2006, incorporated by
reference to the Companys First Quarter Form 10-Q for 2006.
2.2 Agreement for the Sale and Purchase of All the Issued and Outstanding Shares in Noortman Master Paintings B.V., dated June 7, 2006, incorporated by reference to Exhibit 2.1 to the
Companys Second Quarter Form 10-Q for 2006.
3.1 Certificate of Incorporation of Sothebys, as amended as of June 30, 2006, incorporated by reference to Exhibit 3.1 to the Companys current report on Form 8-K, filed on July 7, 2006.
3.2 By-Laws of Sothebys adopted as of March 31, 2006, incorporated by reference to Exhibit 3.2 to the Companys current report on Form 8-K, filed on July 7, 2006.
4.1 See Exhibits 3.1 and 3.2.
4.2 Indenture, dated as of February 5, 1999, between Sothebys Holdings, Inc. and The Chase Manhattan Bank as Trustee, incorporated by reference to Exhibit 4(a) to the Companys current
report on Form 8-K, filed on February 10, 1999 with the Securities and Exchange Commission.
4.3 First Supplemental Indenture, dated as of June 30, 2006, between Sothebys and Wilmington Trust Company, as successor trustee (Supplemental to Indenture dated as of February 5, 1999
between Sothebys Holdings, Inc. and The Chase Manhattan Bank, as trustee, as filed in the Companys current report on Form 8-K on February 10, 1999 with the Securities and
Exchange Commission), incorporated by reference to Exhibit 4.4 to the Companys current report on Form 8-K, filed on July 7, 2006.
4.4 Fixed Rate Note, dated February 5, 1999, made by Sothebys Holdings, Inc. in favor of Cede & Co., incorporated by reference to Exhibit 4(b) to the Companys current report on Form 8-K,
filed on February 10, 1999 with the Securities and Exchange Commission.
4.5 Specimen Common Stock Certificate of Sothebys, incorporated by reference to Exhibit 4.1 to Post-Effective Amendment No. 1 to the Companys Registration Statement on Form 8-A filed
on November 21, 2006.
10.1* Sothebys, Inc. 2005 Benefit Equalization Plan, incorporated by reference to Exhibit 10.2 to the Companys current report on Form 8-K filed on December 15, 2004.
10.2* First Amendment to the Sothebys, Inc. 2005 Benefit Equalization Plan, dated December 9, 2005.
10.3* Sothebys Deferred Compensation Plan, dated December 21, 2006 and effective January 1, 2007. 102
10.4* Sothebys Holdings, Inc. 1987 Stock Option Plan as amended and restated effective June 1, 1994, incorporated by reference to Exhibit 10(o) to the Companys Annual Report on Form 10-K
for the year ended December 31, 1994.
10.5* Sothebys Holdings, Inc. 1997 Stock Option Plan Composite Plan Document, effective January 1, 2000, incorporated by reference to Exhibit 10(k) to the Companys Annual Report on Form
10-K for the year ended December 31, 2000.
10.6* Seventh Amendment to the Sothebys Holdings, Inc. 1997 Stock Option Plan dated November 7, 2005, effective September 8, 2005, incorporated by reference to Exhibit 10.4 to the
Companys Annual Report on Form 10-K for the year ended December 31, 2005.
10.7* Eighth Amendment to the Sothebys 1997 Stock Option Plan Composite Plan Document, dated and effective May 8, 2006, incorporated by reference to Exhibit 10.2 to the Companys
current report on Form 8-K dated May 12, 2006.
10.8 Agreement of Partnership of Acquavella Modern Art, dated May 29, 1990, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc., incorporated by reference to Exhibit
10(b) to the Companys current report on Form 8-K, filed on June 7, 1990, SEC File No. 1-9750, on file at the Washington, D.C. office of the Securities and Exchange Commission.
10.9 First Amendment to Agreement of Partnership, dated December 31, 2000, of Acquavella Modern Art, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc., incorporated
by reference to Exhibit 10(m) to the Companys Annual Report on Form 10-K for the year ended December 31, 2000.
10.10 Second Amendment to Agreement of Partnership, dated December 15, 2001, of Acquavella Modern Art, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc.,
incorporated by reference to Exhibit 10(k) to the Companys Annual Report on Form 10-K for the year ended December 31, 2001.
10.11 Third Amendment to Agreement of Partnership, dated February 10, 2003, of Acquavella Modern Art, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc., incorporated
by reference to Exhibit 10(h) to the Companys Annual Report on Form 10-K for the year ended December 31, 2002.
10.12 Fourth Amendment to Agreement of Partnership, dated January 13, 2004, of Acquavella Modern Art, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc., incorporated
by reference to Exhibit 10 to the Companys Annual Report on Form 10-K for the year ended December 31, 2003.
10.13 Fifth Amendment to Agreement of Partnership, dated December 8, 2004, of Acquavella Modern Art, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc., incorporated
by reference to Exhibit 10.9 to the Companys Annual Report on Form 10-K for the year ended December 31, 2004.
10.14 Sixth Amendment to Agreement of Partnership, dated March 1, 2006, of Acquavella Modern Art, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc. incorporated by
reference to Exhibit 10.11 to the Companys Annual Report on Form 10-K for the year ended December 31, 2005.
10.15* 1998 Stock Compensation Plan for Non-Employee Directors, as amended and restated on March 14, 2005, effective May 4, 2005, incorporated by reference to Exhibit 10.10 to the
Companys Annual Report on Form 10-K for the year ended December 31, 2004. 103
10.16 Amended and Restated Credit Agreement dated as of November 14, 2005, among Sothebys Inc., as the Company, Sothebys Holdings, Inc., as Holdings, Certain U.K. Subsidiaries of
Holdings, Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer, LaSalle Bank N.A., as Syndication Agent and the Other Lenders Party Hereto, Banc of
America Securities, LLC and LaSalle Bank N.A., as Joint Lead Arrangers and Joint Book Managers, incorporated by reference to the Companys Annual Report on Form 10-K for the
year ended December 31, 2005.
10.17 Amendment No. 2 to the Amended and Restated Credit Agreement among Sothebys Holdings, Inc., Sothebys, Inc., Oatshare Limited, Sothebys, and Bank of America, N.A. dated May
18, 2006, incorporated by reference to Exhibit 10.1 to the Companys current report on Form 8-K, filed on May 23, 2006.
10.18 Purchase and Sale Agreement between SIBS, LLC, as Seller and RFR Holding Corp., as Purchaser; Dated: As of December 16, 2002; Property: 1334 York Avenue, New York, New York
10021, incorporated by reference to Exhibit 10(a) to the Companys First Quarter Form 10-Q for 2003.
10.19 Lease between 1334 York Avenue L.P., Landlord, and Sothebys, Inc., Tenant, February 7, 2003; Premises: 1334 York Avenue, New York, New York, incorporated by reference to
Exhibit 10(b) to the Companys First Quarter Form 10-Q for 2003.
10.20 Guaranty of Lease, made by Sothebys in favor of 1334 York Avenue L.P., dated as of June 30, 2006 incorporated by reference to Exhibit 10.29 to the Companys current report on Form
8-K, filed on July 7, 2006.
10.21* Letter Agreement between Sothebys Holdings, Inc. and William F. Ruprecht, with related Terms of Employment, dated March 31, 2006
10.22* Severance Agreement between Sothebys and William S. Sheridan, dated August 3, 2006, incorporated by reference to Exhibit 10.1 to the Companys Third Quarter Form 10-Q for 2006.
10.23* Service Agreement between Sothebys and Robin Woodhead, with related Terms of Employment, dated August 15, 2006, incorporated by reference to Exhibit 10.2 to the Companys Third
Quarter Form 10-Q for 2006.
10.24* Sothebys Holdings, Inc. Amended and Restated Restricted Stock Plan, incorporated by reference to Exhibit 10.1 to the Companys Registration Statement on Form S-8 filed on May 9,
2006.
10.25 Stock Purchase Agreement, dated as of February 17, 2004, by and among NRT Incorporated as the Purchaser, Sothebys Holdings, Inc., as the Seller, and Cendant Corporation as the
Purchaser Guarantor, incorporated by reference to Exhibit 99.1 to the Companys current report on Form 8-K, filed on March 2, 2004.
10.26 Trademark License Agreement, dated as of February 17, 2004, among SPTC, Inc., as Licensor, Sothebys Holdings, Inc. as Guarantor, Monticello Licensee Corporation, as Licensee, and
Cendant Corporation, as Guarantor, incorporated by reference to Exhibit 99.2 to the Companys current report on Form 8-K, filed on March 2, 2004.
10.27 Amendment No. 1 to Trademark License Agreement, dated as of May 2, 2005, among SPTC Delaware, LLC (as an assignee of SPTC, Inc) and Sothebys Holdings, Inc. and Cendant
Corporation and Sothebys International Realty Licensee Corporation (formerly known as Monticello Licensee Corporation), incorporated by reference to Exhibit 10.1 to the Companys
Second Quarter Form 10-Q for 2005.
10.28 Amendment No. 2 to Trademark License Agreement, dated as of May 2, 2005, among SPTC Delaware, LLC (as an assignee of SPTC, Inc) and Sothebys Holdings, Inc. and Cendant
Corporation and Sothebys International Realty Licensee Corporation (formerly known as Monticello Licensee Corporation), incorporated by reference to Exhibit 10.2 to the Companys
Second Quarter Form 10-Q for 2005. 104
10.29* Sothebys Holdings, Inc. Executive Bonus Plan, dated as of February 7, 2005 and effective January 1, 2005, incorporated by reference to Exhibit 10.1 to the Companys First Quarter Form
10-Q for 2005.
10.30 Transaction Agreement by and among Sothebys Holdings, Inc., and The Investors, dated as of September 7, 2005, incorporated by reference to Exhibit 10.1 to the Companys Third
Quarter Form 10-Q for 2005.
21 Subsidiaries of the Registrant
23 Consent of Deloitte & Touche LLP
24 Powers of Attorney
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(15)(b) On October 26, 2006, the Company filed a current report on Form 8-K under Item 8.01, Other Events. On November 14, 2006, the Company filed a current report on Form 8-K under Item 2.02, Results of Operations and Financial Condition and Item 9.01, Financial Statements and
Exhibits. On December 12, 2006, the Company filed a current report on Form 8-K under Item 5.02 Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain
Officers; Compensatory Arrangements of Certain Officers.
(15)(c) The list of exhibits filed with this report is set forth in response to Item 15(a)(3). The required exhibit index has been filed with the exhibits.
(15)(d) The financial statement schedule of the Company listed in response to Item 15(a)(2) is filed pursuant to this Item 15(d).
*
A compensatory agreement or plan required to be filed pursuant to Item 15(c) of Form 10-K
105
SOTHEBYS Column A
Column B
Column C
Column D
Column E Description (a)
Balance at
Charged to
Charged to
Deductions
Balance
(Thousands of dollars) Valuation reserve deducted in the balance sheet from the asset to which it applies: Receivables (b): 2006 Allowance for doubtful accounts and credit losses
$
6,137
$
3,192
$
$
2,240
$
7,089 2005 Allowance for doubtful accounts and credit losses
$
7,931
$
1,820
$
156
$
3,770
$
6,137 2004 Allowance for doubtful accounts and credit losses
$
7,548
$
5,530
$
$
5,147
$
7,931 Deferred tax assets: 2006 Valuation allowance
$
24,885
$
1,368
$
2,894
$
$
29,147 2005 Valuation allowance
$
33,762
$
$
$
8,877
$
24,885 2004 Valuation allowance
$
34,493
$
3,167
$
$
3,898
$
33,762
(a)
The schedule above relates only to the Company s continuing operations and excludes amounts related to the Companys discontinued real estate brokerage business considered to be held for sale
(see Note T of Notes to Consolidated Financial Statements under Part II, Item 8, Financial Statements and Supplementary Data). (b) Consists of Accounts Receivable, as well as Notes Receivables and Consignor Advances. 106
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
Beginning
of Period
Costs and
Expenses
Other
Accounts
at End of
Period
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized. SOTHEBYS
By:
/s/ WILLIAM F. RUPRECHT
William F. Ruprecht Date: March 1, 2007 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates
indicated.
Title
Date
/s/ MICHAEL I. SOVERN* Michael I. Sovern Chairman of the Board
March 1, 2007
/s/ DEVONSHIRE*
Duke of Devonshire Deputy Chairman of the Board
/s/ WILLIAM F. RUPRECHT
William F. Ruprecht President, Chief Executive Officer
/s/ ROBIN G. WOODHEAD*
Robin G. Woodhead Executive Vice President and Director
/s/ BLAKENHAM*
Michael Blakenham Director
/s/ STEVEN B. DODGE*
Steven B. Dodge Director
/s/ ALLEN QUESTROM*
Allen Questrom Director
/s/ DONALD H. STEWART*
Donald H. Stewart Director
/s/ ROBERT S. TAUBMAN*
Robert S. Taubman Director
/s/ DENNIS WEIBLING*
Dennis Weibling Director
/s/ WILLIAM S. SHERIDAN
William S. Sheridan Executive Vice President and
/s/ MICHAEL L. GILLIS
Michael L. Gillis Senior Vice President, Controller and
/s/ WILLIAM S. SHERIDAN
*William S. Sheridan 107
President and Chief Executive Officer
Signature
March 1, 2007
and Director
March 1, 2007
March 1, 2007
March 1, 2007
March 1, 2007
March 1, 2007
March 1, 2007
March 1, 2007
March 1, 2007
Chief Financial Officer
March 1, 2007
Chief Accounting Officer
March 1, 2007
as Attorney-in-Fact
March 1, 2007
EXHIBIT INDEX
Exhibit Description
2.1 Agreement and Plan of Merger between Sothebys Holdings, Inc., a Michigan corporation and Sothebys Delaware, Inc., a Delaware corporation, dated March 31, 2006, incorporated by reference to
the Companys First Quarter Form 10-Q for 2006.
2.2 Agreement for the Sale and Purchase of All the Issued and Outstanding Shares in Noortman Master Paintings B.V., dated June 7, 2006, incorporated by reference to Exhibit 2.1 to the Companys
Second Quarter Form 10-Q for 2006.
3.1 Certificate of Incorporation of Sothebys, as amended as of June 30, 2006, incorporated by reference to Exhibit 3.1 to the Companys current report on Form 8-K, filed on July 7, 2006.
3.2 By-Laws of Sothebys adopted as of March 31, 2006, incorporated by reference to Exhibit 3.2 to the Companys current report on Form 8-K, filed on July 7, 2006.
4.1 See Exhibits 3.1 and 3.2.
4.2 Indenture, dated as of February 5, 1999, between Sothebys Holdings, Inc. and The Chase Manhattan Bank as Trustee, incorporated by reference to Exhibit 4(a) to the Companys current report on
Form 8-K, filed on February 10, 1999 with the Securities and Exchange Commission.
4.3 First Supplemental Indenture, dated as of June 30, 2006, between Sothebys and Wilmington Trust Company, as successor trustee (Supplemental to Indenture dated as of February 5, 1999 between
Sothebys Holdings, Inc. and The Chase Manhattan Bank, as trustee, as filed in the Companys current report on Form 8-K on February 10, 1999 with the Securities and Exchange Commission),
incorporated by reference to Exhibit 4.4 to the Companys current report on Form 8-K, filed on July 7, 2006.
4.4 Fixed Rate Note, dated February 5, 1999, made by Sothebys Holdings, Inc. in favor of Cede & Co., incorporated by reference to Exhibit 4(b) to the Companys current report on Form 8-K, filed on
February 10, 1999 with the Securities and Exchange Commission.
4.5 Specimen Common Stock Certificate of Sothebys, incorporated by reference to Exhibit 4.1 to Post-Effective Amendment No. 1 to the Companys Registration Statement on Form 8-A filed on
November 21, 2006.
10.1* Sothebys, Inc. 2005 Benefit Equalization Plan, incorporated by reference to Exhibit 10.2 to the Companys current report on Form 8-K filed on December 15, 2004.
10.2* First Amendment to the Sothebys, Inc. 2005 Benefit Equalization Plan, dated December 9, 2005.
10.3* Sothebys Deferred Compensation Plan, dated December 21, 2006 and effective January 1, 2007.
10.4* Sothebys Holdings, Inc. 1987 Stock Option Plan as amended and restated effective June 1, 1994, incorporated by reference to Exhibit 10(o) to the Companys Annual Report on Form 10-K for the
year ended December 31, 1994.
10.5* Sothebys Holdings, Inc. 1997 Stock Option Plan Composite Plan Document, effective January 1, 2000, incorporated by reference to Exhibit 10(k) to the Companys Annual Report on Form 10-K for
the year ended December 31, 2000.
10.6* Seventh Amendment to the Sothebys Holdings, Inc. 1997 Stock Option Plan dated November 7, 2005, effective September 8, 2005, incorporated by reference to Exhibit 10.4 to the Companys
Annual Report on Form 10-K for the year ended December 31, 2005.
10.7* Eighth Amendment to the Sothebys 1997 Stock Option Plan Composite Plan Document, dated and effective May 8, 2006, incorporated by reference to Exhibit 10.2 to the Companys current report
on Form 8-K dated May 12, 2006.
10.8 Agreement of Partnership of Acquavella Modern Art, dated May 29, 1990, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc., incorporated by reference to Exhibit 10(b) to the
Companys current report on Form 8-K, filed on June 7, 1990, SEC File No. 1-9750, on file at the Washington, D.C. office of the Securities and Exchange Commission. 108
No.
Exhibit Description
10.9 First Amendment to Agreement of Partnership, dated December 31, 2000, of Acquavella Modern Art, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc., incorporated by
reference to Exhibit 10(m) to the Companys Annual Report on Form 10-K for the year ended December 31, 2000.
10.10 Second Amendment to Agreement of Partnership, dated December 15, 2001, of Acquavella Modern Art, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc., incorporated by
reference to Exhibit 10(k) to the Companys Annual Report on Form 10-K for the year ended December 31, 2001.
10.11 Third Amendment to Agreement of Partnership, dated February 10, 2003, of Acquavella Modern Art, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc., incorporated by
reference to Exhibit 10(h) to the Companys Annual Report on Form 10-K for the year ended December 31, 2002.
10.12 Fourth Amendment to Agreement of Partnership, dated January 13, 2004, of Acquavella Modern Art, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc., incorporated by
reference to Exhibit 10 to the Companys Annual Report on Form 10-K for the year ended December 31, 2003.
10.13 Fifth Amendment to Agreement of Partnership, dated December 8, 2004, of Acquavella Modern Art, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc., incorporated by
reference to Exhibit 10.9 to the Companys Annual Report on Form 10-K for the year ended December 31, 2004.
10.14 Sixth Amendment to Agreement of Partnership, dated March 1, 2006, of Acquavella Modern Art, between Sothebys Nevada, Inc. and Acquavella Contemporary Art, Inc. incorporated by reference
to Exhibit 10.11 to the Companys Annual Report on Form 10-K for the year ended December 31, 2005.
10.15* 1998 Stock Compensation Plan for Non-Employee Directors, as amended and restated on March 14, 2005, effective May 4, 2005, incorporated by reference to Exhibit 10.10 to the Companys Annual
Report on Form 10-K for the year ended December 31, 2004.
10.16 Amended and Restated Credit Agreement dated as of November 14, 2005, among Sothebys Inc., as the Company, Sothebys Holdings, Inc., as Holdings, Certain U.K. Subsidiaries of Holdings, Bank
of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer, LaSalle Bank N.A., as Syndication Agent and the Other Lenders Party Hereto, Banc of America Securities, LLC
and LaSalle Bank N.A., as Joint Lead Arrangers and Joint Book Managers, incorporated by reference to the Companys Annual Report on Form 10-K for the year ended December 31, 2005.
10.17 Amendment No. 2 to the Amended and Restated Credit Agreement among Sothebys Holdings, Inc., Sothebys, Inc., Oatshare Limited, Sothebys, and Bank of America, N.A. dated May 18, 2006,
incorporated by reference to Exhibit 10.1 to the Companys current report on Form 8-K, filed on May 23, 2006.
10.18 Purchase and Sale Agreement between SIBS, LLC, as Seller and RFR Holding Corp., as Purchaser; Dated: As of December 16, 2002; Property: 1334 York Avenue, New York, New York 10021,
incorporated by reference to Exhibit 10(a) to the Companys First Quarter Form 10-Q for 2003.
10.19 Lease between 1334 York Avenue L.P., Landlord, and Sothebys, Inc., Tenant, February 7, 2003; Premises: 1334 York Avenue, New York, New York, incorporated by reference to Exhibit 10(b)
to the Companys First Quarter Form 10-Q for 2003.
10.20 Guaranty of Lease, made by Sothebys in favor of 1334 York Avenue L.P., dated as of June 30, 2006 incorporated by reference to Exhibit 10.29 to the Companys current report on Form 8-K, filed on
July 7, 2006. 109
No.
Exhibit Description
10.21* Letter Agreement between Sothebys Holdings, Inc. and William F. Ruprecht, with related Terms of Employment, dated March 31, 2006
10.22* Severance Agreement between Sothebys and William S. Sheridan, dated August 3, 2006, incorporated by reference to Exhibit 10.1 to the Companys Third Quarter Form 10-Q for 2006.
10.23* Service Agreement between Sothebys and Robin Woodhead, with related Terms of Employment, dated August 15, 2006, incorporated by reference to Exhibit 10.2 to the Companys Third Quarter
Form 10-Q for 2006.
10.24* Sothebys Holdings, Inc. Amended and Restated Restricted Stock Plan, incorporated by reference to Exhibit 10.1 to the Companys Registration Statement on Form S-8 filed on May 9, 2006.
10.25 Stock Purchase Agreement, dated as of February 17, 2004, by and among NRT Incorporated as the Purchaser, Sothebys Holdings, Inc., as the Seller, and Cendant Corporation as the Purchaser
Guarantor, incorporated by reference to Exhibit 99.1 to the Companys current report on Form 8-K, filed on March 2, 2004.
10.26 Trademark License Agreement, dated as of February 17, 2004, among SPTC, Inc., as Licensor, Sothebys Holdings, Inc. as Guarantor, Monticello Licensee Corporation, as Licensee, and Cendant
Corporation, as Guarantor, incorporated by reference to Exhibit 99.2 to the Companys current report on Form 8-K, filed on March 2, 2004.
10.27 Amendment No. 1 to Trademark License Agreement, dated as of May 2, 2005, among SPTC Delaware, LLC (as an assignee of SPTC, Inc) and Sothebys Holdings, Inc. and Cendant Corporation and
Sothebys International Realty Licensee Corporation (formerly known as Monticello Licensee Corporation), incorporated by reference to Exhibit 10.1 to the Companys Second Quarter Form 10-Q
for 2005.
10.28 Amendment No. 2 to Trademark License Agreement, dated as of May 2, 2005, among SPTC Delaware, LLC (as an assignee of SPTC, Inc) and Sothebys Holdings, Inc. and Cendant Corporation and
Sothebys International Realty Licensee Corporation (formerly known as Monticello Licensee Corporation), incorporated by reference to Exhibit 10.2 to the Companys Second Quarter Form 10-Q
for 2005.
10.29* Sothebys Holdings, Inc Executive Bonus Plan, dated as of February 7, 2005 and effective January 1, 2005, incorporated by reference to Exhibit 10.1 to the Companys First Quarter Form 10-Q for
2005.
10.30 Transaction Agreement by and among Sothebys Holdings, Inc., and The Investors, dated as of September 7, 2005, incorporated by reference to Exhibit 10.1 to the Companys Third Quarter Form 10-
Q for 2005.
21 Subsidiaries of the Registrant
23 Consent of Deloitte & Touche LLP
24 Powers of Attorney
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
* 110
No.
A compensatory agreement or plan required to be filed pursuant to Item 15(c) of Form 10-K