Company Quick10K Filing
Quick10K
Sotheby's
Closing Price ($) Shares Out (MM) Market Cap ($MM)
$43.72 47 $2,040
10-K 2018-12-31 Annual: 2018-12-31
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
10-K 2016-12-31 Annual: 2016-12-31
10-Q 2016-09-30 Quarter: 2016-09-30
10-Q 2016-06-30 Quarter: 2016-06-30
10-Q 2016-03-31 Quarter: 2016-03-31
10-K 2015-12-31 Annual: 2015-12-31
10-Q 2015-09-30 Quarter: 2015-09-30
10-Q 2015-06-30 Quarter: 2015-06-30
10-Q 2015-03-31 Quarter: 2015-03-31
10-K 2014-12-31 Annual: 2014-12-31
10-Q 2014-09-30 Quarter: 2014-09-30
10-Q 2014-06-30 Quarter: 2014-06-30
10-K 2013-12-31 Annual: 2013-12-31
8-K 2019-02-14 Shareholder Vote
8-K 2018-12-14 Enter Agreement, Other Events, Exhibits
8-K 2018-12-03 Officers, Regulation FD, Exhibits
8-K 2018-11-26 Regulation FD
8-K 2018-11-01 Earnings, Exhibits
8-K 2018-10-22 Enter Agreement
8-K 2018-09-12 Enter Agreement, Other Events, Exhibits
8-K 2018-08-29 Regulation FD
8-K 2018-08-06 Earnings, Exhibits
8-K 2018-07-02 Enter Agreement, Off-BS Arrangement, Exhibits
8-K 2018-05-04 Shareholder Vote
8-K 2018-03-27 Other Events, Exhibits
8-K 2018-03-14 Other Events
8-K 2018-03-06 Officers
8-K 2018-02-13 Other Events, Exhibits
8-K 2018-01-25 Other Events, Exhibits
MKC McCormick 20,220
MXIM Maxim Integrated Products 16,370
ALX Alexanders 1,940
BCOR Blucora 1,710
CTB Cooper Tire & Rubber 1,630
CSTM Constellium 1,250
KALV Kalvista Pharmaceuticals 436
DSKE Daseke 337
HUSA Houston American Energy 15
BLIN Bridgeline Digital 0
BID 2018-12-31
Part I
Item 1: Description of Business
Item 1A: Risk Factors
Item 1B: Unresolved Staff Comments
Item 2: Properties
Item 3: Legal Proceedings
Item 4: Mine Safety Disclosures
Part II
Item 5: Market for The Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Item 6: Selected Financial Data
Item 7: Management's Discussion and Analysis of Financial Condition and Results Of
Item 7A: Quantitative and Qualitative Disclosures About Market Risk
Item 8: Financial Statements and Supplementary Data
Note 1-Summary of Significant Accounting Policies
Note 2-Recently Issued Accounting Standards
Note 3-Segment Reporting
Note 4-Revenues
Note 5-Notes Receivable
Note 6-Equity Method Investments
Note 7-Fixed Assets
Note 8-Acquisition of Art Agency, Partners
Note 9-Goodwill and Intangible Assets
Note 10-Pension Arrangements
Note 11-Debt
Note 12-Derivative Financial Instruments
Note 13-Sale of Pink Diamond
Note 14-Supplemental Consolidated Balance Sheet Information
Note 15-Supplemental Consolidated Cash Flow Information
Note 16-Shareholders' Equity and Dividends
Note 17-Accumulated Other Comprehensive Loss
Note 18-Income Taxes
Note 19-Uncertain Tax Positions
Note 20-Commitments and Contingencies
Note 21-Auction Guarantees
Note 22-Lease Commitments
Note 23-Share-Based Payments
Note 24-Voluntary Separation Incentive Programs, Net
Note 25-Restructuring Charges
Note 26-Earnings per Share
Note 27-Related Party Transactions
Note 28-Quarterly Results (Unaudited)
Item 9: Changes in and Disagreements with Accountants on Accounting and Financial
Item 9A: Controls and Procedures
Part III
Item 10: Directors, Executive Officers and Corporate Governance
Item 11: Executive Compensation
Item 12: Security Ownership of Certain Beneficial Owners and Management And
Item 13: Certain Relationships and Related Transactions and Director Independence
Item 14: Principal Accountant Fees and Services
Part IV
Item 15: Exhibits, Financial Statement Schedules, and Reports on Form 8-K
EX-3.1 bid-12312018x10kxex31.htm
EX-3.2 bid-12312018x10kxex32.htm
EX-10.19 bid-12312018x10kxex1019.htm
EX-10.27 bid-12312018x10kxex1027.htm
EX-21 exhibit21-10k2018_subsidia.htm
EX-23 exhibit23-10k2018_consent.htm
EX-31.1 bid-12312018x10kxex311.htm
EX-31.2 bid-12312018x10kxex312.htm
EX-32.1 bid-12312018x10kxex321.htm
EX-32.2 bid-12312018x10kxex322.htm

Sotheby's Earnings 2018-12-31

BID 10K Annual Report

Balance SheetIncome StatementCash Flow

10-K 1 bid1231201810k_xbrl2018.htm 10-K Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
 
 
 
 
FORM 10-K
(Mark One)
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2018.
 
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE TRANSITION PERIOD FROM          TO
COMMISSION FILE NUMBER 1-9750
___________________________________________________________________
sothebys-logo28.jpg
(Exact name of registrant as specified in its charter)
__________________________________________________________________
Delaware
38-2478409
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
1334 York Avenue
10021
New York, New York
(Zip Code)
(Address of principal executive offices)
 
 
 
 
 
(212) 606-7000
 
 
(Registrant’s telephone number, including area code)
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
 
 
 
 
 
 
 
 
Title of each class
 
 
Name of each exchange
on which registered
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock,
 
 
New York Stock Exchange
 
 
$0.01 Par Value
 
 
 
 
 
 
 
 
 
 
 
 
 
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 Securities Act. Yes þ No o
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 o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter 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 þ No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s 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. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
ý
 
Accelerated filer
o
Non-accelerated filer
o
 
Smaller reporting company
o
Emerging growth company
o
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes o No þ
As of June 30, 2018, the aggregate market value of the 44,469,032 shares of Common Stock held by non-affiliates of the registrant was $2,416,447,198 based upon the closing price ($54.34) on the New York Stock Exchange composite tape on such date for the Common Stock.
As of February 26, 2019, there were outstanding 46,351,475 shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s proxy statement for the 2019 annual meeting of shareholders are incorporated by reference into Part III of this Form 10-K.
 




TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2



PART I

ITEM 1: DESCRIPTION OF BUSINESS
Company Overview
Sotheby’s has been uniting collectors with world-class works of art1 since 1744. Today, Sotheby's offers property from more than 70 collecting categories to clients from 130 countries and presents auctions in ten different salesrooms, including New York, London, Hong Kong and Paris, and Sotheby’s BidNow program allows clients to view all auctions live online and place bids from anywhere in the world. We also offer collectors a variety of innovative art-related services, including the brokerage of private art sales, private jewelry sales through Sotheby's Diamonds, exclusive private selling exhibitions, art-related financing, and art advisory services, as well as retail wine locations in New York and Hong Kong.
As successor to a business that began in 1744, Sotheby's is the oldest company listed on the New York Stock Exchange ("NYSE") (symbol: BID) and is the only publicly traded investment opportunity in the art market. Sotheby's is incorporated in Delaware.
Business Organization
Our operations are organized under two segments—the Agency segment and the Finance segment, which does business as and is referred to in this report as Sotheby’s Financial Services (“SFS”). The Agency segment earns commissions and fees by acting as agent for clients wishing to sell their artworks through the auction or private sale process. To a much lesser extent, the Agency segment also earns revenues from the sale of artworks that are owned by Sotheby's. SFS earns interest income and associated fees through art-related financing activities by making loans that are secured by works of art. Art Agency, Partners (“AAP”), which was acquired on January 11, 2016 and through which we offer art advisory services, provides art collectors with strategic guidance on collection identity and development, acquisitions, and short and long-term planning, and provides advice to artists and artists' estates. In addition, from time-to-time, AAP brokers private art sales for its advisory clients. Our advisory services are classified within All Other for segment reporting purposes, along with our retail wine business and brand licensing activities, and the results from certain equity method investments. (See Note 3 of Notes to Consolidated Financial Statements for information regarding our segment reporting.)
Agency Segment
Through our Agency segment, we accept works of art on consignment and match sellers (also known as consignors) to buyers through the auction or private sale process. In both auction and private sale transactions, we act as exclusive agent for the seller. Prior to offering a work of art for sale, we perform due diligence activities to authenticate and determine the ownership history and condition of the consigned artwork. (See “Converting Consignment Opportunities” below for further information regarding the consignment process.)
As compensation for our auction services, we earn a commission from both the buyer ("buyer's premium") and, to a lesser extent, the seller ("seller's commission") (collectively, "auction commission revenue"), both of which are calculated as a percentage of the hammer price of the property sold at auction. In certain situations, in order to secure a high-value consignment, we may not charge a seller's commission and/or may share a portion of our buyer's premium with the seller. In 2018, 2017, and 2016, auction commission revenues accounted for approximately 74%, 66%, and 75%, respectively, of our consolidated revenues. Private sale commission revenues are earned through the direct brokering of purchases and sales of art. Private sales are generally initiated by a client wishing to sell their artwork (i.e., the consignor) with Sotheby's acting as its exclusive agent in the transaction. In 2018, 2017, and 2016, private sale commission revenues accounted for approximately 8%, 6%, and 6%, respectively, of our consolidated revenues.




__________
1 In this report, the term "works of art" is meant to include authenticated fine art, decorative art, jewelry, wine, and collectibles, and may also be referred to as "art," "artwork," or "property."


3


Under the standard terms and conditions of our auction sales, we are not obligated to pay the consignor for property that has not been paid for by the buyer. If a buyer defaults on payment, the sale is cancelled, and the property is returned to the consignor. Alternatively, the consignor may reoffer the property at one of our future auctions or negotiate a private sale with us acting as their agent. In certain instances and subject to management approval under our internal corporate governance policy, we may pay the net sale proceeds to the seller before payment is collected from the buyer and/or we may allow the buyer to take possession of the property before making payment. In situations when the buyer takes possession of the property before making payment, we are liable to the seller for the net sale proceeds whether or not the buyer makes payment.
From time-to-time in the ordinary course of business, we will provide a guarantee to the consignor that their consigned artwork will achieve a specified minimum sale price at auction. This type of arrangement is known as an auction guarantee. If the property offered under an auction guarantee sells above the minimum guaranteed price, we are generally entitled to a share of the overage. In the event that the property sells for less than the minimum guaranteed price, we must perform under the auction guarantee by funding the shortfall between the sale price at auction and the amount of the auction guarantee. If the property offered under the auction guarantee does not sell, we must pay the amount of the auction guarantee to the consignor and then take ownership of the unsold property and may recover the amount paid through its future sale. In certain limited situations, if the guaranteed property fails to sell at auction or if the purchaser defaults, the consignor has the right to cancel the auction guarantee and retain the property.
We may reduce our financial exposure under auction guarantees through contractual risk sharing arrangements. Such auction guarantee risk sharing arrangements include irrevocable bid arrangements and, from time-to-time, partner sharing arrangements. In exchange for accepting a share of the financial exposure under the auction guarantee, our counterparties to these arrangements may receive a fee for providing the irrevocable bid, and are generally entitled to receive a share of our auction commission if the property sells and/or a share of the overage, if any.
Auction guarantees are an important financial incentive which may significantly influence an art collector's decision on whether and how to sell their property. As such, auction guarantees provide us the opportunity to secure highly sought-after consignments, often well in advance of a specific selling season. When we evaluate the performance of our portfolio of auction guarantees, we take into consideration the overall net revenues earned on the transaction, which includes our auction commission revenue, as well as any overage or shortfall. Depending on the mix of items subject to an auction guarantee, in advance of peak selling seasons, a small number of guaranteed items may represent a substantial portion of the aggregate amount of outstanding auction guarantees.
(See Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for a discussion of the overall financial performance of the Agency segment for the years ended December 31, 2018, 2017, and 2016. See Note 21 of Notes to Consolidated Financial Statements for additional information about auction guarantees.)
Sotheby's Financial Services
SFS is an art financing company that operates as a niche lender with the ability to tailor attractive financing packages for clients who wish to obtain immediate access to liquidity from their art assets. SFS leverages the art expertise of the Agency segment, skill in international law and finance, and access to capital to provide art collectors and dealers with financing secured by their works of art, allowing them to unlock the value in their collections. A considerable number of traditional lending sources offer conventional loans at a lower cost to borrowers than the average cost of loans offered by SFS and many traditional lenders offer borrowers a variety of integrated financial services such as wealth management. Few lenders, however, are willing to accept works of art as sole collateral for loans, as they do not have access to market information allowing them to effectively appraise collateral during the life of a loan, nor do they have the wherewithal to efficiently monetize loan collateral.
SFS makes term loans secured by artworks that are not presently intended for sale, allowing us to establish or enhance mutually beneficial relationships with art collectors. Term loans may also generate future auction or private sale consignments through the sale of the collateral at the conclusion of the loan and/or through future purchases of new property by the borrower. In certain situations, term loans are made to refinance the accounts receivable balances generated by the auction and private sale purchases of our clients. Term loans normally have an initial maturity of one year with an option to renew for an additional year, and typically carry a variable market rate of interest. To a much lesser extent, SFS also makes consignor advances secured by artworks that are contractually committed, in the near term, to be offered for sale through the Agency segment. Consignor advances allow sellers to receive funds upon consignment for an auction or private sale that will occur up to one year in the future and normally have short-term maturities.

4


Our previous credit agreements provided for dedicated asset-based revolving credit facilities for the Agency segment (the "Agency Credit Facility") and SFS (the "SFS Credit Facility"). Beginning in the first quarter of 2014 and into the third quarter of 2017, the SFS Credit Facility was used to fund a significant portion of client loans. In September 2017, we modified our cash management strategy in order to reduce borrowing costs by applying excess cash balances against revolver credit facility borrowings, and on June 26, 2018, we refinanced our previous credit agreements. Our new credit agreement combined the Agency Credit Facility and SFS Credit Facility into one asset-based revolving credit facility. Subsequent to the refinancing of our previous credit agreements and the resulting elimination of the SFS Credit Facility on June 26, 2018, the SFS loan portfolio is no longer being directly funded with revolving credit facility borrowings.
(See "Sotheby's Financial Services" under Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for information on the financial performance of SFS for the years ended December 31, 2018, 2017, and 2016. See Note 5 of Notes to Consolidated Financial Statements for information about the SFS loan portfolio.)
The Art Market
The global art market, like other asset classes, is influenced over time by the overall strength and stability of the global economy, the financial markets of various countries, geopolitical conditions, and world events. However, the global art market often moves independently and sometimes, counter to, general macroeconomic cycles. Ultimately, we believe that the level of activity and buoyancy of the global art market is most prominently impacted by the collective sentiment of art market participants, as well as the individual circumstances of potential sellers of art. For example, many major artworks are offered for sale only as a result of the death or financial or personal situations of the owner (see "Converting Consignment Opportunities" below). In addition, in the wake of economic uncertainty, potential sellers may not be willing to offer their artworks for sale, and potential buyers may be less willing to purchase works of art. Also, in periods of market expansion, potential sellers may choose to not offer their artworks for sale in order to benefit from potential future price appreciation. Taken together, these factors cause the supply and demand for works of art to be unpredictable and may lead to significant variability in our revenues and earnings from period to period.
The most recent Art Basel & UBS Art Market Report estimates that global art sales totaled $64 billion2 in 2017 with private sales by dealers accounting for 53%2 of the market and public auctions accounting for 47%2. This level of global art sales represents a 12%2 increase when compared to 2016, when global art sales totaled $57 billion2, and a compound annual growth rate of 5.5%2 when compared to 2002, when global art sales totaled $27 billion. The growth since 2002 is indicative of the increasingly global nature of the art market, with a rise in cross-border transactions and a more global distribution network, and a significant increase in global wealth, due in part to rising affluence in newly industrialized countries.
Seasonality
The global art auction market has two principal selling seasons, which generally occur in the second and fourth quarters of the year. In the aggregate, second and fourth quarter Net Auction Sales3 represented 76%, 80%, and 82% of our total annual Net Auction Sales in 2018, 2017, and 2016, respectively, with auction commission revenues comprising approximately 74%, 66%, and 75% of our total revenues in each of these years. Accordingly, our financial results are seasonal, with peak revenues and operating income generally occurring in the second and fourth quarters. Consequently, first and third quarter results have historically reflected lower revenues when compared to the second and fourth quarters and, typically, a net loss due to the fixed nature of many of our operating expenses.
In quarterly reporting periods, the comparison of our results between reporting periods can be significantly influenced by a number of factors, such as changes in the timing of when certain auctions occur, the level of non-recurring single-owner auction sale events, the level and timing of individually negotiated private sale transactions, and changes in certain accounting estimates that rely upon forecasted results such as variable incentive and share-based compensation expense and our estimated annual effective income tax rate. Accordingly, when evaluating our performance, we believe that investors should also consider results for rolling six and twelve month periods, which better reflect the business cycle of the global art auction market. (See Note 28 of Notes to Consolidated Financial Statements for our quarterly results for the years ended December 31, 2018 and 2017.)
__________
2 Source: "The Art Market 2018," an Art Basel & UBS Report.
3 Represents the total hammer (sale) price of property sold at auction, excluding amounts related to the sale of our inventory at auction, which are reported within inventory sales.

5


Competition
Artworks are sold primarily through the major auction houses, numerous art dealers, smaller auction houses, and also directly between private collectors. In recent years, a growing number of art dealers and private collectors also now buy and sell artworks at art fairs such as the The European Fine Art Fair ("TEFAF"), Art Basel, and the Frieze art fairs.
Competition in the global art market is intense. A fundamental challenge facing any auctioneer or art dealer is the sourcing of high quality and valuable property for sale either as agent or as principal. Our primary competitor in the global art market is Christie's, a privately owned auction house. To a lesser extent, we also face competition from a variety of art dealers across all collecting categories, as well as smaller auction houses such as Bonhams, Phillips, and certain regional auction houses. In the Chinese art market, the largest auction houses are Beijing Poly International Auction Co. Ltd., China Guardian Auctions Co. Ltd. and Beijing Council International Auction Company Ltd.
In 2018, 2017, and 2016, Sotheby's and Christie's together totaled approximately $11.4 billion, $10.5 billion, and $8.7 billion, respectively, of Aggregate Auction Sales4, of which we accounted for $5.3 billion (46%), $4.6 billion (44%), and $4.2 billion (49%), respectively.
Converting Consignment Opportunities
The ability to source high quality and valuable property for consignment is highly dependent on the meaningful institutional and personal relationships we have with our clients, which sometimes span generations. As these relationships develop over time, we provide our clients with strategic guidance on collection identity, development and acquisition, and then help them navigate the financial, logistical and personal considerations involved with deciding to sell their valued artworks. A client's decision to sell their art may be part of their long-term financial planning process or could occur suddenly as a result of an unexpected change in circumstances. The timing of when consignment opportunities may arise is often unpredictable and not within our control. As a result, it is difficult to predict with any certainty the supply of high quality and valuable property available for consignment in advance of peak selling seasons.
The more valuable the property, the more likely it is that a seller of art will solicit proposals from more than one potential purchaser or agent. The primary options available to a seller of art are: (i) sale or consignment to an art dealer; (ii) sale or consignment to an auction house; (iii) private sale to a collector or museum; or (iv) consignment to an internet-based service.
A complex array of factors may influence a seller's decision to favor one of these options over the others, and may include any or all of the following considerations:
Factors Influencing a Seller's Decision
- The level and breadth of expertise of the art dealer or auction house with respect to the property.
- The desirability of a public auction in order to achieve the maximum possible price.
- The extent of the prior relationship, if any, between the art dealer or auction house and its staff and the seller, and ease of transacting with such parties.
- The amount of cash offered by an art 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 reputation and historic level of achievement by the art dealer or auction house in attaining high sale prices in the property's specialized category.
- The availability and terms of financial incentives offered by auction houses, including auction guarantees, short-term financing, and auction commission sharing arrangements.
- Recommendations by third parties consulted by the seller.
- The commission charged by art dealers or auction houses to sell a work on consignment.
- The client's desire for privacy.
- The cost, style, and extent of pre-sale marketing and promotion to be undertaken by an art dealer or auction house.
- The level of pre-sale estimates.
- The availability and extent of related services, such as tax or insurance appraisals.
____________
4 Represents the total hammer (sale) price of property sold at auction, plus buyer's premium, excluding amounts related to the sale of our inventory at auction, which are reported within inventory sales.

6


Regulation of the Art Market
Regulation of the art market varies from jurisdiction to jurisdiction. In many jurisdictions, we are subject to laws and regulations, including, but not limited to, import and export regulations, cultural property regulations, data protection and privacy laws, anti-money laundering laws, antitrust laws, copyright and resale royalty laws, laws and regulations involving sales, use, value-added and other indirect taxes, and regulations related to the use of real estate. In addition, we are subject to local auction regulations, such as New York City Auction Regulations Subchapter M of Title 6 §§ 2-121-2-125, et. seq. Such regulations currently do not impose a material impediment to our business, but do affect the art market generally. A material adverse change in such regulations, such as the American Royalties Too Act of 2014 introduced in the U.S. Congress, which would impose a 5% resale royalty (with a cap of $35,000) on sales of art through large auction houses, could affect our business. Additionally, export and import laws and cultural property ownership laws could affect the availability of certain kinds of property for sale at our principal auction locations, increase the cost of moving property to such locations, or expose us to legal claims or government inquiries. We have a Compliance Department which, amongst other activities, develops and updates compliance policies, and audits, monitors, and provides training to our employees on compliance with many of these laws and regulations.
Developing Technology to Attract New Clients and Create Value
We are currently investing in technology to innovate and expand our traditional auction business, as well as to sharpen the differentiation between us and our competitors. The elements of these investments are:
Digital Infrastructure—We are developing a new auction engine and enhancing our digital capabilities to enable a paperless auction room. We have also recently installed a new content management system which will provide improved stability, depth, search optimization, and the potential for innovation.
Data—We are collating and standardizing our various collections of data, including the Sotheby's Mei Moses Index, our expanded customer relationship management system, object databases, and social media programs. The results of this process will establish the foundation for machine learning and other products that will enhance our ability to serve clients. 
Basic Digital Services—We have been investing in basic digital services over the past three years. These basic services include a refreshed public website, an upgraded mobile app with payment and bidding capabilities, an upgraded retail wine store, and the acquisition of Viyet, now relaunched as Sotheby's Home, an online marketplace for interior design.
Content Marketing—We are continuing to develop a range of rich content to engage current and potential clients. In 2018, we produced and distributed more than 2,000 original pieces, including 373 videos, viewed over 28 million times. More than 15,000 visitors who viewed this content registered to bid in our auctions and a similar number requested estimates for consignments.
Advanced Digital Services—We are developing a range of advanced digital services that we believe will serve as a platform for future growth and efficiencies. Such services include our online estimates platform, which went live in 2017, and an improved appraisal interface, which is expected to launch in 2019.
An important measure of the effectiveness of our technology investments is the level of online sales. For the purposes of this discussion, the term "online sales" represents the aggregate sale price of lots purchased through online bids at our live auctions and in our online-only auctions, as well as items purchased through our retail websites, Sotheby’s Home and Sotheby's Wine. In 2018, online sales increased 24% to $220.4 million and include $72.1 million of sales attributable to online-only auctions and sales through Sotheby’s Home and Sotheby's Wine, as compared to $18.9 million in the prior year. Online sales are an important source of client growth and opportunity, with 60% of first-time bidders at Sotheby's coming through digital channels. 
While our technology investments are facilitating the innovation and expansion of our traditional business, these investments have contributed to an overall increase in operating expenses across various categories in recent years, including in 2018.

7


Brand Licensing Activities
Prior to 2004, we were engaged in the marketing and brokerage of luxury residential real estate sales through Sotheby's International Realty ("SIR"). In 2004, we sold SIR to a subsidiary of Realogy Corporation ("Realogy"), formerly Cendant Corporation. In conjunction with the sale, we entered into an agreement with Realogy to license the SIR trademark and certain related trademarks for an initial 50-year term with a 50-year renewal option (the "Realogy License Agreement"). The Realogy License Agreement is applicable worldwide. 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 2018, 2017, and 2016, we earned $10.9 million, $10.3 million, and $9.1 million, respectively, in license fee revenue related to the Realogy License Agreement.
We also license the Sotheby's name for use in connection with the art auction business in Australia, and art education services in the U.S. and the U.K. We will consider additional opportunities to license the Sotheby's brand in businesses where appropriate.
Financial and Geographical Information about Segments
See Note 3 of Notes to Consolidated Financial Statements for financial and geographical information about Sotheby's segments.
Employees
As of December 31, 2018, we have 1,713 employees, with 730 located in the Americas, 536 in the U.K., 238 in Continental Europe, and 209 in Asia. We regard our relations with our employees as good. The table below provides a breakdown of Sotheby's employees by segment as of December 31, 2018 and 2017.
December 31,
 
2018
 
2017
Agency
 
1,515

 
1,486

Finance
 
12

 
10

All Other (a)
 
186

 
166

Total
 
1,713

 
1,662

(a) Employees classified within "All Other" principally relate to our central corporate and information technology departments.
Website Address
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, are available free of charge on the Investor Relations page of our website, www.sothebys.com. These reports are made available on the same day that they are electronically filed with or furnished to the Securities and Exchange Commission (the "SEC"). Information available on the website is not incorporated by reference and is not deemed to be part of this Form 10-K.

8



ITEM 1A: RISK FACTORS
Before you make an investment decision with respect to our common stock, you should carefully consider all of the information included in this Form 10-K and our subsequent periodic filings with the SEC. In particular, you should carefully consider the risk factors described below and the risks and uncertainties related to "Forward Looking Statements," any of which could have a material adverse effect on our business, results of operations, financial condition and the actual outcome of matters as to which forward looking statements are made in this annual report. The following risk factors, which are not ranked in any particular order, should be read in conjunction with the balance of this annual report, including the Consolidated Financial Statements and related notes.
The global economy, the financial markets and political conditions of various countries may negatively affect our business and clients, as well as the supply of and demand for works of art.
The global art market is influenced over time by the overall strength and stability of the global economy and the financial markets of various countries, although this correlation may not be immediately evident. In addition, global political conditions and world events may affect our business through their effect on the economies of various countries, as well as on the willingness of potential buyers and sellers to purchase and sell art in the wake of economic uncertainty. Our business can be particularly influenced by the economies, financial markets and political conditions of the U.S., the U.K., China, and the other major countries or territories of Europe and Asia (including the Middle East). Accordingly, weakness in those economies and financial markets can adversely affect the supply of and demand for works of art and our business. Furthermore, global political conditions may also influence the enactment of legislation that could adversely impact our business.
Competition in the global art market is intense and may adversely impact our business, results of operations, and financial condition.
We compete with other auctioneers and art dealers to obtain valuable consignments to offer for sale either at auction or through private sale. The level of competition is intense and can adversely impact our ability to obtain valuable consignments for sale, as well as the commission margins achieved on such consignments.
We cannot be assured of the amount and quality of property consigned for sale, which may cause significant variability in our results of operations.
The amount and quality of property consigned for sale is influenced by a number of factors not within our control. Many major consignments, and specifically single-owner sale consignments, become available only as a result of the death or financial or marital difficulties of the owner, all of which are unpredictable and may cause significant variability in our results of operations from period to period.
The demand for art is unpredictable, which may cause significant variability in our results of operations.
The demand for art is influenced not only by overall economic conditions, but also by changing trends in the art market as to which collecting categories and artists are most sought after and by the collecting preferences of individual collectors. These conditions and trends are difficult to predict and may adversely impact our ability to obtain and sell consigned property, potentially causing significant variability in our results of operations from period to period.
The U.K.’s decision to leave the European Union, known as Brexit, may adversely impact our business, results of operations, and financial condition.
The U.K.’s decision to leave the European Union, known as Brexit, has introduced additional volatility and uncertainty in global stock and financial markets, economic conditions, and Pound Sterling exchange rates. Uncertainties caused by Brexit could adversely impact the future amount and quality of property consigned for sale and the future demand for such art, particularly in our London salesroom. In addition, uncertainties caused by Brexit could adversely impact our ability to move property between the U.K. and the European Union, and our employees.

9



The anticipated discontinuation of LIBOR may have unforeseen consequences.
On July 27, 2017, the Chief Executive of the U.K. Financial Conduct Authority (the “FCA”), which regulates the London interbank offered rate (“LIBOR”), announced that the FCA will no longer compel banks to submit rates for the calculation of the LIBOR benchmark after 2021. This announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021, and it appears likely that LIBOR will be discontinued or modified by 2021. The likely discontinuation of LIBOR may have consequences which cannot be fully anticipated, including potential impacts on the business of SFS and its loan portfolio, our revolving credit facility, the mortgage on our headquarters building, and the related interest rate collar.
We rely on a select group of clients who make a significant contribution to our revenues, profitability, and operating cash flows.
Sotheby's is a global art business that caters to a select group of the world's most discerning art collectors. Accordingly, our revenues, profitability, and operating cash flows are highly dependent upon our ability to develop and maintain relationships with these clients, as well as their financial strength.
Tax matters may cause significant variability in our results of operations.
We operate in many tax jurisdictions throughout the world, and the provision for income taxes involves a significant amount of judgment regarding the interpretation of relevant facts and laws in these jurisdictions. Our effective income tax rate and recorded tax balances can change significantly between periods due to a number of complex factors including, but not limited to: (i) our projected levels of taxable income; (ii) changes in the jurisdictional mix of our forecasted and/or actual pre-tax income; (iii) increases or decreases to valuation allowances recorded against deferred tax assets; (iv) tax audits conducted by various tax authorities; (v) adjustments to income taxes upon the finalization of income tax returns; (vi) the ability to claim foreign tax credits; and (vii) tax planning strategies.
Additionally, our effective income tax rate could be impacted by future changes in applicable tax laws, as well as by the European Commission’s investigations on illegal state aid, the Organisation for Economic Co-operation and Development project on Base Erosion and Profit Shifting, and future guidance that will be issued with respect to the U.S. Tax Cuts and Jobs Act that may change our interpretation of the new law and its application. Given the unpredictability of these possible changes, it is difficult to assess whether the overall effect of such potential tax changes on our earnings and cash flow would be cumulatively positive or negative, but such changes could ultimately have an adverse impact on our financial results.
Our clients reside in various tax jurisdictions throughout the world and the application of tax laws or tax reporting obligations in these jurisdictions, particularly as they relate to sales, use, value-added and other indirect taxes, is complex and requires a significant amount of judgment, exposing us to claims from tax authorities.
Our clients reside in various tax jurisdictions throughout the world. To the extent that there are changes to tax laws or tax reporting obligations in any of these jurisdictions, such changes could adversely impact the ability and/or willingness of our clients to purchase or sell works of art. Additionally, we are subject to laws and regulations in many countries involving sales, use, value-added and other indirect taxes which are assessed by various governmental authorities and imposed on certain revenue-producing transactions between us and our clients. The application of these laws and regulations to our unique business and global client base, and the estimation of any related liabilities is complex and requires a significant amount of judgment. In addition, changes to the laws and regulations involving sales, use, value-added and other indirect taxes could increase the complexity of our compliance efforts and impact our ability to accurately estimate any related liabilities. We are generally not responsible for these indirect tax liabilities unless we fail to collect the correct amount of sales, use, value-added, or other indirect taxes. Failure to collect the correct amount of indirect tax on a transaction may expose us to claims from tax authorities.
As a result of the U.S. Supreme Court decision in South Dakota v. Wayfair on June 21, 2018, a physical presence is no longer required for U.S. states to impose a sales tax collection obligation on out-of-state sellers. This ruling has significantly increased the number of states that have enacted economic nexus laws and, accordingly, has significantly increased the number of states in which we now collect sales tax, thereby increasing the administrative burden and cost of this added compliance. We will continue to monitor states’ new laws and register to collect sales tax in additional jurisdictions as required. 

10



The loss of key personnel could adversely impact our ability to compete.
We are largely a service business in which the ability of our employees to develop and maintain relationships with potential sellers and buyers of works of art is essential to our success. Moreover, our business is unique, making it important to retain key specialists and members of management. Accordingly, our business is highly dependent upon our success in attracting and retaining qualified personnel.
Our investments in new businesses and technologies involve significant risks and uncertainties and may not succeed.
We have invested in new businesses and technologies to implement our strategic priorities. These investments involve significant risks and uncertainties, and may adversely impact our short-term operating results and liquidity, and if they are unsuccessful, may expose us to the loss of clients and the impairment of assets. Our future operating results are dependent, in part, on our ability to successfully integrate and utilize these new businesses and technologies.
Government laws and regulations may restrict or limit our business or impact the value of our real estate assets.
Many of our activities are subject to laws and regulations including, but not limited to, import and export regulations, cultural property regulations, data protection and privacy laws, anti-money laundering laws, antitrust laws, copyright and resale royalty laws, laws and regulations involving sales, use, value-added and other indirect taxes, and regulations related to the use of real estate. In addition, we are subject to local auction regulations, such as New York City Auction Regulations Subchapter M of Title 6 § 2-121-2-125, et. seq. Such regulations currently do not impose a material impediment to our business, but do affect the art market generally. A material adverse change in such regulations, such as the American Royalties Too Act of 2014 introduced in the U.S. Congress, which would impose a 5% resale royalty (with a cap of $35,000) on sales of art through large auction houses, could affect our business. Additionally, export and import laws and cultural property ownership laws could affect the availability of certain kinds of property for sale at our principal auction locations, increase the cost of moving property to such locations, or expose us to legal claims or government inquiries.
Our ability to collect auction receivables may be adversely impacted by buyers from emerging markets, as well as by the banking and foreign currency laws and regulations and judicial systems of the countries in which we operate and in which our clients reside.
We operate in 40 countries and have a worldwide client base that has grown in recent years due in part to an increase in the activity of buyers from emerging markets, in particular, China. The collection of auction receivables related to buyers from emerging markets may be adversely impacted by the buyer's lack of familiarity with the auction process and the buyer's financial condition. Our ability to collect auction receivables may also be adversely impacted by the banking and foreign currency laws and regulations regarding the movement of funds out of certain countries, as well as by our ability to enforce our rights as a creditor in jurisdictions where the applicable laws and regulations may be less defined, particularly in emerging markets.
Our capital allocation and financial policies may impact our liquidity, financial condition, market capitalization and business, and our ongoing ability to return capital to shareholders (and the size and timing of such return) is subject to ongoing business variables.
The actions taken in reference to our capital allocation and financial policies may impact our current and future liquidity, financial condition, market capitalization, and business. In addition, the amount and timing of any potential return of capital to shareholders depends on various factors, including the amount of excess cash generated by our business in the future, the ability to finance the SFS loan portfolio, the business initiatives contemplated and implemented by management, and the amount of capital that may be required to support our future liquidity needs, among other factors.
Foreign currency exchange rate movements can significantly impact our results of operations and financial condition.
We have operations throughout the world. Approximately 54% of our total revenues were earned outside of the U.S. in 2018, including 25% of our total revenues earned in the U.K. Additionally, we have significant assets and liabilities denominated in the Pound Sterling, the Euro, and the Swiss Franc. Revenues, expenses, gains, and losses recorded in foreign currencies are translated using the monthly average exchange rates prevailing during the period in which they are recognized. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Accordingly, fluctuations in foreign currency exchange rates, particularly for the Pound Sterling, the Euro, and the Swiss Franc, can significantly impact our results of operations and financial condition.

11



Subject to management approval under our internal corporate governance policy, we may pay the net sale proceeds to the consignor before payment is collected from the buyer and/or we may allow the buyer to take possession of purchased property before making payment. In these situations, we are exposed to losses in the event the buyer does not make payment.
Under the standard terms and conditions of our auction and private sales, we are not obligated to pay the consignor for property that has not been paid for by the buyer. However, in certain instances and subject to management approval under our internal corporate governance policy, we may pay the net sale proceeds to the consignor before payment is collected from the buyer while we retain possession of the property. In these situations, if the buyer does not make payment, we take title to the property, but could be exposed to losses if the value of the property subsequently declines. In certain other situations and subject to management approval under our internal corporate governance policy, we may allow the buyer to take possession of the purchased property before making payment. In these situations, we are liable to the seller for the net sale proceeds whether or not the buyer makes payment and would incur a loss in the event of buyer default. (See Note 4 of Notes to Consolidated Financial Statements for information about auction and private sale receivables.)
We could be exposed to losses in the event of title or authenticity claims.
The assessment of property offered for auction or private sale can involve potential claims regarding title and authenticity. The items we sell may be subject to statutory warranties as to title and to a limited guarantee as to authenticity under the Conditions of Sale and Terms of Guarantee that are published in our auction sale catalogues and the terms stated in, and the laws applicable to, agreements governing private sale transactions. Our authentication of the items we offer is based on scholarship and research, but necessarily requires a degree of judgment from our specialists. In the event of a title or authenticity claim against us, we may have recourse against the seller of the property and may have the benefit of insurance, but a claim could nevertheless expose us to losses and to reputational risk.
Auction guarantees create the risk of loss resulting from the potential inaccurate valuation of art.
The market for fine art, decorative art, and jewelry is not a highly liquid trading market and, as a result, the valuation of these items is inherently subjective. Accordingly, we are at risk with respect to our ability to estimate the likely selling prices of property offered with auction guarantees. If our judgments about the likely selling prices of property offered with auction guarantees prove to be inaccurate, there could be a significant adverse impact on our results, financial condition, and liquidity. (See Note 21 of Notes to Consolidated Financial Statements for information related to auction guarantees.)
We could be exposed to losses in the event of nonperformance by our counterparties in auction guarantee risk and reward sharing arrangements.
In certain situations, we reduce our financial exposure under auction guarantees through risk sharing arrangements. Our counterparties to these risk sharing arrangements are typically major international art dealers or major art collectors. We could be exposed to losses in the event any of these counterparties do not perform according to the terms of these contractual arrangements. (See Note 21 of Notes to Consolidated Financial Statements for information related to auction guarantees.)
Demand for art-related financing is unpredictable, which may cause variability in the operating results of SFS.
Our business is, in part, 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. Accordingly, the operating results of SFS are subject to variability from period to period.
Our ability to realize proceeds from the sale of collateral for SFS loans may be delayed or limited.
In situations when there are competing claims on the collateral for SFS loans and/or when a borrower becomes subject to bankruptcy or insolvency laws, our ability to realize proceeds from the sale of its collateral may be limited or delayed.

12



The value of art held in inventory and art pledged as collateral for SFS loans is subjective and often fluctuates, exposing us to losses and significant variability in our results of operations.
The art market is not a highly liquid trading market. As a result, the valuation of art is inherently subjective and its realizable value often fluctuates over time. Accordingly, we are at risk both as to the realizable value of the property held in inventory and as to the realizable value of the property pledged as collateral for SFS loans. If there is evidence that the estimated realizable value of a specific item held in inventory is less than its carrying value, a loss is recorded to reflect our revised estimate of realizable value. In addition, if the estimated realizable value of the property pledged as collateral for an SFS loan is less than the corresponding loan balance, we assess whether it is necessary to record a loss to reduce the carrying value of the loan, after taking into account the ability of the borrower to repay any shortfall between the value of the collateral and the amount of the loan. In estimating the realizable value of art held in inventory and art pledged as collateral for SFS loans, we consider the following complex array of factors: (i) whether the property is expected to be offered at auction or sold privately, and the timing of any such sale; (ii) the supply and demand for the property, taking into account current art market conditions, as well as changing trends as to which collecting categories and artists are most sought after; (iii) recent sale prices achieved for comparable items within a particular collecting category and/or by a particular artist, (iv) the state of the global economy and financial markets; and (v) our intent and ability to hold the property in order to maximize its realizable value. Due to the inherent subjectivity involved in estimating the realizable value of art held in inventory and art pledged as collateral for SFS loans, our estimates of realizable value may prove, with the benefit of hindsight, to be different than the amount ultimately realized upon sale. Accordingly, changes in the valuation of art held in inventory and art pledged as collateral for SFS loans expose us to variability in our results of operations from period to period.
The low rate of historic losses on the SFS loan portfolio may not be indicative of future loan loss experience.
We have historically incurred minimal losses on the SFS loan portfolio. However, despite our stringent loan underwriting standards, our previous loan loss experience may not be indicative of the future performance of the loan portfolio.
The collateral supporting the SFS loan portfolio is concentrated within certain collecting categories. A material decline in these markets could impair our ability to collect the principal and interest owed on certain loans and could require repayments of borrowings on such affected loans under our revolving credit facility.
The collateral supporting the SFS loan portfolio is concentrated within certain collecting categories. Although we believe the SFS loan portfolio is sufficiently collateralized due to its current aggregate loan-to-value ratio of 43%, a material decline in these markets could impair our ability to collect the principal and interest owed on certain loans. Additionally, our revolving credit facility permits borrowings, if any, up to 85% of the portion of any SFS loan that does not exceed a 60% loan-to-value ratio. A material decline in the value of SFS loan collateral could result in an increase in the loan-to-value ratio above 60% for individual loans and, depending on the level of outstanding revolving credit facility borrowings, could require repayment of a portion of the borrowings associated with such loans.
We could be exposed to losses and/or reputational harm as a result of various claims and lawsuits incidental to the ordinary course of our business.
We become involved in various legal proceedings, lawsuits, and other claims incidental to the ordinary course of our business. We are required to assess the likelihood of any adverse judgments or outcomes in these matters, as well as potential ranges of probable or reasonably possible losses. A determination of the amount of losses, if any, to be recorded or disclosed as a result of these contingencies is based on a careful analysis of each individual exposure with, in some cases, the assistance of outside legal counsel. The amount of losses recorded or disclosed for such contingencies may change in the future due to new developments in each matter or a change in settlement strategy.
We could be exposed to reputational harm as a result of wrongful actions by certain third parties.
We are involved in various business arrangements and ventures with unaffiliated third parties. Wrongful actions by such parties could harm our brand and reputation.

13



A breach of the security measures protecting our global network of information systems and those of certain third-party service providers utilized by Sotheby's could adversely impact our operations, reputation and brand.
The protection of client, employee and company data is extremely important to us. The regulatory environment surrounding information security and privacy is becoming increasingly demanding and frequently changing in the jurisdictions in which we do business. Clients and employees have expectations that we will protect their information from cyber-attacks and other security breaches. We have implemented systems and processes that are designed to protect personal and company information and to prevent data losses, however, these measures cannot provide absolute security, and our systems may be vulnerable to cyber-security breaches such as viruses, hacking, and similar disruptions from unauthorized intrusions. In addition, we are dependent on a global network of information systems to conduct our business and are committed to maintaining a strong infrastructure to secure these systems.
As part of our information systems infrastructure, we rely increasingly upon third-party service providers to perform services related to our live auction bidding platform, retail wine and other e-commerce, video broadcasting, website content distribution, marketing, and to store, process and transmit information including client, employee and company information. Any failure on our part or by these third-party service providers to maintain the security of our confidential data and our client and employee personal information could result in business disruption, damage to reputation, financial obligations, lawsuits, sizable fines and costs, and loss of employee and client confidence in Sotheby's, and thus could have a material adverse impact on our business and financial condition, and adversely affect our results of operations.
A significant security breach could require future expenditures to implement additional security measures to protect against new privacy threats or to comply with state, federal and international laws aimed at addressing those threats. To our knowledge, to date, we have not experienced any material impacts related to cyber-attacks or other information security breaches.
Due to the nature of our business, valuable works of art are exhibited and stored at our facilities around the world. Such works of art could be subject to damage or theft, which could have a material adverse effect on our operations, reputation and brand.
Valuable works of art are exhibited and stored at our facilities around the world. Although we maintain state of the art security measures at our premises, valuable artworks may be subject to damage or theft. The damage or theft of valuable property despite these security measures could have a material adverse impact on our business and reputation.
Insurance coverage for artwork may become more difficult to obtain or the terms of such coverage may become less favorable, exposing us to losses resulting from the damage or loss of artwork in our possession.
We maintain insurance coverage for the works of art we own, works of art consigned by clients, and all other property that may be in our custody, which are exhibited and stored at our facilities around the world. An inability to adequately insure such works of art due to limited capacity of the global art insurance market, or the inability to secure coverage on acceptable terms, could, in the future, have a material adverse impact on our business, results of operations, and financial condition.
Our business continuity plans may not be effective in addressing the impact of unexpected events that could impact our business.
Our inability to successfully implement our business continuity plans in the wake of an unexpected event, such as an act of God or a terrorist attack occurring in or near one of our major selling and/or sourcing offices and/or any other unexpected event, could disrupt our ability to operate and adversely impact our operations.
Future costs and obligations related to our U.K. Pension Plan are dependent on unpredictable factors, which may cause variability in our employee benefit costs.
Future costs and obligations related to our defined benefit pension plan in the U.K. are heavily influenced by changes in interest rates, investment performance in the debt and equity markets, changes in statutory requirements in the U.K., and actuarial assumptions, each of which is unpredictable and may cause variability in our employee benefit costs. (See Note 10 of Notes to Consolidated Financial Statements for information related to our defined benefit pension plan in the U.K.)
ITEM 1B: UNRESOLVED STAFF COMMENTS
None.

14



ITEM 2: PROPERTIES
We are headquartered at 1334 York Avenue in New York (the "York Property"). The York Property includes land and approximately 406,000 square feet of building area. The York Property is home to our sole North American auction salesroom and principal North American exhibition space. The York Property is also home to the U.S. operations of SFS, as well as our corporate offices. In September 2017, we initiated an enhancement program to create new state-of-the art galleries, as well as new public and client exhibition spaces. In 2018, we invested $24 million in connection with the York Property enhancement program and we expect to invest up to $30 million in 2019. (See statement on Forward Looking Statements.)
The York Property is subject to a seven-year, $325 million mortgage that matures on July 1, 2022 (the "York Property Mortgage"). As of December 31, 2018, the principal balance of the York Property Mortgage was $260.8 million. (See Note 7 of Notes to Consolidated Financial Statements for additional information on the York Property. See Note 11 of Notes to Consolidated Financial Statements for additional information on the York Property Mortgage.)
Our U.K. operations are based at 34-35 New Bond Street, London, where the main salesrooms, exhibition spaces, and administrative offices are located. Our New Bond Street premises consist of a series of properties that are held under various long-term lease, freehold, or virtual freehold arrangements5. As part of a multi-year refurbishment initiative, we have invested approximately $18 million in our New Bond Street premises in recent years to enhance exhibition and private sales gallery space, and establish a Sotheby's Diamonds salon. We also lease 52,000 square feet for a warehouse facility in Greenford, West London under a lease that expires in 2030. Certain of our London properties secure any U.K. borrowings under our revolving credit facility. (See Note 11 of Notes to Consolidated Financial Statements for additional information on our revolving credit facility.)
We also lease space primarily for Agency segment operations in various locations throughout North America, South America, Continental Europe and Asia, including sales centers in Geneva and Zurich, Switzerland; Milan, Italy; Paris, France; Hong Kong, China.
____________
5 Freeholds are occupancy arrangements in which we own the property outright. Virtual freeholds are occupancy arrangements in which there is a 2,000-year lease with nominal yearly rent payments that cannot be escalated during the term of the lease.

ITEM 3: LEGAL PROCEEDINGS
See Note 20 of Notes to Consolidated Financial Statements for information related to legal proceedings.
ITEM 4: MINE SAFETY DISCLOSURES
Not applicable.


15



PART II

ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Market and Stockholders
Our common stock is traded on the NYSE under the symbol BID. As of February 11, 2019, there were 746 registered holders of record of our common stock.
Dividends and Common Stock Repurchases
The following table provides information regarding our common stock repurchase program during the three months ended December 31, 2018:
Period
 
Total number of shares purchased
 
Average price paid per share
 
Total number of shares purchased as part of publicly announced plans or programs
 
Approximate dollar value of shares that may yet be purchased under publicly announced plans or programs (a)
 
October 2018
 

 
$

 

 
$
24,690

 
November 2018 (b)
 
571,242

 
$
34.01

 
571,242

 
$
90,096,725

 
December 2018 (c)
 
2,112,219

 
$
37.40

 
2,112,219

 
$
581,035

 
Total
 
2,683,461

 
$
36.69

 
2,683,461

 
 
 
(a) Represents the dollar value of shares that were available to be repurchased under our publicly announced share repurchase program at the end of each respective monthly period.
(b) On November 26, 2018, our Board of Directors of Sotheby’s approved a $100 million increase to the Company’s share repurchase authorization.
(c) On December 13, 2018, we paid $70 million upon entry into an ASR agreement (the "December 2018 ASR Agreement"). Pursuant to this ASR Agreement, on December 14, 2018, we received an initial delivery of 1,605,938 shares of our common stock with a value of $59.5 million, or $37.05 per share. The average price per share reported in the table above is calculated using the $59.5 million value of the initial shares delivered under the December 2018 ASR Agreement.
The total number of shares that we will ultimately purchase upon the conclusion of the December 2018 ASR Agreement will generally be based on the average of the daily volume-weighted average prices of our common stock during the term of the agreement, less an agreed discount. Upon final settlement of the December 2018 ASR Agreement, we may be entitled to receive additional shares of our common stock or, under certain circumstances, we may be required to deliver shares or make an additional cash payment to the counterparty, at our option. The December 2018 ASR Agreement is scheduled to expire on March 1, 2019, but may conclude earlier at the counterparty's option, and may be terminated early upon the occurrence of certain events.
(See Note 16 of Notes to Consolidated Financial Statements for information regarding dividends and more detailed information about our common stock repurchase program.)     

16



Equity Compensation Plans
The following table provides information as of December 31, 2018 related to shares of common stock that may be issued under equity compensation plans, which are described in Note 23 of Notes to Consolidated Financial Statements (in thousands, except per share data):
 
 
(A)
 
(B)
 
(C)
Plan Category
 
Number of Securities to be
Issued Upon Exercise of
Outstanding Options, Warrants and Rights (1)
 
Weighted Average Exercise Price of Outstanding Options, Warrants and Rights (2)
 
Number of Securities Remaining Available for Future Issuance Under
Equity Compensation Plans (3)
Equity compensation plans approved by shareholders
 
1,821

 
$

 
6,981

Equity compensation plans not approved by shareholders
 
31

 
$

 

Total
 
1,852

 
$

 
6,981

_____________________________________________________________
(1)
The number of securities that may be issued under equity compensation plans approved by shareholders includes 1,820,270 shares awarded under the Sotheby's Restricted Stock Unit Plan (the "Restricted Stock Unit Plan") and the Sotheby’s 2018 Equity Incentive Plan (the "Equity Plan"). The vesting of stock units issued under these plans is contingent upon future employee service and/or the achievement of certain profitability targets or certain return on invested capital targets. The number of securities that may be issued under equity compensation plans not approved by shareholders consists solely of 31,380 fully-vested restricted stock units granted to Thomas S. Smith, Jr., our President and Chief Executive Officer ("CEO"), as part of an inducement award upon the commencement of his employment on March 31, 2015. This inducement award was not issued pursuant to the Restricted Stock Unit Plan and has not been registered with the SEC.
(2)
The weighted-average exercise price does not take into account 1,820,270 shares awarded under the Restricted Stock Unit Plan or the 31,380 fully-vested restricted stock units granted to Mr. Smith upon the commencement of his employment as our President and CEO on March 31, 2015.
(3)
Includes 6,892,693 shares available for future issuance under the 2018 Equity Plan and 88,047 shares available for issuance under the Sotheby’s Stock Compensation Plan for Non-Employee Directors.

17



Performance Graph
The following graph compares the cumulative total shareholder return on our common stock for the five-year period from December 31, 2013 to December 31, 2018 with the cumulative return of the Standard & Poor's Global Luxury Index (the "S&P Global Luxury Index"), which is a line-of-business index largely composed of companies whose products and services appeal to a segment of the population consistent with our clients, and the Standard & Poor's MidCap 400 Stock Index (the"S&P MidCap 400").
The graph reflects an investment of $100 in our common stock, the S&P Global Luxury Index, and the S&P MidCap 400 on December 31, 2013, and a reinvestment of dividends at the average of the closing stock prices at the beginning and end of each quarter.
chart-fb9cc1dab6055fe89fd.jpg
 
 
12/31/13
 
12/31/14
 
12/31/15
 
12/31/16
 
12/31/17
 
12/31/18
Sotheby's
 
$
100.00

 
$
89.28

 
$
53.83

 
$
83.30

 
$
107.83

 
$
83.05

S&P Global Luxury Index
 
$
100.00

 
$
95.44

 
$
89.79

 
$
90.36

 
$
126.78

 
$
113.07

S&P MidCap 400
 
$
100.00

 
$
109.76

 
$
107.39

 
$
129.63

 
$
150.69

 
$
133.99


18



ITEM 6: SELECTED FINANCIAL DATA
Year ended December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
 
(Thousands of dollars, except per share data)
Income Statement Data:
 
 

 
 

 
 

 
 

 
 

Revenues:
 
 
 
 
 
 
 
 
 
 
Agency commissions and fees (a)
 
$
891,774

 
$
809,571

 
$
724,398

 
$
791,920

 
$
825,126

Inventory sales
 
$
80,808

 
$
178,982

 
$
62,863

 
$
108,699

 
$
69,958

Finance
 
$
43,887

 
$
50,937

 
$
52,716

 
$
50,489

 
$
33,013

Other
 
$
19,271

 
$
17,890

 
$
17,965

 
$
10,386

 
$
9,956

Total revenues (a)
 
$
1,035,740

 
$
1,057,380

 
$
857,942

 
$
961,494

 
$
938,053

Net income attributable to Sotheby's
 
$
108,634

 
$
118,796

 
$
74,112

 
$
43,727

 
$
117,795

Basic earnings per share
 
$
2.10

 
$
2.22

 
$
1.28

 
$
0.64

 
$
1.69

Diluted earnings per share
 
$
2.09

 
$
2.20

 
$
1.27

 
$
0.63

 
$
1.68

Cash dividends declared per common share
 
$

 
$

 
$

 
$
0.40

 
$
4.74

Statistical Metrics:
 
 
 
 
 
 
 
 
 
 
Aggregate Auction Sales (b)
 
$
5,250,503

 
$
4,567,310

 
$
4,247,873

 
$
5,949,030

 
$
6,075,345

Net Auction Sales (c)
 
$
4,395,593

 
$
3,816,792

 
$
3,556,090

 
$
5,016,738

 
$
5,151,419

Private Sales (d)
 
$
1,018,844

 
$
744,640

 
$
583,410

 
$
673,119

 
$
624,511

Consolidated Sales (e)
 
$
6,350,155

 
$
5,490,932

 
$
4,894,146

 
$
6,730,848

 
$
6,769,814

Auction Commission Margin (f)
 
16.1
%
 
17.2
%
 
17.1
%
 
14.3
%
 
14.7
%
Non-GAAP Financial Measures:
 
 
 
 
 
 
 
 
 
 
Adjusted Net Income (g)
 
$
128,941

 
$
121,699

 
$
99,616

 
$
143,131

 
$
142,398

Adjusted Diluted EPS (g)
 
$
2.48

 
$
2.25

 
$
1.71

 
$
2.07

 
$
2.03

EBITDA (g)
 
$
201,851

 
$
199,298

 
$
150,902

 
$
225,322

 
$
248,036

Adjusted EBITDA (g)
 
$
230,066

 
$
200,176

 
$
192,646

 
$
278,771

 
$
289,873

Balance Sheet Data:
 
 

 
 

 
 

 
 

 
 

Working capital
 
$
102,219

 
$
385,463

 
$
525,878

 
$
913,166

 
$
610,315

Total assets
 
$
2,689,088

 
$
3,087,307

 
$
2,504,426

 
$
3,263,313

 
$
3,129,796

Average Loan Portfolio (h)
 
$
541,152

 
$
637,759

 
$
646,135

 
$
732,814

 
$
583,304

Average Credit Facility Borrowings (i)
 
$
106,181

 
$
479,367

 
$
534,433

 
$
541,004

 
$
306,448

Long-term debt, net
 
$
638,786

 
$
653,003

 
$
598,941

 
$
604,961

 
$
295,163

Total equity
 
$
441,494

 
$
616,940

 
$
505,602

 
$
806,704

 
$
878,238


19



Legend:
(a)
On January 1, 2018, we adopted Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers. The adoption of ASC 606 did not impact the timing of our revenue recognition, but it changed the presentation of certain revenues and expenses previously reported on a net basis in our Consolidated Income Statements. Agency commissions and fees in the table above have been recast to reflect the retrospective adoption of ASC 606 for the years ended December 31, 2017 and 2016 to be consistent with the Consolidated Income Statements presented in this report. Agency commissions and fees for the years ended December 31, 2015 and 2014 were not adjusted. (See Note 2 of Notes to Consolidated Financial Statements for additional information on our adoption of ASC 606.)

(b)
Represents the total hammer (sale) price of property sold at auction plus buyer’s premium, excluding amounts related to the sale of our inventory at auction, which are reported within inventory sales.
.
(c)
Represents the total hammer (sale) price of property sold at auction, excluding amounts related to the sale of our inventory at auction, which are reported within inventory sales.
(d)
Represents the total purchase price of property sold in private sales that we have brokered, including our commissions.
(e)
Represents the sum of Aggregate Auction Sales, Private Sales, and inventory sales.
(f)
Represents total auction commission revenues, net of fees owed to the counterparties in auction guarantee risk sharing arrangements and fees owed to third parties who introduce us to auction consignors, as a percentage of Net Auction Sales.
(g)
See "Non-GAAP Financial Measures" under Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for a description of this non-GAAP financial measure and a reconciliation to the most comparable GAAP amount.
(h)
Represents the average SFS loan portfolio outstanding during the period.
(i)
Represents average borrowings outstanding during the period under our revolving credit facility.


20



ITEM 7:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of Operations (or, "MD&A") should be read in conjunction with Note 3 ("Segment Reporting") of Notes to Consolidated Financial Statements.
Critical Accounting Estimates
The preparation of financial statements and related disclosures in accordance with GAAP requires us to make judgments, assumptions, and estimates that affect the amounts reported in our Consolidated Financial Statements and accompanying notes. Actual results may ultimately differ from our original estimates, as future events and circumstances sometimes do not develop as expected. Note 1 of Notes to Consolidated Financial Statements describes the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. In addition, we believe that the following are our most critical accounting estimates, which are not ranked in any particular order, that may affect our reported financial condition and/or results of operations.
(1)
Valuation of Inventory and Loan Collateral—The art market is not a highly liquid trading market. As a result, the valuation of art is inherently subjective and the realizable value of art often fluctuates over time. If there is evidence that the estimated realizable value of a specific item held in inventory is less than its carrying value, we record a loss to reflect our revised estimate of realizable value. If the estimated realizable value of the property pledged as collateral for a loan is less than the corresponding loan balance, we assess whether it is necessary to record a loss to reduce the carrying value of the loan, after taking into account the ability of the borrower to repay any shortfall between the value of the collateral and the amount of the loan.
In estimating the realizable value of art held in inventory and art pledged as collateral for loans, we consider the following complex array of factors: (i) whether the property is expected to be offered at auction or sold privately, and the timing of any such sale; (ii) the supply and demand for the property, taking into account current art market conditions, as well as changing trends as to which collecting categories and artists are most sought after; (iii) recent sale prices achieved for comparable items within a particular collecting category and/or by a particular artist; (iv) the state of the global economy and financial markets; and (v) our intent and ability to hold the property in order to maximize its realizable value.
Due to the inherent subjectivity involved in estimating the realizable value of art held in inventory and art pledged as collateral for loans, our estimates of realizable value may prove, with the benefit of hindsight, to be different than the amount ultimately realized upon sale.
(See Note 1 of Notes to Consolidated Financial Statements for information related to inventory. See Note 5 of Notes to Consolidated Financial Statements for information related to Notes Receivable.)
(2) Accounts Receivable—Accounts receivable principally includes amounts due from buyers as a result of auction and private sale transactions. The recorded amount reflects the aggregate purchase price of the property, which includes our buyer's premium or private sale commission, as well as any applicable taxes and royalties. Under the standard terms and conditions of our auction and private sales, we are not obligated to pay the consignor for property that has not been paid for by the buyer. If a buyer defaults on payment, the sale is cancelled and the property is returned to the consignor. We continually evaluate the collectability of amounts due from individual buyers and only recognize auction commission revenue when the collection of the amount due from the buyer is probable. If we determine that payment from the buyer is not probable, a cancelled sale is recorded in the period in which that determination is made and the associated accounts receivable balance, including our commission, is reversed. Historically, cancelled sales have not been material in relation to the aggregate hammer price of property sold at auction or the aggregate purchase price of property sold in private sales.
In certain instances, and subject to management approval under our internal corporate governance policy, we may pay the net sale proceeds to the seller before payment is collected from the buyer while we retain possession of the property. In these situations, if the buyer does not make payment, Sotheby's takes title to the property, but could be exposed to losses if the value of the property subsequently declines. In certain other situations, and subject to management approval under our internal corporate governance policy, we allow the buyer to take possession of purchased property before making payment. In these situations, we are liable to the seller for the net sale proceeds whether or not the buyer makes payment and would incur a loss in the event of buyer default. We maintain an allowance for doubtful accounts that principally includes estimated losses associated with situations when we have paid the net sale proceeds to the seller, and it is probable that payment will not be collected from the buyer. The allowance for doubtful accounts also includes an estimate of probable losses inherent in the remainder of the accounts receivable balance.

21



Our judgments regarding the collectability of accounts receivable and the amount of any required allowance for doubtful accounts are based on the facts available to management, including an assessment of the buyer's payment history, discussions with the buyer, and the value of any property held as security against the buyer's payment obligation. Our judgments with respect to the collectability of amounts due from buyers for auction and private sale purchases are reevaluated and adjusted as additional facts become known, but may ultimately prove, with the benefit of hindsight, to be incorrect.
(See Note 4 of Notes to Consolidated Financial Statements for information related to accounts receivable.)
(3)
Income Taxes—The provision for income taxes involves a significant amount of judgment regarding the interpretation of the relevant facts and laws in the many jurisdictions in which we operate. Our effective income tax rate and recorded tax balances can change significantly between periods due to a number of complex factors including, but not limited to: (i) our projected levels of taxable income; (ii) changes in the jurisdictional mix of our forecasted and/or actual pre-tax income; (iii) increases or decreases to valuation allowances recorded against deferred tax assets; (iv) tax audits conducted by various tax authorities; (v) adjustments to income taxes upon the finalization of income tax returns; (vi) the ability to claim foreign tax credits; and (vii) tax planning strategies.
On December 22, 2017, the U.S. Tax Cuts and Jobs Act (the “Act”) was enacted into law. Among other things, the Act reduced the U.S. corporate income tax rate from 35% to 21%, and made changes to certain other business-related exclusions, deductions and credits. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), Income Tax Accounting Implications of the Tax Cuts and Jobs Act, which allowed us to record provisional amounts during a measurement period not to extend beyond one year from the enactment date of the Act. In the fourth quarter of 2017, we recorded a provisional net income tax expense of $1.2 million based on reasonable estimates of the tax effects of the Act. This provisional net income tax expense was then adjusted in 2018 through the recording of $8.7 million in tax benefits as we finalized our accounting for the Act. The impact of the provisional accounting effects of the Act are described in greater detail in Note 18 of Notes to Consolidated Financial Statements.
As of December 31, 2018, we had a net deferred tax asset of $22.5 million. This amount includes gross deferred tax assets of $46.1 million, primarily resulting from deductible temporary differences which will reduce taxable income in future periods. To a lesser extent, we also have deferred tax assets relating to net operating loss carryforwards, which are partially offset by a valuation allowance of $2.4 million to reduce the deferred tax assets to the amount that we have determined is more likely than not to be realized. In assessing the need for a valuation allowance, we consider, among other things, projections of future taxable income and ongoing prudent and feasible tax planning strategies. If we determine that sufficient negative evidence exists (for example, if we experience cumulative three-year losses in a certain jurisdiction), then we will consider recording a valuation allowance against a portion or all of the deferred tax assets in that jurisdiction. If, after recording a valuation allowance, our 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 could prove more difficult to support the realization of these deferred tax assets. As a result, an additional valuation allowance could be required, which would have an adverse impact on our effective income tax rate and results. Conversely, if, after recording a valuation allowance, we determine that sufficient positive evidence exists in the jurisdiction in which a valuation allowance is recorded (for example, if we are no longer in a three-year cumulative loss position in the jurisdiction, and we expect to have future taxable income in that jurisdiction based upon our forecasts and the expected timing of deferred tax asset reversals), we may reverse a portion or all of the valuation allowance in that jurisdiction. In such situations, the adjustment made to the deferred tax asset would have a favorable impact on our effective income tax rate and results in the period such determination was made.
Due to the global complexity of tax regulation, we record liabilities to address potential exposures involving uncertain tax positions that we have taken, or expect to take, on income tax returns that could be challenged by taxing authorities. These potential exposures result from the varying applications and interpretations of income tax related statutes, rules, and regulations. As of December 31, 2018, our liability for unrecognized tax benefits, excluding interest and penalties, was $11.5 million. We believe that our recorded tax liabilities are adequate to cover all open years based on an assessment of the relevant facts and circumstances. This assessment involves assumptions and significant judgments about future events and potential actions by taxing authorities, as well as an evaluation of past experiences. The cost of the ultimate resolution of these matters may be greater or less than the liability that we have recorded. To the extent that our opinion as to the outcome of these matters changes, income tax expense will be adjusted accordingly in the period in which such a determination is made.
(See "Income Tax Expense" below, as well as Notes 18 and 19 of Notes to Consolidated Financial Statements.)

22




(4)
Share-Based Payments—We grant share-based payment awards as compensation to certain employees. The amount of compensation expense recognized for share-based payments is based, in part, on our estimate of the number of units or shares ultimately expected to vest as a result of employee service. A substantial portion of the share-based payment awards vest only if we achieve established return on invested capital (or "ROIC") targets. The amount of compensation expense recognized for such performance-based awards is dependent upon our quarterly assessment of the likelihood of achieving these future ROIC targets. If, as a result of our assessment, we project that a greater number of performance share units will vest than previously anticipated, a life-to-date adjustment to increase compensation expense is recorded in the period such determination is made. Conversely, if, as a result of our assessment, we project that a lower number of performance share units will vest than previously anticipated, a life-to-date adjustment to decrease compensation expense is recorded in the period such determination is made. Accordingly, if our projections of future performance against these targets prove, with the benefit of hindsight, to be inaccurate, the amount of life-to-date and future compensation expense related to share-based payments could significantly increase or decrease.
In 2015, we granted a share-based payment award to Thomas S. Smith, Jr., our President and CEO, with a single vesting opportunity after a five-year service period contingent upon the achievement of pre-determined levels of price appreciation in our stock. The compensation expense recognized for this share-based payment is based on our estimate of the grant date fair value of the award. In developing this estimate, we considered then-current market conditions, historical data, and other relevant data.
(See Note 23 of Notes to Consolidated Financial Statements for additional information related to our share-based payment programs.)
(5)
Legal Contingencies—We become involved in various claims and lawsuits incidental to the ordinary course of our business. We are required to assess the likelihood of any adverse judgments or outcomes related to these legal contingencies, as well as potential ranges of probable or reasonably possible losses. The determination of the amount of any losses to be recorded or disclosed as a result of these contingencies is based on a careful analysis of each individual exposure with, in some cases, the assistance of outside legal counsel. The amount of losses recorded or disclosed for such contingencies may change in the future due to new developments in each matter or a change in settlement strategy.
(See Note 20 of Notes to Consolidated Financial Statements for additional information related to legal contingencies.)
Seasonality
The global art auction market has two principal selling seasons, which generally occur in the second and fourth quarters of the year. In the aggregate, second and fourth quarter Net Auction Sales represented 76% and 80% of our total annual Net Auction Sales in 2018 and 2017, respectively, with auction commission revenues comprising approximately 74% and 66% of our total revenues, respectively. Accordingly, our financial results are seasonal, with peak revenues and operating income generally occurring in the second and fourth quarters. Consequently, first and third quarter results have historically reflected lower revenues when compared to the second and fourth quarters and, typically, a net loss due to the fixed nature of many of our operating expenses.
In quarterly reporting periods, the comparison of our results between reporting periods can be significantly influenced by a number of factors, such as changes in the timing of when certain auctions occur, the level of non-recurring single-owner auction sale events, the level and timing of individually negotiated private sale transactions, and changes in certain accounting estimates that rely upon forecasted results such as variable incentive and share-based compensation expense and our estimated annual effective income tax rate. Accordingly, when evaluating our performance, we believe that investors should also consider results for rolling six and twelve month periods, which better reflect the business cycle of the global art auction market. (See Note 28 of Notes to Consolidated Financial Statements for our quarterly results for the years ended December 31, 2018 and 2017.)


23



Business and Industry Trends
Following a period of expansion that began in late-2009 and lasted until the fourth quarter of 2015, the global art market experienced a brief period of lower sales in 2016, particularly in the Impressionist, Modern and Contemporary Art collecting categories, resulting in a 27% decrease in Consolidated Sales5, when compared to 2015. However, even during this brief period of lower sales, collectors continued to purchase top quality works of art for strong prices and our auction sell-through rates remained encouraging. In 2017, the art market strengthened, and we achieved a 12% increase in Consolidated Sales when compared to 2016, which led to a 12% increase in agency commissions and fees. In 2018, the art market was again strong, and Consolidated Sales grew to $6.4 billion, representing a 16% increase when compared to 2017. The strength of the market has paved the way for an increase of 10% in agency commissions and fees when compared to the same period in 2017.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017
Consolidated Results of Operations
Overview—In 2018, we reported net income of $108.6 million, or $2.09 per diluted share, representing a $10.2 million (9%) decrease when compared to the prior year when we reported net income of $118.8 million, or $2.20 per diluted share. After excluding certain items, Adjusted Net Income* improved $7.2 million (6%), from $121.7 million to $128.9 million, and Adjusted Diluted EPS* improved from $2.25 to $2.48. The improvement in Adjusted Net Income* is attributable to a stronger art market as evidenced by a 16% increase in Consolidated Sales and associated increases in auction commissions ($73.4 million / 11%) and private sale commissions ($14.9 million / 22%). The increase in private sale commissions also reflects our continued focus of key resources toward this sale channel. However, results for the year are adversely impacted by a higher level of indirect expenses. The comparison of Adjusted Net Income* to the prior year is also unfavorably impacted by $7.7 million of discrete income tax benefits recorded in 2017 that primarily resulted from the reversal of a tax reserve for a previously uncertain tax position for which the statute of limitations expired.
Outlook—Historically, it is common for us to report a net loss in the first quarter of the year due to the seasonality of our business. We anticipate that our Adjusted Net Loss* for the first quarter of 2019 will be less than what we reported during the first quarters of 2017 and 2016, and instead closer to the average for the prior ten-year period. We are encouraged by a strong pipeline of potential consignments for our second quarter spring sales season in New York. (See statement on Forward Looking Statements.)











___________________
5 See the definition of Consolidated Sales in the Consolidated Financial Data Table below.
*
See "Non-GAAP Financial Measures" below for a description of this non-GAAP financial measure and a reconciliation to the most comparable GAAP amount.




24



Consolidated Financial Data Table—The table below presents a summary of our consolidated results of operations and related statistical metrics for the years ended December 31, 2018 and 2017, as well as a comparison between the two years (in thousands of dollars, except per share data):
 
 
 
 
 
 
Variance
Year Ended December 31,
 
2018
 
2017
 
$ / %
 
%
Revenues:
 
 

 
 

 
 

 
 

Agency commissions and fees (a)
 
$
891,774

 
$
809,571

 
$
82,203

 
10
%
Inventory sales
 
80,808

 
178,982

 
(98,174
)
 
(55
%)
Finance
 
43,887

 
50,937

 
(7,050
)
 
(14
%)
Other
 
19,271

 
17,890

 
1,381

 
8
%
Total revenues
 
1,035,740

 
1,057,380

 
(21,640
)
 
(2
%)
Expenses:
 
 
 
 
 
 
 
 
Agency direct costs (a)
 
184,491

 
150,133

 
34,358

 
23
%
Cost of inventory sales
 
81,103

 
181,487

 
(100,384
)
 
(55
%)
Cost of finance revenues (b)
 
4,056

 
19,312

 
(15,256
)
 
(79
%)
Marketing
 
23,897

 
25,377

 
(1,480
)
 
(6
%)
Salaries and related (c)
 
342,687

 
318,555

 
24,132

 
8
%
General and administrative
 
180,360

 
172,950

 
7,410

 
4
%
Depreciation and amortization
 
27,048

 
24,053

 
2,995

 
12
%
Voluntary separation incentive programs, net
 

 
(162
)
 
162

 
100
%
Restructuring charges
 
10,753

 

 
10,753

 
N/A

Total expenses
 
854,395

 
891,705

 
(37,310
)
 
(4
%)
Operating income
 
181,345

 
165,675

 
15,670

 
9
%
Net interest expense (b) (d)
 
(38,517
)
 
(31,034
)
 
(7,483
)
 
(24
%)
Extinguishment of debt
 
(10,855
)
 

 
(10,855
)
 
N/A

Write-off of credit facility fees
 
(3,982
)
 

 
(3,982
)
 
N/A

Non-operating income
 
4,688

 
7,045

 
(2,357
)
 
(33
%)
Income before taxes
 
132,679

 
141,686

 
(9,007
)
 
(6
%)
Income tax expense
 
27,652

 
25,415

 
2,237

 
9
%
Equity in earnings of investees
 
3,591

 
2,508

 
1,083

 
43
%
Net income
 
108,618

 
118,779

 
(10,161
)
 
(9
%)
Less: Net loss attributable to noncontrolling interest
 
(16
)
 
(17
)
 
1

 
6
%
Net income attributable to Sotheby's
 
$
108,634

 
$
118,796

 
$
(10,162
)
 
(9
%)
Diluted earnings per share - Sotheby's common shareholders
 
$
2.09

 
$
2.20

 
$
(0.11
)
 
(5
%)
Statistical Metrics:
 
 

 
 

 
 

 


Aggregate Auction Sales (e)
 
$
5,250,503

 
$
4,567,310

 
$
683,193

 
15
%
Net Auction Sales (f)
 
$
4,395,593

 
$
3,816,792

 
$
578,801

 
15
%
Private Sales (g)
 
$
1,018,844

 
$
744,640

 
$
274,204

 
37
%
Consolidated Sales (h)
 
$
6,350,155

 
$
5,490,932

 
$
859,223

 
16
%
Effective income tax rate
 
20.8
%
 
17.9
%
 
2.9
%
 
N/A

Non-GAAP Financial Measures:
 
 
 
 
 
 
 
 
Adjusted Expenses (i)
 
$
568,008

 
$
539,038

 
$
28,970

 
5
%
Adjusted Operating Income (i)
 
$
198,082

 
$
167,410

 
$
30,672

 
18
%
Adjusted Net Income (i)
 
$
128,941

 
$
121,699

 
$
7,242

 
6
%
Adjusted Diluted EPS (i)
 
$
2.48

 
$
2.25

 
$
0.23

 
10
%
Adjusted Effective Income Tax Rate (i)
 
24.8
%
 
24.6
%
 
0.2
%
 
N/A

EBITDA (i)
 
$
201,851

 
$
199,298

 
$
2,553

 
1
%
Adjusted EBITDA (i)
 
$
230,066

 
$
200,176

 
$
29,890

 
15
%

25



Legend:
(a)
On January 1, 2018, we adopted Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers. The adoption of ASC 606 did not impact the timing of our revenue recognition, but it changed the presentation of certain Agency-related revenues and expenses previously reported on a net basis in our Consolidated Income Statements. Results for the year ended December 31, 2017 have been recast to reflect the retrospective adoption of ASC 606. (See Note 2 of Notes to Consolidated Financial Statements for additional information on our adoption of ASC 606.)
(b)
Our previous credit agreements provided for dedicated asset-based revolving credit facilities for the Agency segment and SFS. The SFS Credit Facility was used to fund a significant portion of client loans. Accordingly, any borrowing costs associated with the SFS Credit Facility were recorded within cost of finance revenues in our Consolidated Income Statements. In September 2017, we modified our cash management strategy in order to reduce borrowing costs by applying excess cash balances against revolver credit facility borrowings. On June 26, 2018, we refinanced our previous credit agreements. The new credit agreement that was entered into in connection with this refinancing combined the Agency Credit Facility and the SFS Credit Facility into one asset-based revolving credit facility. Subsequent to the refinancing and resulting elimination of the SFS Credit Facility, the SFS loan portfolio is no longer directly funded with revolving credit facility borrowings. Accordingly, beginning in the third quarter of 2018, all borrowing costs associated with our revolving credit facility are recorded as interest expense in our Consolidated Income Statements.
(c)
We do not allocate salaries and related costs to our cost of revenue, marketing expense, and general and administrative expense line items, as many of our employees perform duties that could be categorized across more than one of these line items.
(d)
Represents interest expense principally attributable to long-term debt and, beginning in the third quarter of 2018,
revolving credit facility borrowings, less non-operating interest income.
(e)
Represents the total hammer (sale) price of property sold at auction plus buyer’s premium, excluding amounts related to the sale of our inventory at auction, which are reported within inventory sales.
(f)
Represents the total hammer (sale) price of property sold at auction, excluding amounts related to the sale of our inventory at auction, which are reported within inventory sales.
(g)
Represents the total purchase price of property sold in private sales that we have brokered, including our commissions.
(h)
Represents the sum of Aggregate Auction Sales, Private Sales, and inventory sales.
(i)
See "Non-GAAP Financial Measures" below for a description of this non-GAAP financial measure and a reconciliation to the most comparable GAAP amount.
Agency Segment
Agency Segment Overview—In 2018, Agency segment income before taxes increased $7.1 million (7%) when compared to the prior year. After excluding certain items, Adjusted Agency Segment Income Before Taxes* increased $21 million (20%) when compared to the prior year. In 2018, the art market continued to be strong as evidenced by a 15% increase in Consolidated Sales and associated increases in auction commissions ($73.4 million / 11%) and private sale commissions ($14.9 million / 22%). The increase in private sale commissions also reflects our continued focus of key resources toward this sale channel. However, results for the period were adversely impacted by a higher level of indirect expenses.
Agency Segment Financial Data Table—The table below presents a summary of Agency segment income before taxes and related statistical metrics, in thousands of dollars, for the years ended December 31, 2018 and 2017. A detailed discussion of the significant factors impacting the comparison of Agency segment results between the current and prior year periods is presented below the table.








______________________
*
See "Non-GAAP Financial Measures" below for a description of this non-GAAP financial measure and a reconciliation to the most comparable GAAP amount.




26



 
 
 
 
 
 
Variance
Year Ended December 31,
 
2018
 
2017
 
$ / %
 
%
Revenues:
 
 
 
 
 
 
 
 
Auction commissions and fees:
 
 

 
 

 
 

 
 

Auction commissions (a) (b)
 
$
767,881

 
$
694,501

 
$
73,380

 
11
%
Auction related fees, net (a) (b)
 
29,088

 
32,459

 
(3,371
)
 
(10
%)
Total Auction commissions and fees (b)
 
796,969

 
726,960

 
70,009

 
10
%
Private sale commissions (a) (b)
 
82,263

 
67,343

 
14,920

 
22
%
Other Agency commissions and fees (a)
 
11,181

 
13,617

 
(2,436
)
 
(18
%)
Total Agency commissions and fees (b)
 
890,413

 
807,920

 
82,493

 
10
%
Inventory sales (a)
 
66,234

 
167,628

 
(101,394
)
 
(60
%)
Total Agency segment revenues (b)
 
956,647

 
975,548

 
(18,901
)
 
(2
%)
Expenses:
 
 
 
 
 
 
 
 
Agency direct costs:
 
 
 
 
 


 


Auction direct costs (b)
 
176,699

 
143,468

 
33,231

 
23
%
Private sale expenses (b)
 
7,446

 
6,361

 
1,085

 
17
%
Intersegment costs (c)
 
6,969

 
9,168

 
(2,199
)
 
(24
%)
Total Agency direct costs (b)
 
191,114

 
158,997

 
32,117

 
20
%
Cost of inventory sales (d)
 
70,601

 
173,160

 
(102,559
)
 
(59
%)
Marketing
 
23,454

 
24,860

 
(1,406
)
 
(6
%)
Salaries and related (e)
 
327,267

 
305,677

 
21,590

 
7
%
General and administrative
 
172,450

 
165,224

 
7,226

 
4
%
Depreciation and amortization
 
26,102

 
23,015

 
3,087

 
13
%
Restructuring charges
 
10,660

 

 
10,660

 
N/A

Voluntary separation incentive programs, net
 

 
(148
)
 
148

 
100
%
Total Agency segment expenses
 
821,648

 
850,785

 
(29,137
)
 
(3
%)
Agency segment operating income
 
134,999

 
124,763

 
10,236

 
8
%
Net interest expense (f)
 
(31,935
)
 
(28,294
)
 
(3,641
)
 
(13
%)
Non-operating income
 
5,303

 
6,479

 
(1,176
)
 
(18
%)
Equity in earnings of investees
 
2,688

 
995

 
1,693

 
*

Agency segment income before taxes
 
$
111,055

 
$
103,943

 
$
7,112

 
7
%
Statistical Metrics:
 
 
 
 
 
 
 
 
Aggregate Auction Sales (g)
 
$
5,250,503

 
$
4,567,310

 
$
683,193

 
15
%
Net Auction Sales (h)
 
$
4,395,593

 
$
3,816,792

 
$
578,801

 
15
%
Items sold at auction with a hammer (sale) price greater than $1 million
 
626

 
558

 
68

 
12
%
Total hammer (sale) price of items sold at auction with a hammer price greater than $1 million
 
$
2,729,772

 
$
2,322,634

 
$
407,138

 
18
%
Items sold at auction with a hammer (sale) price greater than $3 million
 
222

 
192

 
30

 
16
%
Total hammer (sale) price of items sold at auction with a hammer (sale) price greater than $3 million
 
$
2,039,725

 
$
1,700,768

 
$
338,957

 
20
%
Auction Commission Margin (i)
 
16.1
%
 
17.2
%
 
(1.1
%)
 
N/A

Private Sales (j)
 
$
1,002,860

 
$
736,825

 
$
266,035

 
36
%
Consolidated Sales (k)
 
$
6,319,597

 
$
5,471,763

 
$
847,834

 
15
%
Non-GAAP Financial Measures:
 
 
 
 
 
 
 
 
Adjusted Agency Segment Income Before Taxes (l)
 
$
127,699

 
$
106,732

 
$
20,967

 
20
%

27



Legend:
*
Represents a variance in excess of 100%.
(a)
See Note 4 of Notes to Consolidated Financial Statements for a description of each component of Agency segment revenues.
(b)
On January 1, 2018, we adopted ASC 606, Revenue from Contracts with Customers. The adoption of ASC 606 did not impact the timing of our revenue recognition, but it changed the presentation of certain Agency-related revenues and expenses previously reported on a net basis in our Consolidated Income Statements. Results for the year ended December 31, 2017 have been recast to reflect the retrospective adoption of ASC 606. (See Note 2 of Notes to Consolidated Financial Statements for additional information on our adoption of ASC 606.)

(c)
Principally includes fees charged to the Agency segment to compensate SFS for generating auction and private sale consignments through the sale of term loan collateral. In addition, this line item includes amounts charged by SFS for loans issued with favorable terms as an accommodation to the Agency segment in order to secure a consignment or enhance a client relationship.
(d)
Includes the net book value of inventory sold, commissions and fees paid to third parties who help facilitate the sale of inventory, and writedowns associated with our periodic assessment of inventory valuation.

(e)
We do not allocate salaries and related costs to our cost of revenue, marketing expense, and general and administrative
expense line items, as many of our employees perform duties that could be categorized across more than one of these line items.
(f)
Represents interest expense attributable to long-term debt, less non-operating interest income. On June 26, 2018, we refinanced our previous credit agreements, which provided for dedicated asset-based revolving credit facilities for the Agency segment and SFS. The new credit agreement that was entered into in connection with this refinancing combined the Agency Credit Facility and the SFS Credit Facility into one asset-based revolving credit facility. As a result of this refinancing and the concurrent elimination of the separate segment-based revolving credit facilities, beginning in the third quarter of 2018, revolving credit facility costs are no longer allocated to our segments for the purpose of measuring segment profitability. Segment results for all prior periods have been recast to reflect this change in the measurement of segment profitability.

(g)
Represents the total hammer (sale) price of property sold at auction plus buyer's premium, excluding amounts related
to the sale of our inventory at auction, which are reported within inventory sales.
(h)
Represents the total hammer (sale) price of property sold at auction, excluding amounts related to the sale of our
inventory at auction, which are reported within inventory sales.
(i)
Represents total auction commissions, net of fees owed to the counterparties in auction guarantee risk sharing arrangements and fees owed to third parties who introduce us to auction consignors (both of which are recorded within auction direct costs), as a percentage of Net Auction Sales.

(j)
Represents the total purchase price of property sold in private sales that we have brokered, including our commissions.

(k)
Represents the sum of Aggregate Auction Sales, Private Sales, and inventory sales attributable to the Agency segment.
(l)
See "Non-GAAP Financial Measures" below for a description of this non-GAAP financial measure and a
reconciliation to the most comparable GAAP amount.
Auction Results—In our role as auctioneer, we accept works of art on consignment and match sellers (also known as consignors) to buyers through the auction process. In an auction transaction, we act as exclusive agent for the seller. The terms of our arrangement with the seller are stipulated in a consignment agreement, which, among other things, entitles us to collect and retain an auction commission as compensation for our service. Our auction commission includes a premium charged to the buyer and, to a lesser extent, a commission charged to the seller, both of which are calculated as a percentage of the hammer price of the property sold at auction. In certain situations, in order to secure a high-value consignment, we may not charge a seller's commission and/or may share a portion of our buyer's premium with the seller. In situations when we share a portion of our buyer's premium with the seller, our auction commission revenue is recorded net of the amount paid to the seller.
Our buyer's premium is based on a tiered rate structure, which generally charges buyers a lower percentage for higher valued property, while lower valued property is charged a higher rate of commission. Accordingly, our aggregate Auction Commission Margin6 may be impacted by the mix of property sold in a period. Auction Commission Margin may also be adversely impacted by arrangements whereby we share our buyer's premium with a consignor in order to secure a competitive high-value consignment, as well as by our use of auction guarantees. For example, in situations when guaranteed property sells for less than the guaranteed price, our buyer's premium from that sale is used to reduce the loss on the transaction. (See Note 21 of Notes to Consolidated Financial Statements for information related to our use of auction guarantees.)
__________________________________________________
6 Auction Commission Margin represents total auction commissions, net of fees owed to the counterparties in auction guarantee risk sharing arrangements and fees owed to third parties who introduce us to auction consignors, as a percentage of Net Auction Sales.

28



In 2018, our net auction results7 increased $36.8 million (6%) primarily due to a 15% increase in Net Auction Sales, reflecting the strength of the art market during the year across most collecting categories, but most prominently in Asian Art and Contemporary Art. A significant portion of this growth was at the high-end of our business as evidenced by the 20% increase in Net Auction Sales of items with a hammer price greater than $3 million. Many of these high-value consignments required the use of auction guarantees, which in 2018 resulted in a net principal loss and significantly contributed to a decrease in Auction Commission Margin from 17.2% to 16.1%. This decrease is principally due to the sale of two high value paintings in the second quarter of 2018, one of which involved the use of buyer’s premium to mitigate a loss on an auction guarantee and the other which involved an item that earned a minimal auction commission at the final hammer price. These two transactions collectively reduced our Auction Commission Margin by 0.6% in the current year. Excluding these two transactions, our Auction Commission Margin would have been 16.7% in 2018. The remainder of the decrease in Auction Commission Margin when compared to the prior year is a reflection of the increase in sales of higher valued property, a portion of which relates to competitive high-value consignments from fiduciary sources such as estates, foundations and charities.
Private Sale Results—Private sale commission revenues are earned through the direct brokering of purchases and sales of art. Private sales are generally initiated by a client wishing to sell their artwork (i.e., the consignor) with Sotheby's acting as its exclusive agent in the transaction. Because private sales are individually negotiated, non-recurring transactions, the volume and value of transactions completed can vary from period to period, with associated variability in revenues.
In 2018, private sale commissions increased $14.9 million (22%) due to an increase in high-value transaction volume during the current year period, which reflects our continued focus of key resources towards this sales channel. 
Inventory Activities—Agency segment inventory activities include amounts earned from the sale of: (i) artworks that have been obtained as a result of the failure of guaranteed property to sell at auction; (ii) artworks that have been purchased opportunistically, including property acquired for sale at auction; and (iii) other objects obtained incidental to the auction process (e.g., as a result of buyer default).
In 2018, the net results of our Agency segment inventory activities improved $1.2 million, primarily due to a lower level of inventory writedowns in the current year, the impact of which was partially offset by a higher level of profitable sales recognized in 2017. Also significantly impacting the comparison of inventory sales and cost of inventory sales to the prior year is the recognition of the sale of a Fancy Vivid Pink Diamond for $71.2 million, which resulted in a gain of approximately $0.4 million (see Note 13 of Notes to Consolidated Financial Statements).












_________________________________
7 Net auction results include auction commissions and fees (including any net overage or shortfall related to auction guarantees) less auction related direct costs.




29




Sotheby's Financial Services
The following table presents a summary of SFS income before taxes and related loan portfolio metrics, in thousands of dollars, as of and for the years ended December 31, 2018 and 2017:
 
 
 
 
 
 
Variance
Year Ended December 31,
 
2018
 
2017
 
$ / %
 
%
Revenues:
 
 
 
 
 
 
 
 
Client paid revenues (a)
 
$
43,887

 
$
50,937

 
$
(7,050
)
 
(14
%)
Intersegment revenues (b)
 
6,969

 
9,168

 
(2,199
)
 
(24
%)
Total finance revenues
 
50,856

 
60,105

 
(9,249
)
 
(15
%)
Expenses:
 
 
 
 
 
 
 
 
Corporate finance charge (c)
 
16,895

 
18,504

 
(1,609
)
 
(9
%)
Marketing
 
86

 
164

 
(78
)
 
(48
%)
Salaries and related (d)
 
4,966

 
5,024

 
(58
)
 
(1
%)
General and administrative
 
1,792

 
3,547

 
(1,755
)
 
(49
%)
Depreciation and amortization
 
120

 
244

 
(124
)
 
(51
%)
Total SFS expenses
 
23,859

 
27,483

 
(3,624
)
 
(13
%)
SFS operating income
 
26,997

 
32,622

 
(5,625
)
 
(17
%)
Non-operating (expense) income
 
(961
)
 
481

 
(1,442
)
 
N/A

SFS income before taxes
 
$
26,036

 
$
33,103

 
$
(7,067
)
 
(21
%)
Loan Portfolio Metrics:
 
 
 
 
 
 
 
 
Loan Portfolio Balance (e)
 
$
693,977

 
$
590,609

 
$
103,368

 
18
%
Average Loan Portfolio (f)
 
$
541,152

 
$
637,759

 
$
(96,607
)
 
(15
%)
Finance Revenue Percentage (g)
 
9.4
%
 
9.4
%
 
%
 
N/A

Client Paid Interest Revenue Percentage (h)
 
7.3
%
 
7.3
%
 
%
 
N/A

Legend:
 
 
 
(a)
Includes client paid interest, facility fees, and collateral release fees.
(b)
Principally includes fees charged to the Agency segment to compensate SFS for generating auction and private sale consignments through the sale of term loan collateral. In addition, this line item includes interest and fees earned from the Agency segment for loans issued with favorable terms as an accommodation to the Agency segment in order to secure a consignment or enhance a client relationship.
(c)
On June 26, 2018, we refinanced our previous credit agreements, which provided for dedicated asset-based revolving credit facilities for the Agency segment and SFS. The new credit agreement that was entered into in connection with this refinancing combined the Agency Credit Facility and the SFS Credit Facility into one asset-based revolving credit facility. As a result of this refinancing and the concurrent elimination of the separate segment-based revolving credit facilities, beginning in the third quarter of 2018, for the purpose of measuring segment profitability, SFS receives a corporate finance charge that is calculated assuming that 85% of their loan portfolio is funded with debt. This charge is eliminated in the consolidation of Sotheby's results. Segment results for all prior periods have been recast to reflect this change in the measurement of segment profitability.
(d)
We do not allocate salaries and related costs to our cost of revenue, marketing expense, and general and administrative expense line items, as many of our employees perform duties that could be categorized across more than one of these line items.
(e)
Represents the period end net loan portfolio balance.
(f)
Represents the average loan portfolio outstanding during the period.
(g)
Represents the annualized percentage of total client paid and intersegment finance revenues in relation to the
Average Loan Portfolio.
(h)
Represents the annualized percentage of total client paid interest revenue in relation to the Average Loan Portfolio.

30



SFS income before taxes decreased $7.1 million (21%) largely due to a 15% decrease in the Average Loan Portfolio resulting from the repayments of certain client loans in response to higher LIBOR rates during the year. The comparison to the prior year is also influenced by significant client paid interest recognized in 2017 related to retroactive interest rate increases triggered on a client loan during that year and default rate interest collected on a significant loan, which offset the impact of the generally higher interest rates earned on the loan portfolio in 2018.
While the Average Loan Portfolio decreased 15% in the current year when compared to 2017, a number of significant new loans were funded in the fourth quarter of 2018 resulting in a 17% increase in the period end net portfolio balance when compared to September 30, 2018.
Marketing Expenses
Marketing expenses are costs related to the promotion of the Sotheby's brand and include digital and print advertising, client relationship development, Sotheby's lifestyle magazines, and certain sponsorship agreements. In 2018, marketing expenses decreased $1.5 million (6%) primarily due to lower museum sponsorship and client development costs, partially offset by costs associated with the launch of Sotheby's Home in 2018.
Salaries and Related Costs
For the years ended December 31, 2018 and 2017, salaries and related costs consisted of the following (in thousands of dollars):
 
 
 
 
 
 
Variance
Year Ended December 31,
 
2018
 
2017
 
$
 
%
Full-time salaries
 
$
166,044

 
$
153,707

 
$
12,337

 
8
%
Incentive compensation expense
 
62,786

 
59,562

 
3,224

 
5
%
Employee benefits and payroll taxes
 
54,922

 
61,755

 
(6,833
)
 
(11
%)
Share-based payment expense
 
29,703

 
23,479

 
6,224

 
27
%
Contractual severance agreements, net
 
2,625

 

 
2,625

 
N/A

Other compensation expense (a)
 
26,607

 
20,052

 
6,555

 
33
%
Total salaries and related costs
 
$
342,687

 
$
318,555

 
$
24,132

 
8
%
Legend:
(a) Other compensation expense typically includes the cost of temporary labor and overtime, as well as amortization expense related to certain retention-based, new-hire, and other employment arrangements.
In 2018, salaries and related costs increased $24.1 million (8%) when compared to the prior year. The comparison to the prior year is adversely impacted by changes in foreign currency exchange rates, which increased salaries and related costs by $3.9 million. Excluding the impact of changes in foreign currency exchange rates, salaries and related costs increased $20.2 million (6%) in 2018. See below for a detailed discussion of the significant factors impacting the comparison of the various elements of salaries and related costs between the current and prior year periods.
Full-Time Salaries—In 2018, full-time salaries increased $12.3 million (8%) when compared to the prior year. The comparison to the prior year is adversely impacted by changes in foreign currency exchange rates, which increased full-time salaries by $1.9 million. Excluding the impact of changes in foreign currency exchange rates, full-time salaries increased $10.4 million (7%) in 2018 principally due to headcount and base salary increases.
Incentive Compensation—Incentive compensation consists of the accrual for annual cash incentive bonuses, as well as amounts awarded to employees for brokering certain eligible private sale and other transactions. Payments made under our annual cash incentive bonus plan are aligned with performance against Sotheby's annual financial plan. In 2018, incentive compensation increased $3.2 million (5%) primarily due to the significant increase in private sales results during the year.

31



Employee Benefits and Payroll Taxes—Employee benefits include the cost of certain of our retirement plans and health and welfare programs, as well as certain employee severance costs. Generally, the amount of employee benefit costs recognized in a period is dependent upon headcount and overall compensation levels, in addition to our financial performance, as certain of our retirement plans provide for profit-sharing contributions. The amount of expense recorded in a period is also dependent upon changes in the fair value of the liability associated with our deferred compensation plan ("DCP"), which result from gains and losses in participant deemed investment funds.
In 2018, employee benefits and payroll taxes decreased $6.8 million (11%) when compared to the prior year. The comparison to the prior year is adversely impacted by changes in foreign currency exchange rates, which increased employee benefits and payroll taxes by $1.1 million. Excluding the impact of changes in foreign currency exchange rates, employee benefits and payroll taxes decreased $7.9 million (13%) in 2018. This decrease is principally due to lower DCP costs as a result of a decline in the performance of deemed participant investments, as well as a lower level of non-restructuring related severance costs. On a consolidated basis, the lower level of DCP costs are largely offset by market losses in the trust assets related to the DCP, which are reflected in our Consolidated Income Statements within non-operating income.
Share-Based Payment Expense—Share-based payment expense relates to the amortization of equity compensation awards such as performance share units, market-based share units, restricted stock units, and restricted shares. The amount of compensation expense recognized for share-based payments is based, in part, on our estimate of the number of units or shares ultimately expected to vest as a result of employee service. In addition, performance share units vest only if we achieve established profitability targets (for awards granted prior to 2016) or certain ROIC targets (for awards granted beginning in 2016). The amount of compensation expense recognized for such performance-based awards is dependent upon our quarterly assessment of the likelihood of achieving these future profitability or ROIC targets. If, as a result of our assessment, we project that a greater number of performance share units will vest than previously anticipated, a life-to-date adjustment to increase compensation expense is recorded in the period such determination is made. Conversely, if, as a result of our assessment, we project that a lower number of performance share units will vest than previously anticipated, a life-to-date adjustment to decrease compensation expense is recorded in the period such determination is made.
Share-based payment expense increased by $6.2 million (27%) in 2018, reflecting an increase in our estimate of the number of performance share units ultimately expected to vest relative to the prior year. (See Note 23 of Notes to Consolidated Financial Statements for more detailed information related to our share-based compensation programs.)
Contractual Severance Agreements—In 2018, we recorded net charges of $2.6 million resulting from contractual severance agreements entered into with certain former employees, which allowed us to redirect compensation towards the headcount supporting our various growth initiatives.
Other Compensation Expense—In 2018, other compensation expense increased $6.6 million (33%) when compared to the prior year, primarily due to higher costs from retention-based, new-hire arrangements and temporary labor costs, especially with respect to various digital initiatives.
General and Administrative Expenses
General and administrative expenses include professional fees, facilities-related expenses, and travel and entertainment costs, as well as other indirect expenses. In 2018, general and administrative expenses increased $7.4 million (4%) when compared to the prior year. The comparison to the prior year is adversely impacted by changes in foreign currency exchange rates, which increased general and administrative expenses by $1.6 million. Excluding the impact of foreign currency exchange rate changes, general and administrative expenses increased $5.8 million (3%) during 2018. This increase is due to a higher level of spending on digital initiatives and facilities-related expenses, which include the cost of off-site storage during the York Property enhancement project, as well as higher travel and entertainment. These factors are partially offset by professional fee recoveries realized in the second quarter of 2018 following the resolution of certain legal matters and lower bad debt expense as the prior year included a $1.5 million charge associated with an uncollectible Agency segment loan (see Note 5 of Notes to Consolidated Financial Statements).
Depreciation and Amortization Expense
In 2018, depreciation and amortization expense increased $3 million (12%) in 2018, when compared to the prior year. This increase is primarily due to higher accelerated depreciation charges associated with certain building improvements and other fixed assets that were removed from service as of July 1, 2018 in connection with enhancements being made to the York Property, as well as an increase in intangible asset amortization expense. (See Item 2, "Properties" for additional information regarding the York Property enhancement program. See Note 9 of Notes to Consolidated Financial Statements for information on intangible assets.)


32



Restructuring Charges
Beginning in the second quarter of 2018, we implemented a restructuring plan with the principal goal of reducing headcount through the elimination of certain Agency segment and corporate level positions (the "2018 Restructuring Plan"). The 2018 Restructuring Plan was completed in the fourth quarter of 2018 and resulted in $10.8 million of related charges, almost entirely attributable to severance-related costs. As of December 31, 2018, the remaining restructuring liability was $5.9 million and is recorded on our Consolidated Balance Sheets within accounts payable and accrued liabilities. This liability is expected to be substantially settled through cash payments to be made throughout 2019.
Net Interest Expense
In 2018, net interest expense increased $7.5 million (24%) largely due to $3.2 million of incremental interest expense associated with the refinancing of $300 million of 5.25% Senior Notes, due 2022, (the "2022 Notes") with proceeds from the issuance of $400 million of 4.875% Senior Notes, due 2025 (the "2025 Notes"). The comparison to the prior year is also unfavorably influenced by a change in the classification of revolving credit facility costs that was made in the third quarter of 2018, as discussed in more detail below.
Our previous credit agreements provided for dedicated asset-based revolving credit facilities for the Agency segment and SFS. The SFS Credit Facility was used to fund a significant portion of client loans. Accordingly, any borrowing costs associated with the SFS Credit Facility were recorded within cost of finance revenues in our Consolidated Income Statements. In September 2017, we modified our cash management strategy in order to reduce borrowing costs by applying excess cash balances against revolving credit facility borrowings. On June 26, 2018, we refinanced our previous credit agreements. The new credit agreement that was entered into in connection with this refinancing combined the Agency Credit Facility and the SFS Credit Facility into one asset-based revolving credit facility. Subsequent to the refinancing and resulting elimination of the SFS Credit Facility, the SFS loan portfolio is no longer directly funded with revolving credit facility borrowings. Accordingly, beginning in the third quarter of 2018, all borrowing costs associated with our revolving credit facility are recorded as interest expense in our Consolidated Income Statements. This change in classification contributed $2.4 million to the increase in net interest expense between the current and prior year periods. However, on an all-in basis (i.e., combining the amounts recorded in cost of finance revenues and interest expense), the costs associated with our revolving credit facilities and borrowings thereunder decreased by $11.4 million (52%) in 2018 when compared to the prior year primarily as a result of lower borrowings due to the change in our cash management strategy.
Write-off of Credit Facility Fees
Prior to June 26, 2018, we were party to credit agreements with an international syndicate of lenders that provided for dedicated asset-based revolving credit facilities for the Agency segment and SFS (collectively, the "Previous Credit Agreements"). On June 26, 2018, we refinanced the Previous Credit Agreements and entered into a new credit agreement with an international syndicate of lenders led by JPMorgan Chase Bank, N.A. As a result of this refinancing, $4 million of unamortized fees related to the Previous Credit Agreements were written off in the second quarter of 2018. See Note 11 of Notes to Consolidated Financial Statements.
Extinguishment of Debt
On December 12, 2017, we issued $400 million aggregate principal amount of 2025 Senior Notes. The net proceeds from the issuance of the 2025 Senior Notes were approximately $395.5 million, after deducting fees paid to the initial purchasers. On January 11, 2018, a significant portion of these proceeds were used to redeem $300 million aggregate principal amount of 2022 Senior Notes for a redemption price of $312.3 million, which included $4.4 million of accrued interest and a call premium of $7.9 million. As a result of the redemption of the 2022 Senior Notes, we wrote-off $3 million of related unamortized debt issuance costs, which, when combined with the $7.9 million call premium, resulted in a total loss on the extinguishment of debt of $10.9 million recognized in the first quarter of 2018.
Non-Operating Income
In 2018, non-operating income decreased $2.4 million (33%) primarily due to a decline in the performance of the trust assets related to the DCP and a lower net credit associated with our U.K. Pension Plan (see Note 10 of Notes to Consolidated Financial Statements). These factors are partially offset by gains realized on the settlement of certain foreign currency denominated transactions in the current year. As discussed above under "Salaries and Related Costs," on a consolidated basis, market losses in the trust assets related to the DCP are largely offset by the the lower level of DCP costs reflected in our Consolidated Income Statements within salaries and related costs.



33


Income Tax Expense
Our effective income tax rate is 20.8% for the year ended December 31, 2018, compared to 17.9% in the prior year. The increase in our effective income tax rate is primarily due to a net tax charge of $4.8 million recorded in the current year related to the effective settlement of an income tax audit and a $7 million benefit recorded in the prior year to reverse a liability for a previously uncertain tax position for which the statute of limitations had expired. These factors are partially offset by an income tax benefit of $8.7 million recorded in the current year to adjust the provisional income tax expense of $1.2 million recorded in the prior year upon the enactment of the U.S. Tax Cuts and Jobs Act in 2017, as discussed below.
U.S. Tax Reform—The Act was enacted into law on December 22, 2017. Certain provisions of the Act have the effect of reducing our effective tax rate beginning on January 1, 2018, such as: (i) a reduction of the U.S. corporate income tax rate from 35% to 21%; (ii) the transition from a worldwide tax system to a modified territorial tax system, under which dividends from foreign subsidiaries are not subject to additional U.S. tax; and (iii) the creation of Foreign Derived Intangible Income (“FDII”), a new category of income that is taxed at a lower rate. Conversely, certain provisions of the Act have the effect of increasing our effective tax rate beginning on January 1, 2018, such as: (i) the creation of global intangible low-taxed income (“GILTI”), which requires income earned by foreign subsidiaries in excess of a nominal return on their depreciable assets to be included currently in the income of the U.S. shareholder; (ii) the imposition of the Base Erosion Anti-Abuse Tax (“BEAT”), a minimum tax on certain non-US related-party payments; and (iii) more restrictive limitations on the deductibility of executive compensation.
Upon enactment of the Act, the SEC issued SAB 118, which allowed companies to record the income tax effects of the Act as a provisional amount based on reasonable estimates for those tax effects and provided a one-year measurement period for companies to finalize the accounting of the income tax effects of the Act. In accordance with SAB 118, in the fourth quarter of 2017, we recorded a provisional net income tax expense of approximately $1.2 million based on reasonable estimates of the tax effects of the Act. This provisional net income tax expense was adjusted in 2018 through the recording of $8.7 million in tax benefits as we finalized our accounting for the Act. In total, between 2017 and 2018, we recorded a net income tax benefit of $7.5 million related to the Act, which consists of the following components:
An expense of $36.4 million to record a liability for the one-time transition tax on certain unremitted and untaxed earnings of our foreign subsidiaries. This amount consists of a $40.4 million liability that was recorded in the fourth quarter of 2017, which was adjusted in 2018 through a $4 million income tax benefit that was recorded to reduce the liability as a result of guidance that was issued by the IRS during the year and as a result of revisions made to certain estimates used in the calculation as of December 31, 2017;
An expense of $16.3 million to reduce the value of our net deferred tax assets, primarily as a result of the change in the U.S. corporate income tax rate from 35% to 21%. This amount consists of a $19.8 million charge recorded in the fourth quarter of 2017, which was adjusted in 2018 through a $2.2 million income tax benefit to increase the value of our net deferred tax assets based on further analysis of available tax accounting methods and elections and a $1.3 million income tax benefit to increase the value of our deferred tax assets related to certain executive compensation based on guidance that was issued by the IRS during the year; and
An income tax benefit of $60.2 million to reduce our deferred tax liability related to the earnings of our foreign subsidiaries that were not deemed to be indefinitely reinvested. This amount consists of a $59 million income tax benefit recorded in the fourth quarter of 2017, which was adjusted in 2018 through a $1.2 million income tax benefit recorded to reduce our estimate of the deferred tax liability.
Our accounting for the effects of the Act is complete as of December 31, 2018; however, there may be some elements of the Act that remain subject to further clarification by the issuance of future regulations or notices by the U.S. Treasury Department or IRS which could result in adjustments to previously recorded amounts, including the issuance of final regulations on January 15, 2019 related to the one-time transition tax. We are evaluating the effect of the final regulations on the amount of the transition tax liability but don't believe that the regulations will have a material impact on the recorded liability.
The FASB voted to permit companies to elect to record deferred taxes on temporary basis differences that are expected to reverse as GILTI in the future, rather than recording the tax effect of those temporary differences as a period cost. We have chosen to account for any taxes associated with GILTI as a period cost and, accordingly, we have included the impact of changes in these temporary differences on GILTI as a period cost in our current tax provision.


34


Equity in Earnings of Investees
In 2018, our share of earnings from equity method investees increased $1.1 million primarily due to improved performance by RM Sotheby's, partially offset by lower results from Acquavella Modern Art. (See Note 6 of Notes to Consolidated Financial Statements for additional information regarding our equity method investments.)
Impact of Changes in Foreign Currency Exchange Rates
For the year ended December 31, 2018, changes in foreign currency exchange rates had a net favorable impact of approximately $0.9 million on our operating income, with revenues favorably impacted by $10.1 million and expenses unfavorably impacted by $9.2 million.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2017 AND 2016
Consolidated Results of Operations
Overview—In 2017, our net income was $118.8 million, or $2.20 per diluted share, representing a $44.7 million (60%) improvement when compared to 2016 when we reported net income of $74.1 million, or $1.27 per diluted share. After excluding certain items, Adjusted Net Income* improved $22.1 million (22%), from $99.6 million to $121.7 million, and Adjusted Diluted EPS* improved from $1.71 to $2.25. The improvement in Adjusted Net Income* was principally due to a stronger art market, which resulted in a 12% increase in Consolidated Sales and a 11% increase in auction commissions and fees when compared to 2016, as well as a significant improvement in our inventory activities. These factors were partially offset by a higher level of indirect expenses largely due to investments in growth initiatives and a higher level of incentive compensation reflecting improved performance against plan targets.
















_______________________
* See "Non-GAAP Financial Measures" below for a description of this non-GAAP financial measure and a reconciliation to the most comparable GAAP amount.


35



Consolidated Financial Data Table—The table below presents a summary of our consolidated results of operations and related statistical metrics for the years ended December 31, 2017 and 2016, as well as a comparison between the two years (in thousands of dollars, except per share data):
 
 
 
 
 
 
Variance
Year Ended December 31,
 
2017
 
2016
 
$ / %
 
%
Revenues:
 
 

 
 

 
 

 
 

Agency commissions and fees (a)
 
$
809,571

 
$
724,398

 
$
85,173

 
12
%
Inventory sales
 
178,982

 
62,863

 
116,119

 
*

Finance
 
50,937

 
52,716

 
(1,779
)
 
(3
%)
Other
 
17,890

 
17,965

 
(75
)
 
%
Total revenues
 
1,057,380

 
857,942

 
199,438

 
23
%
Expenses:
 
 
 
 
 
 
 
 
Agency direct costs (a)
 
150,133

 
125,889

 
24,244

 
19
%
Cost of inventory sales
 
181,487

 
81,782

 
99,705

 
*

Cost of finance revenues
 
19,312

 
17,738

 
1,574

 
9
%
Marketing
 
25,377

 
19,695

 
5,682

 
29
%
Salaries and related (b)
 
318,555

 
315,640

 
2,915

 
1
%
General and administrative
 
172,950

 
161,356

 
11,594

 
7
%
Depreciation and amortization
 
24,053

 
21,817

 
2,236

 
10
%
Voluntary separation incentive programs, net
 
(162
)
 
(610
)
 
448

 
73
%
Total expenses
 
891,705

 
743,307

 
148,398

 
20
%
Operating income
 
165,675

 
114,635

 
51,040

 
45
%
Net interest expense (c)
 
(31,034
)
 
(29,016
)
 
(2,018
)
 
(7
%)
Non-operating income
 
7,045

 
11,115

 
(4,070
)
 
(37
%)
Income before taxes
 
141,686

 
96,734

 
44,952

 
46
%
Income tax expense
 
25,415

 
25,957

 
(542
)
 
(2
%)
Equity in earnings of investees
 
2,508

 
3,262

 
(754
)
 
(23
%)
Net income
 
118,779

 
74,039

 
44,740

 
60
%
Less: Net loss attributable to noncontrolling interest
 
(17
)
 
(73
)
 
56

 
77
%
Net income attributable to Sotheby's
 
$
118,796

 
$
74,112

 
$
44,684

 
60
%
Diluted earnings per share - Sotheby's common shareholders
 
$
2.20

 
$
1.27

 
$
0.93

 
73
%
Statistical Metrics:
 
 

 
 

 
 

 
 
Aggregate Auction Sales (d)
 
$
4,567,310

 
$
4,247,873

 
$
319,437

 
8
%
Net Auction Sales (e)
 
$
3,816,792

 
$
3,556,090

 
$
260,702

 
7
%
Private Sales (f)
 
$
744,640

 
$
583,410

 
$
161,230

 
28
%
Consolidated Sales (g)
 
$
5,490,932

 
$
4,894,146

 
$
596,786

 
12
%
Effective income tax rate
 
17.9
%
 
26.8
%
 
(8.9
%)
 
N/A

Non-GAAP Financial Measures:
 
 
 
 
 
 
 
 
Adjusted Expenses (h)
 
$
539,038

 
$
476,154

 
$
62,884

 
13
%
Adjusted Operating Income (h)
 
$
167,410

 
$
156,379

 
$
11,031

 
7
%
Adjusted Net Income (h)
 
$
121,699

 
$
99,616

 
$
22,083

 
22
%
Adjusted Diluted EPS (h)
 
$
2.25

 
$
1.71

 
$
0.54

 
32
%
Adjusted Effective Income Tax Rate (h)
 
24.6
%
 
23.0
%
 
1.6
%
 
N/A

EBITDA (h)
 
$
199,298

 
$
150,902