NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1.
Basis of Presentation
Accounting Principles
—The unaudited Condensed Consolidated Financial Statements included herein have been prepared by the management of Sotheby’s (or the "Company") in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") and pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted from this report, as is permitted by such rules and regulations. In the opinion of management, the unaudited Condensed Consolidated Financial Statements reflect all adjustments of a normal recurring nature that are necessary for a fair presentation of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year (see
Note 2
). Management urges you to read these Condensed Consolidated Financial Statements in conjunction with the information included in Sotheby’s 2015 Form 10-K filed with the SEC on February 26, 2016.
Principles of Consolidation
—The unaudited Condensed Consolidated Financial Statements include the accounts of Sotheby’s wholly-owned subsidiaries and Sotheby's (Beijing) Auction Co., Ltd. ("Sotheby's Beijing"), a joint venture formed in 2012 in which Sotheby's has a controlling
80%
ownership interest. The net loss attributable to the minority owner of Sotheby's Beijing is reported as "Net Loss Attributable to Noncontrolling Interest" in the Condensed Consolidated Income Statements and the non-controlling
20%
ownership interest is reported as "Noncontrolling Interest" within the Equity section of the Condensed Consolidated Balance Sheets. Intercompany transactions and balances among Sotheby's subsidiaries have been eliminated.
Equity investments through which Sotheby’s exercises significant influence over the investee, but does not control, are accounted for using the equity method. Under the equity method, Sotheby’s share of investee earnings is recorded within Equity in Earnings of Investees in the Condensed Consolidated Income Statements. Sotheby’s interest in the net assets of its investees is recorded within Equity Method Investments on the Condensed Consolidated Balance Sheets. Sotheby's equity method investees include Acquavella Modern Art, a partnership through which a collection of fine art is being sold, and RM Sotheby's (formerly RM Auctions), an auction house for investment-quality automobiles. Sotheby's acquired a
25%
ownership interest in RM Auctions on February 18, 2015 for
$30.7 million
. For the three months ended June 30, 2016 and 2015, Sotheby's results include
($0.3) million
and
$1 million
, respectively, of equity (losses) earnings related to RM Sotheby's. For the six months ended June 30, 2016 and 2015, Sotheby's results include
$0.1 million
and
$1.7 million
, respectively, of equity earnings related to RM Sotheby's.
Estimates and Assumptions
—The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Adoption of Recently Issued Accounting Standards
—In November 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2015-17,
Balance Sheet Classification of Deferred Taxes
, which requires entities to present deferred tax assets and liabilities as non-current in a classified balance sheet, instead of separating them into current and non-current amounts. ASU 2015-17 is effective for financial statements issued for annual periods beginning after December 15, 2016, with early adoption permitted in any intervening interim or annual period. Sotheby's early adopted ASU 2015-17 as of December 31, 2015 on a prospective basis. Accordingly, prior period information presented in this report has not been adjusted to reflect the updated presentation of deferred tax assets and liabilities.
In April 2015, the FASB issued ASU 2015-03,
Simplifying the Presentation of Debt Issuance Costs
, and in August 2015 issued ASU 2015-15,
Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements.
These standards require unamortized debt issuance costs to be included as a direct deduction from the related debt liability on the balance sheet, but permit companies to continue to record unamortized debt issuance costs related to revolving credit facility arrangements as assets. Under previous guidance, all unamortized debt issuance costs were reported as assets on the balance sheet. Sotheby's adopted and applied ASU 2015-03 on a retrospective basis on its January 1, 2016 effective date. As permitted by ASU 2015-15, Sotheby's will continue to present debt issuance costs related to revolving credit facility arrangements as an asset on its balance sheet, regardless of whether there are any outstanding borrowings under the arrangement. The following tables summarize the effect of adopting ASU 2015-03 on Sotheby's previously issued financial statements (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2015
|
Condensed Consolidated Balance Sheets:
|
|
As Previously Reported
|
|
ASU 2015-03 Adjustments
|
|
As Adjusted
|
Other long-term assets
|
|
$
|
26,512
|
|
|
$
|
(10,816
|
)
|
|
$
|
15,696
|
|
York Property Mortgage, current
|
|
$
|
7,302
|
|
|
$
|
(1,010
|
)
|
|
$
|
6,292
|
|
Long-term debt, net
|
|
$
|
614,767
|
|
|
$
|
(9,806
|
)
|
|
$
|
604,961
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2015
|
Condensed Consolidated Balance Sheets:
|
|
As Previously Reported
|
|
ASU 2015-03 Adjustments
|
|
As Adjusted
|
Other long-term assets
|
|
$
|
20,756
|
|
|
$
|
(4,515
|
)
|
|
$
|
16,241
|
|
York Property Mortgage, current
|
|
$
|
6,542
|
|
|
$
|
—
|
|
|
$
|
6,542
|
|
Long-term debt, net
|
|
$
|
512,067
|
|
|
$
|
(4,515
|
)
|
|
$
|
507,552
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2015
|
Condensed Consolidated Statements of Cash Flows:
|
|
As Previously Reported
|
|
ASU 2015-03 Adjustments
|
|
As Adjusted
|
Operating Activities:
|
|
|
|
|
|
|
Adjustments to reconcile net income attributable to Sotheby's to net cash used by operating activities:
|
|
|
|
|
|
|
Amortization of debt discount and issuance costs
|
|
$
|
1,782
|
|
|
$
|
520
|
|
|
$
|
2,302
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
Other long-term assets
|
|
$
|
3,251
|
|
|
$
|
(520
|
)
|
|
$
|
2,731
|
|
Net cash used by operating activities
|
|
$
|
(66,300
|
)
|
|
$
|
—
|
|
|
$
|
(66,300
|
)
|
2.
Seasonality of Business
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
1
represented
78%
and
79%
of total Net Auction Sales in 2015 and 2014, respectively, with auction commission revenues comprising approximately
75%
and
81%
, respectively, of Sotheby's total revenues in those years. Accordingly, Sotheby’s 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 Sotheby’s operating expenses.
___________________________________________________________________
1
Net Auction Sales represents the hammer (sale) price of property sold at auction.
3.
Earnings Per Share
Basic earnings per share
—Basic earnings per share attributable to Sotheby's common shareholders is computed under the two-class method using the weighted average number of common shares outstanding during the period. The two-class method requires that the amount of net income attributable to participating securities be deducted from consolidated net income in the computation of basic earnings per share. In periods with a net loss, the net loss attributable to participating securities is not deducted from consolidated net loss in the computation of basic loss per share as the impact would be anti-dilutive. Sotheby's participating securities include unvested restricted stock units and unvested restricted stock shares held by employees, both of which have non-forfeitable rights to dividends. See
Note 14
for information on Sotheby's share-based payment programs.
Diluted earnings per share
—Diluted earnings per share attributable to Sotheby's common shareholders is computed in a similar manner to basic earnings per share under the two-class method, using the weighted average number of common shares outstanding during the period and, if dilutive, the weighted average number of potential common shares outstanding during the period. Sotheby's potential common shares include unvested performance share units held by employees, incremental common shares issuable upon the exercise of employee stock options, and deferred stock units held by members of the Board of Directors. See
Note 14
for information on Sotheby's share-based payment programs.
For the three and six months ended
June 30, 2016
,
1 million
and
1.1 million
potential common shares related to share-based payment awards were excluded from the computation of diluted earnings per share because the financial performance or stock price targets inherent in such awards were not achieved as of the balance sheet date. For the three and six months ended
June 30, 2015
,
0.9 million
and
1 million
potential common shares related to unvested performance share units were excluded from the computation of diluted earnings per share because the financial performance or stock price targets inherent in such awards were not achieved as of the balance sheet date.
The table below summarizes the computation of basic and diluted earnings per share for the
three and six
months ended
June 30, 2016
and
2015
(in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
Basic:
|
|
|
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
Net income attributable to Sotheby’s
|
|
$
|
88,964
|
|
|
$
|
67,572
|
|
|
$
|
63,080
|
|
|
$
|
72,774
|
|
|
Less: Net income attributable to participating securities
|
|
1,226
|
|
|
590
|
|
|
821
|
|
|
485
|
|
|
Net income attributable to Sotheby’s common shareholders
|
|
$
|
87,738
|
|
|
$
|
66,982
|
|
|
$
|
62,259
|
|
|
$
|
72,289
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average basic shares outstanding
|
|
57,104
|
|
|
69,332
|
|
|
60,063
|
|
|
69,211
|
|
|
Basic earnings per share - Sotheby’s common shareholders
|
|
$
|
1.54
|
|
|
$
|
0.97
|
|
|
$
|
1.04
|
|
|
$
|
1.04
|
|
|
Diluted
:
|
|
|
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
Net income attributable to Sotheby’s
|
|
$
|
88,964
|
|
|
$
|
67,572
|
|
|
$
|
63,080
|
|
|
$
|
72,774
|
|
|
Less: Net income attributable to participating securities
|
|
1,226
|
|
|
590
|
|
|
821
|
|
|
485
|
|
|
Net income attributable to Sotheby’s common shareholders
|
|
$
|
87,738
|
|
|
$
|
66,982
|
|
|
$
|
62,259
|
|
|
$
|
72,289
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
57,104
|
|
|
69,332
|
|
|
60,063
|
|
|
69,211
|
|
|
Weighted average effect of Sotheby's dilutive potential common shares:
|
|
|
|
|
|
|
|
|
|
Performance share units
|
|
458
|
|
|
368
|
|
|
454
|
|
|
404
|
|
|
Deferred stock units
|
|
137
|
|
|
164
|
|
|
153
|
|
|
159
|
|
|
Stock options
|
|
13
|
|
|
20
|
|
|
12
|
|
|
20
|
|
|
Weighted average dilutive potential common shares outstanding
|
|
608
|
|
|
552
|
|
|
619
|
|
|
583
|
|
|
Weighted average diluted shares outstanding
|
|
57,712
|
|
|
69,884
|
|
|
60,682
|
|
|
69,794
|
|
|
Diluted earnings per share - Sotheby’s common shareholders
|
|
$
|
1.52
|
|
|
$
|
0.96
|
|
|
$
|
1.03
|
|
|
$
|
1.04
|
|
The decrease in weighted average basic and diluted shares outstanding between the two reporting periods is due to Common Stock repurchases executed during the twelve month period ended
June 30, 2016
. See
Note 13
for additional information on Sotheby's share repurchase program.
4.
Segment Reporting
Sotheby’s is a global art business whose 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 (or "SFS"). The Agency segment earns commissions by matching buyers and sellers of authenticated fine art, decorative art, jewelry, wine, and collectibles (collectively, "art" or "works of art" or "artwork" or "property") through the auction or private sale process. To a much lesser extent, Agency segment activities also include the sale of artworks that are principally acquired as a consequence of the auction process, as well as the activities of RM Sotheby's, an equity investee that operates as an auction house for investment-quality automobiles. Sotheby's Financial Services earns interest income through art-related financing activities by making loans that are secured by works of art (see
Note 5
).
On January 11, 2016, Sotheby's acquired certain entities comprising the business of Art Agency, Partners ("AAP"), a firm that provides a range of art-related services to art collectors. Through this acquisition, Sotheby's aims to grow its auction and private sale revenues within the Agency segment by enhancing its relationships with art collectors and improving its position in the fine art market, particularly in Impressionist, Modern and Contemporary Art. Also, as a result of this acquisition, Sotheby's has added a new revenue stream by integrating AAP's art advisory business, which is classified within All Other for segment reporting purposes. See
Note 6
for additional information related to the acquisition of AAP.
The table below presents Sotheby’s revenues and income before taxes by segment for the
three and six months ended June 30, 2016
and
2015
(in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2016
|
|
Agency
|
|
SFS
|
|
All Other
|
|
Reconciling items (a)
|
|
Total
|
Revenues
|
|
$
|
277,058
|
|
|
$
|
16,552
|
|
|
$
|
6,857
|
|
|
$
|
(1,802
|
)
|
|
$
|
298,665
|
|
Segment income before taxes
|
|
$
|
110,716
|
|
|
$
|
10,675
|
|
|
$
|
1,894
|
|
|
$
|
(191
|
)
|
(b)
|
$
|
123,094
|
|
Three Months Ended June 30, 2015
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
314,403
|
|
|
$
|
16,339
|
|
|
$
|
5,633
|
|
|
$
|
(4,369
|
)
|
|
$
|
332,006
|
|
Segment income before taxes
|
|
$
|
106,189
|
|
|
$
|
10,170
|
|
|
$
|
3,426
|
|
|
$
|
(11,526
|
)
|
(b)
|
$
|
108,259
|
|
Six Months Ended June 30, 2016
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
362,833
|
|
|
$
|
33,032
|
|
|
$
|
12,858
|
|
|
$
|
(3,527
|
)
|
|
$
|
405,196
|
|
Segment income before taxes
|
|
$
|
60,424
|
|
|
$
|
20,940
|
|
|
$
|
3,225
|
|
|
$
|
(587
|
)
|
(b)
|
$
|
84,002
|
|
Six Months Ended June 30, 2015
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
454,092
|
|
|
$
|
32,296
|
|
|
$
|
8,932
|
|
|
$
|
(7,639
|
)
|
|
$
|
487,681
|
|
Segment income before taxes
|
|
$
|
106,627
|
|
|
$
|
20,990
|
|
(b)
|
$
|
5,414
|
|
|
$
|
(16,859
|
)
|
(b)
|
$
|
116,172
|
|
|
|
(a)
|
The reconciling items related to Revenues consist principally of amounts charged by SFS to the Agency segment, including interest and facility fees related to certain loans made to Agency segment clients, as well as fees charged for term loan collateral sold at auction or privately through the Agency segment.
|
|
|
(b)
|
The reconciling items related to segment income before taxes are detailed in the table below.
|
The table below presents a reconciliation of segment income before taxes to consolidated income before taxes for the
three and six months ended
June 30, 2016
and
2015
(in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Agency
|
|
$
|
110,716
|
|
|
$
|
106,189
|
|
|
$
|
60,424
|
|
|
$
|
106,627
|
|
SFS
|
|
10,675
|
|
|
10,170
|
|
|
20,940
|
|
|
20,990
|
|
All Other
|
|
1,894
|
|
|
3,426
|
|
|
3,225
|
|
|
5,414
|
|
Segment income before taxes
|
|
123,285
|
|
|
119,785
|
|
|
84,589
|
|
|
133,031
|
|
Reconciling items:
|
|
|
|
|
|
|
|
|
CEO separation and transition costs (see Note 16)
|
|
—
|
|
|
(43
|
)
|
|
—
|
|
|
(4,232
|
)
|
Leadership transition severance costs (a)
|
|
—
|
|
|
(9,501
|
)
|
|
—
|
|
|
(9,501
|
)
|
Equity in (earnings) losses of investees (b):
|
|
|
|
|
|
|
|
|
RM Sotheby's
|
|
267
|
|
|
(969
|
)
|
|
(50
|
)
|
|
(1,695
|
)
|
Acquavella Modern Art
|
|
(458
|
)
|
|
(1,013
|
)
|
|
(537
|
)
|
|
(1,431
|
)
|
Total equity in earnings of investees
|
|
(191
|
)
|
|
(1,982
|
)
|
|
(587
|
)
|
|
(3,126
|
)
|
Income before taxes
|
|
$
|
123,094
|
|
|
$
|
108,259
|
|
|
$
|
84,002
|
|
|
$
|
116,172
|
|
|
|
(a)
|
In the second quarter of
2015
, in conjunction with its leadership transition, Sotheby's incurred severance costs of
$9.5 million
associated with the termination of the employment of certain Executive Officers, including its former Chief Operating Officer.
|
|
|
(b)
|
For segment reporting purposes, Sotheby's share of earnings related to its equity investees is included as part of segment income before taxes. However, such earnings are reported separately below income before taxes in the Condensed Consolidated Income Statements. For the periods presented above, Agency segment results include equity (losses) earnings related to RM Sotheby's and All Other includes equity earnings related to Acquavella Modern Art.
|
The table below presents Sotheby's assets by segment, as well as a reconciliation of segment assets to consolidated assets as of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
(in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2016
|
|
December 31, 2015
|
|
June 30, 2015
|
Agency
|
|
$
|
2,114,220
|
|
|
$
|
2,499,441
|
|
|
$
|
2,242,896
|
|
SFS
|
|
642,118
|
|
|
721,781
|
|
|
812,012
|
|
All Other
|
|
40,520
|
|
|
25,178
|
|
|
26,647
|
|
Total segment assets
|
|
2,796,858
|
|
|
3,246,400
|
|
|
3,081,555
|
|
Unallocated amounts:
|
|
|
|
|
|
|
|
|
Deferred tax assets and income tax receivable
|
|
11,637
|
|
|
16,913
|
|
|
51,449
|
|
Consolidated assets
|
|
$
|
2,808,495
|
|
|
$
|
3,263,313
|
|
|
$
|
3,133,004
|
|
In April 2015, the FASB issued ASU 2015-03,
Simplifying the Presentation of Debt Issuance Costs
, and in August 2015 issued ASU 2015-15,
Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements.
These standards require unamortized debt issuance costs to be included as a direct deduction from the related debt liability on the balance sheet, but permit companies to continue to record unamortized debt issuance costs related to revolving credit facility arrangements as assets. Under previous guidance, all unamortized debt issuance costs were reported as assets on the balance sheet. Sotheby's adopted and applied ASU 2015-03 on a retrospective basis on its January 1, 2016 effective date. As permitted by ASU 2015-15, Sotheby's will continue to present debt issuance costs related to revolving credit facility arrangements as an asset on its balance sheet, regardless of whether there are any outstanding borrowings under the arrangement. Prior period balances of Agency segment assets presented in the table above, which previously included unamortized debt issuance costs related to long-term debt, have been adjusted to conform to the current period presentation. See
Note 1
for additional information on the effects of the retrospective adoption of ASU 2015-03.
5.
Receivables
Accounts Receivable (Net)
—Through its Agency segment, Sotheby's accepts property on consignment and matches sellers, also known as consignors, to buyers through the auction or private sale process. Following an auction or private sale, Sotheby's invoices the buyer for the purchase price of the property (including any commissions owed by the buyer), collects payment from the buyer, and remits to the consignor the net sale proceeds after deducting its commissions, expenses and applicable taxes and royalties.
Under Sotheby’s standard auction payment terms, payments from buyers are due no more than
30
days from the sale date and payments to consignors are due
35
days from the sale date. For private sales, payment from the buyer is typically due on the sale date, with the net sale proceeds being due to the consignor shortly thereafter. Extended payment terms are sometimes provided to an auction or private sale buyer. For auctions, the extent to which extended payment terms are provided to buyers can vary considerably from selling season to selling season. Extended payment terms typically extend the payment due date to a date that is no longer than one year from the sale date. In limited circumstances, the payment due date may be extended to a date that is beyond one year from the sale date. When providing extended payment terms, Sotheby’s attempts to match the timing of cash receipt from the buyer with the timing of payment to the consignor, but is not always successful in doing so. All extended payment term arrangements are approved by management under Sotheby's internal corporate governance policy.
In the limited circumstances when the payment due date is extended to a date that is beyond one year from the sale date, if the consignor does not provide Sotheby's matched payment terms (i.e., Sotheby's pays the consignor prior to receiving payment from the buyer), the receivable balance is reclassified from Accounts Receivable to Notes Receivable in the Condensed Consolidated Balance Sheets. As of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
, Notes Receivable within the Agency segment included
$12.2 million
,
$24.3 million
, and
$22.6 million
, respectively, of such balances that have been reclassified from Accounts Receivable.
Under the standard terms and conditions of its auction and private sales, Sotheby’s is 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 may be cancelled, and the property will be returned to the consignor. Alternatively, the consignor may reoffer the property at a future Sotheby's auction or negotiate a private sale with Sotheby's acting as its agent. In certain instances and subject to management approval under Sotheby’s internal corporate governance policy, the consignor may be paid the net sale proceeds before payment is collected from the buyer and/or the buyer may be allowed to take possession of the property before making payment. In situations when the buyer takes possession of the property before making payment, Sotheby’s is liable to the seller for the net sales proceeds whether or not the buyer makes payment. As of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
, Accounts Receivable (net) included
$104.5 million
,
$165.2 million
, and
$107.6 million
, respectively, related to situations when Sotheby's paid the consignor all or a portion of the net sales proceeds before payment was collected from the buyer. As of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
, Accounts Receivable (net) also included
$33.9 million
,
$93.1 million
, and
$75.4 million
, respectively, related to situations when the buyer was allowed to take possession of the property before making payment to Sotheby’s.
Notes Receivable (Sotheby's Financial Services)
—SFS provides certain collectors and art dealers with financing secured by works of art that Sotheby's either has in its possession or permits borrowers to possess. SFS generally makes
two
types of secured loans: (1) advances secured by consigned property where the borrowers are contractually committed, in the near term, to sell the property through Sotheby's Agency segment (a "consignor advance") and (2) general purpose term loans secured by property not presently intended for sale (a "term loan").
Consignor advances allow sellers to receive funds upon consignment for an auction or private sale that will typically occur up to
one
year in the future and normally have short-term maturities. Term loans allow Sotheby's to establish or enhance mutually beneficial relationships with borrowers and may generate future auction or private sale consignments and/or purchases. In certain situations, term loans are also made to refinance receivables generated by clients' auction and private sale purchases. Term loans normally have initial maturities of up to
two
years and typically carry a variable market rate of interest.
The lending activities of SFS are predominantly funded with borrowings drawn from a dedicated revolving credit facility. Cash balances are also used to fund a portion of the SFS loan portfolio. See
Note 8
for information related to the SFS Credit Facility.
As of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
, Notes Receivable (net) consisted of the following secured loans issued by SFS (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2016
|
|
December 31,
2015
|
|
June 30,
2015
|
Consignor advances
|
|
$
|
17,950
|
|
|
$
|
30,180
|
|
|
$
|
30,291
|
|
Term loans
|
|
611,731
|
|
|
652,078
|
|
|
743,749
|
|
Total
|
|
$
|
629,681
|
|
|
$
|
682,258
|
|
|
$
|
774,040
|
|
As of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
, the table above includes
$104.4 million
,
$108.8 million
, and
$106.5 million
, respectively, of term loans made by SFS as of each balance sheet date to refinance client auction and private sale purchases. For the
six months ended
June 30, 2016
and
June 30, 2015
, SFS made
$9.3 million
and
$32.6 million
, respectively, of such loans. These loans are accounted for as non-cash transfers between Accounts Receivable (net) and Notes Receivable (net) and are, therefore, not reflected as the funding of Notes Receivable within Investing Activities in the Condensed Consolidated Statements of Cash Flows. Upon repayment, the cash received in settlement of such loans is classified within Operating Activities in the Condensed Consolidated Statements of Cash Flows. For the
six months ended
June 30, 2016
and
June 30, 2015
, such repayments totaled
$13.7 million
and
$16.4 million
, respectively.
The collection of secured loans can be adversely impacted by a decline in the art market in general or in the value of the collateral, which is concentrated within certain collecting categories. In addition, in situations when there are competing claims on the collateral and/or when a borrower becomes subject to bankruptcy or insolvency laws, Sotheby’s ability to realize on its collateral may be limited or delayed.
Management aims to mitigate the risks associated with potential collateral devaluation by targeting a
50%
loan to value ("LTV") ratio (i.e., the principal loan amount divided by the low auction estimate of the collateral). Loans may also be made with LTV ratios between
51%
and
60%
, and, in rare circumstances, loans may also be made at an initial LTV ratio higher than
60%
. The SFS Credit Facility permits borrowings on the portion of any loan that does not exceed a
60%
LTV ratio.
The LTV ratio of certain loans may increase above the
50%
target due to decreases in the low auction estimates of the collateral. The revaluation of term loan collateral is performed by Sotheby’s specialists on a semi-annual basis or more frequently if there is a material change in circumstances related to the loan, the value of the collateral, the disposal plans for the collateral, or if an event of default occurs. Management believes that the LTV ratio is a critical credit quality indicator for the secured loans made by SFS.
The table below provides the aggregate LTV ratio for the SFS loan portfolio as of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
(in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2016
|
|
December 31,
2015
|
|
June 30,
2015
|
Secured loans
|
|
$
|
629,681
|
|
|
$
|
682,258
|
|
|
$
|
774,040
|
|
Low auction estimate of collateral
|
|
$
|
1,296,760
|
|
|
$
|
1,380,022
|
|
|
$
|
1,539,092
|
|
Aggregate LTV ratio
|
|
49
|
%
|
|
49
|
%
|
|
50
|
%
|
The table below provides the aggregate LTV ratio for secured loans made by SFS with an LTV ratio above
50%
as of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
(in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2016
|
|
December 31,
2015
|
|
June 30,
2015
|
Secured loans with an LTV ratio above 50%
|
|
$
|
316,170
|
|
|
$
|
354,049
|
|
|
$
|
441,246
|
|
Low auction estimate of collateral related to secured loans with an LTV ratio above 50%
|
|
$
|
571,922
|
|
|
$
|
626,829
|
|
|
$
|
784,119
|
|
Aggregate LTV ratio of secured loans with an LTV ratio above 50%
|
|
55
|
%
|
|
56
|
%
|
|
56
|
%
|
The table below provides other credit quality information regarding secured loans made by SFS as of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
(in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2016
|
|
December 31,
2015
|
|
June 30,
2015
|
Total secured loans
|
|
$
|
629,681
|
|
|
$
|
682,258
|
|
|
$
|
774,040
|
|
Loans past due
|
|
$
|
3,952
|
|
|
$
|
11,819
|
|
|
$
|
420
|
|
Loans more than 90 days past due
|
|
$
|
167
|
|
|
$
|
7,828
|
|
|
$
|
—
|
|
Non-accrual loans
|
|
$
|
167
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Impaired loans
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Allowance for credit losses:
|
|
|
|
|
|
|
|
|
Allowance for credit losses for impaired loans
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Allowance for credit losses based on historical data
|
|
1,373
|
|
|
1,458
|
|
|
1,359
|
|
Total allowance for credit losses - secured loans
|
|
$
|
1,373
|
|
|
$
|
1,458
|
|
|
$
|
1,359
|
|
Management considers a loan to be past due when principal payments are not paid in accordance with the stated terms of the loan. As of
June 30, 2016
,
$4 million
of the Notes Receivable (net) balance was considered to be past due, of which
$0.2 million
was more than
90
days past due. The collateral securing the past due loans has a low auction estimate of approximately
$15.8 million
resulting in an LTV ratio of approximately
25%
. Sotheby's is continuing to accrue interest on virtually all past due loans. In consideration of payments received to date in the third quarter of
2016
, the collateral value related to these loans, current collateral disposal plans, and negotiations with the borrowers, as well as the creditworthiness of the borrowers, management believes that the principal and interest amounts due for these loans will be collected.
A non-accrual loan is a loan for which future Finance revenue is not recorded due to management’s determination that it is probable that future interest on the loan is not collectible. Any cash receipts subsequently received on non-accrual loans are first applied to reduce the recorded principal balance of the loan, with any proceeds in excess of the principal balance then applied to interest owed by the borrower. The recognition of Finance revenue may resume on a non-accrual loan if sufficient additional collateral is provided by the borrower or if management becomes aware of other circumstances that indicate that it is probable that the borrower will make future interest payments on the loan. As of
June 30, 2016
, there was
$0.2 million
of non-accrual loans outstanding. As of
December 31, 2015
and
June 30, 2015
, there were
no
non-accrual loans outstanding.
A loan is considered to be impaired when management determines that it is probable that a portion of the principal and interest owed by the borrower will not be recovered after taking into account the estimated realizable value of the collateral securing the loan, as well as the ability of the borrower to repay any shortfall between the value of the collateral and the amount of the loan. If a loan is considered to be impaired, Finance revenue is no longer recognized and bad debt expense is recorded for any principal or accrued interest that is deemed uncollectible. As of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
, there were
no
impaired loans outstanding.
During the period January 1, 2016 to
June 30, 2016
, activity related to the Allowance for Credit Losses was as follows (in thousands of dollars):
|
|
|
|
|
Allowance for credit losses as of January 1, 2016
|
$
|
1,458
|
|
Change in loan loss provision
|
(85
|
)
|
Allowance for credit losses as of June 30, 2016
|
$
|
1,373
|
|
As of
June 30, 2016
, unfunded commitments to extend additional credit through SFS were approximately
$11.3 million
.
Notes Receivable (Agency Segment)
—Sotheby’s is obligated under the terms of certain auction guarantees to advance a portion of the guaranteed amount prior to the auction. In addition, in certain limited situations, the Agency segment will also provide advances to consignors that are secured by property scheduled to be offered at auction in the near term. Such auction guarantee and Agency segment consignor advances are recorded on the Condensed Consolidated Balance Sheets within Notes Receivable (net). There were
no
auction guarantee advances outstanding for any of the reporting periods. As of
June 30, 2015
, there were
$2.5 million
of Agency segment consignor advances outstanding. See
Note 12
for additional information related to auction guarantees.
In the limited circumstances when the payment due date for an auction or private sale receivable is extended to a date that is beyond one year from the sale date, if the consignor does not provide Sotheby's matched payment terms, the receivable balance is reclassified from Accounts Receivable (net) to Notes Receivable (net) in the Condensed Consolidated Balance Sheets. As of
June 30, 2016
and
December 31, 2015
, Notes Receivable (net) within the Agency segment included
$12.2 million
and
$24.3 million
, respectively, of such amounts reclassified from Accounts Receivable (net), against which Sotheby's holds approximately
$6.6 million
of collateral. As of
June 30, 2015
, Notes Receivable (net) within the Agency segment included
$22.6 million
, against which Sotheby's held
$3.7 million
of collateral. These Notes Receivable are accounted for as non-cash transfers between Accounts Receivable (net) and Notes Receivable (net) and are, therefore, not reflected within Investing Activities in the Condensed Consolidated Statements of Cash Flows. Upon repayment, the cash received in settlement of such Notes Receivable is classified within Operating Activities in the Condensed Consolidated Statements of Cash Flows.
Under certain circumstances, Sotheby's provides loans to art dealers to finance the purchase of works of art. In these situations, Sotheby's acquires a partial ownership interest or a security interest in the purchased property in addition to providing the loan. Upon the eventual sale of the property acquired, the loan is repaid. As of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
, such loans totaled
$4.1 million
,
$4.2 million
, and
$4.4 million
, respectively. Sotheby's is no longer accruing interest with respect to one of these loans with a balance of
$2.1 million
, but management believes that this balance is collectible.
Notes Receivable (Other)
—In the second quarter of
2013
, Sotheby's sold its interest in an equity method investee for
$4.3 million
. The sale price was funded by an upfront cash payment to Sotheby's of
$0.8 million
and the issuance of a
$3.5 million
unsecured loan. This loan matures in December 2018, has a variable market rate of interest, and requires monthly payments during the loan term. As of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
, the carrying value of this loan was approximately
$2.3 million
,
$2.4 million
, and
$2.6 million
, respectively.
6.
Acquisition of Art Agency, Partners
On January 11, 2016, Sotheby's acquired certain entities comprising the business of Art Agency, Partners ("AAP"), a firm that provides a range of art-related services to art collectors, for initial cash consideration of
$50 million
. Through this acquisition, Sotheby's aims to grow its auction and private sale revenues by enhancing its relationships with art collectors and improving its position in the fine art market, particularly in Impressionist, Modern and Contemporary Art. Also, as a result of this acquisition, Sotheby's has added a new revenue stream by integrating AAP's art advisory business, providing a new avenue for growth.
Sotheby's has agreed to make earn-out payments to the former owners of AAP not to exceed
$35 million
in the aggregate over the next
four
to
five years
, contingent on the achievement of a minimum level of financial performance in the Agency segment within the Impressionist, Modern and Contemporary Art collecting categories, as well as from AAP's existing art advisory business. For accounting purposes, the earn-out payments are recorded as compensation expense within Salaries and Related Costs and are being expensed on a pro-rata basis over the earn-out period. For the
three and six months ended
June 30, 2016
, Sotheby's recognized approximately
$2.2 million
and
$4.4 million
, respectively, of compensation expense related to this earn-out arrangement.
In connection with this acquisition, each of the former owners of AAP entered into a
five
-year employment agreement with Sotheby’s. Each employment agreement includes non-competition and non-solicitation covenants that will continue in effect for
twelve
months following the end of employment.
The table below summarizes the allocation of the total purchase price paid to the assets acquired and liabilities assumed as of
June 30, 2016
(in thousands of dollars):
|
|
|
|
|
|
Purchase price:
|
|
|
Initial cash consideration
|
|
$
|
50,000
|
|
Working capital adjustment
|
|
1,189
|
|
Total purchase price
|
|
$
|
51,189
|
|
Allocation of purchase price:
|
|
|
Net working capital acquired
|
|
$
|
1,572
|
|
Fixed assets and other long-term assets
|
|
173
|
|
Goodwill
|
|
34,490
|
|
Intangible assets - Customer relationships (see Note 7)
|
|
10,800
|
|
Intangible assets - Non-compete agreements (see Note 7)
|
|
3,060
|
|
Deferred tax assets
|
|
1,094
|
|
Total purchase price
|
|
$
|
51,189
|
|
In the second quarter of
2016
, Sotheby's completed the purchase price allocation related to the acquisition of AAP and attributed
$28.3 million
of the resulting goodwill to the Agency segment and
$6.2 million
to the acquired art advisory business, which is reported within All Other for segment reporting purposes. The goodwill is tax deductible over a period of
15
years. See
Note 7
for additional information related to goodwill.
Sotheby's incurred
$0.8 million
of transaction costs in connection with the acquisition of AAP, which were recognized within General and Administrative Expenses in the fourth quarter of
2015
(
$0.6 million
) and the first quarter of
2016
(
$0.2 million
).
It is impracticable to compute the amount of revenues and earnings contributed to the Agency segment as a result of the acquisition because the related activities have been integrated into the segment. Disclosure of pro-forma revenues and earnings attributable to the acquisition is also excluded because it is impracticable to determine since AAP was a closely-held private entity and its historical financial records are not available in U.S. GAAP.
7.
Goodwill and Intangible Assets
Goodwill
—As of January 1, 2015, all goodwill was attributable to the Agency segment. On January 11, 2016, Sotheby's acquired certain entities comprising the business of AAP, a firm that provides a range of art-related services to art collectors. In the second quarter of
2016
, Sotheby's completed the purchase price allocation related to the acquisition of AAP and attributed
$28.3 million
of the resulting goodwill to the Agency segment and
$6.2 million
to the acquired art advisory business, which is reported within All Other for segment reporting purposes.
For the six months ended June 30, 2016 and
2015
, changes in the carrying value of Goodwill were as follows (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2016
|
|
Six Months Ended June 30, 2015
|
|
|
Agency
|
|
All Other
|
|
Total
|
|
Agency
|
|
All Other
|
|
Total
|
Beginning balance
|
|
$
|
13,621
|
|
|
$
|
—
|
|
|
$
|
13,621
|
|
|
$
|
14,017
|
|
|
$
|
—
|
|
|
$
|
14,017
|
|
Goodwill acquired (see Note 6)
|
|
28,339
|
|
|
6,151
|
|
|
34,490
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Foreign currency exchange rate changes
|
|
(195
|
)
|
|
—
|
|
|
(195
|
)
|
|
(188
|
)
|
|
—
|
|
|
(188
|
)
|
Ending balance
|
|
$
|
41,765
|
|
|
$
|
6,151
|
|
|
$
|
47,916
|
|
|
$
|
13,829
|
|
|
$
|
—
|
|
|
$
|
13,829
|
|
Intangible Assets
—As of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
, intangible assets consisted of the following (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization Period
|
|
June 30,
2016
|
|
December 31,
2015
|
|
June 30,
2015
|
Indefinite lived intangible assets:
|
|
|
|
|
|
|
|
|
License (a)
|
|
N/A
|
|
$
|
324
|
|
|
$
|
324
|
|
|
$
|
324
|
|
Intangible assets subject to amortization:
|
|
|
|
|
|
|
|
|
Customer relationships - AAP (see Note 6)
|
|
8 years
|
|
10,800
|
|
|
—
|
|
|
—
|
|
Non-compete agreements - AAP (see Note 6)
|
|
6 years
|
|
3,060
|
|
|
—
|
|
|
—
|
|
Total intangible assets subject to amortization
|
|
|
|
13,860
|
|
|
—
|
|
|
—
|
|
Accumulated amortization
|
|
|
|
(930
|
)
|
|
—
|
|
|
—
|
|
Total amortizable intangible assets (net)
|
|
|
|
12,930
|
|
|
—
|
|
|
—
|
|
Total intangible assets (net)
|
|
|
|
$
|
13,254
|
|
|
$
|
324
|
|
|
$
|
324
|
|
(a) Relates to a license obtained in conjunction with the purchase of a retail wine business in
2008
.
For the three and six months ended
June 30, 2016
, amortization expense related to intangible assets was approximately
$0.4 million
and
$0.9 million
, respectively.
No
such amortization expense was recorded in the prior year periods.
The estimated aggregate amortization expense for the remaining useful lives of intangible assets subject to amortization during the
five
-year period succeeding the
June 30, 2016
balance sheet date are as follows (in thousands of dollars):
|
|
|
|
|
|
Period
|
|
Amount
|
July 2016 to June 2017
|
|
$
|
1,860
|
|
July 2017 to June 2018
|
|
$
|
1,860
|
|
July 2018 to June 2019
|
|
$
|
1,860
|
|
July 2019 to June 2020
|
|
$
|
1,860
|
|
July 2020 to June 2021
|
|
$
|
1,860
|
|
8.
Debt
Revolving Credit Facilities
—Sotheby's and certain of its wholly-owned subsidiaries are parties to a credit agreement with an international syndicate of lenders which provides for separate dedicated revolving credit facilities for the Agency segment (the "Agency Credit Facility") and SFS (the "SFS Credit Facility") (the "Credit Agreement"). On June 15, 2015, the Credit Agreement was amended to increase the commitments under the SFS Credit Facility in order to support the lending activities of SFS and to extend the maturity date of the Credit Agreement by
one
year to August 22, 2020.
The Agency Credit Facility is an asset-based revolving credit facility of which the proceeds may be used primarily for the working capital and other general corporate needs of the Agency segment. The SFS Credit Facility is an asset-based revolving credit facility of which the proceeds may be used primarily for the working capital and other general corporate needs of SFS, including the funding of client loans. The Credit Agreement allows Sotheby's to transfer the proceeds of borrowings under each of the revolving credit facilities between the Agency segment and SFS.
The maximum aggregate borrowing capacity of the Credit Agreement, which is subject to a borrowing base, is approximately
$1.335 billion
, with
$300 million
committed to the Agency segment and
$1.035 billion
committed to SFS, including a
$485 million
increase that was secured for SFS in conjunction with the
June 2015
amendment. The borrowing capacity of the Agency Credit Facility includes a
$50 million
incremental revolving credit facility with higher advance rates against certain assets and higher commitment and borrowing costs (the "Incremental Facility"). In July 2016, the Credit Agreement was amended to extend the maturity date of the Incremental Facility to August 22, 2017. This maturity date may be extended for an additional
365
days on an annual basis with the consent of the lenders who agree to extend their commitments under the Incremental Facility.
The Credit Agreement has a sub-limit of
$400 million
for foreign currency borrowings, with up to
$50 million
available for foreign currency borrowings under the Agency Credit Facility and up to
$350 million
available for foreign currency borrowings under the SFS Credit Facility. The Credit Agreement also includes an accordion feature, which allows Sotheby’s to seek an increase to the combined borrowing capacity of the Credit Agreement until February 23, 2020 by an amount not to exceed
$150 million
in the aggregate. Though new commitments would need to be obtained, the uncommitted accordion feature permits Sotheby’s to seek an increase to the aggregate commitments of either or both of the Agency and SFS credit facilities under an expedited arrangement process.
The borrowing base under the Agency Credit Facility is determined by a calculation that is primarily based upon a percentage of the carrying values of certain auction guarantee advances (see
Note 5
), a percentage of the carrying value of certain inventory, a percentage of the carrying value of certain extended payment term receivables arising from auction or private sale transactions (see
Note 5
), and the fair value of certain of Sotheby's trademarks. The borrowing base of the Incremental Facility is determined by a calculation that is based on a percentage of the carrying value of certain inventory and the fair value of certain of Sotheby's trademarks. The borrowing base under the SFS Credit Facility is determined by a calculation that is primarily based upon a percentage of the carrying values of certain loans in the SFS loan portfolio and the fair value of certain of Sotheby's trademarks.
The obligations under the Credit Agreements are cross-guaranteed and cross-collateralized. Domestic borrowers are jointly and severally liable for all obligations under the Credit Agreement and, subject to certain limitations, borrowers in the U.K. and Sotheby's Hong Kong Limited, are jointly and severally liable for all obligations of the foreign borrowers under the Credit Agreement. In addition, the obligations of the borrowers under the Credit Agreement are guaranteed by certain of their subsidiaries. Sotheby's obligations under the Credit Agreement are secured by liens on all or substantially all of the personal property of the entities that are borrowers and guarantors under the Credit Agreement.
The Credit Agreement contains certain customary affirmative and negative covenants including, but not limited to, limitations on capital expenditures, a
$600 million
limitation on net outstanding auction guarantees (i.e., auction guarantees less the impact of related risk and reward sharing arrangements), and limitations on the use of proceeds from borrowings under the Credit Agreement.
The Credit Agreement does not limit dividend payments and Common Stock repurchases provided that, both before and after giving effect thereto: (i) there are no events of default, (ii) the aggregate available borrowing capacity equals or exceeds
$100 million
, and (iii) the Liquidity Amount, as defined in the Credit Agreement, equals or exceeds
$200 million
. The Credit Agreement also contains certain financial covenants, which are only applicable during certain defined compliance periods. These financial covenants were not applicable for the twelve month period ended
June 30, 2016
.
Since August 2009, Sotheby’s has incurred aggregate fees of approximately
$21.5 million
in conjunction with the establishment of and subsequent amendments to the Credit Agreement. These fees are being amortized on a straight-line basis through the
August 22, 2020
maturity date of the Credit Agreement.
The following tables summarize information relevant to the Credit Agreement as of and for the periods ended
June 30, 2016
, December 31, 2015, and
June 30, 2015
(in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of and for the three and six months ended June 30, 2016
|
|
Agency Credit Facility
|
|
SFS Credit Facility
|
|
Total
|
Maximum borrowing capacity
|
|
$
|
300,000
|
|
|
$
|
1,035,000
|
|
|
$
|
1,335,000
|
|
Borrowing base
|
|
$
|
202,699
|
|
|
$
|
529,100
|
|
|
$
|
731,799
|
|
Borrowings outstanding
|
|
$
|
—
|
|
|
$
|
523,500
|
|
|
$
|
523,500
|
|
Available borrowing capacity (a)
|
|
$
|
202,699
|
|
|
$
|
5,600
|
|
|
$
|
208,299
|
|
Average Borrowings Outstanding:
|
|
|
|
|
|
|
Three months ended June 30, 2016
|
|
$
|
—
|
|
|
$
|
518,544
|
|
|
$
|
518,544
|
|
Six months ended June 30, 2016
|
|
$
|
—
|
|
|
$
|
529,129
|
|
|
$
|
529,129
|
|
Borrowing Costs - Three Months Ended June 30, 2016:
|
|
|
|
|
|
|
Interest
|
|
$
|
—
|
|
(b)
|
$
|
3,457
|
|
(c)
|
$
|
3,457
|
|
Fee amortization
|
|
715
|
|
(b)
|
696
|
|
(c)
|
1,411
|
|
Total borrowing costs
|
|
$
|
715
|
|
|
$
|
4,153
|
|
|
$
|
4,868
|
|
Borrowing Costs - Six Months Ended June 30, 2016:
|
|
|
|
|
|
|
Interest
|
|
$
|
—
|
|
(b)
|
$
|
7,130
|
|
(c)
|
$
|
7,130
|
|
Fee amortization
|
|
1,388
|
|
(b)
|
1,417
|
|
(c)
|
2,805
|
|
Total borrowing costs
|
|
$
|
1,388
|
|
|
$
|
8,547
|
|
|
$
|
9,935
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of and for the year ended December 31, 2015
|
|
Agency Credit Facility
|
|
SFS Credit Facility
|
|
Total
|
Maximum borrowing capacity
|
|
$
|
300,000
|
|
|
$
|
1,035,000
|
|
|
$
|
1,335,000
|
|
Borrowing base
|
|
$
|
225,642
|
|
|
$
|
547,586
|
|
|
$
|
773,228
|
|
Borrowings outstanding
|
|
$
|
—
|
|
|
$
|
541,500
|
|
|
$
|
541,500
|
|
Available borrowing capacity (a)
|
|
$
|
225,642
|
|
|
$
|
6,086
|
|
|
$
|
231,728
|
|
Average borrowings outstanding
|
|
$
|
—
|
|
|
$
|
541,004
|
|
|
$
|
541,004
|
|
Borrowing Costs - Year Ended December 31, 2015:
|
|
|
|
|
|
|
Interest
|
|
$
|
—
|
|
(b)
|
$
|
14,060
|
|
(c)
|
$
|
14,060
|
|
Fee amortization
|
|
2,752
|
|
(b)
|
1,720
|
|
(c)
|
4,472
|
|
Total borrowing costs
|
|
$
|
2,752
|
|
|
$
|
15,780
|
|
|
$
|
18,532
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of and for the three and six months ended June 30, 2015
|
|
Agency Credit Facility
|
|
SFS Credit Facility
|
|
Total
|
Maximum borrowing capacity
|
|
$
|
300,000
|
|
|
$
|
1,035,000
|
|
|
$
|
1,335,000
|
|
Borrowing base
|
|
$
|
221,812
|
|
|
$
|
622,849
|
|
|
$
|
844,661
|
|
Borrowings outstanding
|
|
$
|
—
|
|
|
$
|
593,000
|
|
|
$
|
593,000
|
|
Available borrowing capacity (a)
|
|
$
|
221,812
|
|
|
$
|
29,849
|
|
|
$
|
251,661
|
|
Average Borrowings Outstanding:
|
|
|
|
|
|
|
Three months ended June 30, 2015
|
|
$
|
—
|
|
|
$
|
538,868
|
|
|
$
|
538,868
|
|
Six months ended June 30, 2015
|
|
$
|
—
|
|
|
$
|
506,052
|
|
|
$
|
506,052
|
|
Borrowing Costs - Three Months Ended June 30, 2015:
|
|
|
|
|
|
|
Interest
|
|
$
|
—
|
|
(b)
|
$
|
3,662
|
|
(c)
|
$
|
3,662
|
|
Fee amortization
|
|
751
|
|
(b)
|
212
|
|
(c)
|
963
|
|
Total borrowing costs
|
|
$
|
751
|
|
|
$
|
3,874
|
|
|
$
|
4,625
|
|
Borrowing Costs - Six Months Ended June 30, 2015:
|
|
|
|
|
|
|
Interest
|
|
$
|
—
|
|
(b)
|
$
|
6,829
|
|
(c)
|
$
|
6,829
|
|
Fee amortization
|
|
1,457
|
|
(b)
|
433
|
|
(c)
|
1,890
|
|
Total borrowing costs
|
|
$
|
1,457
|
|
|
$
|
7,262
|
|
|
$
|
8,719
|
|
Legend:
(a) The available borrowing capacity is calculated as the borrowing base less borrowings outstanding.
(b) Borrowing costs related to the Agency Credit Facility, which include interest and fee amortization, are reflected in the Condensed Consolidated Income Statements as Interest Expense. See the table below for additional information related to Interest Expense associated with the Agency Credit Facility.
(c) Borrowing costs related to the SFS Credit Facility are reflected in the Condensed Consolidated Income Statements within Cost of Finance Revenues. For the
three and six months ended June 30, 2016
, the weighted average cost of borrowings related to the SFS Credit Facility was approximately
3.2%
. For the year ended December 31, 2015 and for the three and six months ended June 30, 2015, the weighted average cost of borrowings related to the SFS Credit Facility was approximately
2.9%
.
Long-Term Debt
—As of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
, Long-Term Debt consisted of the following (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2016
|
|
December 31,
2015
|
|
June 30,
2015
|
York Property Mortgage, net of unamortized debt issuance costs of $6,060, $6,565, and $0
|
|
$
|
312,398
|
|
|
$
|
315,504
|
|
|
$
|
218,609
|
|
2022 Senior Notes, net of unamortized debt issuance costs of $3,963, $4,251, and $4,515
|
|
296,037
|
|
|
295,749
|
|
|
295,485
|
|
Less current portion:
|
|
|
|
|
|
|
York Property Mortgage, net of unamortized debt issuance costs of
$1,010
, $1,010, and
$0
|
|
(6,491
|
)
|
|
(6,292
|
)
|
|
(6,542
|
)
|
Total Long-Term Debt, net
|
|
$
|
601,944
|
|
|
$
|
604,961
|
|
|
$
|
507,552
|
|
On January 1, 2016, Sotheby's retrospectively adopted ASU 2015-03, which requires unamortized debt issuance costs to be included as a direct deduction from the related debt liability on the balance sheet. Under previous guidance, all unamortized debt issuance costs were reported as assets on the balance sheet. See
Note 1
for information on the impact of the retrospective adoption of ASU 2015-03.
See the captioned sections below for information related to the York Property Mortgage and the 2022 Senior Notes.
York Property Mortgage
—On February 6, 2009, Sotheby's purchased the land and building located at 1334 York Avenue, New York, New York (the "York Property") from RFR Holding Corp. ("RFR") for a purchase price of
$370 million
. The York Property is home to Sotheby's sole North American auction salesroom and principal North American exhibition space, including S|2, Sotheby's private sale exhibition gallery. The York Property is also home to the U.S. operations of SFS, as well as Sotheby's corporate offices.
Sotheby's financed the
$370 million
purchase price through an initial
$50 million
cash payment made in conjunction with the signing of the related purchase and sale agreement on January 11, 2008, an
$85 million
cash payment made when the purchase was consummated on February 6, 2009, and the assumption of a
$235 million
mortgage that carried an initial annual rate of interest of approximately
5.6%
(the "Original York Property Mortgage"). The Original York Property Mortgage was due to mature on July 1, 2035, but had an optional pre-payment date of July 1, 2015, after which the annual rate of interest was scheduled to increase to
10.6%
.
On July 1, 2015, Sotheby's entered into a
seven
-year,
$325 million
mortgage loan (the "York Property Mortgage") to refinance the Original York Property Mortgage. After the repayment of the Original York Property Mortgage and the funding of all closing costs, reserves, and expenses, Sotheby's received net cash proceeds of approximately
$98 million
. The York Property Mortgage bears interest based on the
one
-month LIBOR rate (the "LIBOR rate") plus a spread of
2.25%
and is being amortized based on a
25
-year mortgage-style amortization schedule over the seven-year term of the mortgage, with the remaining principal balance of
$268.2 million
due to be paid on the July 1, 2022 maturity date.
In connection with the York Property Mortgage, Sotheby's entered into interest rate protection agreements secured by the York Property, consisting of a
two
-year interest rate swap effective as of July 1, 2015 and a
five
-year interest rate collar effective as of July 1, 2017. Both instruments have a notional amount equal to the applicable principal balance of the York Property Mortgage and have an identical amortization schedule to that of the mortgage. These interest rate protection agreements effectively hedge the LIBOR rate on the entire outstanding principal balance of the York Property Mortgage at an annual rate equal to
0.877%
for the first two years, and then at an annual rate of no less than
1.917%
, but no more than
3.75%
, for the remainder of the
seven
-year term. After taking into account the interest rate protection agreements, the annual interest rate for the first two years of the York Property Mortgage will be approximately
3.127%
and then will be between a floor of
4.167%
and a cap of
6%
for the remainder of the seven-year term. See
Note 18
for additional information related to the interest rate protection agreements.
The York Property, the York Property Mortgage, and the related interest rate protection agreements are held by 1334 York, LLC (the "LLC"), a separate legal entity of Sotheby's that maintains its own books and records and whose results are ultimately consolidated into Sotheby's financial statements. The LLC is the sole owner and lessor of the York Property. The LLC presently leases the York Property to Sotheby's, Inc., which is also controlled by Sotheby's. The assets of the LLC are not available to satisfy the obligations of other Sotheby's affiliates or any other entity.
The loan agreement governing the York Property Mortgage contains the following financial covenants, which are subject to additional terms and conditions as provided in the underlying loan agreement:
|
|
•
|
As of July 1, 2020, the loan to value ("LTV") ratio (i.e., the principal balance of the York Property Mortgage divided by the appraised value of the York Property) may not exceed
65%
(the "Maximum LTV") based on the then-outstanding principal balance of the York Property Mortgage. If the LTV ratio exceeds the Maximum LTV, the LLC may, at its option, post cash or a letter of credit or pay down the York Property Mortgage without any prepayment penalty or premium, in an amount that will cause the LTV ratio not to exceed the Maximum LTV.
|
|
|
•
|
At all times during the term of the York Property Mortgage, the Debt Yield will not be less than
8.5%
(the "Minimum Debt Yield"). The Debt Yield is calculated by dividing the annual net operating income of the LLC, which primarily consists of lease income from Sotheby's, Inc. (calculated on a cash basis), by the outstanding principal balance of the York Property Mortgage. If the Debt Yield falls below the Minimum Debt Yield, the LLC has the option to post cash or a letter of credit or prepay the York Property Mortgage without any prepayment penalty or premium, in an amount that will cause the Debt Yield to exceed the Minimum Debt Yield.
|
|
|
•
|
If Sotheby’s corporate credit rating from Standard & Poor’s Rating Services is downgraded to "BB-", the lender may require that the LLC establish cash management accounts (the "Cash Management Accounts") under the lender's control for potential monthly debt service, insurance, and tax payments. If the rating is downgraded to "B+" or "B", the lender may require the LLC to deposit a certain amount of debt service into the Cash Management Accounts (approximately
6
and
12
months of debt service, respectively). If the rating is downgraded to lower than "B", the LLC must make principal payments on the mortgage such that the LTV ratio does not exceed
65%
. On February 9, 2016, Sotheby's corporate credit rating from S&P was downgraded to "BB-" from "BB". As a result, a Cash Management Account was established under the control of the lender for monthly debt service, insurance, and tax payments. The lender will retain any excess cash after debt service, insurance, and taxes as security (estimated to be
$6 million
annually). As of
June 30, 2016
, the Cash Management Account had a balance of
$2.3 million
, which is reflected within Restricted Cash on the Condensed Consolidated Balance Sheets.
|
|
|
•
|
At all times during the term of the York Property Mortgage, Sotheby’s is required to maintain a net worth of at least
$425 million
, subject to a cure period.
|
As of
June 30, 2016
, the fair value of the York Property Mortgage approximates its book value due to the variable interest rate associated with the mortgage. The fair value measurement is considered to be a Level 2 fair value measurement in the fair value hierarchy as per Accounting Standards Codification 820,
Fair Value Measurements
("ASC 820").
2022 Senior Notes
—On September 27, 2012, Sotheby's issued
$300 million
aggregate principal amount of
5.25%
Senior Notes, due
October 1, 2022
(the "2022 Senior Notes"). The 2022 Senior Notes were offered only to qualified institutional buyers in accordance with Rule 144A and to non-U.S. Persons under Regulation S under the Securities Act of 1933, as amended (the "Securities Act"). Holders of the 2022 Senior Notes do not have registration rights, and the 2022 Senior Notes have not been and will not be registered under the Securities Act.
The net proceeds from the issuance of the 2022 Senior Notes were approximately
$300 million
, after deducting fees paid to the initial purchasers, and were principally used to retire
$80 million
of unsecured debt that was due in June 2015 and
$182 million
of convertible debt that was due in June 2013.
The 2022 Senior Notes are guaranteed, jointly and severally, on a senior unsecured basis by certain of Sotheby's existing and future domestic subsidiaries to the extent and on the same basis that such subsidiaries guarantee borrowings under the New Credit Agreement. Interest on the 2022 Senior Notes is payable semi-annually in cash on April 1 and October 1 of each year.
The 2022 Senior Notes are redeemable by Sotheby's, in whole or in part, on or after October 1, 2017, at specified redemption prices set forth in the underlying indenture, plus accrued and unpaid interest to, but excluding, the redemption date. Prior to October 1, 2017, the 2022 Senior Notes are redeemable, in whole or in part, at a redemption price equal to
100%
of the principal amount to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date, plus a premium equal to the greater of
1%
of the principal amount of the 2022 Senior Notes and a make-whole premium (as defined in the underlying indenture). The 2022 Senior Notes are not callable by holders unless Sotheby's is in default under the terms of the underlying indenture.
As of
June 30, 2016
, the
$300 million
principal amount of the 2022 Senior Notes had a fair value of approximately
$291 million
based on a broker quoted price derived via a pricing model using observable and unobservable inputs. As such, this fair value measurement is considered to be a Level 3 fair value measurement in the fair value hierarchy as per ASC 820.
Future Principal and Interest Payments
—The aggregate future principal and interest payments due under the York Property Mortgage, the 2022 Senior Notes, and Sotheby's credit revolving facility during the five-year period after the
June 30, 2016
balance sheet date are as follows (in thousands of dollars):
|
|
|
|
|
|
Period
|
|
Amount
|
July 2016 to June 2017
|
|
$
|
33,240
|
|
July 2017 to June 2018
|
|
$
|
36,582
|
|
July 2018 to June 2019
|
|
$
|
36,592
|
|
July 2019 to June 2020
|
|
$
|
36,602
|
|
July 2020 to June 2021
|
|
$
|
560,115
|
|
In consideration of the interest rate protection agreements relating to the York Property Mortgage, the table above assumes that the annual interest rate for the first two years of the mortgage will be approximately
3.127%
, and then will be at the interest rate collar's floor rate of
4.167%
for the remainder of the seven-year term.
Interest Expense
—For the
three and six months ended June 30, 2016
and
2015
, Interest Expense consisted of the following (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Six Months Ended
|
|
|
June 30,
|
June 30,
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Agency Credit Facility:
|
|
|
|
|
|
|
|
|
Amendment and arrangement fees
|
|
$
|
278
|
|
|
$
|
314
|
|
|
$
|
556
|
|
|
$
|
629
|
|
Commitment fees
|
|
437
|
|
|
437
|
|
|
832
|
|
|
828
|
|
Sub-total
|
|
715
|
|
|
751
|
|
|
1,388
|
|
|
1,457
|
|
York Property Mortgage
|
|
2,774
|
|
|
4,064
|
|
|
5,562
|
|
|
8,075
|
|
2022 Senior Notes
|
|
4,106
|
|
|
4,098
|
|
|
8,204
|
|
|
8,196
|
|
Other interest expense
|
|
43
|
|
|
161
|
|
|
30
|
|
|
7
|
|
Total Interest Expense
|
|
$
|
7,638
|
|
|
$
|
9,074
|
|
|
$
|
15,184
|
|
|
$
|
17,735
|
|
In the table above, Interest Expense related to the York Property Mortgage and the 2022 Senior Notes includes the amortization of debt issuance costs and, when applicable, the amortization of discount. Borrowing costs related to the SFS Credit Facility are reflected within Cost of Finance Revenues in the Condensed Consolidated Income Statements.
9.
Defined Benefit Pension Plan
Sotheby’s sponsors a defined benefit pension plan in the U.K. (the "U.K. Pension Plan"). Effective April 1, 2004, participation in the U.K. Pension Plan was closed to new employees and a defined contribution plan (the “U.K. Defined Contribution Plan”) was made available on that date. On April 30, 2016, after the completion of a statutory consultation process, the U.K. Pension Plan was closed to accrual of future service costs for active participants, who have become participants in the U.K. Defined Contribution Plan.
The table below summarizes the components of the net pension (benefit) cost related to the U.K. Pension Plan for the
three and six
months ended
June 30, 2016
and
2015
(in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Service cost
|
|
$
|
289
|
|
|
$
|
1,126
|
|
|
$
|
1,153
|
|
|
$
|
2,241
|
|
Interest cost
|
|
2,611
|
|
|
3,237
|
|
|
5,215
|
|
|
6,442
|
|
Expected return on plan assets
|
|
(4,733
|
)
|
|
(5,053
|
)
|
|
(9,454
|
)
|
|
(10,057
|
)
|
Amortization of actuarial loss
|
|
—
|
|
|
993
|
|
|
—
|
|
|
1,977
|
|
Amortization of prior service cost
|
|
—
|
|
|
91
|
|
|
—
|
|
|
181
|
|
Net pension (benefit) cost
|
|
$
|
(1,833
|
)
|
|
$
|
394
|
|
|
$
|
(3,086
|
)
|
|
$
|
784
|
|
For the
six months ended
June 30, 2016
, Sotheby's contributed
$0.6 million
to the U.K. Pension Plan. Total contributions by Sotheby's for the year ending December 31, 2016 will be determined in conjunction with the ongoing triennial statutory funding valuation of the plan, which is expected to be completed by the end of 2016.
10.
Commitments and Contingencies
Compensation Arrangements
—As of
June 30, 2016
, Sotheby’s had compensation arrangements with certain senior employees, which expire at various points between
February 28, 2017
and
March 31, 2020
. Such arrangements may provide, among other benefits, for minimum salary levels and for compensation under Sotheby's incentive compensation programs that is payable only if specified Company and individual goals are attained. Additionally, under certain circumstances, certain of these arrangements provide annual share-based payments, severance payments, and other cash compensation. The aggregate remaining commitment for salaries and other cash compensation related to these compensation arrangements, excluding any participation in Sotheby’s incentive compensation programs, was approximately
$10.9 million
as of
June 30, 2016
.
Legal Contingencies
—Sotheby’s becomes involved in various claims and lawsuits incidental to the ordinary course of its business, including the matter described below. Management is 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. While the impact of any one or more legal claims or proceedings could be material to Sotheby's operating results in any period, management does not believe that the outcome of any of these pending claims or proceedings, individually or in the aggregate, will have a material adverse effect on Sotheby’s consolidated financial condition.
Estate of Robert Graham, et al. v. Sotheby's, Inc.
is a purported class action commenced in the U.S. District Court for the Central District of California in October 2011 on behalf of U.S. artists (and their estates) whose artworks were sold by Sotheby's in the State of California or at auction by California sellers and for which a royalty was allegedly due under the California Resale Royalties Act (the "Resale Royalties Act"). Plaintiffs seek unspecified damages, punitive damages and injunctive relief for alleged violations of the Resale Royalties Act and the California Unfair Competition Law. In January 2012, Sotheby’s filed a motion to dismiss the action on the grounds, among others, that the Resale Royalties Act violates the U.S. Constitution and is preempted by the U.S. Copyright Act of 1976. In February 2012, the plaintiffs filed their response to Sotheby's motion to dismiss. The court heard oral arguments on the motion to dismiss on March 12, 2012. On May 17, 2012, the court issued an order dismissing the action on the ground that the Resale Royalties Act violated the Commerce Clause of the U.S. Constitution. The plaintiffs appealed this ruling. On May 5, 2015, an en banc panel of the U.S. Court of Appeals for the Ninth Circuit issued a decision affirming the lower court decision that the Resale Royalties Act was unconstitutional insofar as it sought to apply to sales outside of the state of California. The plaintiffs filed a motion for certiorari to the U.S. Supreme Court, which was denied on January 11, 2016. On April 12, 2016, the district court granted Sotheby's motion to dismiss the remaining claims in the action, which relate to sales that occurred in California. The plaintiffs have appealed this decision.
See
Note 5
for information related to unfunded commitments to extend additional credit through SFS. See
Note 6
for information regarding the contingent consideration arrangement related to the AAP acquisition. See
Note 8
for information related to debt commitments. See
Note 12
for information related to Sotheby's auction guarantees. See
Note 21
for information related to income tax contingencies.
11.
Other Current Liabilities
In the second quarter of
2016
, Sotheby's sold an undivided legal and beneficial
50%
ownership interest in a Fancy Vivid Pink Diamond (the "Pink Diamond"), weighing 59.60 carats, for
$34.2 million
in cash. The entire value of the Pink Diamond will continue to be reported within Inventory on the Condensed Consolidated Balance Sheets pending the future sale of a
100%
interest in the property. Until such time, the amount received by Sotheby's will be recorded within Other Current Liabilities on the Condensed Consolidated Balance Sheets. Upon completion of the future sale of a
100%
interest in the Pink Diamond, the revenue associated with the final sale will include the
$34.2 million
already collected and will be recorded within Inventory Sales on the income statement with the corresponding acquisition cost recorded as Cost of Inventory Sales.
12.
Auction Guarantees
From time-to-time in the ordinary course of its business, Sotheby’s will guarantee to a consignor a minimum sale price in connection with the sale of property at auction (an "auction guarantee"). If the property offered under the auction guarantee sells above the minimum guaranteed price, Sotheby’s is generally entitled to a share of the excess proceeds (the "overage"). In the event that the property sells for less than the minimum guaranteed price, Sotheby’s must perform under the auction guarantee by funding the difference between the sale price at auction and the amount of the auction guarantee (the "shortfall"). The amount of any shortfall recorded in Sotheby's financial statements is reduced by any auction commissions earned on property sold under the auction guarantee. If any item of property offered under the auction guarantee does not sell, the amount of the auction guarantee must be paid, but Sotheby’s takes ownership of the unsold property and may recover the amount paid through its future sale. 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.
In situations when an item of guaranteed property does not sell, Sotheby's takes ownership of the property and it is recorded as Inventory on the Condensed Consolidated Balance Sheets at the lower of its cost (i.e., the amount paid under the auction guarantee) or management’s estimate of the property's net realizable value (i.e., the expected sale price upon its eventual disposition). The market for fine art, decorative art, and jewelry is not a highly liquid trading market. As a result, the valuation of property acquired as a result of failed auction guarantees is inherently subjective and its realizable value often fluctuates over time. Accordingly, the proceeds ultimately realized by Sotheby’s on the sale of previously guaranteed property may equal, exceed, or be less than the estimated net realizable value recorded as Inventory on the Condensed Consolidated Balance Sheets.
Sotheby’s may reduce its financial exposure under auction guarantees through contractual risk and reward sharing arrangements. Such auction guarantee risk and reward sharing arrangements include irrevocable bids and partner sharing arrangements. An irrevocable bid is an arrangement under which a counterparty commits to bid a predetermined price on the guaranteed property. If the irrevocable bid is not the winning bid, the counterparty is generally entitled to receive a share of the auction commission earned on the sale and/or a share of any overage. If the irrevocable bid is the winning bid, the counterparty may receive a fixed fee as compensation for providing the irrevocable bid. This fee may be netted against the counterparty's obligation to pay the full purchase price (i.e., the hammer price plus the applicable buyer's premium). In a partner sharing arrangement, a counterparty commits to fund: (i) a share of the difference between the sale price at auction and the amount of the auction guarantee if the property sells for less than the minimum guaranteed price or (ii) a share of the minimum guaranteed price if the property does not sell while taking ownership of a proportionate share of the unsold property. In exchange for accepting a share of the financial exposure under the auction guarantee, the counterparty in a partner sharing arrangement is generally entitled to receive a share of the auction commission earned if the property sells and/or a share of any overage.
The counterparties to the auction guarantee risk and reward sharing arrangements entered into by Sotheby's are typically major international art dealers or major art collectors. Sotheby’s could be exposed to losses in the event any of these counterparties do not perform according to the terms of these contractual arrangements.
Although irrevocable bid and partner sharing arrangements may be used to reduce the risk associated with auction guarantees, Sotheby's may also enter into auction guarantees without securing such arrangements. In these circumstances, Sotheby's could be exposed to deterioration in auction commission margins and/or auction guarantee losses if one or more of the guaranteed items fails to sell at its minimum guaranteed price. Furthermore, in such situations, Sotheby's liquidity could be reduced.
Sotheby's credit agreement has a covenant that imposes a
$600 million
limitation on net outstanding auction guarantees (i.e., the aggregate financial exposure under outstanding auction guarantees less the impact of related risk and reward sharing arrangements). In addition to compliance with this covenant, significant auction guarantees and related risk and reward sharing arrangements are subject to approval by Sotheby's Board of Directors.
As of
June 30, 2016
, Sotheby’s had outstanding auction guarantees totaling approximately
$3.3 million
. Each of the outstanding auction guarantees has a minimum guaranteed price that is within or below the range of the pre-sale auction estimates for the underlying property. A substantial portion of property related to these auction guarantees was offered at an auction in July 2016. As of
December 31, 2015
and
June 30, 2015
, the carrying value of the liability representing the estimated fair value of Sotheby’s obligation to perform under its outstanding auction guarantees totaled
$1 million
and
$0.5 million
, respectively, and is recorded within Accounts Payable and Accrued Liabilities on the Condensed Consolidated Balance Sheets. As of
June 30, 2016
, the liability related to Sotheby's obligation to perform under its outstanding auction guarantees was not material.
On September 2, 2015, Sotheby's entered into an arrangement with the Estate of A. Alfred Taubman (the "Estate") under which it is selling works of art from the collection of A. Alfred Taubman (the "Taubman Collection"). Robert S. Taubman, a trustee and beneficiary of the Estate, was a director of Sotheby's at the time the arrangement was consummated. In connection with this arrangement, Sotheby's provided an auction guarantee of
$509 million
, after taking into account items withdrawn by the Estate prior to sale. As of
June 30, 2016
, the remaining outstanding auction guarantee related to the Taubman Collection totaled
$0.8 million
. See
Note 22
for additional information related to this related party auction guarantee.
As of July 29, 2016, Sotheby's had outstanding auction guarantees totaling
$110.1 million
. Each of the auction guarantees outstanding as of July 29, 2016, had a minimum guaranteed price that was within or below the range of the pre-sale auction estimates for the underlying property. A substantial portion of the property related to these auction guarantees is being offered at auctions in the fourth quarter of 2016, with the remaining property scheduled to be offered in the first quarter of 2017.
13.
Shareholders' Equity and Dividends
Common Stock Repurchase Program
—In January 2014, the Board of Directors authorized a
five
-year,
$150 million
Common Stock repurchase program. In March 2014, Sotheby's repurchased
558,171
shares of its Common Stock for an aggregate purchase price of
$25 million
(
$44.79
per share) pursuant to an accelerated share repurchase ("ASR") agreement.
On August 6, 2015, the Board of Directors approved an increase of
$125 million
to Sotheby's share repurchase authorization, which resulted in a total share repurchase authorization of
$250 million
as of that date. On August 13, 2015, Sotheby's entered into an ASR agreement (the "August 2015 ASR Agreement") pursuant to which it received an initial delivery of
2,667,378
shares of its Common Stock for an initial purchase price of
$125 million
. The initial shares received by Sotheby's on August 13, 2015 had a value of
$100 million
, or
$37.49
per share. In November 2015, the counterparty to the August 2015 ASR Agreement elected to conclude the agreement, and Sotheby's received an additional
1,038,280
shares of its Common Stock. Accordingly, in total, the August 2015 ASR Agreement resulted in the repurchase of
3,705,658
shares of Sotheby's Common Stock for an average price of
$33.73
per share.
On January 21, 2016, the Board of Directors approved a
$200 million
increase to Sotheby's remaining
$125 million
share repurchase authorization, resulting in an updated total share repurchase authorization of
$325 million
. For the six months ended June 30, 2016, Sotheby's repurchased
10,988,730
shares of its Common Stock for
$282.2 million
(including fees and commissions) at an average price of
$25.68
per share under this increased authorization through open market purchases and purchases made pursuant to a Rule 10b5-1 plan. As of August 4, 2016,
$42.9 million
remains under the current share repurchase authorization. Management expects to continue to repurchase shares of Common Stock under this authorization via open market purchases, purchases made pursuant to a Rule 10b5-1 plan, and/or accelerated share repurchase agreements, subject to the factors described in the following paragraph.
The timing of share repurchases and the actual amount purchased will depend on a variety of factors, including the market price of Sotheby's Common Stock, general market and economic conditions, securities law requirements, and other corporate considerations. Repurchases may continue to be made pursuant to plans intended to comply with Rule 10b5-1 under the Exchange Act, which allows Sotheby's to purchase its shares during periods when it otherwise might be prevented from doing so under insider trading laws or because of self-imposed trading blackout periods. The repurchase authorization does not require the purchase of a specific number of shares and is subject to suspension or termination by the Board of Directors at any time.
Quarterly Cash Dividends
—For the
three and six months ended
June 30, 2015
, Sotheby's declared and paid quarterly cash dividends at a rate of
$0.10
per share for a total of
$6.9 million
and
$13.8 million
, respectively. On January 21, 2016, the Board of Directors decided to eliminate Sotheby's
$0.10
per share quarterly cash dividend and allocate the capital instead to repurchase shares of Common Stock, as discussed above.
Special Dividend
—In January 2014, the Board of Directors declared a special dividend of
$300 million
(
$4.34
per share) that was paid on March 17, 2014. The special dividend was funded principally by the repatriation of
$250 million
of cash from Sotheby’s foreign subsidiaries, with the remaining
$50 million
funded by then existing domestic cash balances. In conjunction with this special dividend, Sotheby's accrued approximately
$11 million
for dividend equivalents owed on share-based payments to employees and charged to retained earnings. Through June 30, 2016, approximately
$7.2 million
of such dividend equivalents has been paid to employees, including
$1.4 million
and
$2 million
paid in March 2016 and March 2015, respectively. See
Note 14
for information related to Sotheby's share-based payment programs.
14.
Share-Based Payments
Share-based payments to employees include performance-based stock unit awards, market-based stock unit awards, restricted stock units, restricted stock shares, and stock options. A description of each of these share-based payments is provided below.
For the
three and six months ended
June 30, 2016
and
2015
, compensation expense related to share-based payments is reflected in the following accounts in the Condensed Consolidated Income Statements (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Salaries and related costs
|
|
$
|
2,291
|
|
|
$
|
9,582
|
|
|
$
|
8,128
|
|
|
$
|
15,235
|
|
Voluntary separation incentive programs (see Note 15)
|
|
(334
|
)
|
|
—
|
|
|
$
|
(640
|
)
|
|
$
|
—
|
|
CEO separation and transition costs (see Note 16)
|
|
—
|
|
|
—
|
|
|
$
|
—
|
|
|
$
|
2,000
|
|
Total share-based payment expense (pre-tax)
|
|
$
|
1,957
|
|
|
$
|
9,582
|
|
|
$
|
7,488
|
|
|
$
|
17,235
|
|
Total share-based payment expense (after-tax)
|
|
$
|
1,609
|
|
|
$
|
6,623
|
|
|
$
|
5,410
|
|
|
$
|
11,453
|
|
For the three and
six months ended
June 30, 2016
, Sotheby's recognized credits of
($0.3) million
and
($0.6) million
, respectively, related to share-based payments associated with the voluntary separation programs enacted in the fourth quarter of 2015. These credits are the result of changes in management's estimate of the number of performance-based stock units held by program participants that are expected to vest.
For the
six months ended
June 30, 2016
, Sotheby's recognized a
($1.3) million
tax shortfall related to share-based payment arrangements. This tax shortfall represents the amount by which the tax deduction resulting from the vesting of share-based payments in the period was less than the tax benefit initially recognized in Sotheby's financial statements upon the amortization of compensation expense. The
($1.3) million
tax shortfall in the period is accounted for as a reduction to previously recognized excess tax benefits related to share-based payments recorded within Additional Paid-in Capital on the Condensed Consolidated Balance Sheets.
For the
six months ended
June 30, 2015
, Sotheby's recognized
$1.1 million
of excess tax benefits related to share-based payment arrangements. These tax benefits represent the amount by which the tax deduction resulting from the vesting of share-based payments in the period exceeded the tax benefit initially recognized in Sotheby's financial statements upon the amortization of compensation expense. Excess tax benefits are recognized on the Condensed Consolidated Balance Sheets as an increase to Additional Paid-in Capital and are classified within Financing Activities in the Condensed Consolidated Statements of Cash Flows.
As of
June 30, 2016
, unrecognized compensation expense related to the unvested portion of share-based payments was
$28.3 million
. This compensation expense is expected to be amortized over a weighted-average period of approximately
2.5
years. Sotheby’s does not capitalize any compensation expense related to share-based payments to employees.
Sotheby's Restricted Stock Unit Plan
—Sotheby's Third Amended and Restated Restricted Stock Unit Plan (the "Restricted Stock Unit Plan") provides for the issuance of Restricted Stock Units ("RSU's") and restricted stock shares to employees, subject to the approval of the Compensation Committee of the Board of Directors (the "Compensation Committee"). In making awards under the Restricted Stock Unit Plan, the Compensation Committee takes into account the nature of the services rendered by employees, their present and potential future contributions to Sotheby's success, and such other factors as the Compensation Committee in its discretion deems relevant.
RSU's and restricted stock shares issued under the Restricted Stock Unit Plan generally vest evenly over a
three
-year service period. Prior to vesting, holders of RSU's and restricted stock shares are entitled to receive non-forfeitable dividend equivalents and dividends, respectively, at the same rate as dividends are paid on Sotheby's Common Stock (if and when such dividends are paid). Prior to vesting, holders of RSU's do not have voting rights, while holders of restricted stock shares have voting rights. RSU's and restricted stock shares may not be sold, assigned, transferred, pledged or otherwise encumbered until they vest.
Performance Share Units (or "PSU's") are RSU's that generally vest over
three
or
four
years, subject to the achievement of certain profitability targets (for awards granted prior to 2016) or certain return on invested capital ("ROIC") targets (for awards granted in 2016). Prior to vesting, holders of PSU's do not have voting rights and are not entitled to receive dividends or dividend equivalents. Dividend equivalents are generally credited to holders of PSU's at the same rate as dividends are paid on Sotheby's Common Stock (if and when such dividends are paid), but are only paid for PSU's that vest and become shares of Common Stock. PSU's may not be sold, assigned, transferred, pledged or otherwise encumbered until they vest.
For the
six months ended
June 30, 2016
, the Compensation Committee granted share-based payment awards with a total grant date fair value of
$23.7 million
, as follows:
|
|
•
|
607,606
PSU's with a grant date fair value of
$14.4 million
and a single vesting opportunity after a three-year service period. These PSU awards provide recipients with an opportunity to vest in incremental PSU's of up to
200%
of the initial units awarded subject to the achievement of certain ROIC targets. The maximum number of shares of Common Stock that may be issued with respect to these awards is
1,215,212
.
|
|
|
•
|
394,371
RSU's with annual vesting over a
three
-year service period and a grant date fair value of
$9.3 million
.
|
Summary of Outstanding Share-Based Payment Awards
—For the
six months ended
June 30, 2016
, changes to the number of outstanding RSU’s, PSU’s, and Restricted Stock shares were as follows (shares in thousands):
|
|
|
|
|
|
|
|
|
Restricted Stock Shares, RSU's and PSU's
|
|
Weighted
Average
Grant Date
Fair Value
|
Outstanding at January 1, 2016
|
2,019
|
|
|
$
|
43.61
|
|
Granted
|
1,002
|
|
|
$
|
23.66
|
|
Vested
|
(533
|
)
|
|
$
|
39.63
|
|
Canceled
|
(164
|
)
|
|
$
|
38.29
|
|
Outstanding at June 30, 2016
|
2,324
|
|
|
$
|
36.30
|
|
As of
June 30, 2016
,
2.6 million
shares were available for future awards pursuant to the Restricted Stock Unit Plan. The aggregate fair value of RSU’s and PSU's that vested during the
six
months ended
June 30, 2016
and
2015
was
$13.8 million
and
$22.9 million
, respectively, based on the closing stock price on the dates the shares vested.
Stock Options
—Stock options issued pursuant to the Sotheby's 1997 Stock Option Plan are exercisable into authorized, but unissued shares of Sotheby's Common Stock. Stock options vest evenly over
four
years and expire
ten
years after the date of grant. As of
June 30, 2016
,
104,100
shares of Common Stock were available for the issuance of stock options under the Stock Option Plan. As of
June 30, 2016
,
50,000
stock options were outstanding and exercisable with a weighted average exercise price of
$22.11
per share, a weighted average remaining contractual term of
3.6
years, and an aggregate intrinsic value of
$0.3 million
.
No
stock options were exercised or granted during the
six months ended
June 30, 2016
and
2015
.
15.
Voluntary Separation Incentive Programs (Net)
On November 13, 2015, Sotheby's announced a series of regional voluntary separation incentive programs (the "Programs") aimed at reducing headcount and associated compensation costs. The Programs were offered to Sotheby's employees in jurisdictions where it was practical to do so. Employees who elected to participate in the Programs were accepted only upon approval by Sotheby's management. Employee transitions under the Programs commenced on December 31, 2015 and will occur throughout 2016.
In the fourth quarter of 2015, Sotheby's recognized a charge of
$36.9 million
as a result of the Programs, consisting of
$33.8 million
in cash severance benefits and
$3.1 million
in accelerated equity compensation expense related to awards that will continue to vest after termination of employment, subject to Sotheby's achievement of the underlying profitability targets, when applicable. The liability related to the
$33.8 million
in cash severance benefits is recorded within Accounts Payable and Accrued Liabilities on the December 31, 2015 Condensed Consolidated Balance Sheet and includes
$4.7 million
related to 2015 incentive compensation that would have been paid to participants had they not participated in the Programs.
For the
three and six months ended
June 30, 2016
, Sotheby's recognized net credits of
($0.2) million
and
($0.5) million
, respectively, to the previously recorded charge primarily as a result of management’s quarterly assessment of the likelihood that performance-based stock units held by participants in the Programs will vest. As of
June 30, 2016
, Sotheby's has made cash payments of approximately
$31.3 million
related to the Programs. Accordingly, the remaining accrued liability related to the Programs recorded within Accounts Payable and Accrued Liabilities on the
June 30, 2016
Condensed Consolidated Balance Sheet was
$2.5 million
. The remaining liability is expected to be settled through cash payments made principally in the third quarter of 2016.
16.
CEO Separation and Transition Costs
In the first quarter of 2015, Sotheby's recognized
$4.2 million
in costs associated with the hiring of Thomas S. Smith, Jr. as its President and Chief Executive Officer. These costs principally relate to compensation of
$3.1 million
owed to Mr. Smith to replace incentive compensation that he expected to receive from his previous employer, consisting of a fully-vested restricted stock unit award with a fair value of
$2 million
granted on March 31, 2015 and a
$1.1 million
cash payment that was paid in September 2015. There was no required service period associated with this compensation. The CEO Separation and Transition Costs recognized in the first quarter of 2015 also include approximately
$1.1 million
in recruitment and other professional fees associated with the CEO hiring process.
17.
Restructuring Charges (Net)
On July 16, 2014, the Board of Directors approved a restructuring plan (the "2014 Restructuring Plan") principally impacting Sotheby's operations in the United States ("U.S.") and the U.K. The 2014 Restructuring Plan resulted in Restructuring Charges (net) of
$14.2 million
recognized in 2014, consisting of
$13.9 million
in employee termination benefits and approximately
$0.3 million
in lease exit costs. For the
three and six months ended
June 30, 2015, Sotheby's recognized credits of approximately
($0.5) million
and
($0.9) million
, respectively, in Restructuring Charges (net) as a result of adjustments to the initial accrual for employee termination benefits. The headcount reductions resulting from the 2014 Restructuring Plan were completed in the third quarter of 2015 and the associated liability has been fully settled.
18.
Derivative Financial Instruments
Derivative Financial Instruments Designated as Cash Flow Hedges
—On July 1, 2015, Sotheby's entered into a
seven
-year,
$325 million
mortgage loan to refinance its previous mortgage on the York Property. The York Property Mortgage bears interest based on the
one
-month LIBOR rate plus a spread of
2.25%
and is being amortized based on a
25
-year mortgage-style amortization schedule over the
seven
-year term of the mortgage. In connection with the York Property Mortgage, Sotheby's entered into interest rate protection agreements secured by the York Property, consisting of a
two
-year interest rate swap (the "Swap"), effective as of
July 1, 2015
, and a
five
-year interest rate collar (the "Collar"), effective as of
July 1, 2017
. Both of these instruments have a notional amount equal to the applicable principal balance of the York Property Mortgage and have an identical amortization schedule to that of the mortgage. The York Property, the York Property Mortgage, and the related interest rate protection agreements are held by 1334 York, LLC, a separate legal entity of Sotheby's that maintains its own books and records and whose results are ultimately consolidated into Sotheby's financial statements. See
Note 8
for additional information related to the York Property Mortgage.
As of
June 30, 2016
, the notional value of the Swap was equal to the
$318.5 million
principal balance of the York Property Mortgage on that date, and the notional value of the Collar was
$310.3 million
, which is equal to the forecasted principal balance of the York Property Mortgage as of the Collar's effective date. These interest rate protection agreements effectively hedge the LIBOR rate on the entire outstanding principal balance of the York Property Mortgage at an annual rate equal to
0.877%
for the first two years, and then at an annual rate of no less than
1.917%
, but no more than
3.75%
, for the remainder of the
seven
-year term. After taking into account the interest rate protection agreements, the annual interest rate for the first two years of the York Property Mortgage will be approximately
3.127%
and then will be between a floor of
4.167%
and a cap of
6%
for the remainder of the
seven
-year term.
At their inception, the Swap and the Collar were each individually designated as cash flow hedges of the risk associated with the variability in expected cash outflows related to the monthly one-month LIBOR-indexed interest payments on the York Property Mortgage. Accordingly, to the extent that the Swap and the Collar are effective, any unrealized gains and losses related to changes in their fair value are recorded to Accumulated Other Comprehensive Loss on the Condensed Consolidated Balance Sheets and then reclassified to Interest Expense in the Condensed Consolidated Income Statements as interest expense related to the mortgage is recorded. Any hedge ineffectiveness is immediately recognized in Interest Expense. There was
no
hedge ineffectiveness related to the Swap or the Collar during the
three and six months ended
June 30, 2016
. Management performs a quarterly assessment to determine whether the Swap and the Collar continue to be highly effective in hedging the risk associated with the variability in expected cash outflows related to the monthly one-month LIBOR-indexed interest payments on the York Property Mortgage.
As of
June 30, 2016
and December 31, 2015, the fair value of the Swap recorded in Other Current Liabilities on the Condensed Consolidated Balance Sheets was
$1.3 million
and
$0.4 million
, respectively. For the three and six months ended
June 30, 2016
, the loss in fair value associated with the Swap recognized in Other Comprehensive Loss was
$0.3 million
(net of tax) and
$1.1 million
(net of tax), respectively, and the amount reclassified to Interest Expense during the three and six-month periods was
$0.2 million
(net of tax) and
$0.4 million
(net of tax), respectively.
As of
June 30, 2016
and
December 31, 2015
, the fair value of the Collar recorded in Other Long-Term Liabilities on the Condensed Consolidated Balance Sheets was
$16.2 million
and
$6.8 million
, respectively. For the
three and six months ended
June 30, 2016
, the loss in fair value associated with the Collar recognized in Other Comprehensive Loss was
$1.9 million
(net of tax) and
$5.8 million
(net of tax), respectively.
The liabilities associated with the Swap and the Collar have been designated as Level 2 fair value measurements within the fair value hierarchy provided by ASC 820. Level 2 fair value measurements have pricing inputs other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value may be determined through the use of models or other valuation methodologies. The fair value of the Swap is based on a discounted cash flow methodology using the contractual terms of the instrument and observable LIBOR-curve rates that are consistent with the timing of the interest payments related to the York Property Mortgage. The fair value of the Collar is based on an option pricing model using observable LIBOR-curve rates for each forecasted monthly settlement, with the projected cash flows discounted using the contractual terms of the instrument, which are consistent with the timing of the interest payments related to the York Property Mortgage.
Derivative Financial Instruments Designated as Net Investment Hedges
—In the fourth quarter of 2015, in consideration of the expansion of Sotheby's Common Stock repurchase program, as well as the need for cash in the U.S. to fund other corporate strategic initiatives, management assessed its U.S. and foreign cash needs and concluded that approximately
$600 million
of accumulated foreign earnings would be repatriated to the U.S. in the foreseeable future. As of
June 30, 2016
, approximately
$337 million
of these foreign earnings had been repatriated and used, in part, to fund Common Stock repurchases during the first six months of 2016. Management expects that additional repatriations will be made later in 2016, though the specific timing of any further repatriation of foreign earnings is currently being evaluated. These accumulated foreign earnings represent almost the entire value of Sotheby’s foreign currency denominated net investments in the subsidiaries from which the earnings are being repatriated. As a result, Sotheby's is exposed to variability in the U.S. Dollar equivalent of these foreign currency denominated net investments and, by extension, the U.S. Dollar equivalent of any foreign earnings repatriated to the U.S. due to potential changes in foreign currency exchange rates. Accordingly, on June 1, 2016, Sotheby's entered into foreign currency forward exchange contracts with an aggregate notional value of
$295.5 million
, which were each designated as a net investment hedge. As of
June 30, 2016
, the aggregate notional value of these contracts was
$214.8 million
.
Sotheby’s uses the forward rate method to assess the effectiveness of its net investment hedges. Under the forward rate method, if both the notional amount of the derivative designated as a hedge of a net investment in a foreign subsidiary equals the portion of the net investment designated as being hedged and the derivative relates solely to the foreign exchange rate between the functional currency of the hedged net investment and the investor’s functional currency, then all changes in fair value of the derivative are reported in the cumulative translation adjustment accounts within Accumulated Other Comprehensive Loss on the Condensed Consolidated Balance Sheets.
The foreign currency forward exchange contracts designated as net investment hedges are considered Level 2 fair value measurements within the fair value hierarchy provided by ASC 820. Level 2 fair value measurements have pricing inputs other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value may be determined through the use of models or other valuation methodologies. The fair value of these foreign currency forward exchange contracts is based on the estimated amount to settle the contracts using applicable market exchange rates as of the balance sheet date.
The following table summarizes fair value information related to the derivative financial instruments designated as hedging instruments as reflected on Sotheby's Condensed Consolidated Balance Sheets as of
June 30, 2016
(in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
Liabilities
|
|
|
Balance Sheet Classification
|
|
Fair Value
|
|
Balance Sheet Classification
|
|
Fair Value
|
Cash Flow Hedges:
|
|
|
|
|
|
|
|
|
|
|
Interest rate swap
|
|
N/A
|
|
$
|
—
|
|
|
Other Current Liabilities
|
|
$
|
1,341
|
|
Interest rate collar
|
|
N/A
|
|
—
|
|
|
Other Long-Term Liabilities
|
|
16,194
|
|
Total cash flow hedges
|
|
|
|
—
|
|
|
|
|
17,535
|
|
Net Investment Hedges:
|
|
|
|
|
|
|
|
|
Foreign exchange contracts
|
|
Other Current Assets
|
|
12,828
|
|
|
Other Current Liabilities
|
|
315
|
|
Total
|
|
|
|
$
|
12,828
|
|
|
|
|
$
|
17,850
|
|
The following tables summarize the effect of the derivative financial instruments designated as hedging instruments on Sotheby's Condensed Consolidated Income Statements and Condensed Consolidated Statements of Comprehensive Income for the
three and six months ended
June 30, 2016
and
2015
(in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
|
Gain (Loss) Recognized in Other Comprehensive Income(Loss) - Effective Portion
|
|
Classification of Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss into Net Income
|
|
Amount Reclassified from Accumulated Other Comprehensive Loss into Net Income - Effective Portion
|
|
|
2016
|
|
2015
|
|
|
|
2016
|
|
2015
|
Cash Flow Hedges:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swap
|
|
$
|
(290
|
)
|
|
$
|
—
|
|
|
Interest Expense
|
|
$
|
216
|
|
|
$
|
—
|
|
Interest rate collar
|
|
(1,873
|
)
|
|
—
|
|
|
Interest Expense
|
|
—
|
|
|
—
|
|
Total cash flow hedges
|
|
(2,163
|
)
|
|
—
|
|
|
|
|
216
|
|
|
—
|
|
Net Investment Hedges:
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange contracts
|
|
5,773
|
|
|
—
|
|
|
Other Income/(Expense)
|
|
—
|
|
|
—
|
|
Total
|
|
$
|
3,610
|
|
|
$
|
—
|
|
|
|
|
$
|
216
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
|
|
Gain (Loss) Recognized in Other Comprehensive Income (Loss) - Effective Portion
|
|
Classification of Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss into Net Income
|
|
Amount Reclassified from Accumulated Other Comprehensive Loss into Net Income - Effective Portion
|
|
|
2016
|
|
2015
|
|
|
|
2016
|
|
2015
|
Cash Flow Hedges:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swap
|
|
$
|
(1,083
|
)
|
|
$
|
—
|
|
|
Interest Expense
|
|
$
|
439
|
|
|
$
|
—
|
|
Interest rate collar
|
|
(5,792
|
)
|
|
—
|
|
|
Interest Expense
|
|
—
|
|
|
—
|
|
|
|
(6,875
|
)
|
|
—
|
|
|
|
|
439
|
|
|
—
|
|
Net Investment Hedges:
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange contracts
|
|
5,773
|
|
|
—
|
|
|
Other Income/(Expense)
|
|
—
|
|
|
—
|
|
Total
|
|
$
|
(1,102
|
)
|
|
$
|
—
|
|
|
|
|
$
|
439
|
|
|
$
|
—
|
|
Derivative Financial Instruments Not Designated as Hedging Instruments
—Sotheby’s also utilizes forward exchange contracts to hedge cash flow exposures related to foreign currency exchange rate movements arising from short-term foreign currency denominated intercompany balances and, to a much lesser extent, foreign currency denominated client payable balances, as well as foreign currency denominated auction guarantee obligations. Such forward exchange contracts are typically short-term with settlement dates less than six months from their inception. All instruments used to offset cash flow exposures related to foreign currency exchange rate movements are not designated as hedging instruments for accounting purposes. Accordingly, changes in the fair value of these instruments are recognized in the Condensed Consolidated Income Statements in Other Income (Expense).
As of
June 30, 2016
, the notional value of outstanding forward exchange contracts was
$439.1 million
. Notional values do not quantify risk or represent assets or liabilities of Sotheby’s, but are used to calculate cash settlements under outstanding forward exchange contracts. Sotheby’s is exposed to credit-related risks in the event of nonperformance by the three counterparties to its outstanding forward exchange contracts. Sotheby’s does not expect any of these counterparties to fail to meet their obligations, given their high short-term (A1/P1) credit ratings. As of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
, the fair values of these contracts were not material to Sotheby's consolidated financial statements.
19.
Accumulated Other Comprehensive Loss
The following is a summary of the changes in Accumulated Other Comprehensive Loss, for the
three and six months ended
June 30, 2016
and
2015
(in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2016
|
|
Foreign Currency Items
|
|
Defined Benefit Pension Items
|
|
Derivative Financial Instruments
|
|
Total
|
Balance at March 31, 2016
|
|
$
|
(55,242
|
)
|
|
$
|
(9,201
|
)
|
|
$
|
(8,795
|
)
|
|
$
|
(73,238
|
)
|
Other comprehensive (loss) income before reclassifications
|
|
(16,032
|
)
|
|
572
|
|
|
3,610
|
|
|
(11,850
|
)
|
Amounts reclassified from accumulated other comprehensive loss
|
|
—
|
|
|
—
|
|
|
216
|
|
|
216
|
|
Net other comprehensive (loss) income
|
|
(16,032
|
)
|
|
572
|
|
|
3,826
|
|
|
(11,634
|
)
|
Balance at June 30, 2016
|
|
$
|
(71,274
|
)
|
|
$
|
(8,629
|
)
|
|
$
|
(4,969
|
)
|
|
$
|
(84,872
|
)
|
Three Months Ended June 30, 2015
|
|
Foreign Currency Items
|
|
Defined Benefit Pension Items
|
|
Derivative Financial Instruments
|
|
Total
|
Balance at March 31, 2015
|
|
$
|
(54,681
|
)
|
|
$
|
(40,496
|
)
|
|
$
|
—
|
|
|
$
|
(95,177
|
)
|
Other comprehensive income (loss) before reclassifications
|
|
20,079
|
|
|
(2,526
|
)
|
|
—
|
|
|
17,553
|
|
Amounts reclassified from accumulated other comprehensive loss
|
|
—
|
|
|
867
|
|
|
—
|
|
|
867
|
|
Net other comprehensive income (loss)
|
|
20,079
|
|
|
(1,659
|
)
|
|
—
|
|
|
18,420
|
|
Balance at June 30, 2015
|
|
$
|
(34,602
|
)
|
|
$
|
(42,155
|
)
|
|
$
|
—
|
|
|
$
|
(76,757
|
)
|
Six Months Ended June 30, 2016
|
|
Foreign Currency Items
|
|
Defined Benefit Pension Items
|
|
Derivative Financial Instruments
|
|
Total
|
Balance at January 1, 2016
|
|
$
|
(52,279
|
)
|
|
$
|
(9,619
|
)
|
|
$
|
(4,306
|
)
|
|
$
|
(66,204
|
)
|
Other comprehensive (loss) income before reclassifications
|
|
(18,995
|
)
|
|
990
|
|
|
(1,102
|
)
|
|
(19,107
|
)
|
Amounts reclassified from accumulated other comprehensive loss
|
|
—
|
|
|
—
|
|
|
439
|
|
|
439
|
|
Net other comprehensive (loss) income
|
|
(18,995
|
)
|
|
990
|
|
|
(663
|
)
|
|
(18,668
|
)
|
Balance at June 30, 2016
|
|
$
|
(71,274
|
)
|
|
$
|
(8,629
|
)
|
|
$
|
(4,969
|
)
|
|
$
|
(84,872
|
)
|
Six Months Ended June 30, 2015
|
|
Foreign Currency Items
|
|
Defined Benefit Pension Items
|
|
Derivative Financial Instruments
|
|
Total
|
Balance at January 1, 2015
|
|
$
|
(33,223
|
)
|
|
$
|
(43,543
|
)
|
|
$
|
—
|
|
|
$
|
(76,766
|
)
|
Other comprehensive (loss) income before reclassifications
|
|
(1,379
|
)
|
|
(337
|
)
|
|
—
|
|
|
(1,716
|
)
|
Amounts reclassified from accumulated other comprehensive loss
|
|
—
|
|
|
1,725
|
|
|
—
|
|
|
1,725
|
|
Net other comprehensive (loss) income
|
|
(1,379
|
)
|
|
1,388
|
|
|
—
|
|
|
9
|
|
Balance at June 30, 2015
|
|
$
|
(34,602
|
)
|
|
$
|
(42,155
|
)
|
|
$
|
—
|
|
|
$
|
(76,757
|
)
|
For the
three and six months ended
June 30, 2016
, included in Other Comprehensive (Loss) Income before reclassifications are
$0.6 million
(net of tax) and
$1 million
(net of tax), respectively, related to changes in the foreign currency translation adjustment account associated with accumulated unrealized losses related to the U.K. Pension Plan. For the
three and six months ended
June 30, 2015
, such amounts totaled
($2.5) million
(net of tax) and
($0.3) million
(net of tax), respectively.
For the
three and six months ended
June 30, 2015
,
$0.2 million
(net of tax) and
0.4 million
(net of tax), respectively, was reclassified from Accumulated Other Comprehensive Loss and recognized on a pre-tax basis within Interest Expense in the Condensed Consolidated Income Statements as a result of monthly interest accruals related to the Swap associated with the York Property Mortgage (see
Note 18
).
For the
three and six months ended
June 30, 2015
,
$0.9 million
(net of tax) and
$1.7 million
(net of tax), respectively, was reclassified from Accumulated Other Comprehensive Loss and recognized on a pre-tax basis within Salaries and Related Costs in the Condensed Consolidated Income Statements as a result of the amortization of actuarial losses and prior service costs related to the U.K. Pension Plan.
20.
Income Taxes
The quarterly income tax provision is calculated using an estimated annual effective income tax rate based on historical information and forward looking estimates. The estimated annual effective income tax rate may fluctuate due to changes in forecasted annual pre-tax income, changes in the jurisdictional mix of forecasted pre-tax income and changes to actual or forecasted permanent book to tax differences (e.g., non-deductible expenses). Furthermore, the effective income tax rate may fluctuate as the result of changes to the valuation allowance for net deferred tax assets, the impact of future tax settlements with federal, state or foreign tax authorities, or the impact of tax law changes. Management identifies items which are unusual and non-recurring in nature and treats these as discrete events. The tax effect of these discrete events is booked entirely in the quarter in which they occur.
As discussed above, Sotheby's effective income tax rate may fluctuate due to changes in the jurisdictional mix of forecasted pre-tax income. The impact of such changes could be meaningful in countries with statutory tax rates that are significantly lower than the U.S. statutory tax rate of
35%
, if incremental U.S. deferred income taxes are not being recorded on the earnings of those countries. This is particularly true in countries where Sotheby's has significant auction operations such as Hong Kong and Switzerland, where the current statutory tax rates are approximately
17%
and
23%
, respectively.
Prior to the fourth quarter of 2015, based on its projections and planned uses of U.S. and foreign earnings, management had intended that approximately
$400 million
of accumulated foreign earnings relating to years prior to 2014 would be indefinitely reinvested outside of the U.S. As a result, Sotheby’s did not initially record deferred income taxes on these earnings in its financial statements. In the fourth quarter of 2015, however, in consideration of the expansion of Sotheby's Common Stock repurchase program (see Note 13), as well as the need for cash in the U.S. to fund other corporate strategic initiatives, management reassessed Sotheby's U.S. and foreign cash needs and concluded that these foreign earnings would instead be repatriated to the U.S. in the foreseeable future. Consequently, in the fourth quarter of 2015, Sotheby's recognized a liability for the deferred income taxes on these foreign earnings. In addition, Sotheby’s had accrued incremental taxes during 2014 and 2015 on approximately
$200 million
of foreign earnings for those years. As a result, as of December 31, 2015, Sotheby’s had recognized total net deferred tax liabilities of approximately
$92 million
for foreign earnings deemed not to be indefinitely reinvested outside of the U.S.
As of June 30, 2016, approximately
$337 million
of the foreign earnings discussed above had been repatriated and used, in part, to fund Common Stock repurchases during the first six months of 2016. Management expects that additional repatriations will be made later in 2016, though the specific timing of any further repatriation of foreign earnings and the cash payment of the associated taxes is currently being evaluated.
Based on current projections and planned uses of U.S. and foreign cash, management believes that its cash balances and earnings in the U.S., as well as the amount of unremitted foreign earnings for which a deferred tax liability has been recorded, will be sufficient to satisfy its current cash needs in the U.S. Accordingly, management plans to indefinitely reinvest a portion of its prospective foreign earnings (i.e., those related to Sotheby’s non-U.K. foreign subsidiaries) outside of the U.S.
As of June 30, 2016, Sotheby’s estimates that its annual effective income tax rate, excluding discrete items, will be approximately
26%
as compared to its estimate of approximately
35%
as of June 30, 2015. The decrease in the estimate of the annual effective income tax rate is due, in part, to management’s change in assertion regarding the indefinite reinvestment of Sotheby’s 2016 foreign earnings (except those related to Sotheby’s subsidiaries in the U.K.). In 2015, as discussed above, U.S. deferred income taxes were recorded on substantially all of the foreign earnings generated by Sotheby’s in that year. As a result, the mix of pre-tax income among the various jurisdictions did not have a material effect on Sotheby's 2015 effective income tax rate. The annual effective income tax rate for the current period, however, is influenced by changes in the mix of pre-tax income among the various jurisdictions where Sotheby's operates and results in a decrease in the forecasted annual effective income tax rate when compared to the prior period.
Sotheby’s effective income tax rate for the
three and six months ended
June 30, 2016
is approximately
28%
and
26%
, respectively, compared to an effective income tax rate of approximately
40%
for the
three and six months ended
June 30, 2015
. The decrease in the effective income tax rate as compared to the prior periods is principally due to the decrease in the estimated annual effective income tax rate, which is the result of management’s change in assertion regarding the indefinite reinvestment of certain foreign earnings, as discussed above, and changes in the mix of pre-tax income among the various jurisdictions where Sotheby’s operates. The decrease in the effective income tax rate between the current and prior periods is also influenced by discrete tax expense of
$4 million
recorded in the second quarter of 2015 as a result of legislation enacted in New York City.
21.
Uncertain Tax Positions
As of
June 30, 2016
, Sotheby’s liability for unrecognized tax benefits, excluding interest and penalties, was
$19.5 million
, representing a net decrease of
$2.5 million
when compared to a liability of
$22 million
as of
December 31, 2015
. This net decrease is primarily the result of the expiration of a statute of limitations for certain tax years. As of
June 30, 2015
, Sotheby’s liability for unrecognized tax benefits, excluding interest and penalties, was
$20.5 million
. As of
June 30, 2016
,
December 31, 2015
, and
June 30, 2015
, the total amount of unrecognized tax benefits that, if recognized, would favorably affect Sotheby’s effective tax rate was
$13.7 million
,
$12.8 million
, and
$12.7 million
, respectively. Sotheby's believes it is reasonably possible that a decrease of
$3.1 million
in the balance of unrecognized tax benefits can occur within 12 months of the
June 30, 2016
balance sheet date as a result of the expiration of statutes of limitations and the settlement of an audit.
Sotheby’s is subject to taxation in the U.S. and various U.S. state and foreign jurisdictions and, as a result, is subject to tax audits in these jurisdictions. Sotheby’s is currently under examination by various U.S. state and foreign taxing authorities. The earliest open tax year for the major jurisdictions in which Sotheby's does business, which include the U.S. (including various state and local jurisdictions), the U.K., and Hong Kong, is 2009.
Sotheby’s recognizes interest expense and penalties related to unrecognized tax benefits as a component of Income Tax Expense. The accrual for such interest and penalties decreased by
$0.1 million
for the
six months ended June 30, 2016
.
Sotheby’s policy is to record interest expense related to sales, value added and other non-income based taxes as Interest Expense in its Condensed Consolidated Income Statements. Penalties related to such taxes are recorded as General and Administrative Expenses in its Condensed Consolidated Income Statements. Interest expense and penalties related to income taxes are recorded as a component of Income Tax Expense in Sotheby’s Condensed Consolidated Income Statements.
22.
Related Party Transactions
From time-to-time, in the ordinary course of business, related parties such as members of the Board of Directors and employees transact with Sotheby's to buy and sell property at auction and through private sales. For the
three and six months ended June 30, 2016
, Sotheby’s recognized Agency Commissions and Fees of
$0.1 million
and
$0.7 million
, respectively, related to property consigned or purchased by related parties. For the
three and six months ended
June 30, 2015
, such amounts totaled
$1.3 million
and
$2 million
, respectively.
On September 2, 2015, Sotheby's entered into an arrangement with the Estate of A. Alfred Taubman under which it is selling works of art from the collection of A. Alfred Taubman. Robert S. Taubman, a trustee and beneficiary of the Estate, was a director of Sotheby's at the time the arrangement was consummated. In connection with this arrangement, Sotheby's provided an auction guarantee of
$509 million
, after taking into account items withdrawn by the Estate prior to sale. Through
June 30, 2016
, total aggregate proceeds (i.e., the hammer price plus buyer's premium) from sales of Taubman Collection property were
$473.5 million
. The results of these sales, combined with the initially estimated value of items which were taken into inventory after failing to sell at auction (
$33 million
) resulted in a loss on the auction guarantee of approximately
$3 million
, which was recognized in the fourth quarter of 2015. As of
June 30, 2016
and
December 31, 2015
, Sotheby's owed
$10.5 million
and
$285.4 million
, respectively, to the Estate. Subsequent to June 30, 2016, an additional
$10.1 million
was paid to the Estate in settlement of the outstanding liability. As of
June 30, 2016
, the remaining outstanding auction guarantee related to the Taubman Collection totaled
$0.8 million
.
As of
June 30, 2015
, Accounts Receivables (net) included
$0.3 million
associated with auction or private sale purchases made by related parties. As of
June 30, 2016
, Related Party Client Payables included
$10.6 million
associated with amounts owed to related party consignors, including the
$10.5 million
owed to the Estate discussed above.
23.
Recent Accounting Standards Not Yet Adopted
In May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts with Customers
, which introduces a new five-step framework for revenue recognition. The core principal of the standard is that entities should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. This ASU also requires enhanced disclosures regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from an entity's contracts with customers. This standard can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. On August 12, 2015, the FASB issued ASU 2015-14,
Revenue from Contracts with Customers - Deferral of Effective Date
, which defers the effective date of ASU 2014-09 to January 1, 2018 with early adoption beginning January 1, 2017. Management is currently assessing the potential impact of adopting this new accounting standard, including all subsequently issued amendments by the FASB to this standard, on Sotheby’s financial statements.
In January 2016, the FASB issued ASU 2016-01,
Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities.
ASU 2016-01 addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments, including requirements to measure most equity investments at fair value with changes in fair value recognized in net income, to perform a qualitative assessment of equity investments without readily determinable fair values, and to separately present financial assets and liabilities by measurement category and by type of financial asset on the balance sheet or in the accompanying notes to the financial statements. ASU 2016-01 will be effective for Sotheby's beginning on January 1, 2018, and will be applied by means of a cumulative effect adjustment to the balance sheet, except for effects related to equity securities without readily determinable values, which will be applied prospectively. Management is currently assessing the potential impact of adopting this new accounting standard on Sotheby’s financial statements.
In February 2016, the FASB issued ASU 2016-02,
Leases
, which requires an entity to recognize long-term lease arrangements as assets and liabilities on the balance sheet of the lessee. Under ASU 2016-02, a right-of-use asset and lease obligation will be recorded for all long-term leases, whether operating or financing, while the income statement will reflect lease expense for operating leases and interest expense for financing leases. The amendments also require certain new quantitative and qualitative disclosures regarding leasing arrangements. ASU 2016-02 will be effective for Sotheby's beginning on January 1, 2019. Lessees must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. Early adoption is permitted. Management is currently assessing the potential impact of adopting this new accounting standard on Sotheby’s financial statements.
In March 2016, the FASB issued ASU 2016-05,
Derivatives and Hedging: Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships
, which clarifies that a change in the counterparty to a derivative instrument that has been designated as a hedging instrument would not, in and of itself, be considered a termination of the derivative instrument, provided that all other hedge accounting criteria continue to be met. ASU 2016-05 is effective for Sotheby's beginning on January 1, 2017. Early adoption is permitted, including in an interim period. Management is currently assessing the potential impact of adopting this new accounting standard, but does not expect its adoption to have a material effect on Sotheby's financial statements.
In March 2016, the FASB issued ASU 2016-06,
Derivatives and Hedging - Contingent Put and Call Options in Debt Instruments
, which aims to reduce the diversity of practice in identifying embedded derivatives in debt instruments. ASU 2016-06 clarifies that the nature of an exercise contingency is not subject to the “clearly and closely” criteria for purposes of assessing whether the call or put option must be separated from the debt instrument and accounted for separately as a derivative. ASU 2016-06 will be effective for Sotheby's beginning on January 1, 2017. Management is currently assessing the potential impact of adopting this new accounting standard, but does not expect its adoption to have a material effect on Sotheby's financial statements.
In March 2016, the FASB issued ASU 2016-09,
Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting.
ASU 2016-09 simplifies several aspects of the accounting and presentation of share-based payment transactions, including the accounting for related income tax consequences and certain classifications within the statement of cash flows. This standard requires companies to record all excess tax benefits and deficiencies resulting from the vesting of share-based payments to the income statement, whereas current guidance generally permits such items to be recorded to the equity section of the balance sheet provided that an adequate level of previously recorded excess tax benefits exist. ASU 2016-09 is effective for Sotheby's beginning on January 1, 2017. Management is currently assessing the full potential impact of adopting this new accounting standard on Sotheby’s financial statements, but expects the adoption of ASU 2016-09 to potentially result in increased volatility to Sotheby's effective income tax rate beginning in 2017.
In June 2016, the FASB issued ASU 2016-13,
Measurement of Credit Losses on Financial Instruments
, which amends previously issued guidance regarding the impairment of financial instruments by creating an impairment model that is based on expected losses rather than incurred losses. ASU 2016-13 is effective for Sotheby's beginning on January 1, 2020. Early adoption is permitted. Management is currently assessing the potential impact of adopting this new accounting standard on Sotheby’s financial statements.