Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
 
 
 
 
 
FORM 10-Q
 
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended September 30, 2018
Commission File Number 1-9750
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12523609&doc=14
(Exact name of registrant as specified in its charter)
 
 
 
Delaware
 
38-2478409
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
1334 York Avenue
New York, New York
 
10021
(Address of principal executive offices)
 
(Zip Code)
Registrant's telephone number, including area code: (212) 606-7000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of the Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
ý
 
Accelerated filer
¨
Non-accelerated filer
¨
 
Smaller reporting company
¨
Emerging growth company
¨
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  ý
As of October 29, 2018, there were 49,017,304 outstanding shares of common stock, par value $0.01 per share, of the registrant.
______________________________________________________________________________________________________




TABLE OF CONTENTS
 
 
PAGE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2



PART I: FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

SOTHEBY’S
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands, except per share data)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2018
 
September 30, 2017
 
September 30, 2018
 
September 30, 2017
Revenues:
 
 

 
 

 
 

 
 
Agency commissions and fees
 
$
96,721

 
$
81,264

 
$
553,126

 
$
494,297

Inventory sales
 
6,498

 
81,501

 
62,840

 
172,815

Finance
 
11,423

 
11,697

 
30,945

 
37,823

Other
 
4,519

 
5,546

 
13,682

 
14,241

Total revenues
 
119,161

 
180,008

 
660,593

 
719,176

Expenses:
 
 

 
 

 
 

 
 

Agency direct costs
 
19,622

 
18,935

 
114,344

 
95,066

Cost of inventory sales
 
6,322

 
78,734

 
64,731

 
172,396

Cost of finance revenues
 

 
6,054

 
4,056

 
16,169

Marketing
 
4,824

 
5,933

 
16,822

 
17,795

Salaries and related
 
67,274

 
63,218

 
242,711

 
217,308

General and administrative
 
42,291

 
42,483

 
131,775

 
124,796

Depreciation and amortization
 
5,714

 
5,707

 
20,157

 
16,767

Voluntary separation incentive programs, net
 

 

 

 
(162
)
Restructuring charges
 
3,781

 

 
5,927

 

Total expenses
 
149,828

 
221,064

 
600,523

 
660,135

Operating (loss) income
 
(30,667
)
 
(41,056
)
 
60,070

 
59,041

Interest income
 
502

 
278

 
1,349

 
902

Interest expense
 
(10,084
)
 
(8,067
)
 
(28,291
)
 
(23,172
)
Write-off of credit facility fees
 

 

 
(3,982
)
 

Extinguishment of debt
 

 

 
(10,855
)
 

Non-operating income
 
3,172

 
3,130

 
7,045

 
6,118

(Loss) income before taxes
 
(37,077
)
 
(45,715
)
 
25,336

 
42,889

Income tax (benefit) expense
 
(7,759
)
 
(21,328
)
 
5,943

 
2,848

Equity in earnings of investees
 
1,476

 
901

 
3,516

 
2,034

Net (loss) income
 
(27,842
)
 
(23,486
)
 
22,909

 
42,075

Less: Net loss attributable to noncontrolling interest

(4
)
 
(7
)
 
(13
)
 
(12
)
Net (loss) income attributable to Sotheby's
 
$
(27,838
)
 
$
(23,479
)
 
$
22,922

 
$
42,087

Basic (loss) earnings per share - Sotheby’s common shareholders
 
$
(0.55
)
 
$
(0.45
)
 
$
0.44

 
$
0.79

Diluted (loss) earnings per share - Sotheby's common shareholders
 
$
(0.55
)
 
$
(0.45
)
 
$
0.43

 
$
0.78

Weighted average basic shares outstanding
 
50,927

 
52,532

 
51,724

 
52,755

Weighted average diluted shares outstanding
 
50,927

 
52,532

 
52,036

 
53,183


See accompanying Notes to Condensed Consolidated Financial Statements

3



SOTHEBY’S
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(UNAUDITED)
(Thousands of dollars)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2018
 
September 30, 2017
 
September 30, 2018
 
September 30, 2017
Net (loss) income
 
$
(27,842
)
 
$
(23,486
)
 
$
22,909

 
$
42,075

Other comprehensive (loss) income:
 
 
 
 
 
 
 
 
Currency translation adjustments
 
(151
)
 
3,437

 
(7,157
)
 
11,788

Cash flow hedges
 
96

 
410

 
1,402

 
1,286

Net investment hedges
 
(238
)
 
(911
)
 
1,502

 
(2,989
)
Defined benefit pension plan
 
76

 
219

 
239

 
642

Total other comprehensive (loss) income
 
(217
)
 
3,155

 
(4,014
)
 
10,727

Comprehensive (loss) income
 
(28,059
)
 
(20,331
)
 
18,895

 
52,802

Less: Comprehensive loss attributable to noncontrolling interests
 
(4
)
 
(7
)
 
(13
)
 
(12
)
Comprehensive (loss) income attributable to Sotheby's
 
$
(28,055
)
 
$
(20,324
)
 
$
18,908

 
$
52,814


See accompanying Notes to Condensed Consolidated Financial Statements



4




SOTHEBY’S
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(Thousands of dollars)
 
 
September 30,
2018
 
December 31, 2017
 
September 30,
2017
 
 
 
 
A S S E T S
 
 

 
 
 
 

Current assets:
 
 

 
 
 
 

Cash and cash equivalents
 
$
156,272

 
$
544,432

 
$
311,298

Restricted cash (see Notes 8 and 11)
 
1,824

 
361,578

 
5,548

Accounts receivable, net of allowance for doubtful accounts of $9,504, $8,722, and $8,487
 
611,183

 
795,239

 
453,906

Notes receivable, net of allowance for credit losses of $1,067, $1,253, and $1,295
 
151,374

 
87,746

 
51,524

Inventory
 
54,024

 
74,483

 
63,319

Income tax receivables
 
29,449

 
6,601

 
25,312

Prepaid expenses and other current assets (see Note 11)
 
57,153

 
32,010

 
55,523

Total current assets
 
1,061,279

 
1,902,089

 
966,430

Notes receivable, net of allowance for credit losses of $1,525, $1,525, and $0
 
465,963

 
507,538

 
558,342

Fixed assets, net of accumulated depreciation and amortization of $236,024, $229,751, and $223,856
 
367,690

 
352,035

 
350,470

Goodwill
 
55,658

 
50,547

 
50,496

Intangible assets, net
 
13,981

 
11,492

 
11,987

Income tax receivables
 
4,535

 
324

 
4,942

Deferred income taxes
 
31,916

 
35,674

 
7,926

Other long-term assets (see Note 11)
 
234,449

 
227,608

 
196,082

Total assets
 
$
2,235,471

 
$
3,087,307

 
$
2,146,675

L I A B I L I T I E S  A N D  S H A R E H O L D E R S’  E Q U I T Y
 
 

 
 

 
 

Current liabilities:
 
 

 
 

 
 

Client payables
 
$
627,466

 
$
996,197

 
$
376,108

Accounts payable and accrued liabilities
 
101,919

 
90,298

 
88,107

Accrued salaries and related costs
 
60,047

 
94,310

 
57,092

Current portion of long-term debt, net
 
13,514

 
308,932

 
11,912

Accrued income taxes
 
42,385

 
8,127

 
13,395

Other current liabilities (see Note 10)
 
12,675

 
18,762

 
10,990

Total current liabilities
 
858,006

 
1,516,626

 
557,604

Credit facility borrowings
 
215,000

 
196,500

 
434,000

Long-term debt, net
 
640,515

 
653,003

 
557,190

Accrued income taxes
 
8,708

 
37,651

 
15,816

Deferred income taxes
 
14,190

 
15,163

 
10,377

Other long-term liabilities (see Note 11)
 
46,569

 
51,424

 
51,667

Total liabilities
 
1,782,988

 
2,470,367

 
1,626,654

Commitments and contingencies (see Note 15)
 


 


 


Shareholders’ equity:
 
 

 
 

 
 

Common stock, $0.01 par value
 
711

 
709

 
709

Authorized shares — 200,000,000
 
 

 
 
 
 

Issued shares —71,175,100; 70,830,184; and 70,777,023
 
 

 
 
 
 

Outstanding shares —49,017,304; 52,461,996; and 52,503,235
 
 
 
 
 
 
Additional paid-in capital
 
456,279

 
453,364

 
446,017

Treasury stock shares, at cost — 22,157,796; 18,368,188; and 18,273,788
 
(740,805
)
 
(554,551
)
 
(550,249
)
Retained earnings
 
802,621

 
779,699

 
702,990

Accumulated other comprehensive loss
 
(66,480
)
 
(62,466
)
 
(79,631
)
Total shareholders’ equity
 
452,326

 
616,755

 
519,836

Noncontrolling interest
 
157

 
185

 
185

Total equity
 
452,483

 
616,940

 
520,021

Total liabilities and shareholders’ equity
 
$
2,235,471

 
$
3,087,307

 
$
2,146,675

See accompanying Notes to Condensed Consolidated Financial Statements

5




SOTHEBY’S
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(Thousands of dollars)

 
 
Nine Months Ended
 
 
September 30,
2018
 
September 30,
2017
Operating Activities:
 
 

 
 

Net income attributable to Sotheby's
 
$
22,922

 
$
42,087

Adjustments to reconcile net income attributable to Sotheby's to net cash used by operating activities:
 
 
 
 
Extinguishment of debt
 
10,855

 

Write-off of credit facility fees
 
3,982

 

Depreciation and amortization
 
20,157

 
16,767

Deferred income tax expense
 
91

 
9,396

Share-based payments
 
21,425

 
17,423

Net pension benefit
 
(2,395
)
 
(3,719
)
Inventory writedowns and bad debt provisions
 
8,496

 
9,127

Amortization of debt issuance costs
 
1,311

 
1,240

Equity in earnings of investees
 
(3,516
)
 
(2,034
)
Other
 
1,285

 
683

Changes in assets and liabilities:
 
 

 
 

Accounts receivable
 
88,767

 
29,878

Client payables
 
(358,956
)
 
(167,233
)
Inventory
 
11,315

 
88,422

Changes in other operating assets and liabilities (see Note 12)
 
(83,323
)
 
(117,776
)
Net cash used by operating activities
 
(257,584
)
 
(75,739
)
Investing Activities:
 
 

 
 

Funding of notes receivable
 
(199,781
)
 
(152,242
)
Collections of notes receivable
 
266,878

 
206,899

Capital expenditures
 
(36,005
)
 
(14,462
)
Acquisitions, net of cash acquired
 
(5,777
)
 
(75
)
Funding of investments
 
(64
)
 
(6,169
)
Distributions from investees
 
2,916

 
4,675

Proceeds from the sale of equity investment
 

 
2,125

Proceeds from company-owned life insurance
 

 
2,100

Settlement of net investment hedges
 
(1,858
)
 
29,110

Net cash provided by investing activities
 
26,309

 
71,961

Financing Activities:
 
 

 
 

Proceeds from credit facility borrowings
 
323,000

 
31,500

Repayments of credit facility borrowings
 
(304,500
)
 
(162,500
)
Repayments of York Property Mortgage
 
(12,214
)
 
(37,709
)
Settlement of 2022 Senior Notes, including call premium
 
(307,875
)
 

Debt issuance and other borrowing costs
 
(4,208
)
 
(163
)
Repurchases of common stock
 
(186,254
)
 
(40,193
)
Purchase of forward contract indexed to Sotheby's common stock
 
(9,500
)
 

Dividends paid
 

 
(2,375
)
Funding of employee tax obligations upon the vesting of share-based payments
 
(9,921
)
 
(16,774
)
Net cash used by financing activities
 
(511,472
)
 
(228,214
)
Effect of exchange rate changes on cash, cash equivalents, and restricted cash
 
(5,946
)
 
10,472

Decrease in cash, cash equivalents, and restricted cash
 
(748,693
)
 
(221,520
)
Cash, cash equivalents, and restricted cash at beginning of period
 
923,926

 
556,201

Cash, cash equivalents, and restricted cash at end of period
 
$
175,233

 
$
334,681

Supplemental information on non-cash investing and financing activities:
See Note 5 for information regarding non-cash transfers between Accounts Receivable (net) and Notes Receivable (net).
See Note 9 for information regarding derivative financial instruments designated as net investment hedges.
See accompanying Notes to Condensed Consolidated Financial Statements

6



SOTHEBY’S
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. Basis of Presentation
Company Overview—Sotheby's (or the "Company") offers collectors the opportunity to connect with and transact in the world's most extraordinary art and luxury goods, which in this report may collectively be referred to as "art," "works of art," "artwork," or "property." Auctioneers since 1744, today we present auctions in ten different salesrooms, including New York, London, Hong Kong and Paris. We also offer collectors a variety of innovative art-related services, including the brokerage of private art sales, private jewelry sales through Sotheby's Diamonds, exclusive private selling exhibitions, art-related financing, and art advisory services, as well as retail wine locations in New York and Hong Kong.
Accounting Principles—The unaudited Condensed Consolidated Financial Statements included herein have been prepared by the management of Sotheby’s 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 our opinion, 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. The interim results presented in our Condensed Consolidated Statements of Operations are not necessarily indicative of results for a full year. See Note 2 for information about the seasonality of our business. We urge you to read these unaudited Condensed Consolidated Financial Statements in conjunction with the information included in our 2017 Form 10-K filed with the SEC on March 1, 2018.
Principles of Consolidation—The unaudited Condensed Consolidated Financial Statements include the accounts of our wholly-owned subsidiaries and Sotheby's (Beijing) Auction Co., Ltd. ("Sotheby's Beijing"), a joint venture in which we have 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 our Condensed Consolidated Statements of Operations, and the non-controlling 20% ownership interest is reported as "Noncontrolling Interest" within the Equity section of our Condensed Consolidated Balance Sheets. Intercompany transactions and balances among our subsidiaries are eliminated in consolidation.
Equity investments through which we may significantly influence, but not control, the investee, are accounted for using the equity method. Under the equity method, our share of investee earnings or losses is recorded in our Condensed Consolidated Statements of Operations within Equity in Earnings of Investees. Our interest in the net assets of these investees is recorded on our Condensed Consolidated Balance Sheets within Other Long-Term Assets. Our equity method investees include: (i) Acquavella Modern Art ("AMA"), a partnership through which a collection of fine art is being sold, (ii) RM Sotheby's, an auction house for investment-quality automobiles, and (iii) a partnership formed in the second quarter of 2017 through which artworks are being purchased and sold.
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.
Revenue Recognition—In May 2014, the Financial Accounting Standards Board (the "FASB") issued an Accounting Standards Update ("ASU") which amends revenue recognition guidance and requires more detailed disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. This ASU is codified in U.S. GAAP under Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers.
We adopted ASC 606 on January 1, 2018 using the full retrospective method. The adoption of ASC 606 did not impact the timing of our revenue recognition, but it changed the presentation of certain revenues and expenses previously reported on a net basis in our Condensed Consolidated Statements of Operations. Specifically, the following items previously reported on a net basis within Agency Commissions and Fees are now reported on a gross basis within Agency Direct Costs: (i) fees owed to the counterparties in auction guarantee risk sharing arrangements and (ii) fees owed to third parties who introduce us to auction or private sale consignors. In addition, consignor expense recoveries and buyer shipping fees previously reported on a net basis within Agency Direct Costs are now reported on a gross basis within Agency Commission and Fees. The table below under "Summary of Adjustments to Prior Period Presentation" shows the impact of the retrospective adoption of ASC 606 on our Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2017.

7



Statement of Cash Flows—In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows, which updated the guidance on how certain cash receipts and cash payments should be presented and classified within the statement of cash flows. We retrospectively adopted ASU 2016-15 on January 1, 2018. The adoption of ASU 2016-15 changed how we classify cash proceeds received from our investment in company-owned life insurance ("COLI"), which is held in a rabbi trust and used to fund certain deferred compensation liabilities. Prior to the adoption of ASU 2016-15, COLI proceeds were classified as cash inflows from operating activities, but are now classified as cash inflows from investing activities. The adoption of ASU 2016-15 also required us to make certain accounting policy elections with respect to the statement of cash flows. First, ASU 2016-15 clarifies that COLI premiums paid may be classified as cash outflows from operating or investing activities, or a combination of both. In connection with the adoption of ASU 2016-15, we made an accounting policy election to classify COLI premiums paid as cash outflows from operating activities, consistent with our previous presentation of such payments. Second, ASU 2016-15 allows distributions received from equity method investees to be classified using either the cumulative earnings approach or the nature of distribution approach. In connection with the adoption of ASU 2016-15, we made an accounting policy election to classify distributions received from equity method investees using the cumulative earnings approach, consistent with our previous presentation of such distributions. The other aspects of ASU 2016-15 did not result in a change to our existing accounting policies for the preparation of the statement of cash flows. The table below under "Summary of Adjustments to Prior Period Presentation" shows the impact of our retrospective adoption of ASU 2016-15 on our Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2017.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows, to add and clarify guidance on the classification and presentation of restricted cash and restricted cash equivalents in the statement of cash flows. In particular, ASU 2016-18 requires that restricted cash and restricted cash equivalents be included within cash and cash equivalents when reconciling the beginning-of-period and end-of-period totals disclosed in the statement of cash flows. Transfers between restricted and unrestricted cash accounts are not to be reported within the statement of cash flows. Only restricted cash receipts or payments directly with third parties are to be reported in the statement of cash flows as either an operating, investing, or financing activity, depending on the nature of the transaction. We retrospectively adopted ASU 2016-18 on January 1, 2018. The table below under "Summary of Adjustments to Prior Period Presentation" shows the impact of our retrospective adoption of ASU 2016-18 on our Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2017. (See Note 11 for information related to our restricted cash balances.)
Presentation of Pension and Postretirement Costs—In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which requires that the service cost component of net periodic pension cost be presented in the same statement of operations line item as other employee compensation costs, while the remaining components of net periodic pension cost be presented outside of operating (loss) income. We retrospectively adopted ASU 2017-07 on January 1, 2018. The table below under "Summary of Adjustments to Prior Period Presentation" shows the impact of our retrospective adoption of ASU 2017-07 on our Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2017. (See Note 7 for information related to our defined benefit pension plan in the U.K.)
Accounting for Cloud Computing Arrangements—In August 2018, the FASB issued ASU 2018-15, Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which aligns the requirements for capitalizing costs incurred to implement a cloud computing arrangement that is a service contract with the requirements for capitalizing costs incurred to develop or obtain internal-use software. We adopted ASU 2018-15 on a prospective basis beginning in the third quarter of 2018. We expect the adoption of ASU 2018-15 to allow us to capitalize approximately $1 million in hosting arrangement implementation costs in the fourth quarter of 2018, which will be amortized to the statement of operations in future periods over the terms of the underlying service agreements. Prior to the adoption of ASU 2018-15, these costs would have been expensed to the statement of operations as incurred.









8




Summary of Adjustments to Prior Period Presentation—The following table summarizes the impact of the retrospective adoption of ASC 606 and ASU 2017-07 on our Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2017 (in thousands of dollars):
Three Months Ended September 30, 2017
 
As Previously Reported
 
ASC 606
Adjustment
 
ASU 2017-07
Adjustment
 
As Adjusted
Revenues:
 
 
 
 
 
 
 
 
Agency commissions and fees
 
$
72,650

 
$
8,614

 
$

 
$
81,264

Total revenues
 
$
171,394

 
$
8,614

 
$

 
$
180,008

Expenses:
 
 
 
 
 
 
 
 
Agency direct costs
 
$
10,321

 
$
8,614

 
$

 
$
18,935

Salaries and related
 
$
61,946

 
$

 
$
1,272

 
$
63,218

Total expenses
 
$
211,178

 
$
8,614

 
$
1,272

 
$
221,064

Operating loss
 
$
(39,784
)
 
$

 
$
(1,272
)
 
$
(41,056
)
Non-operating income
 
$
1,858

 
$

 
$
1,272

 
$
3,130

Net loss attributable to Sotheby's
 
$
(23,479
)
 
$

 
$

 
$
(23,479
)
Nine Months Ended September 30, 2017
 
As Previously Reported
 
ASC 606
Adjustment
 
ASU 2017-07
Adjustment
 
As Adjusted
Revenues:
 
 
 
 
 
 
 
 
Agency commissions and fees
 
$
448,950

 
$
45,347

 
$

 
$
494,297

Total revenues
 
$
673,829

 
$
45,347

 
$

 
$
719,176

Expenses:
 
 
 
 
 
 
 
 
Agency direct costs
 
$
49,719

 
$
45,347

 
$

 
$
95,066

Salaries and related
 
$
213,589

 
$

 
$
3,719

 
$
217,308

Total expenses
 
$
611,069

 
$
45,347

 
$
3,719

 
$
660,135

Operating income
 
$
62,760

 
$

 
$
(3,719
)
 
$
59,041

Non-operating income
 
$
2,399

 
$

 
$
3,719

 
$
6,118

Net income attributable to Sotheby's
 
$
42,087

 
$

 
$

 
$
42,087

















9



The following table summarizes the impact of the retrospective adoption of ASU 2016-15 and ASU 2016-18 on our Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2017 (in thousands of dollars):
 
 
As Previously Reported
 
ASU 2016-15 Adjustments
 
ASU 2016-18 Adjustments
 
As Adjusted
Operating Activities:
 
 
 
 
 
 
 
 
Changes in other operating assets and liabilities
 
$
(115,676
)
 
$
(2,100
)
 
$

 
$
(117,776
)
Net cash used by operating activities
 
$
(73,639
)
 
$
(2,100
)
 
$

 
$
(75,739
)
Investing Activities:
 
 
 
 
 
 
 
 
Proceeds from company-owned life insurance
 
$

 
$
2,100

 
$

 
$
2,100

Decrease in restricted cash
 
$
38,575

 
$

 
$
(38,575
)
 
$

Net cash provided by investing activities
 
$
108,436

 
$
2,100

 
$
(38,575
)
 
$
71,961

Financing Activities:
 
 
 
 
 
 
 
 
Decrease in restricted cash related to York Property Mortgage
 
$
2,857

 
$

 
$
(2,857
)
 
$

Net cash used by financing activities
 
$
(225,357
)
 
$

 
$
(2,857
)
 
$
(228,214
)
Effect of exchange rate changes on cash, cash equivalents, and restricted cash
 
$
5,827

 
$

 
$
4,645

 
$
10,472

Decrease in cash, cash equivalents, and restricted cash (a)
 
$
(184,733
)
 
$

 
$
(36,787
)
 
$
(221,520
)
Cash, cash equivalents, and restricted cash at beginning of period (a)
 
$
496,031

 
$

 
60,170

 
$
556,201

Cash, cash equivalents, and restricted cash at end of period (a)
 
$
311,298

 
$

 
$
23,383

 
$
334,681

(a)
Restricted cash is included only in the adjusted balances, reflecting the retrospective adoption of ASU 2016-18.
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 Sales1 represented 80% and 82% of our total annual Net Auction Sales in 2017 and 2016, respectively, with auction commission revenues comprising approximately 66% and 75%, of our total revenues, respectively. Accordingly, our financial results are seasonal, with peak revenues and operating income generally occurring in the second and fourth quarters. Consequently, first and third quarter results have historically reflected lower revenues when compared to the second and fourth quarters and, typically, a net loss due to the fixed nature of many of our operating expenses.











___________________________________________________________________
1 Represents the total hammer (sale) price of property sold at auction.

10



3. Segment Reporting
Our operations are organized under two segments—the Agency segment and the Finance segment, which does business as and is referred to in this report as Sotheby's Financial Services (or "SFS"). Thomas S. Smith, Jr, Sotheby's CEO, is our chief operating decision maker. Mr. Smith regularly evaluates financial information about each of our segments in deciding how to allocate resources and assess performance. The performance of each segment is measured based on segment income before taxes, which excludes the unallocated amounts and reconciling items highlighted in the table below.
Through our Agency segment, we accept works of art on consignment and match sellers (also known as consignors) to buyers through the auction or private sale process. In both auction and private sale transactions, we act as exclusive agent for the seller. Prior to offering a work of art for sale, we perform due diligence activities to authenticate and determine the ownership history and condition of the consigned artwork. 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, and RM Sotheby's, an equity investee that operates as an auction house for investment-quality automobiles. The Agency segment is an aggregation of the auction, private sale, and other related activities that are conducted across various collecting categories, all of which have similar economic characteristics and are similar in their services, customers, and the manner in which their services are provided.
SFS is an art financing company that operates as a niche lender with the ability to tailor attractive financing packages for clients who wish to obtain immediate access to liquidity from their art assets. SFS leverages the art expertise of the Agency segment, skill in international law and finance, and access to capital to provide art collectors and dealers with financing secured by their works of art, allowing them to unlock the value in their collections.
Art Agency, Partners (“AAP”), through which we offer art advisory services, provides art collectors with strategic guidance on collection identity and development, acquisitions, short and long-term planning, and provides advice to artists and artists' estates. In addition, from time-to-time, AAP brokers private art sales for its advisory clients. Our advisory services are classified within All Other for segment reporting purposes, along with our retail wine business, brand licensing activities, and the results from other equity method investments.

11



The following table presents our segment information for the three and nine months ended September 30, 2018 and 2017 (in thousands of dollars):
Three Months Ended September 30, 2018
 
Agency
 
SFS
 
All Other
 
Reconciling items
 
Total
Revenues
 
$
98,314

 
$
12,822

 
$
9,424

 
$
(1,399
)
(c)
$
119,161

Segment (loss) income before taxes (a)
 
$
(46,803
)
 
$
7,152

 
$
2,093

 
$
481

(d)
$
(37,077
)
Three Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
Revenues (b)
 
$
160,774

 
$
13,781

 
$
7,537

 
$
(2,084
)
(c)
$
180,008

Segment (loss) income before taxes (a)
 
$
(54,335
)
 
$
7,212

 
$
4,282

 
$
(2,874
)
(d)
$
(45,715
)
Nine Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
Revenues
 
$
605,492

 
$
37,061

 
$
24,156

 
$
(6,116
)
(c)
$
660,593

Segment income before taxes (a)
 
$
15,175

 
$
20,283

 
$
4,532

 
$
(14,654
)
(d)
$
25,336

Nine Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
Revenues (b)
 
$
660,439

 
$
44,514

 
$
20,914

 
$
(6,691
)
(c)
$
719,176

Segment income before taxes (a)
 
$
15,833

 
$
24,381

 
$
9,003

 
$
(6,328
)
(d)
$
42,889

(a)
Our previous credit agreements provided for dedicated asset-based revolving credit facilities for the Agency segment and SFS. The SFS Credit Facility was used to fund a significant portion of client loans. Accordingly, any borrowing costs associated with the SFS Credit Facility were recorded within cost of finance revenues in our Condensed Consolidated Statements of Operations. In September 2017, we modified our cash management strategy in order to reduce borrowing costs by applying excess cash balances against revolver credit facility borrowings.
On June 26, 2018, we refinanced our previous credit agreements. The new credit agreement combined these credit facilities into one asset-based revolving credit facility. As a result of this refinancing, beginning in the third quarter of 2018, revolving credit facility costs are no longer allocated to our segments for the purpose of measuring segment profitability.
Subsequent to the refinancing of our previous credit agreements and the resulting elimination of the SFS Credit Facility on June 26, 2018, the SFS loan portfolio is no longer being directly funded with revolving credit facility borrowings. However, beginning in the third quarter of 2018, for the purpose of measuring segment profitability, SFS receives a corporate finance charge that is calculated assuming that 85% of their loan portfolio is funded with debt. This charge is eliminated in the consolidation of Sotheby's results.
Segment results for periods prior to the third quarter of 2018 have been recast to reflect these changes in the measurement of segment profitability.
(b)
Agency segment revenue for the three and nine months ended September 30, 2017 has been recast to reflect the retrospective adoption of ASC 606. See Notes 1 and 4.
(c)
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.
(d)
The unallocated amounts and reconciling items related to segment (loss) income before taxes are detailed in the table below.

12



The table below presents a reconciliation of total segment (loss) income before taxes to consolidated (loss) income before taxes for the three and nine months ended September 30, 2018 and 2017 (in thousands of dollars):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Agency
 
$
(46,803
)
 
$
(54,335
)
 
$
15,175

 
$
15,833

SFS
 
7,152

 
7,212

 
20,283

 
24,381

All Other
 
2,093

 
4,282

 
4,532

 
9,003

Segment (loss) income before taxes
 
(37,558
)
 
(42,841
)
 
39,990

 
49,217

Unallocated amounts and reconciling items:
 
 
 
 
 
 
 
 
Extinguishment of debt
 

 

 
(10,855
)
 

Revolving credit facility costs (a)
 
(1,921
)
 
(6,780
)
 
(12,149
)
 
(18,259
)
SFS corporate finance charge
 
3,878

 
4,807

 
11,866

 
13,965

Equity in earnings of investees (b)
 
(1,476
)
 
(901
)
 
(3,516
)
 
(2,034
)
(Loss) income before taxes
 
$
(37,077
)
 
$
(45,715
)
 
$
25,336

 
$
42,889

(a)
For the nine months ended September 30, 2018, revolving credit facility costs in the table above includes approximately $4 million of unamortized fees related to our previous credit agreements that were written off in the second quarter of 2018.
(b)
For segment reporting purposes, our share of earnings related to equity investees is included as part of income before taxes. However, such earnings are reported separately below (loss) income before taxes in our Condensed Consolidated Statements of Operations.
The table below presents segment assets, as well as a reconciliation of segment assets to consolidated assets as of September 30, 2018, December 31, 2017, and September 30, 2017 (in thousands of dollars):
 
 
September 30, 2018
 
December 31, 2017
 
September 30, 2017
Agency
 
$
1,516,644

 
$
2,395,429

 
$
1,441,249

SFS
 
616,092

 
608,713

 
627,815

All Other
 
36,835

 
40,566

 
39,431

Total segment assets
 
2,169,571

 
3,044,708

 
2,108,495

Unallocated amounts and reconciling items:
 
 

 
 

 
 
Deferred tax assets and income tax receivable
 
65,900

 
42,599

 
38,180

Consolidated assets
 
$
2,235,471

 
$
3,087,307

 
$
2,146,675

Substantially all of our capital expenditures for the nine months ended September 30, 2018, the year ended December 31, 2017, and the nine months ended September 30, 2017 were attributable to the Agency segment.


13



4. Revenues
The Agency segment, which is our predominant source of revenue, earns commissions and fees by acting as agent for clients wishing to sell their artworks through the auction or private sale process. To a much lesser extent, the Agency segment also earns revenues from the sale of artworks that are owned by Sotheby's. Outside of the Agency segment, we earn revenues from art advisory services, retail wine sales, and brand licensing activities, which are aggregated and classified within All Other for segment reporting purposes, as well as from the art-related financing activities conducted by SFS. The revenues earned by the Agency and All Other segments are accounted for in accordance with ASC 606, Revenue from Contracts with Customers, which was retrospectively adopted on January 1, 2018. The revenues earned by SFS are not within the scope of ASC 606. (See Note 1 for information regarding the retrospective adoption of ASC 606.)
The following table summarizes our revenues by segment and type for the three and nine months ended September 30, 2018 and 2017 (in thousands of dollars):
 
 
Three Months Ended September 30, 2018
 
Three Months Ended September 30, 2017

 
Agency
 
SFS
 
All Other
 
Total
 
Agency
 
SFS
 
All Other
 
Total
Revenue from contracts with customers:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency commissions and fees:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Auction commissions
 
$
72,734

 
$

 
$
(156
)
 
$
72,578

 
$
62,731

 
$

 
$

 
$
62,731

Auction related fees, net (a)
 
7,685

 

 
(15
)
 
7,670

 
3,543

 

 

 
3,543

Private sale commissions
 
12,759

 

 

 
12,759

 
12,902

 

 

 
12,902

Other Agency commissions and fees
 
3,556

 

 
158

 
3,714

 
2,088

 

 

 
2,088

Total Agency commissions and fees
 
96,734

 

 
(13
)
 
96,721

 
81,264

 

 

 
81,264

Inventory sales
 
1,580

 

 
4,918

 
6,498

 
79,510

 

 
1,991

 
81,501

Advisory revenues
 

 

 
1,169

 
1,169

 

 

 
1,422

 
1,422

License fee and other revenues
 

 

 
3,350

 
3,350

 

 

 
4,124

 
4,124

Total revenue from contracts with customers
 
98,314

 

 
9,424

 
107,738

 
160,774

 

 
7,537

 
168,311

Finance revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest and related fees
 

 
11,423

 

 
11,423

 

 
11,697

 

 
11,697

Total revenues
 
$
98,314

 
$
11,423

 
$
9,424

 
$
119,161

 
$
160,774

 
$
11,697

 
$
7,537

 
$
180,008


14




 
Nine Months Ended September 30, 2018
 
Nine Months Ended September 30, 2017

 
Agency
 
SFS
 
All Other
 
Total
 
Agency
 
SFS
 
All Other
 
Total
Revenue from contracts with customers:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency commissions and fees:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Auction commissions
 
$
462,663

 
$

 
$
(156
)
 
$
462,507

 
$
420,296

 
$

 
$

 
$
420,296

Auction related fees, net (a)
 
25,509

 

 
(15
)
 
25,494

 
25,041

 

 

 
25,041

Private sale commissions
 
56,260

 

 
500

 
56,760

 
40,949

 

 

 
40,949

Other Agency commissions and fees
 
7,907

 

 
458

 
8,365

 
8,011

 

 

 
8,011

Total Agency commissions and fees
 
552,339

 

 
787

 
553,126

 
494,297

 

 

 
494,297

Inventory sales
 
53,153

 

 
9,687

 
62,840

 
166,142

 

 
6,673

 
172,815

Advisory revenues
 

 

 
3,575

 
3,575

 

 

 
4,251

 
4,251

License fee and other revenues
 

 

 
10,107

 
10,107

 

 

 
9,990

 
9,990

Total revenue from contracts with customers
 
605,492

 

 
24,156

 
629,648

 
660,439

 

 
20,914

 
681,353

Finance revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest and related fees
 

 
30,945

 

 
30,945

 

 
37,823

 

 
37,823

Total revenues
 
$
605,492

 
$
30,945

 
$
24,156

 
$
660,593

 
$
660,439

 
$
37,823

 
$
20,914

 
$
719,176

(a)
Auction Related Fees, net includes the net overage or shortfall attributable to auction guarantees, consignor expense recoveries, and shipping fees charged to buyers.
Auction Commissions—In our role as auctioneer, we accept works of art on consignment and match sellers (also known as consignors) to buyers through the auction process. In an auction transaction, we act as exclusive agent for the seller. The terms of our arrangement with the seller are stipulated in a consignment agreement, which, among other things, entitles us to collect and retain an auction commission as compensation for our service. Our auction commission includes a premium charged to the buyer and, to a lesser extent, a commission charged to the seller, both of which are calculated as a percentage of the hammer price of the property sold at auction. In certain situations, in order to secure a high-value consignment, we may not charge a seller's commission and/or may share a portion of our buyer's premium with the seller. In situations when we share a portion of our buyer's premium with the seller, our auction commission revenue is recorded net of the amount paid to the seller.
Prior to the date of the auction, we perform a number of activities in connection with our obligations under an auction consignment agreement, which may include: (i) transporting the consigned artwork to the location of the auction sale; (ii) performing due diligence to authenticate and determine the ownership history and condition of the consigned artwork; (iii) preparing the consigned artwork for auction (e.g., framing and cleaning); (iv) preparing catalogue content related to the consigned artwork (e.g., photography and description of the artwork); (v) marketing the artwork through exhibitions and advertising campaigns; (vi) establishing presale estimates for the consigned artwork in response to an assessment of buyer demand and overall market conditions; and (vii) conducting pre-auction bidder registration and qualification. The services associated with these activities are necessary components of our auction service, which culminates in the creation of a public marketplace for the sale and purchase of art that, if successful, results in the matching of the seller to a buyer upon the fall of the auctioneer's hammer.
Upon the fall of the auctioneer's hammer, the highest bidder becomes legally obligated to pay the aggregate purchase price (i.e., the hammer price plus buyer's premium) and the consignor is legally obligated to relinquish the property in exchange for the net sale proceeds (i.e., the hammer price less any seller's commission and expense recoveries). However, if the bidding for an individual artwork does not reach its reserve price (i.e., the confidential minimum hammer price at which the consignor has agreed to sell), the sale is not completed, and we are not entitled to collect a commission. Accordingly, the consignor receives the benefit of our auction service only when the sale is completed, upon the fall of the auctioneer's hammer, at which point in time we recognize our auction commission revenue.

15



Under the standard terms and conditions of our auction sales, we are not obligated to pay the consignor for property that has not been paid for by the buyer. If a buyer defaults on payment, the sale is cancelled, and the property is returned to the consignor. We continually evaluate the collectability of amounts due from individual buyers and only recognize auction commission revenue when the collection of the amount due from the buyer is probable. If we determine that payment from the buyer is not probable, a cancelled sale is recorded in the period in which that determination is made and the associated Accounts Receivable balance, including our auction commission, is reversed. Our judgments regarding the collectability of Accounts Receivable are based on an assessment of the buyer's payment history, discussions with the buyer, and the value of any property held as security against the buyer's payment obligation. Our judgments with respect to the collectability of amounts due from buyers for auction purchases may prove, with the benefit of hindsight, to be incorrect. Historically, cancelled sales have not been material in relation to the aggregate hammer price of property sold at auction.
For artworks purchased at auction, the buyer is provided a five-year guarantee of authenticity. Subject to certain limitations, this guarantee generally attests to the authorship of the artwork. In the event a valid claim is made by the buyer under the authenticity guarantee, the sale is rescinded and we are obligated to refund the aggregate purchase price to the buyer. In these circumstances, the consignor is obligated to return any net sale proceeds paid to them. Outside of a valid authenticity claim, the buyer has no right to rescind an auction sale. The authenticity guarantee provided to the auction buyer is a product warranty that is associated with the provision of our auction service; it may not be purchased separately and does not provide an additional service to the buyer.
Auction Guarantee Overage (Shortfall)—From time-to-time, in the ordinary course of business, we will provide a guarantee to the consignor that their consigned artwork will achieve a specified minimum sale price at auction. This type of arrangement is known as an auction guarantee. If the property offered under an auction guarantee sells above the minimum guaranteed price, we are generally entitled to a share of the overage. In the event that the property sells for less than the minimum guaranteed price, we must perform under the auction guarantee by funding the shortfall between the sale price at auction and the amount of the auction guarantee. If the property offered under the auction guarantee does not sell, we must pay the amount of the auction guarantee to the consignor and then take ownership of the unsold property and may recover the amount paid through its future sale. In certain limited situations, if the guaranteed property fails to sell at auction or if the purchaser defaults, the consignor has the right to cancel the auction guarantee and retain the property. 
In situations when an item of guaranteed property does not sell and we take ownership of the property, it is taken into Inventory and recorded on our balance sheet at the lower of its cost (i.e., the amount paid under the auction guarantee) or our estimate of the property’s net realizable value (i.e., the expected sale price upon its eventual disposition).
We may reduce our financial exposure under auction guarantees through contractual risk sharing arrangements. Such auction guarantee risk sharing arrangements include irrevocable bid arrangements and, from time-to-time, partner sharing arrangements.
An irrevocable bid is an arrangement under which a counterparty irrevocably 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, as their fee, a share of the buyer's premium earned on the sale and/or a share of any auction guarantee overage. Such fees paid to irrevocable bid counterparties are recorded within Agency Direct Costs in the period of the sale. If the irrevocable bid is the winning bid, the counterparty may sometimes receive a fee as compensation for providing the irrevocable bid. This fee is netted against the counterparty's obligation to pay the full purchase price (i.e., the hammer price plus buyer's premium) and is recorded as a reduction to our auction commission revenue in the period of the sale.
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, if the property sells, the counterparty in a partner sharing arrangement is generally entitled to receive, as their fee, a share of the buyer's premium earned on the sale and/or a share of any auction guarantee overage. Such fees paid to the counterparties in auction guarantee partner sharing arrangements are recorded within Agency Direct Costs in the period of the sale.
Similar to a standard auction transaction, for property sold under an auction guarantee, the consignor receives the benefit of our auction service only when the sale is completed, upon the fall of the auctioneer's hammer, at which point in time we recognize our auction commission revenue and any auction guarantee overage or shortfall. In the event that the property offered under an auction guarantee sells for a hammer price that is less than the minimum guaranteed price, the amount of the shortfall is recorded net of any buyer’s premium commission earned on the sale. An auction guarantee shortfall may also be recognized prior to the date of the auction if we determine that it is probable that the expected selling price of the property, including buyer's premium, will not exceed the amount of the auction guarantee.

16



Consignor Expense Recoveries—We incur various direct costs in the fulfillment of our auction service. These costs principally relate to the transport of consigned artworks to the location of the auction sale, various sale marketing activities including catalogue production and distribution, and the exhibition of consigned artworks. Auction consignment agreements sometimes permit us to recover all or a portion of these costs from the consignor through a deduction from their net sale proceeds if the item is sold at auction. Such recoveries are recognized as revenue in the period of the auction sale.
Buyer Shipping Fees—Auction buyers may be charged a fee for shipping services associated with their purchased property. Such fees are recognized as revenue in the period when the shipping service is provided.
Private Sale Commissions—Private sale commission revenues are earned through the direct brokering of purchases and sales of art. Private sales are generally initiated by a client wishing to sell their artwork (i.e., the consignor) with Sotheby's acting as their exclusive agent in the transaction. Such arrangements are evidenced by a legally binding consignment agreement between us and the seller, which outlines the terms of the arrangement, including the desired sale price and the amount or rate of commission that we may earn if a sale is completed, as well as, in certain instances, the period of time over which the artwork may be offered for private sale. The terms of the private sale consignment agreement create our sole performance obligation, which is to broker a legally binding sale of the consigned artwork to a qualified buyer as exclusive agent for the seller.
In connection with our efforts to fulfill our performance obligation under a private sale consignment agreement, we perform a number of activities, which may include: (i) transporting the consigned artwork to the location of the sale; (ii) performing due diligence to authenticate and determine the ownership history and condition of the consigned artwork; (iii) preparing the consigned artwork for sale (e.g., framing and cleaning); (iv) providing advice as to an appropriate asking price for the consigned artwork in response to an assessment of buyer demand and overall market conditions; (v) marketing the artwork to a select group of potential buyers or through theme-based private sale exhibitions; and (vi) completing all relevant administrative tasks related to completion of the sale.
In certain situations, when completing a private sale, we may execute a legally binding agreement with the buyer stipulating the terms pursuant to which the buyer will purchase the consigned artwork. In situations when a legally binding buyer agreement is not executed, only an invoice is issued to provide the buyer with the information necessary for finalizing the transaction (e.g., the amount owed and any associated taxes and royalties, the payment due date, payment instructions, etc.).
The consignor receives the benefit of our private sale service only upon the completion of a legally binding sale. For private sales where we execute a buyer agreement, the consignor receives the benefit of our private sale service and revenue is recognized at the point in time when the agreement is signed by the buyer. At this point in time, the buyer becomes legally obligated to pay the purchase price and the consignor is legally obligated to relinquish the property in exchange for the net sale proceeds (i.e., the purchase price less our commission). In the absence of an executed buyer agreement, the consignor receives the benefit of our private sale service and revenue is recognized at the point in time when the full purchase price is paid by the buyer. At this point in time, we have performed all of our service obligations in the transaction and the consignor is legally obligated to relinquish the property in exchange for the net sale proceeds. If we are not successful in completing a sale according to the terms of the private sale consignment agreement, we are not entitled to collect a commission.
For artworks purchased in a private sale transaction, the buyer is provided a guarantee of authenticity for a period of up to five years. Subject to certain limitations, this guarantee generally attests to the authorship of the artwork. In the event a valid claim is made by the buyer under the authenticity guarantee, the sale is rescinded and we are obligated to refund the purchase price to the buyer. In these circumstances, the consignor is obligated to return any net sale proceeds paid to them. Outside of a valid authenticity claim, the buyer has no right to rescind a completed private sale. The authenticity guarantee provided to the buyer is a product warranty that is associated with the provision of our private sale service; it may not be purchased separately and does not provide an additional service to the buyer.
Other Agency Commissions and Fees—From time-to-time, we earn commissions and fees connected with sales of art brokered by third parties. These commissions and fees are recognized at a point in time in the period when we receive confirmation from the third parties that the sale has been completed.

17



Inventory Sales—From time-to-time, the Agency segment earns revenue from the sale of: (i) artworks that have been obtained as a result of the failure of guaranteed property to sell at auction; (ii) artworks that have been purchased opportunistically, including property acquired for sale at auction; and (iii) other objects obtained incidental to the auction process (e.g., as a result of buyer default).
Inventory sales may be consummated through either a private sale transaction or through an auction sale. For artworks that are sold privately, an executed agreement with the buyer is used to document the terms and conditions of the transaction. For artworks that are sold at auction, the sale is completed pursuant to the conditions of sale published in the corresponding auction catalogue. Regardless of the method of sale, title and control of the artwork are transferred to the buyer only upon payment of the full purchase price. Accordingly, sales of inventory are recognized at a point in time in the period when title and control of the artwork is transferred to the buyer.
Advisory Revenues—Advisory revenues consist of fees earned from providing art-related advice to certain clients. These arrangements may be evidenced by a legally binding written retainer agreement with the client, which outlines the nature of the services to be provided and the amount of fees to be earned. Advisory retainer agreements are typically one year in duration. Advisory services are also sometimes provided on the basis of a verbal agreement with the client. For advisory arrangements with written retainer agreements, revenues are recognized ratably over time, based on the contractual period and as services are provided to the client. In the absence of a written retainer agreement, revenue recognition is deferred until we have performed our substantive service obligations and the client has made payment for those services, thereby evidencing the terms of the arrangement.
License Fee Revenues—Prior to 2004, we were engaged in the marketing and brokerage of luxury residential real estate sales through Sotheby's International Realty ("SIR"). In 2004, we sold SIR to a subsidiary of Realogy Corporation ("Realogy"), formerly Cendant Corporation. In conjunction with the sale, we entered into an agreement with Realogy to license the SIR trademark and certain related trademarks for an initial 50-year term with a 50-year renewal option (the "Realogy License Agreement"). The Realogy License Agreement is applicable worldwide.The Realogy License Agreement provides for an ongoing license fee during its term based on the volume of commerce transacted under the licensed trademarks. We also license the Sotheby's name for use in connection with the art auction business in Australia, and art education services in the U.S. and the U.K. The license fees earned from these arrangements are sales-based and are recognized in the periods in which the underlying sales occur.
Sales, Use and Value-Added Taxes—Sales, use and value-added taxes assessed by governmental authorities that are both imposed on and concurrent with revenue-producing transactions between us and our clients are reported on a net basis within revenues.
Resale Royalties—In certain foreign jurisdictions, various resale royalties and other fees are imposed on auctioneers upon the completion of an auction sale. These royalties and fees are reported on a gross basis within Agency Direct Costs.
Contract Balances—Following the completion of an auction or private sale, we invoice the buyer for the aggregate purchase price of the property, which includes our buyer's premium or private sale commission, as well as any applicable taxes and royalties. The amount owed by the buyer is recorded within Accounts Receivable, and the amount of net sale proceeds due to the seller is recorded within Client Payables. Upon collection from the buyer, we are obligated to remit the net proceeds to the seller after deducting our commissions and related fees, as well as any applicable taxes and royalties, which are ultimately paid to the appropriate taxing authority or royalty association.
Under our standard auction payment terms, the purchase price is due from the buyer no more than 30 days after the sale date, with the net proceeds due to the consignor 35 days after the sale date. For private sales, payment from the buyer is typically due on the sale date, with the net sale proceeds due to the consignor shortly thereafter. We also sometimes provide extended payment terms to an auction or private sale buyer. For auctions, the extent to which extended payment terms are provided 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, we attempt to match the timing of cash receipt from the buyer with the timing of our payment to the consignor, but are not always successful in doing so. All extended payment term arrangements are approved by management under our internal corporate governance policy.

18



In the limited circumstances when the buyer's payment due date is extended to a date that is beyond one year from the sale date, if the seller does not provide matched payment terms (i.e., we pay the seller before receiving payment from the buyer), the receivable balance is reclassified from Accounts Receivable to Notes Receivable on our Condensed Consolidated Balance Sheets. See Note 5 for information on Agency segment Notes Receivable.
When the buyer's due date is extended to a date that is one year or less from the sale date, as a practical expedient, we do not record a discount to our commission to account for the effects of the financing component. However, in the limited circumstances when the buyer's due date is extended to a date that is beyond one year from the sale date, we record a discount to our commission revenue to reflect the financing component, if material.
The table below summarizes the balances related to our contracts with customers as of and for the nine months ended September 30, 2018 and 2017 (in thousands of dollars):
 
 
September 30,
2018
 
September 30,
2017
Accounts Receivable
 

 

Balance as of beginning of period
 
$
783,706

 
$
424,418

Balance as of end of period
 
$
599,681

 
$
442,111

(Decrease)/increase
 
$
(184,025
)
 
$
17,693

Client Payables
 
 
 
 
Balance as of beginning of period
 
$
996,197

 
$
511,876

Balance as of end of period
 
$
627,466

 
$
376,108

Decrease
 
$
(368,731
)
 
$
(135,768
)
The balances of Accounts Receivable presented in the table above relate almost entirely to amounts due from auction and private sale buyers. To a much lesser extent, they also include amounts owed to us in relation to our advisory services and brand licensing activities. Interest and related fees due to SFS, which are recorded within Accounts Receivable on our Condensed Consolidated Balance Sheets, are excluded from this table because they are not considered to be contract balances under ASC 606.
The net decreases in Accounts Receivable and Client Payables during the nine months ended September 30, 2018 are largely the result of auction sale proceeds that have been collected from buyers and remitted to sellers. The net changes in Accounts Receivable and Client Payables during the nine months ended September 30, 2017 were largely attributable to the funding of certain consignor settlements prior to collecting from buyers. When compared to September 30, 2017, the increases in Accounts Receivable and Client Payables as of September 30, 2018 are principally due to the higher levels of auction and private sales through the third quarter of 2018, a decrease in early consignor settlements (as discussed in the following paragraph), and the general timing of buyer and consignor settlements.
In certain instances, and subject to management approval under our internal corporate governance policy, we may pay the net sale proceeds to the seller before payment is collected from the buyer and/or we may allow the buyer to take possession of the property before making payment. In situations when the buyer takes possession of the property before making payment, we are liable to the seller for the net sales proceeds whether or not the buyer makes payment. As of September 30, 2018, December 31, 2017, and September 30, 2017, Accounts Receivable included $47.2 million, $92.1 million, and $144.9 million, respectively, related to situations when we paid the seller all or a portion of the net sales proceeds before payment was collected from the buyer. As of September 30, 2018, December 31, 2017, and September 30, 2017, Accounts Receivable (net) also included $12 million, $53.8 million, and $16.4 million, respectively, related to situations when we allowed the buyer to take possession of the property before making payment.
Deferred revenue balances are generally not material.
Contract Costs—We incur various direct costs in the fulfillment of our auction services. These costs principally relate to the transport of consigned artworks to the location of the auction sale, various sale marketing activities including catalogue production and distribution, and the exhibition of consigned artworks. A large portion of these costs are funded prior to the auction and are recorded on our Condensed Consolidated Balance Sheets within Prepaid Expenses and Other Current Assets until the date of the auction sale when they are expensed to Direct Costs of Services in the Condensed Consolidated Statements of Operations. As of September 30, 2018, December 31, 2017, and September 30, 2017, the contract cost balances recorded within Prepaid Expenses and Other Current Assets were $10.4 million, $9.6 million, and $8.2 million, respectively.

19




5. Notes Receivable
Sotheby's Financial Services—SFS makes term loans secured by artworks that are not presently intended for sale, allowing us to establish or enhance mutually beneficial relationships with art collectors. Term loans may also generate future auction or private sale consignments through the sale of the collateral at the conclusion of the loan and/or through future purchases of new property by the borrower. In certain situations, term loans are made to refinance the accounts receivable balances generated by the auction and private sale purchases of our clients. Term loans normally have initial maturities of up to two years and typically carry a variable market rate of interest. To a much lesser extent, SFS also makes consignor advances secured by artworks that are contractually committed, in the near term, to be offered for sale through the Agency segment. Consignor advances allow sellers to receive funds upon consignment for an auction or private sale that will occur up to one year in the future and normally have short-term maturities.
As of September 30, 2018, December 31, 2017, and September 30, 2017, the net Notes Receivable balance of SFS was $593 million, $590.6 million, and $602.2 million, respectively. As of September 30, 2018, December 31, 2017, and September 30, 2017, the total net Notes Receivable balance of SFS included $132.5 million, $54.4 million, and $57.9 million, respectively, of term loans issued by SFS to refinance client auction and private sale purchases. For the nine months ended September 30, 2018 and 2017, SFS issued $119.2 million and $6.5 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 our Condensed Consolidated Statements of Cash Flows. Upon repayment, the cash received in settlement of such Notes Receivable is classified within Operating Activities in our Condensed Consolidated Statements of Cash Flows. For the nine months ended September 30, 2018 and 2017, such repayments totaled $41.1 million and $37.3 million, respectively.
The repayment 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, our ability to realize on our collateral may be limited or delayed.
We aim to mitigate the risk associated with a potential devaluation in our collateral by targeting a 50% loan-to-value ("LTV") ratio (i.e., the principal loan amount divided by the low auction estimate of the collateral). However, loans may also be made with LTV ratios between 51% and 60%, and, in rare circumstances, loans may be made at an initial LTV ratio higher than 60%
The LTV ratio of certain loans may increase above the 50% target due to a decrease in the low auction estimates of the collateral. The revaluation of term loan collateral is performed by our specialists on an annual basis or more frequently if there is a material change in the circumstances related to the loan, the value of the collateral, the disposal plans for the collateral, or if an event of default occurs. We believe that the LTV ratio is the 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 September 30, 2018, December 31, 2017, and September 30, 2017 (in thousands of dollars):
 
 
September 30,
2018
 
December 31,
2017
 
September 30,
2017
Secured loans
 
$
592,962

 
$
590,609

 
$
602,176

Low auction estimate of collateral
 
$
1,425,960

 
$
1,369,235

 
$
1,378,737

Aggregate LTV ratio
 
42
%
 
43
%
 
44
%
The table below provides the aggregate LTV ratio for secured loans made by SFS with an LTV ratio above 50% as of September 30, 2018, December 31, 2017, and September 30, 2017 (in thousands of dollars):
 
 
September 30,
2018
 
December 31,
2017
 
September 30,
2017
Secured loans with an LTV ratio above 50%
 
$
225,491

 
$
168,116

 
$
179,568

Low auction estimate of collateral related to secured loans with an LTV ratio above 50%
 
$
382,997

 
$
269,063

 
$
306,603

Aggregate LTV ratio of secured loans with an LTV ratio above 50%
 
59
%
 
62
%
 
59
%

20



The table below provides other credit quality information regarding secured loans made by SFS as of September 30, 2018, December 31, 2017, and September 30, 2017 (in thousands of dollars):
 
 
September 30,
2018
 
December 31,
2017
 
September 30,
2017
Total secured loans
 
$
592,962

 
$
590,609

 
$
602,176

Loans past due
 
$
77,751

 
$
62,570

 
$
79,038

Loans more than 90 days past due
 
$
27,315

 
$
56,087

 
$
78,367

Non-accrual loans
 
$
6,330

 
$

 
$

Impaired loans
 
$

 
$

 
$

Allowance for credit losses:
 
 
 
 

 
 

Allowance for credit losses for impaired loans
 
$

 
$

 
$

Allowance for credit losses based on historical data
 
1,067

 
1,253

 
1,295

Total allowance for credit losses - secured loans
 
$
1,067

 
$
1,253

 
$
1,295

We consider a loan to be past due when principal payments are not paid by the contractual maturity date. Typically, a loan becomes past due only for a short period of time during which either the loan is renewed or collateral is sold to satisfy the borrower's obligations. As of September 30, 2018, $77.8 million of the net Notes Receivable balance was past due, of which $27.3 million was more than 90 days past due. We are continuing to accrue interest on $71.4 million of past due loans and, as of September 30, 2018, the collateral securing such loans had a low auction estimate of approximately $259.4 million, resulting in an LTV ratio of approximately 28%. In consideration of expected loan renewals, collateral sales to date for which the proceeds have not yet been collected from the buyer, as well as the value of the remaining collateral and our current collateral disposal plans, we believe that the principal and interest amounts owed for these past due loans will be collected.
A non-accrual loan is a loan for which future Finance revenue is not recorded due to our 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 we become aware of other circumstances that indicate that it is probable that the borrower will make future interest payments on the loan. As of January 1, 2018, one of the past due loans included in the table above was placed on non-accrual status. Through September 30, 2018, our investment in this loan was reduced by $41.1 million as the result of proceeds collected from collateral sales. As of September 30, 2018, our recorded investment in this loan was approximately $8.1 million, consisting of the $6.3 million principal balance and $1.8 million in accrued interest. Additional collateral sale proceeds of $7.2 million are expected to be collected from auction buyers in the first quarter of 2019. Following the collection of these collateral sale proceeds, our recorded investment in the loan will be less than $1 million which we expect to recover through the future sale of the remaining loan collateral.
A loan is considered to be impaired when we determine 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 September 30, 2018, December 31, 2017, and September 30, 2017, there were no impaired loans outstanding.
As of September 30, 2018, unfunded commitments to extend additional credit through SFS were approximately $46 million.
Agency Segment—As discussed above, 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 matched payment terms, the receivable balance is reclassified from Accounts Receivable (net) to Notes Receivable (net) on our Condensed Consolidated Balance Sheets. As of September 30, 2018, December 31, 2017, and September 30, 2017, Notes Receivable (net) within the Agency segment included $1.2 million, $2.7 million, and $2.7 million of such amounts reclassified from Accounts Receivable (net). These Notes Receivable 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 our Condensed Consolidated Statements of Cash Flows. Upon repayment, the cash received in settlement of such Notes Receivable is classified within Operating Activities in our Condensed Consolidated Statements of Cash Flows. For the nine months ended September 30, 2018 and 2017, such repayments totaled $1 million and $5 million, respectively.

21



Under certain circumstances, we provide loans to certain art dealers to finance the purchase of works of art. In these situations, we acquire 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 September 30, 2018, such loans totaled $3.1 million, including one loan with a balance of $2.1 million for which we are no longer accruing interest but believe that the recorded balance of the loan is collectible. As of September 30, 2017, such loans totaled $3.8 million. In the fourth quarter of 2017, we determined one of these loans to be impaired as a result of the bankruptcy of the art dealer and recorded a credit loss of $1.5 million in the period. We have commenced legal proceedings against one of the individuals who personally guaranteed this loan. As of December 31, 2017, we had one loan outstanding of this type with a balance of $2.1 million.
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 Agency segment consignor advances are recorded on our Condensed Consolidated Balance Sheets within Notes Receivable (net) and totaled $3.4 million as of September 30, 2018. There were no Agency segment consignor advances outstanding as of December 31, 2017 and September 30, 2017.
Allowance for Credit Losses—During the period January 1, 2018 to September 30, 2018, activity related to the Allowance for Credit Losses by segment was as follows (in thousands of dollars):
 
SFS
 
Agency
 
Total
Balance as of January 1, 2018
$
1,253

 
$
1,525

 
$
2,778

Change in loan loss provision based on historical data
(186
)
 

 
(186
)
Balance as of September 30, 2018
$
1,067

 
$
1,525

 
$
2,592


22



6. Goodwill and Intangible Assets
Goodwill—For the nine months ended September 30, 2018 and 2017, changes in the carrying value of Goodwill were as follows (in thousands of dollars):
 
 
Nine Months Ended September 30, 2018
 
Nine Months Ended September 30, 2017
 
 
Agency
 
All Other
 
Total
 
Agency
 
All Other
 
Total
Beginning balance as of January 1
 
$
44,396

 
$
6,151

 
$
50,547

 
$
43,878

 
$
6,151

 
$
50,029

Goodwill acquired
 
5,259

 

 
5,259

 

 

 

Foreign currency exchange rate changes
 
(148
)
 

 
(148
)
 
467

 

 
467

Ending balance as of September 30
 
$
49,507

 
$
6,151

 
$
55,658

 
$
44,345

 
$
6,151

 
$
50,496

On February 2, 2018, we acquired Viyet, an online marketplace for interior design specializing in vintage and antique furniture, decorative objects, and accessories. This acquisition complements and enhances our online sales program, and provides an additional sale format to offer clients. In October 2018, Viyet was rebranded as Sotheby's Home.
Intangible Assets—As of September 30, 2018, December 31, 2017, and September 30, 2017, intangible assets consisted of the following (in thousands of dollars):
 
 
Amortization Period
 
September 30, 2018
 
December 31, 2017
 
September 30,
2017
Indefinite lived intangible assets:
 
 
 
 
 
 
 
 
License (a)
 
N/A
 
$
324

 
$
324

 
$
324

Intangible assets subject to amortization:
 
 
 
 
 
 
 
 
Customer relationships - Art Advisory Partners
 
8 years
 
10,800

 
10,800

 
10,800

Non-compete agreements - Art Advisory Partners
 
6 years
 
3,060

 
3,060

 
3,060

Artworks database (b)
 
10 years
 
1,275

 
1,200

 
1,200

Technology
 
4 years
 
4,461

 

 

Total intangible assets subject to amortization
 
 
 
19,596

 
15,060

 
15,060

Accumulated amortization
 
 
 
(5,939
)
 
(3,892
)
 
(3,397
)
Total amortizable intangible assets (net)
 
 
 
13,657

 
11,168

 
11,663

Total intangible assets (net)
 
 
 
$
13,981

 
$
11,492

 
$
11,987

(a)
Relates to a license obtained in conjunction with the purchase of a retail wine business in 2008.
(b)
Relates to a database containing historic information concerning repeat sales of works of art. This database was acquired along with the associated business in exchange for an initial cash payment made in the third quarter of 2016 and subsequent cash payments made in the third quarters of 2018 and 2017.
For the three and nine months ended September 30, 2018, amortization expense related to intangible assets was approximately $0.7 million and $2 million, respectively. For the three and nine months ended September 30, 2017, amortization expense related to intangible assets was approximately $0.5 million and $1.5 million, respectively.
The estimated aggregate amortization expense for the remaining useful lives of intangible assets subject to amortization during the five-year period succeeding the September 30, 2018 balance sheet date are as follows (in thousands of dollars):
Period
 
Amount
October 2018 to September 2019
 
$
3,103

October 2019 to September 2020
 
$
3,103

October 2020 to September 2021
 
$
3,103

October 2021 to September 2022
 
$
1,977

October 2022 to September 2023
 
$
1,478


23



7. Defined Benefit Pension Plan
We sponsor a defined benefit pension plan in the U.K. (the "U.K. Pension Plan"), which was closed to future service cost accruals on April 30, 2016. For the three and nine months ended September 30, 2018 and 2017, the components of the net pension credit for the U.K. Pension Plan recorded within Non-Operating Income in our Condensed Consolidated Statements of Operations were as follows (in thousands of dollars):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Interest cost
 
$
1,855

 
$
2,047

 
$
5,775

 
$
5,984

Expected return on plan assets
 
(2,717
)
 
(3,598