Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
 
 
 
 
FORM 10-K
(Mark One)
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2017.
 
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE TRANSITION PERIOD FROM          TO
COMMISSION FILE NUMBER 1-9750
___________________________________________________________________
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12096626&doc=17
(Exact name of registrant as specified in its charter)
__________________________________________________________________
Delaware
38-2478409
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
1334 York Avenue
10021
New York, New York
(Zip Code)
(Address of principal executive offices)
 
 
 
 
 
(212) 606-7000
 
 
(Registrant’s telephone number, including area code)
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
 
 
 
 
 
 
 
 
Title of each class
 
 
Name of each exchange
on which registered
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock,
 
 
New York Stock Exchange
 
 
$0.01 Par Value
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities registered pursuant to Section 12(g) of the Act: None
 
 
 
 
 
 
 
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
ý
 
Accelerated filer
o
Non-accelerated filer
o
(Do not check if a smaller reporting company)
Smaller reporting company
o
Emerging growth company
o
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes o No þ
As of June 30, 2017, the aggregate market value of the 45,348,206 shares of Common Stock held by non-affiliates of the registrant was $2,433,838,216 based upon the closing price ($53.67) on the New York Stock Exchange composite tape on such date for the Common Stock.
As of February 26, 2018, there were outstanding 52,461,996 shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s proxy statement for the 2018 annual meeting of shareholders are incorporated by reference into Part III of this Form 10-K.
 




TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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PART I

ITEM 1: DESCRIPTION OF BUSINESS
Company Overview
Sotheby's offers collectors the opportunity to connect with and transact in the world's most extraordinary art and luxury goods. Auctioneers since 1744, today we present auctions in ten different salesrooms, including New York, London, Hong Kong and Paris, and Sotheby’s BidNow program allows clients to view all auctions live online and place bids on their mobile devices from anywhere in the world. We also offer collectors a variety of innovative art-related services, including the brokerage of private art sales, private jewelry sales through Sotheby's Diamonds, exclusive private selling exhibitions, art-related financing, and art advisory services, as well as retail wine locations in New York and Hong Kong.
As successor to a business that began in 1744, Sotheby's is the oldest company listed on the New York Stock Exchange ("NYSE") (symbol: BID) and is the only publicly traded investment opportunity in the art market. Sotheby's is incorporated in Delaware.
Business Organization
Our operations are organized under two segments—the Agency segment and the Finance segment, which does business as and is referred to in this report as Sotheby’s Financial Services (“SFS”). The Agency segment earns commissions 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, the Agency segment also includes the sale of artworks that are owned by Sotheby's, principally as a consequence of the auction process, as well as our investment in RM Sotheby's, an auction house for investment-quality automobiles. SFS earns interest income and associated fees through art-related financing activities by making loans that are secured by works of art. Art Agency, Partners (“AAP”), which was acquired on January 11, 2016 and through which we offer art advisory services, provides art collectors with strategic guidance on collection identity and development, acquisitions, and short and long-term planning, and provides advice to artists and artists' estates. In addition, from time-to-time, AAP brokers private art sales for its advisory clients. Our advisory services are classified within All Other for segment reporting purposes, along with our retail wine business and brand licensing activities, and the results from certain equity method investments. See Note 2 of Notes to Consolidated Financial Statements for information regarding our segment reporting.
Agency Segment
Through our Agency segment, we accept property on consignment, stimulate buyer interest through professional marketing techniques, and match sellers (also known as consignors) to buyers through the auction or private sale process. Prior to offering a work of art for sale, we perform due diligence activities to authenticate and determine the ownership history of the property being sold. See “Converting Consignment Opportunities” below for further information regarding the consignment process.
Following an auction or private sale, we invoice the buyer for the purchase price of the property (including any commission, as well as any applicable taxes and royalties), collect payment from the buyer, and remit to the consignor the net sale proceeds after deducting our commissions, expenses and applicable taxes and royalties. As compensation for our auction services, we earn a commission from both the buyer ("buyer's premium") and, to a lesser extent, the seller ("seller's commission") (collectively, "auction commission revenue"), both of which are calculated as a percentage of the hammer price of the property sold at auction. In 2017, 2016, and 2015, auction commission revenues accounted for approximately 66%, 75%, and 75%, respectively, of our consolidated revenues. In 2017, the decrease in auction commission revenues as a percentage of our consolidated revenues is attributable to a substantially higher level of inventory sales, due in part to the sale of a significant item from inventory in the current year (see Note 11 of Notes to Consolidated Financial Statements). Private sale commission revenues are earned through the direct brokering of purchases and sales of art. Private sales are initiated either by a client wishing to sell property with Sotheby's acting as its exclusive agent in the transaction, or by a prospective buyer who is interested in purchasing a certain work of art privately. In 2017, 2016, and 2015, private sale commission revenues accounted for approximately 7%, 7%, and 6%, respectively, of our consolidated revenues.

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Under the standard terms and conditions of our auction and private sales, we are not obligated to pay the consignor for property that has not been paid for by the buyer. If a buyer defaults on payment, the sale is cancelled, and the property is returned to the consignor. Alternatively, the consignor may reoffer the property at one of our future auctions or negotiate a private sale with us acting as their agent. In certain instances and subject to management approval under our internal corporate governance policy, we may pay the net sale proceeds to the consignor before payment is collected from the buyer and/or we may allow the buyer to take possession of the property before making payment. In situations when the buyer takes possession of the property before making payment, we are liable to the seller for the net sale proceeds whether or not the buyer makes payment.
From time-to-time in the ordinary course of our business, we 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, we are 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, we 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"). If any item of property offered under the auction guarantee does not sell, the amount of the auction guarantee must be paid, but we take ownership of the unsold property and may recover the amount paid through its future sale. In certain limited situations, if the guaranteed property fails to sell at auction or if the purchaser defaults, the consignor has the right to cancel the auction guarantee and retain the property.
We may reduce our financial exposure under auction guarantees through contractual risk and reward sharing arrangements. Such auction guarantee risk and reward sharing arrangements include irrevocable bids and partner sharing arrangements. In exchange for accepting a share of the financial exposure under the auction guarantee, our counterparties to these arrangements may receive a fee for providing the irrevocable bid, and are generally entitled to receive a share of our auction commission if the property sells and/or a share of the overage, if any.
Auction guarantees are an important financial incentive which may significantly influence an art collector's decision on whether and how to sell their property. As such, auction guarantees provide us the opportunity to secure highly sought-after consignments, often well in advance of a specific selling season. When we evaluate the performance of our portfolio of auction guarantees, we take into consideration the overall net revenues earned on the transaction, which includes our auction commission revenue, as well as any overage or shortfall. Depending on the mix of items subject to an auction guarantee, in advance of peak selling seasons, a small number of guaranteed items may represent a substantial portion of the aggregate amount of outstanding auction guarantees.
See "Auction Commission Margin" under Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for a complete discussion of the factors impacting auction commission margin, as well as a discussion of the overall financial performance of the Agency segment for the years ended December 31, 2017, 2016 and 2015. See Note 4 of Notes to Consolidated Financial Statements for additional information about auction and private sale receivables. See Note 19 of Notes to Consolidated Financial Statements for additional information about auction guarantees.
Sotheby's Financial Services
SFS is an art financing company that operates as a niche lender with the ability to tailor attractive financing packages for clients who wish to obtain immediate access to liquidity from their art assets. SFS leverages the art expertise of the Agency segment, skill in international law and finance, and access to capital to provide art collectors and dealers with financing secured by their works of art, allowing them to unlock the value in their collections. A considerable number of traditional lending sources offer conventional loans at a lower cost to borrowers than the average cost of loans offered by SFS and many traditional lenders offer borrowers a variety of integrated financial services such as wealth management. Few lenders, however, are willing to accept works of art as sole collateral for loans, as they do not have access to market information allowing them to effectively appraise collateral during the life of a loan, nor do they have the wherewithal to efficiently monetize loan collateral.
SFS makes term loans secured by artworks that are not presently intended for sale, allowing us to establish or enhance mutually beneficial relationships with art collectors. Term loans may also generate future auction or private sale consignments through the sale of the collateral at the conclusion of the loan and/or through future purchases of new property by the borrower. In certain situations, term loans are made to refinance receivables 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 our 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.

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The lending activities of SFS are funded with borrowings drawn from a dedicated revolving credit facility and cash balances, including amounts generated by the Agency segment. In September 2017, we modified our cash management strategy in order to reduce borrowing costs by applying excess cash balances against revolving credit facility borrowings. As a result, since September 2017, we have reduced revolving credit facility borrowings to $196.5 million as of December 31, 2017.
See "Sotheby's Financial Services" under Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for information on the financial performance of SFS for the years ended December 31, 2017, 2016 and 2015. See Note 4 of Notes to Consolidated Financial Statements for information about the SFS loan portfolio. See Note 9 of Notes to Consolidated Financial Statements for information about the SFS revolving credit facility.
The Art Market
The global art market, like other asset classes, is influenced over time by the overall strength and stability of the global economy, the financial markets of various countries, geopolitical conditions, and world events. However, the global art market often moves independently and sometimes, counter to, general macroeconomic cycles. Ultimately, we believe that the level of activity and buoyancy of the global art market is most prominently impacted by the collective sentiment of art market participants, as well as the individual circumstances of potential sellers of art. For example, many major artworks are offered for sale only as a result of the death or financial or personal situations of the owner (see "Converting Consignment Opportunities" below). In addition, in the wake of economic uncertainty, potential sellers may not be willing to offer their artworks for sale, and potential buyers may be less willing to purchase works of art. Also, in periods of market expansion, potential sellers may choose to not offer their artworks for sale in order to benefit from potential future price appreciation. Taken together, these factors cause the supply and demand for works of art to be unpredictable and may lead to significant variability in our revenues and earnings from period to period.
It is not possible to measure with any particular accuracy the entire global art market or to reach definitive conclusions regarding overall competition because privately owned art dealers and auction houses frequently do not publicly report annual totals for art sales, revenues, or profits, and the amounts reported may not be verifiable. However, the most recent Art Basel & UBS Art Market Report estimates that global art sales totaled approximately $57 billion in 2016 with private sales by dealers and other agents accounting for 60% of the market and public auctions accounting for 40%. By comparison, in 2002, global art sales totaled $27 billion, reflecting a compound annual growth rate of 5.3%. This growth is indicative of the increasingly global nature of the art market, with a rise in cross-border transactions and a more global distribution network, and a significant increase in global wealth, due in part to rising affluence in newly industrialized countries.
Seasonality
The global art auction market has two principal selling seasons, which generally occur in the second and fourth quarters of the year. In the aggregate, second and fourth quarter Net Auction Sales1 represented 80%, 82%, and 78% of our total annual Net Auction Sales in 2017, 2016, and 2015, respectively, with auction commission revenues comprising approximately 66%, 75%, and 75% of our total revenues in each of these years. Accordingly, our financial results are seasonal, with peak revenues and operating income generally occurring in the second and fourth quarters. Consequently, first and third quarter results have historically reflected lower revenues when compared to the second and fourth quarters and, typically, a net loss due to the fixed nature of many of our operating expenses.
In quarterly reporting periods, the comparison of our results between reporting periods can be significantly influenced by a number of factors, such as changes in the timing of when certain auctions occur, the level of non-recurring single-owner auction sale events, the level and timing of individually negotiated private sale transactions, and changes in certain accounting estimates that rely upon forecasted results such as variable incentive and share-based compensation expense and our estimated annual effective income tax rate. Accordingly, when evaluating our performance, we believe that investors should also consider results for last six and twelve month periods, which better reflect the business cycle of the global art auction market. See Note 28 of Notes to Consolidated Financial Statements for our quarterly results for the years ended December 31, 2017 and 2016.

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


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Competition
Artworks are sold primarily through the major auction houses, numerous art dealers, smaller auction houses, and also directly between private collectors. In recent years, a growing number of art dealers and private collectors also now buy and sell artworks at art fairs such as the The European Fine Art Fair ("TEFAF"), Art Basel, and the Frieze art fairs.
Competition in the global art market is intense. A fundamental challenge facing any auctioneer or art dealer is the sourcing of high quality and valuable property for sale either as agent or as principal. Our primary competitor in the global art market is Christie's, a privately owned auction house. To a lesser extent, we also face competition from a variety of art dealers across all collecting categories, as well as smaller auction houses such as Bonhams, Phillips, and certain regional auction houses. In the Chinese art market, the largest auction houses are Beijing Poly International Auction Co. Ltd., China Guardian Auctions Co. Ltd. and Beijing Hanhai Auction Co. Ltd.
In 2017, 2016 and 2015, Sotheby's and Christie's together totaled approximately $10.5 billion, $8.7 billion, and $12.3 billion, respectively, of Aggregate Auction Sales2, of which we accounted for $4.6 billion (44%), $4.2 billion (49%), and $5.9 billion (48%), respectively.
Converting Consignment Opportunities
The ability to source high quality and valuable property for consignment is highly dependent on the meaningful institutional and personal relationships we have with our clients, which sometimes span generations. As these relationships develop over time, we provide our clients with strategic guidance on collection identity, development and acquisition, and then help them navigate the financial, logistical and personal considerations involved with deciding to sell their valued artworks. A client's decision to sell their art may be part of their long-term financial planning process or could occur suddenly as a result of an unexpected change in circumstances. The timing of when consignment opportunities may arise is often unpredictable and not within our control. As a result, it is difficult to predict with any certainty the supply of high quality and valuable property available for consignment in advance of peak selling seasons.
The more valuable the property, the more likely it is that a seller of art will solicit proposals from more than one potential purchaser or agent. The primary options available to a seller of art have been (i) sale or consignment to an art dealer; (ii) sale or consignment to an auction house; (iii) private sale to a collector or museum; or (iv) consignment to an internet based service.












____________
2 Represents the total hammer (sale) price of property sold at auction, plus buyer's premium.




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A complex array of factors may influence a seller's decision to favor one of these options over the others, and may include any or all of the following considerations:
Factors Influencing a Seller's Decision
- The level and breadth of expertise of the art dealer or auction house with respect to the property.
- The desirability of a public auction in order to achieve the maximum possible price.
- The extent of the prior relationship, if any, between the art dealer or auction house and its staff and the seller, and ease of transacting with such parties.
- The amount of cash offered by an art dealer, auction house or other purchaser to purchase the property outright, which is greatly influenced by the amount and cost of capital resources available to such parties.
- The reputation and historic level of achievement by the art dealer or auction house in attaining high sale prices in the property's specialized category.
- The availability and terms of financial incentives offered by auction houses, including auction guarantees, short-term financing, and auction commission sharing arrangements.
- Recommendations by third parties consulted by the seller.
- The commission charged by art dealers or auction houses to sell a work on consignment.
- The client's desire for privacy.
- The cost, style, and extent of pre-sale marketing and promotion to be undertaken by an art dealer or auction house.
- The level of pre-sale estimates.
- The availability and extent of related services, such as tax or insurance appraisals.
Regulation of the Art Market
Regulation of the art market varies from jurisdiction to jurisdiction. In many jurisdictions, we are subject to laws and regulations, including, but not limited to, import and export regulations, cultural property regulations, data protection and privacy laws, anti-money laundering laws, antitrust laws, copyright and resale royalty laws, laws and regulations involving sales, use, value-added and other indirect taxes, and regulations related to the use of real estate. In addition, we are subject to local auction regulations, such as New York City Auction Regulations Subchapter M of Title 6 §§ 2-121-2-125, et. seq. Such regulations currently do not impose a material impediment to our business, but do affect the art market generally. A material adverse change in such regulations, such as the American Royalties Too Act of 2014 introduced in the U.S. Congress, which would impose a 5% resale royalty (with a cap of $35,000) on sales of art through large auction houses, could affect our business. Additionally, export and import laws and cultural property ownership laws could affect the availability of certain kinds of property for sale at our principal auction locations, increase the cost of moving property to such locations, or expose us to legal claims or government inquiries. We have a Compliance Department which, amongst other activities, develops and updates compliance policies, and audits, monitors, and provides training to our employees on compliance with many of these laws and regulations.
Brand Licensing Activities
Prior to 2004, we were engaged in the marketing and brokerage of luxury residential real estate sales through Sotheby's International Realty ("SIR"). In 2004, we sold SIR to a subsidiary of Realogy Corporation ("Realogy"), formerly Cendant Corporation. In conjunction with the sale, we entered into an agreement with Realogy to license the SIR trademark and certain related trademarks for an initial 50-year term with a 50-year renewal option (the "Realogy License Agreement"). The Realogy License Agreement is applicable worldwide.
The Realogy License Agreement provides for an ongoing license fee during its term based on the volume of commerce transacted under the licensed trademarks. In 2017, 2016, and 2015, we earned $10.3 million, $9.1 million, and $8.1 million, respectively, in license fee revenue related to the Realogy License Agreement.
We also license the Sotheby's name for use in connection with the art auction business in Australia, and art education services in the U.S. and the U.K. We will consider additional opportunities to license the Sotheby's brand in businesses where appropriate.



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Financial and Geographical Information about Segments
See Note 2 of Notes to Consolidated Financial Statements for financial and geographical information about Sotheby's segments.
Employees
As of December 31, 2017, we have 1,662 employees, with 689 located in the Americas, 533 in the U.K., 232 in Continental Europe, and 208 in Asia. We regard our relations with our employees as good. The table below provides a breakdown of Sotheby's employees by segment as of December 31, 2017 and 2016.
December 31,
 
2017
 
2016
Agency (a)
 
1,486

 
1,447

Finance
 
10

 
11

All Other (a) (b)
 
166

 
159

Total
 
1,662

 
1,617

(a) Beginning in 2017, employees responsible for marketing activities are included in the Agency segment. In previous Form 10-K filings, such employees were included in All Other. The prior year amounts in the table above have been adjusted to conform to the current period presentation.
(b) Employees classified within "All Other" principally relate to our central corporate and information technology departments.
Website Address
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, are available free of charge on the Investor Relations page of our website, www.sothebys.com. These reports are made available on the same day that they are electronically filed with or furnished to the Securities and Exchange Commission (the "SEC"). Information available on the website is not incorporated by reference and is not deemed to be part of this Form 10-K.
ITEM 1A: RISK FACTORS
Before you make an investment decision with respect to our common stock, you should carefully consider all of the information included in this Form 10-K and our subsequent periodic filings with the SEC. In particular, you should carefully consider the risk factors described below and the risks and uncertainties related to "Forward Looking Statements," any of which could have a material adverse effect on our business, results of operations, financial condition and the actual outcome of matters as to which forward looking statements are made in this annual report. The following risk factors, which are not ranked in any particular order, should be read in conjunction with the balance of this annual report, including the Consolidated Financial Statements and related notes.
The global economy, the financial markets and political conditions of various countries may negatively affect our business and clients, as well as the supply of and demand for works of art.
The global art market is influenced over time by the overall strength and stability of the global economy and the financial markets of various countries, although this correlation may not be immediately evident. In addition, global political conditions and world events may affect our business through their effect on the economies of various countries, as well as on the willingness of potential buyers and sellers to purchase and sell art in the wake of economic uncertainty. Our business can be particularly influenced by the economies, financial markets and political conditions of the U.S., the U.K., China, and the other major countries or territories of Europe and Asia (including the Middle East). Accordingly, weakness in those economies and financial markets can adversely affect the supply of and demand for works of art and our business. Furthermore, global political conditions may also influence the enactment of legislation that could adversely impact our business.
Competition in the global art market is intense and may adversely impact our business, results of operations, and financial condition.
We compete with other auctioneers and art dealers to obtain valuable consignments to offer for sale either at auction or through private sale. The level of competition is intense and can adversely impact our ability to obtain valuable consignments for sale, as well as the commission margins achieved on such consignments.

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We cannot be assured of the amount and quality of property consigned for sale, which may cause significant variability in our results of operations.
The amount and quality of property consigned for sale is influenced by a number of factors not within our control. Many major consignments, and specifically single-owner sale consignments, become available only as a result of the death or financial or marital difficulties of the owner, all of which are unpredictable and may cause significant variability in our results of operations from period to period.
The demand for art is unpredictable, which may cause significant variability in our results of operations.
The demand for art is influenced not only by overall economic conditions, but also by changing trends in the art market as to which collecting categories and artists are most sought after and by the collecting preferences of individual collectors. These conditions and trends are difficult to predict and may adversely impact our ability to obtain and sell consigned property, potentially causing significant variability in our results of operations from period to period.
We rely on a select group of clients who make a significant contribution to our revenues, profitability, and operating cash flows.
Sotheby's is a global art business that caters to a select group of the world's most discerning art collectors. Accordingly, our revenues, profitability, and operating cash flows are highly dependent upon our ability to develop and maintain relationships with these clients, as well as their financial strength.

Tax matters may cause significant variability in our results of operations.
We operate in many tax jurisdictions throughout the world, and the provision for income taxes involves a significant amount of judgment regarding the interpretation of relevant facts and laws in these jurisdictions. Our effective income tax rate and recorded tax balances can change significantly between periods due to a number of complex factors including, but not limited to: (i) our projected levels of taxable income; (ii) changes in the jurisdictional mix of our forecasted and/or actual pre-tax income; (iii) increases or decreases to valuation allowances recorded against deferred tax assets; (iv) tax audits conducted by various tax authorities; (v) adjustments to income taxes upon the finalization of income tax returns; (vi) the ability to claim foreign tax credits; and (vii) tax planning strategies. Additionally, our effective income tax rate could be impacted by future changes in applicable laws, including the European Commission’s investigations on illegal state aid and the Organisation for Economic Co-operation and Development project on Base Erosion and Profit Shifting, which may result in changes to long-standing tax principles. Given the unpredictability of these possible changes and their potential interdependency, it is very difficult to assess whether the overall effect of such potential tax changes would be cumulatively positive or negative for our earnings and cash flow, but such changes could adversely impact our financial results.

Our estimates of the effects of the U.S. Tax Cuts and Jobs Act on our business and financial statements require the exercise of significant judgment and are subject to change as regulations and guidance evolve.
The U.S. Tax Cuts and Jobs Act (the "Act"), which was enacted into law on December 22, 2017, significantly changes U.S. income tax law and includes numerous provisions that affect our business. Our compliance with the Act may require the collection of information that we do not regularly produce, the use of estimates in our financial statements, and the exercise of significant judgment in accounting for the provision for income taxes. As regulations and guidance evolve with respect to the Act, and as we gather more information and perform more analysis, our results may differ from previous estimates and may materially affect our financial position. In addition, it is uncertain how various states will respond to the newly enacted federal tax law. See Note 16 of Notes to Consolidated Financial Statements for additional information on the impact of the Act on our financial statements.


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Our clients reside in various tax jurisdictions throughout the world and the application of tax laws or tax reporting obligations in these jurisdictions, particularly as they relate to sales, use, value-added and other indirect taxes, is complex and requires a significant amount of judgment, exposing us to claims from tax authorities.
Our clients reside in various tax jurisdictions throughout the world. To the extent that there are changes to tax laws or tax reporting obligations in any of these jurisdictions, such changes could adversely impact the ability and/or willingness of our clients to purchase or sell works of art. Additionally, we are subject to laws and regulations in many countries involving sales, use, value-added and other indirect taxes which are assessed by various governmental authorities and imposed on certain revenue-producing transactions between us and our clients. The application of these laws and regulations to our unique business and global client base, and the estimation of any related liabilities is complex and requires a significant amount of judgment. We are generally not responsible for these indirect tax liabilities unless we fail to collect the correct amount of sales, use, value-added, or other indirect taxes. Failure to collect the correct amount of indirect tax on a transaction may expose us to claims from tax authorities.

The loss of key personnel could adversely impact our ability to compete.
We are largely a service business in which the ability of our employees to develop and maintain relationships with potential sellers and buyers of works of art is essential to our success. Moreover, our business is unique, making it important to retain key specialists and members of management. Accordingly, our business is highly dependent upon our success in attracting and retaining qualified personnel.
Our investments in new businesses and technologies involve significant risks and uncertainties and may not succeed.
We have invested in new businesses and technologies to implement our strategic priorities. These investments involve significant risks and uncertainties, and may adversely impact our short-term operating results and liquidity, and if they are unsuccessful, may expose us to the loss of clients and the impairment of assets. Our future operating results are dependent, in part, on our ability to successfully integrate and utilize these new businesses and technologies.
Government laws and regulations may restrict or limit our business or impact the value of our real estate assets.
Many of our activities are subject to laws and regulations including, but not limited to, import and export regulations, cultural property regulations, data protection and privacy laws, anti-money laundering laws, antitrust laws, copyright and resale royalty laws, laws and regulations involving sales, use, value-added and other indirect taxes, and regulations related to the use of real estate. In addition, we are subject to local auction regulations, such as New York City Auction Regulations Subchapter M of Title 6 § 2-121-2-125, et. seq. Such regulations currently do not impose a material impediment to our business, but do affect the art market generally. A material adverse change in such regulations, such as the American Royalties Too Act of 2014 introduced in the U.S. Congress, which would impose a 5% resale royalty (with a cap of $35,000) on sales of art through large auction houses, could affect our business. Additionally, export and import laws and cultural property ownership laws could affect the availability of certain kinds of property for sale at our principal auction locations, increase the cost of moving property to such locations, or expose us to legal claims or government inquiries.
Our ability to collect auction receivables may be adversely impacted by buyers from emerging markets, as well as by the banking and foreign currency laws and regulations and judicial systems of the countries in which we operate and in which our clients reside.
We operate in 40 countries and have a worldwide client base that has grown in recent years due in part to an increase in the activity of buyers from emerging markets, in particular, China. The collection of auction receivables related to buyers from emerging markets may be adversely impacted by the buyer's lack of familiarity with the auction process and the buyer's financial condition. Our ability to collect auction receivables may also be adversely impacted by the banking and foreign currency laws and regulations regarding the movement of funds out of certain countries, as well as by our ability to enforce our rights as a creditor in jurisdictions where the applicable laws and regulations may be less defined, particularly in emerging markets.

10



Our capital allocation and financial policies may impact our liquidity, financial condition, market capitalization and business, and our ongoing ability to return capital to shareholders (and the size and timing of such return) is subject to ongoing business variables.
The actions taken in reference to our capital allocation and financial policies may impact our current and future liquidity, financial condition, market capitalization, and business. In addition, the amount and timing of any potential return of capital to shareholders depends on various factors, including the amount of excess cash generated by our business in the future, the ability to finance the SFS loan portfolio, the business initiatives contemplated and implemented by management, and the amount of capital that may be required to support our future liquidity needs, among other factors.
Foreign currency exchange rate movements can significantly impact our results of operations and financial condition.
We have operations throughout the world. Approximately 61% of our total revenues were earned outside of the U.S. in 2017, including 23% of our total revenues earned in the U.K. Additionally, we have significant assets and liabilities denominated in the Pound Sterling, the Euro, and the Swiss Franc. Revenues, expenses, gains, and losses recorded in foreign currencies are translated using the monthly average exchange rates prevailing during the period in which they are recognized. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Accordingly, fluctuations in foreign currency exchange rates, particularly for the Pound Sterling, the Euro, and the Swiss Franc, can significantly impact our results of operations and financial condition.
Subject to management approval under our internal corporate governance policy, we may pay the net sale proceeds to the consignor before payment is collected from the buyer and/or we may allow the buyer to take possession of purchased property before making payment. In these situations, we are exposed to losses in the event the buyer does not make payment.
Under the standard terms and conditions of our auction and private sales, we are not obligated to pay the consignor for property that has not been paid for by the buyer. However, in certain instances and subject to management approval under our internal corporate governance policy, we may pay the net sale proceeds to the consignor before payment is collected from the buyer while we retain possession of the property. In these situations, if the buyer does not make payment, we take title to the property, but could be exposed to losses if the value of the property subsequently declines. In certain other situations and subject to management approval under our internal corporate governance policy, we may allow the buyer to take possession of the purchased property before making payment. In these situations, we are liable to the seller for the net sale proceeds whether or not the buyer makes payment and would incur a loss in the event of buyer default. See Note 4 of Notes to Consolidated Financial Statements for information about auction and private sale receivables.
We could be exposed to losses in the event of title or authenticity claims.
The assessment of property offered for auction or private sale can involve potential claims regarding title and authenticity. The items we sell may be subject to statutory warranties as to title and to a limited guarantee as to authenticity under the Conditions of Sale and Terms of Guarantee that are published in our auction sale catalogues and the terms stated in, and the laws applicable to, agreements governing private sale transactions. Our authentication of the items we offer is based on scholarship and research, but necessarily requires a degree of judgment from our specialists. In the event of a title or authenticity claim against us, we may have recourse against the seller of the property and may have the benefit of insurance, but a claim could nevertheless expose us to losses and to reputational risk.
Auction guarantees create the risk of loss resulting from the potential inaccurate valuation of art.
The market for fine art, decorative art, and jewelry is not a highly liquid trading market and, as a result, the valuation of these items is inherently subjective. Accordingly, we are at risk with respect to our ability to estimate the likely selling prices of property offered with auction guarantees. If our judgments about the likely selling prices of property offered with auction guarantees prove to be inaccurate, there could be a significant adverse impact on our results, financial condition, and liquidity. See Note 19 of Notes to Consolidated Financial Statements for information related to auction guarantees.
We could be exposed to losses in the event of nonperformance by our counterparties in auction guarantee risk and reward sharing arrangements.
In certain situations, we reduce our financial exposure under auction guarantees through risk and reward sharing arrangements. Our counterparties to these risk and reward sharing arrangements are typically major international art dealers or major art collectors. We could be exposed to losses in the event any of these counterparties do not perform according to the terms of these contractual arrangements. See Note 19 of Notes to Consolidated Financial Statements for information related to auction guarantees.

11



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

12



We could be exposed to reputational harm as a result of wrongful actions by certain third parties.
We are involved in various business arrangements and ventures with unaffiliated third parties. Wrongful actions by such parties could harm our brand and reputation.
A breach of the security measures protecting our global network of information systems and those of certain third-party service providers utilized by Sotheby's could adversely impact our operations, reputation and brand.
The protection of client, employee and company data is extremely important to us. The regulatory environment surrounding information security and privacy is becoming increasingly demanding and frequently changing in the jurisdictions in which we do business. Clients and employees have expectations that we will protect their information from cyber-attacks and other security breaches. We have implemented systems and processes that are designed to protect personal and company information and to prevent data losses, however, these measures cannot provide absolute security, and our systems may be vulnerable to cyber-security breaches such as viruses, hacking, and similar disruptions from unauthorized intrusions. In addition, we are dependent on a global network of information systems to conduct our business and are committed to maintaining a strong infrastructure to secure these systems. As part of our information systems infrastructure, we rely increasingly upon third-party service providers to perform services related to our live auction bidding platform, retail wine and other e-commerce, video broadcasting, website content distribution, marketing, and to store, process and transmit information including client, employee and company information. Any failure on our part or by these third-party service providers to maintain the security of our confidential data and our client and employee personal information could result in business disruption, damage to reputation, financial obligations, lawsuits, sizable fines and costs, and loss of employee and client confidence in Sotheby's, and thus could have a material adverse impact on our business and financial condition, and adversely affect our results of operations. A significant security breach could require future expenditures to implement additional security measures to protect against new privacy threats or to comply with state, federal and international laws aimed at addressing those threats.
Due to the nature of our business, valuable works of art are exhibited and stored at our facilities around the world. Such works of art could be subject to damage or theft, which could have a material adverse effect on our operations, reputation and brand.
Valuable works of art are exhibited and stored at our facilities around the world. Although we maintain state of the art security measures at our premises, valuable artworks may be subject to damage or theft. The damage or theft of valuable property despite these security measures could have a material adverse impact on our business and reputation.
Insurance coverage for artwork may become more difficult to obtain or the terms of such coverage may become less favorable, exposing us to losses resulting from the damage or loss of artwork in our possession.
We maintain insurance coverage for the works of art we own, works of art consigned by clients, and all other property that may be in our custody, which are exhibited and stored at our facilities around the world. An inability to adequately insure such works of art due to limited capacity of the global art insurance market, or the inability to secure coverage on acceptable terms, could, in the future, have a material adverse impact on our business, results of operations, and financial condition.
Our business continuity plans may not be effective in addressing the impact of unexpected events that could impact our business.
Our inability to successfully implement our business continuity plans in the wake of an unexpected event, such as an act of God or a terrorist attack occurring in or near one of our major selling and/or sourcing offices and/or any other unexpected event, could disrupt our ability to operate and adversely impact our operations.
Future costs and obligations related to our U.K. Pension Plan are dependent on unpredictable factors, which may cause variability in our employee benefit costs.
Future costs and obligations related to our defined benefit pension plan in the U.K. are heavily influenced by changes in interest rates, investment performance in the debt and equity markets, changes in statutory requirements in the U.K., and actuarial assumptions, each of which is unpredictable and may cause variability in our employee benefit costs. See Note 8 of Notes to Consolidated Financial Statements for information related to our defined benefit pension plan in the U.K.
ITEM 1B: UNRESOLVED STAFF COMMENTS
None.

13



ITEM 2: PROPERTIES
We are headquartered at 1334 York Avenue in New York (the "York Property"). The York Property includes land and approximately 406,000 square feet of building area. The York Property is home to our sole North American auction salesroom and principal North American exhibition space. The York Property is also home to the U.S. operations of SFS, as well as our corporate offices. We recently completed a review of our New York real estate holdings and concluded that we will continue to occupy our York Property headquarters for the foreseeable future. In September 2017, we decided to undertake an enhancement program, beginning in June 2018, to create new state-of-the art galleries, as well as new public and client exhibition spaces. 
We expect to invest between $40 million and $50 million over the next two years on this program. The York Property is subject to a seven-year, $325 million mortgage that matures on July 1, 2022 (the "York Property Mortgage"). As of December 31, 2017, the principal balance of the York Property Mortgage was $275.1 million. See Note 6 of Notes to Consolidated Financial Statements for additional information on the York Property. See Note 9 of Notes to Consolidated Financial Statements for additional information on the York Property Mortgage. See statement on Forward Looking Statements.
Our U.K. operations are based in London on New Bond Street, where the main salesrooms, exhibition spaces, and administrative offices are located. As part of a multi-year refurbishment initiative, we have invested approximately $15 million in New Bond Street in recent years to enhance exhibition and private sales gallery space, and establish a Sotheby's Diamonds salon. Almost the entire New Bond Street complex is either owned or held under various long-term lease, freehold, and virtual freehold arrangements. (Freeholds are occupancy arrangements in which we own the property outright. Virtual freeholds are occupancy arrangements in which there is a 2,000-year lease with nominal yearly rent payments that cannot be escalated during the term of the lease.) We also lease 52,000 square feet for a warehouse facility in Greenford, West London under a lease that expires in 2030.
We also lease space primarily for Agency segment operations in various locations throughout North America, South America, Continental Europe and Asia, including sales centers in Geneva and Zurich, Switzerland; Milan, Italy; Paris, France; and Hong Kong, China.
ITEM 3: LEGAL PROCEEDINGS
See Note 18 of Notes to Consolidated Financial Statements for information related to legal proceedings.
ITEM 4: MINE SAFETY DISCLOSURES
Not applicable.


14



PART II

ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Market and Stockholders
Our common stock is traded on the NYSE under the symbol BID. As of February 12, 2018, there were 768 registered holders of record of our common stock. The quarterly price ranges for our common stock for the years ended December 31, 2017 and 2016 were as follows:
 
 
2017
 
2016
 
 
High
 
Low
 
High
 
Low
Quarter Ended
 
 
 
 
 
 
 
 
March 31
 
$
49.87

 
$
38.46

 
$
27.49

 
$
18.86

June 30
 
$
56.21

 
$
43.66

 
$
32.25

 
$
24.96

September 30
 
$
57.95

 
$
42.78

 
$
41.23

 
$
26.20

December 31
 
$
54.44

 
$
44.08

 
$
42.66

 
$
33.85

Dividends and Common Stock Repurchases
See Note 14 of Notes to Consolidated Financial Statements for detailed information regarding dividends and common stock repurchases. The following table provides information regarding our common stock repurchase program during the three months ended December 31, 2017:
Period
 
Total number of shares purchased
 
Average price paid per share
 
Total number of shares purchased as part of publicly announced plans or programs
 
Approximate dollar value of shares that may yet be purchased under publicly announced plans or programs (a)
 
October 2017
 

 
$

 

 
$
100,033,273

 
November 2017
 
94,400

 
$
45.58

 
94,400

 
$
95,730,763

 
December 2017
 

 
$

 

 
$
95,730,763

 
Total
 
94,400

 
$
45.48

 
94,400

 
 
 
(a) Represents the dollar value of shares that were available to be repurchased under our publicly announced share repurchase program at the end of each respective monthly period.
On February 28, 2018, the Board of Directors approved a $100 million increase to our share repurchase authorization, resulting in an updated share repurchase authorization of $195.7 million as of that date.



15



Equity Compensation Plans
The following table provides information as of December 31, 2017 related to shares of common stock that may be issued under our existing equity compensation plans, including the Stock Option Plan, Restricted Stock Unit Plan, and Directors Stock Plan, each of which are described in Note 21 of Notes to Consolidated Financial Statements (in thousands, except per share data):
 
 
(A)
 
(B)
 
(C)
Plan Category
 
Number of
Securities to be
Issued Upon
Exercise of
Outstanding
Options, Warrants
and Rights (1)
 
Weighted Average
Exercise Price of
Outstanding Options,
Warrants and Rights (2)
 
Number of Securities
Remaining Available for
Future Issuance Under
Equity Compensation Plans (3)
Equity compensation plans approved by shareholders
 
1,875

 
$

 
2,632

Equity compensation plans not approved by shareholders
 
47

 
$

 

Total
 
1,922

 
$

 
2,632

_____________________________________________________________
(1)
The number of securities that may be issued under equity compensation plans approved by shareholders includes 1,875,381 shares awarded under our Restricted Stock Unit Plan for which vesting is contingent upon future employee service and/or the achievement of certain profitability targets. The number of securities that may be issued under equity compensation plans not approved by shareholders consists solely of an inducement award of 47,070 fully-vested restricted stock units that were granted to Thomas S. Smith, Jr., our President and Chief Executive Officer ("CEO"), upon the commencement of his employment on March 31, 2015. This inducement award was not issued pursuant to our Restricted Stock Unit Plan and has not been registered with the SEC. See Note 21 of Notes to Consolidated Financial Statements for a description of this inducement award.
(2)
The weighted-average exercise price does not take into account 1,875,381 shares awarded under our Restricted Stock Unit Plan or the 47,070 fully-vested restricted stock units granted to Mr. Smith upon the commencement of his employment as our President and CEO on March 31, 2015.
(3)
Includes 2,413,151 shares available for future issuance under our Restricted Stock Unit Plan, 104,100 shares available for issuance under our Stock Option Plan, and 114,869 shares available for issuance under our Directors Stock Plan.

16



Performance Graph
The following graph compares the cumulative total shareholder return on our common stock for the five-year period from December 31, 2012 to December 31, 2017 with the cumulative return of the Standard & Poor's Global Luxury Index (the "S&P Global Luxury Index"), which is a line-of-business index largely composed of companies whose products and services appeal to a segment of the population consistent with our clients, and the Standard & Poor's MidCap 400 Stock Index (the"S&P MidCap 400").
The graph reflects an investment of $100 in our common stock, the S&P Global Luxury Index, and the S&P MidCap 400 on December 31, 2012, and a reinvestment of dividends at the average of the closing stock prices at the beginning and end of each quarter.
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12096626&doc=16
 
 
12/31/12
 
12/31/13
 
12/31/14
 
12/31/15
 
12/31/16
 
12/31/17
Sotheby's
 
$
100.00

 
$
158.91

 
$
141.87

 
$
85.54

 
$
132.37

 
$
171.35

S&P Global Luxury Index
 
$
100.00

 
$
135.59

 
$
129.41

 
$
121.74

 
$
122.52

 
$
171.91

S&P MidCap 400
 
$
100.00

 
$
133.52

 
$
146.55

 
$
143.39

 
$
173.09

 
$
201.20


17



ITEM 6: SELECTED FINANCIAL DATA
Year ended December 31,
 
2017
 
2016
 
2015
 
2014
 
2013
 
 
(Thousands of dollars, except per share data)
Income Statement Data:
 
 

 
 

 
 

 
 

 
 

Revenues:
 
 
 
 
 
 
 
 
 
 
Agency commissions and fees
 
$
741,580

 
$
671,833

 
$
791,920

 
$
825,126

 
$
793,639

Inventory sales
 
$
178,982

 
$
62,863

 
$
108,699

 
$
69,958

 
$
30,638

Finance
 
$
50,937

 
$
52,716

 
$
50,489

 
$
33,013

 
$
21,277

Other
 
$
17,890

 
$
17,965

 
$
10,386

 
$
9,956

 
$
8,124

Total revenues
 
$
989,389

 
$
805,377

 
$
961,494

 
$
938,053

 
$
853,678

Net income attributable to Sotheby's
 
$
118,796

 
$
74,112

 
$
43,727

 
$
117,795

 
$
130,006

Basic earnings per share
 
$
2.22

 
$
1.28

 
$
0.64

 
$
1.69

 
$
1.90

Diluted earnings per share
 
$
2.20

 
$
1.27

 
$
0.63

 
$
1.68

 
$
1.88

Cash dividends declared per common share
 
$

 
$

 
$
0.40

 
$
4.74

 
$
0.20

Statistical Metrics:
 
 
 
 
 
 
 
 
 
 
Aggregate Auction Sales (a)
 
$
4,567,310

 
$
4,247,873

 
$
5,949,030

 
$
6,075,345

 
$
5,127,155

Net Auction Sales (b)
 
$
3,816,792

 
$
3,556,090

 
$
5,016,738

 
$
5,151,419

 
$
4,338,948

Private Sales (c)
 
$
744,640

 
$
583,410

 
$
673,119

 
$
624,511

 
$
1,179,038

Consolidated Sales (d)
 
$
5,490,932

 
$
4,894,146

 
$
6,730,848

 
$
6,769,814

 
$
6,336,831

Auction Commission Margin (e)
 
17.2
%
 
17.1
%
 
14.3
%
 
14.7
%
 
15.9
%
Non-GAAP Financial Measures:
 
 
 
 
 
 
 
 
 
 
Adjusted Net Income (f)
 
$
121,699

 
$
99,616

 
$
143,131

 
$
142,398

 
$
139,461

Adjusted Diluted EPS (f)
 
$
2.25

 
$
1.71

 
$
2.07

 
$
2.03

 
$
2.02

EBITDA (f)
 
$
199,298

 
$
150,902

 
$
225,322

 
$
248,036

 
$
245,066

Adjusted EBITDA (f)
 
$
200,176

 
$
192,646

 
$
278,771

 
$
289,873

 
$
246,438

Balance Sheet Data:
 
 

 
 

 
 

 
 

 
 

Working capital
 
$
385,463

 
$
525,878

 
$
913,166

 
$
610,315

 
$
829,784

Total assets
 
$
3,087,307

 
$
2,504,426

 
$
3,263,313

 
$
3,129,796

 
$
2,887,480

Average Loan Portfolio (g)
 
$
637,759

 
$
646,135

 
$
732,814

 
$
583,304

 
$
433,619

Average Credit Facility Borrowings (h)
 
$
479,367

 
$
534,433

 
$
541,004

 
$
306,448

 
$

Long-term debt, net
 
$
653,003

 
$
598,941

 
$
604,961

 
$
295,163

 
$
509,480

Total equity
 
$
616,940

 
$
505,602

 
$
806,704

 
$
878,238

 
$
1,139,665

Legend:
(a)
Represents the total hammer (sale) price of property sold at auction plus buyer’s premium.
(b)
Represents the total hammer (sale) price of property sold at auction, excluding amounts related to the sale of our inventory at auction, which are reported within inventory sales.
(c)
Represents the total purchase price of property sold in private sales that we have brokered, including our commissions.
(d)
Represents the sum of Aggregate Auction Sales, Private Sales, and inventory sales. For the purposes of this calculation, when applicable, amounts that are associated with the sale of our inventory at auction and included in Aggregate Auction Sales are eliminated.
(e)
Represents total auction commission revenues as a percentage of Net Auction Sales.
(f)
See "Non-GAAP Financial Measures" under Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for a description of this non-GAAP financial measure and a reconciliation to the most comparable GAAP amount.
(g)
Represents the average SFS loan portfolio outstanding during the period.
(h)
Represents average borrowings outstanding during the period under the revolving credit facility for SFS.


18



ITEM 7:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of Operations (or, "MD&A") should be read in conjunction with Note 2 ("Segment Reporting") of Notes to Consolidated Financial Statements.
Critical Accounting Estimates
The preparation of financial statements and related disclosures in accordance with GAAP requires us to make judgments, assumptions, and estimates that affect the amounts reported in our Consolidated Financial Statements and accompanying notes. Actual results may ultimately differ from our original estimates, as future events and circumstances sometimes do not develop as expected. Note 1 of Notes to Consolidated Financial Statements describes the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. In addition, we believe that the following are our most critical accounting estimates, which are not ranked in any particular order, that may affect our reported financial condition and/or results of operations.
(1)
Valuation of Inventory and Loan Collateral—The art market is not a highly liquid trading market. As a result, the valuation of art is inherently subjective and the realizable value of art often fluctuates over time. If there is evidence that the estimated realizable value of a specific item held in inventory is less than its carrying value, we record a loss to reflect our revised estimate of realizable value. If the estimated realizable value of the property pledged as collateral for an SFS loan is less than the corresponding loan balance, we assess whether it is necessary to record a loss to reduce the carrying value of the loan, after taking into account the ability of the borrower to repay any shortfall between the value of the collateral and the amount of the loan.
In estimating the realizable value of art held in inventory and art pledged as collateral for SFS loans, we consider the following complex array of factors: (i) whether the property is expected to be offered at auction or sold privately, and the timing of any such sale; (ii) the supply and demand for the property, taking into account current art market conditions, as well as changing trends as to which collecting categories and artists are most sought after; (iii) recent sale prices achieved for comparable items within a particular collecting category and/or by a particular artist; (iv) the state of the global economy and financial markets; and (v) our intent and ability to hold the property in order to maximize its realizable value.
Due to the inherent subjectivity involved in estimating the realizable value of art held in inventory and art pledged as collateral for SFS loans, our estimates of realizable value may prove, with the benefit of hindsight, to be different than the amount ultimately realized upon sale.
See Note 1 of Notes to Consolidated Financial Statements for information related to inventory. See Note 4 of Notes to Consolidated Financial Statements for information related to SFS loans.
(2) Accounts Receivable—Accounts receivable principally includes amounts due from buyers as a result of auction and private sale transactions. The recorded amount reflects the purchase price of the property (including any commissions, as well as any applicable taxes and royalties). Under the standard terms and conditions of our auction and private sales, we are not obligated to pay the consignor for property that has not been paid for by the buyer. If a buyer defaults on payment, the sale is cancelled and the property is returned to the consignor. We continually evaluate the collectability of amounts due from individual buyers and, if we determine that it is probable that a buyer will default, 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. Historically, cancelled sales have not been material in relation to the aggregate hammer price of property sold at auction.
In certain instances and subject to management approval under our internal corporate governance policy, we may pay the consignor the net sale proceeds before payment is collected from the buyer while we retain possession of the property. In these situations, if the buyer does not make payment, Sotheby's takes title to the property, but could be exposed to losses if the value of the property subsequently declines. In certain other situations and subject to management approval under our internal corporate governance policy, we allow the buyer to take possession of purchased property before making payment. In these situations, we are liable to the seller for the net sale proceeds whether or not the buyer makes payment and would incur a loss in the event of buyer default. We maintain an allowance for doubtful accounts that principally includes estimated losses associated with situations when we have paid the net sale proceeds to the seller, and it is probable that payment will not be collected from the buyer. The allowance for doubtful accounts also includes an estimate of probable losses inherent in the remainder of the accounts receivable balance.

19



Our judgments regarding the collectability of accounts receivable and the amount of any required allowance for doubtful accounts are based on the facts available to management, including an assessment of the buyer's payment history, discussions with the buyer, and the value of any property held as security against the buyer's payment obligation. Our judgments with respect to the collectability of amounts due from buyers for auction and private sale purchases are reevaluated and adjusted as additional facts become known, but may ultimately prove, with the benefit of hindsight, to be incorrect. See Note 4 of Notes to Consolidated Financial Statements for information related to accounts receivable.
(3)
Income Taxes—The provision for income taxes involves a significant amount of judgment regarding the interpretation of the relevant facts and laws in the many jurisdictions in which we operate. Our effective income tax rate and recorded tax balances can change significantly between periods due to a number of complex factors including, but not limited to: (i) our projected levels of taxable income; (ii) changes in the jurisdictional mix of our forecasted and/or actual pre-tax income; (iii) increases or decreases to valuation allowances recorded against deferred tax assets; (iv) tax audits conducted by various tax authorities; (v) adjustments to income taxes upon the finalization of income tax returns; (vi) the ability to claim foreign tax credits; and (vii) tax planning strategies.
On December 22, 2017, the U.S. Tax Cuts and Jobs Act was enacted into law. Among other things, the Act reduces the U.S. corporate income tax rate from 35% to 21%, and makes changes to certain other business-related exclusions, deductions and credits. The SEC soon thereafter issued Staff Accounting Bulletin No. 118 ("SAB 118"), which allows companies to record the income tax effects of the Act as a provisional amount based upon reasonable estimates. As of December 31, 2017, we have not completed our accounting for the income tax effects of the Act. However, in accordance with SAB 118, we recorded a provisional net income tax expense of approximately $1.2 million in the fourth quarter of 2017 based on reasonable estimates for those tax effects. This provisional net income tax expense is subject to adjustment as we complete our analysis of the Act, collect and prepare the necessary data, and interpret any additional guidance issued by the U.S. Treasury Department, the IRS, the Financial Accounting Standards Board (the "FASB"), and other standard-setting and regulatory bodies. Adjustments may impact our provision for income taxes and effective tax rate in the period in which the adjustments are determined. Our accounting for the income tax effects of the Act will be completed during the measurement period, which should not extend beyond one year from the enactment date. The impact of the provisional accounting effects of the Act are described in greater detail in Note 16 of Notes to Consolidated Financial Statements.
As of December 31, 2017, we had net deferred tax assets of $20.5 million, which include the provisional effects of the Act recorded in the fourth quarter of 2017. This amount includes gross deferred tax assets of $47.5 million, primarily resulting from deductible temporary differences which will reduce taxable income in future periods. To a lesser extent, we also have deferred tax assets relating to net operating loss carryforwards, which are partially offset by a valuation allowance of $3.2 million to reduce the deferred tax assets to the amount that we have determined is more likely than not to be realized. In assessing the need for a valuation allowance, we consider, among other things, projections of future taxable income and ongoing prudent and feasible tax planning strategies. If we determine that sufficient negative evidence exists (for example, if we experience cumulative three-year losses in a certain jurisdiction), then we will consider recording a valuation allowance against a portion or all of the deferred tax assets in that jurisdiction. If, after recording a valuation allowance, our projections of future taxable income and other positive evidence considered in evaluating the need for a valuation allowance prove, with the benefit of hindsight, to be inaccurate, it could prove more difficult to support the realization of these deferred tax assets. As a result, an additional valuation allowance could be required, which would have an adverse impact on our effective income tax rate and results. Conversely, if, after recording a valuation allowance, we determine that sufficient positive evidence exists in the jurisdiction in which a valuation allowance is recorded (for example, if we are no longer in a three-year cumulative loss position in the jurisdiction, and we expect to have future taxable income in that jurisdiction based upon our forecasts and the expected timing of deferred tax asset reversals), we may reverse a portion or all of the valuation allowance in that jurisdiction. In such situations, the adjustment made to the deferred tax asset would have a favorable impact on our effective income tax rate and results in the period such determination was made.
Due to the global complexity of tax regulation, we record liabilities to address potential exposures involving uncertain tax positions that we have taken, or expect to take, on income tax returns that could be challenged by taxing authorities. These potential exposures result from the varying applications and interpretations of income tax related statutes, rules, and regulations. As of December 31, 2017, our liability for unrecognized tax benefits, excluding interest and penalties, was $13.2 million. We believe that our recorded tax liabilities are adequate to cover all open years based on an assessment of the relevant facts and circumstances. This assessment involves assumptions and significant judgments about future events and potential actions by taxing authorities, as well as an evaluation of past experiences. The cost of the ultimate resolution of these matters may be greater or less than the liability that we have recorded. To the extent that our opinion as to the outcome of these matters changes, income tax expense will be adjusted accordingly in the period in which such a determination is made.
See "Income Tax Expense" below, as well as Note 16 and Note 17 of Notes to Consolidated Financial Statements.

20




(4)
Share-Based Payments—We grant share-based payment awards as compensation to certain employees. The amount of compensation expense recognized for share-based payments is based, in part, on our estimate of the number of shares ultimately expected to vest as a result of employee service. A substantial portion of the share-based payment awards vest only if we achieve established profitability targets (for awards granted prior to 2016) or certain return on invested capital (or "ROIC") targets (for awards granted beginning in 2016). The amount of compensation expense recognized for such performance-based awards is dependent upon our quarterly assessment of the likelihood of achieving these future profitability or ROIC targets. If, as a result of our assessment, we project that a greater number of performance share units will vest than previously anticipated, a life-to-date adjustment to increase compensation expense is recorded in the period such determination is made. Conversely, if, as a result of our assessment, we project that a lower number of performance share units will vest than previously anticipated, a life-to-date adjustment to decrease compensation expense is recorded in the period such determination is made. Accordingly, if our projections of future performance against these targets prove, with the benefit of hindsight, to be inaccurate, the amount of life-to-date and future compensation expense related to share-based payments could significantly increase or decrease.
In 2015, we granted a share-based payment award to Thomas S. Smith, Jr., our President and CEO, with a single vesting opportunity after a five-year service period contingent upon the achievement of pre-determined levels of price appreciation in our stock. The compensation expense recognized for this share-based payment is based on our estimate of the grant date fair value of the award. In developing this estimate, we considered then-current market conditions, historical data, and other relevant data. See Note 21 of Notes to Consolidated Financial Statements for additional information related to our share-based payment programs.
(5)
Legal Contingencies—We become involved in various claims and lawsuits incidental to the ordinary course of our business. We are required to assess the likelihood of any adverse judgments or outcomes related to these legal contingencies, as well as potential ranges of probable or reasonably possible losses. The determination of the amount of any losses to be recorded or disclosed as a result of these contingencies is based on a careful analysis of each individual exposure with, in some cases, the assistance of outside legal counsel. The amount of losses recorded or disclosed for such contingencies may change in the future due to new developments in each matter or a change in settlement strategy. See Note 18 of Notes to Consolidated Financial Statements for additional information related to legal contingencies.
Seasonality
The global art auction market has two principal selling seasons, which generally occur in the second and fourth quarters of the year. In the aggregate, second and fourth quarter Net Auction 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.
In quarterly reporting periods, the comparison of our results between reporting periods can be significantly influenced by a number of factors, such as changes in the timing of when certain auctions occur, the level of non-recurring single-owner auction sale events, the level and timing of individually negotiated private sale transactions, and changes in certain accounting estimates that rely upon forecasted results such as variable incentive and share-based compensation expense and our estimated annual effective income tax rate. Accordingly, when evaluating our performance, we believe that investors should also consider results for rolling six and twelve month periods, which better reflect the business cycle of the global art auction market. See Note 28 of Notes to Consolidated Financial Statements for our quarterly results for the years ended December 31, 2017 and 2016.




______________________
1 
See the definition of Net Auction Sales in the Consolidated Financial Data Table below.


21



Business and Industry Trends
Following a period of expansion that began in late-2009 and lasted until the fourth quarter of 2015, the global art market entered a period of lower sales, particularly in the Impressionist, Modern and Contemporary Art collecting categories, which resulted in a 27% decrease in Consolidated Sales1 in 2016, when compared to 2015. However, even during this period of lower sales, collectors continued to purchase top quality works of art for strong prices and our auction sell-through rates remained encouraging. In 2017, the art market strengthened, and we achieved a 12% increase in Consolidated Sales when compared to 2016, which led to an 10% increase in agency commissions and fees.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2017 AND 2016
Consolidated Results of Operations
Overview—In 2017, our net income was $118.8 million, or $2.20 per diluted share, representing a $44.7 million (60%) improvement when compared to the prior year when we reported net income of $74.1 million, or $1.27 per diluted share. After excluding certain unusual items, including $1.2 million of net income tax expense associated with the U.S. Tax Cuts and Jobs Act, Adjusted Net Income* improved $22.1 million (22%), from $99.6 million to $121.7 million, and Adjusted Diluted EPS* improved from $1.71 to $2.25. The improvement in Adjusted Net Income* is principally due to a stronger art market, which resulted in a 12% increase in Consolidated Sales1 and a 10% increase in agency commissions and fees when compared to the prior year, as well as a significant improvement in our inventory activities. These factors are partially offset by a higher level of indirect expenses largely due to investments in growth initiatives and a higher level of incentive compensation reflecting improved performance against plan targets. (See "Income Tax Expense" below for a more detailed discussion of the impact of the U.S. Tax Cuts and Jobs Act on our Consolidated Financial Statements.)
Outlook—As a result of the strengthening of the art market in 2017 and sales results to date in 2018, we are encouraged by the direction of the art market and our prospects for the upcoming year. In 2018, we expect that the stronger art market will result in a higher level of agency commissions and fees. We also expect to continue investing in technology and marketing programs to drive our future growth and reduce our cost structure over the long-term.
The comparison of our results for the first quarter of 2018 to the prior year will be materially influenced by a change in the timing of the spring Modern and Contemporary Art sales in Hong Kong, which will be held in the first quarter of 2018 after occurring in the second quarter of 2017. Accordingly, first quarter revenue in 2018 will likely be higher than the prior year.
Taking into account the effects of the U.S. Tax Cuts and Jobs Act and our projected jurisdictional mix of earnings, we estimate that our effective income tax rate for 2018, excluding discrete items, will be in the range of 25% to 27%. However, we are still evaluating the effects of certain provisions of the Act, which could have an impact on our effective income tax rate in the future. Accordingly, this estimate is subject to change.
(See statement on Forward Looking Statements.)










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

22



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

 
 

 
 

 
 

Agency commissions and fees
$
741,580

 
$
671,833

 
$
69,747

 
10
%
Inventory sales
178,982

 
62,863

 
116,119

 
*

Finance
50,937

 
52,716

 
(1,779
)
 
(3
%)
Other
17,890

 
17,965

 
(75
)
 
%
Total revenues
989,389

 
805,377

 
184,012

 
23
%
Expenses:
 
 
 
 
 
 
 
Agency direct costs
82,142

 
73,324

 
8,818

 
12
%
Cost of inventory sales
181,487

 
81,782

 
99,705

 
*

Cost of finance revenues
19,312

 
17,738

 
1,574

 
9
%
Marketing
25,377

 
19,695

 
5,682

 
29
%
Salaries and related (a)
313,895

 
307,659

 
6,236

 
2
%
General and administrative
172,950

 
161,356

 
11,594

 
7
%
Depreciation and amortization
24,053

 
21,817

 
2,236

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

 
73
%
Total expenses
819,054

 
682,761

 
136,293

 
20
%
Operating income
170,335

 
122,616

 
47,719

 
39
%
Net interest expense (c)
(31,034
)
 
(29,016
)
 
(2,018
)
 
(7
%)
Non-operating income
2,385

 
3,134

 
(749
)
 
(24
%)
Income before taxes
141,686

 
96,734

 
44,952

 
46
%
Income tax expense
25,415

 
25,957

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

 
3,262

 
(754
)
 
(23
%)
Net income
118,779

 
74,039

 
44,740

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

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

 
$
74,112

 
$
44,684

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

 
$
1.27

 
$
0.93

 
73
%
Statistical Metrics:
 

 
 

 
 

 


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

 
$
4,247,873

 
$
319,437

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

 
$
3,556,090

 
$
260,702

 
7
%
Private Sales (f)
$
744,640

 
$
583,410

 
$
161,230

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

 
$
4,894,146

 
$
596,786

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

Non-GAAP Financial Measures:
 
 
 
 
 
 
 
Adjusted Expenses (h)
$
616,520

 
$
541,497

 
$
75,023

 
14
%
Adjusted Operating Income (h)
$
172,070

 
$
164,360

 
$
7,710

 
5
%
Adjusted Net Income (h)
$
121,699

 
$
99,616

 
$
22,083

 
22
%
Adjusted Diluted EPS (h)
$
2.25

 
$
1.71

 
$
0.54

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

EBITDA (h)
$
199,298

 
$
150,902

 
$
48,396

 
32
%
Adjusted EBITDA (h)
$
200,176

 
$
192,646

 
$
7,530

 
4
%

23



Legend:
 *
Represents a variance in excess of 100%.
(a)
We do not allocate salaries and related costs to our cost of revenue, marketing expense, and general and administrative expense line items, as many of our employees perform duties that could be categorized across more than one of these line items.
(b)
See Note 22 of Notes to Consolidated Financial Statements for information on the Voluntary Separation Incentive Programs enacted in the fourth quarter of 2015.
(c)
Represents interest expense less interest income.
(d)
Represents the total hammer (sale) price of property sold at auction plus buyer’s premium, excluding amounts related to the sale of our inventory at auction, which are reported within inventory sales.
(e)
Represents the total hammer (sale) price of property sold at auction, excluding amounts related to the sale of our inventory at auction, which are reported within inventory sales.
(f)
Represents the total purchase price of property sold in private sales that we have brokered, including our commissions.
(g)
Represents the sum of Aggregate Auction Sales, Private Sales, and inventory sales.
(h)
See "Non-GAAP Financial Measures" below for a description of this non-GAAP financial measure and a reconciliation to the most comparable GAAP amount.
Agency Segment
Agency Segment Overview—In 2017, Agency segment income before taxes increased $36.6 million (57%), from $64.6 million to $101.2 million. After excluding certain items in the current and prior year, Adjusted Agency Segment Income Before Taxes* improved $9 million (10%), from $94.9 million to $104 million. The improvement in Adjusted Agency Segment Income Before Taxes* is principally due to a stronger art market, which resulted in a 12% increase in Consolidated Sales and associated increases in auction commissions (8%) and private sale commissions (26%), as well as a significant improvement in our inventory activities and better results from our portfolio of auction guarantees. These factors are partially offset by a higher level of indirect expenses largely due to investments in growth initiatives and a higher level of incentive compensation reflecting improved performance against plan targets.





















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



24



Agency Segment Financial Data Table—The table below presents a summary of Agency segment income before taxes and related statistical metrics for the years ended December 31, 2017 and 2016, as well as a comparison between the two years (in thousands of dollars):
 
 
 
 
 
 
Variance
 
 
2017
 
2016
 
$ / %
 
%
Revenues:
 
 
 
 
 
 
 
 
Agency commissions and fees:
 
 

 
 

 
 

 
 

Auction commissions
 
$
654,512

 
$
607,770

 
$
46,742

 
8
%
Private sale commissions
 
66,244

 
52,463

 
13,781

 
26
%
Other Agency commissions and fees, net
 
19,173

 
11,600

 
7,573

 
65
%
Total Agency commissions and fees
 
739,929

 
671,833

 
68,096

 
10
%
Inventory sales
 
167,628

 
54,829

 
112,799

 
*

Total Agency segment revenues
 
907,557

 
726,662

 
180,895

 
25
%
Expenses:
 
 
 
 
 
 
 
 
Agency direct costs:
 
 
 
 
 


 


Auction direct costs
 
76,576

 
69,179

 
7,397

 
11
%
Private sale expenses
 
5,262

 
4,145

 
1,117

 
27
%
Intersegment costs (a)
 
9,168

 
8,518

 
650

 
8
%
Total Agency direct costs
 
91,006

 
81,842

 
9,164

 
11
%
Cost of inventory sales
 
173,160

 
75,574

 
97,586

 
*

Marketing
 
24,860

 
19,311

 
5,549

 
29
%
Salaries and related (b)
 
301,017

 
285,803

 
15,214

 
5
%
General and administrative
 
165,224

 
155,448

 
9,776

 
6
%
Depreciation and amortization
 
23,015

 
21,081

 
1,934

 
9
%
Voluntary separation incentive programs, net
 
(148
)
 
(614
)
 
466

 
76
%
Total Agency segment expenses
 
778,134

 
638,445

 
139,689

 
22
%
Agency segment operating income
 
129,423

 
88,217

 
41,206

 
47
%
Net interest expense (c)
 
(31,034
)
 
(29,016
)
 
(2,018
)
 
(7
%)
Non-operating income
 
1,819

 
3,403

 
(1,584
)
 
(47
%)
Equity in earnings of investees
 
995

 
1,967

 
(972
)
 
(49
%)
Agency segment income before taxes
 
$
101,203

 
$
64,571

 
$
36,632

 
57
%
Statistical Metrics:
 
 
 
 
 
 
 
 
Aggregate Auction Sales (d)
 
$
4,567,310

 
$
4,247,873

 
$
319,437

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

 
$
3,556,090

 
$
260,702

 
7
%
Items sold at auction with a hammer (sale) price greater than $1 million
 
558

 
528

 
30

 
6
%
Total hammer (sale) price of items sold at auction with a hammer price greater than $1 million
 
$
2,322,634

 
$
1,963,512

 
$
359,122

 
18
%
Items sold at auction with a hammer (sale) price greater than $3 million
 
192

 
163

 
29

 
18
%
Total hammer (sale) price of items sold at auction with a hammer (sale) price greater than $3 million
 
$
1,700,768

 
$
1,369,147

 
$
331,621

 
24
%
Auction Commission Margin (f)
 
17.2
%
 
17.1
%
 
0.1
%
 
N/A

Private Sales (g)
 
$
736,825

 
$
583,410

 
$
153,415

 
26
%
Consolidated Sales (h)

 
$
5,471,763

 
$
4,886,112

 
$
585,651

 
12
%
Non-GAAP Financial Measures:
 
 
 
 
 
 
 
 
Adjusted Agency Segment Income Before Taxes (i)
 
$
103,992

 
$
94,946

 
$
9,046

 
10
%

25



Legend:
*
Represents a variance in excess of 100%.
(a)
Principally includes fees charged to the Agency segment to compensate SFS for generating auction and private sale consignments through the sale of term loan collateral. In addition, this line item includes amounts charged by SFS for loans issued with favorable terms as an accommodation to the Agency segment in order to secure a consignment or enhance a client relationship.
(b)
We do not allocate salaries and related costs to our cost of revenue, marketing expense, and general and administrative
expense line items, as many of our employees perform duties that could be categorized across more than one of these line items.
(c)
Represents interest expense less interest income.
(d)
Represents the total hammer (sale) price of property sold at auction plus buyer's premium, excluding amounts related
to the sale of our inventory at auction, which are reported within inventory sales.
(e)
Represents the total hammer (sale) price of property sold at auction, excluding amounts related to the sale of our
inventory at auction, which are reported within inventory sales.
(f)
Represents total auction commission revenues as a percentage of Net Auction Sales.
(g)
Represents the total purchase price of property sold in private sales that we have brokered, including our commissions.
(h)
Represents the sum of Aggregate Auction Sales, Private Sales, and inventory sales within the Agency segment.
(i)
See "Non-GAAP Financial Measures" below for a description of this non-GAAP financial measure and a
reconciliation to the most comparable GAAP amount.
Auction Commission Revenues—In our role as auctioneer, we accept property on consignment and match sellers to buyers through the auction process. As compensation for our auction services, we earn a commission from both the buyer ("buyer's premium") and, to a lesser extent, the seller ("seller's commission") (collectively, "auction commission revenue"), both of which are calculated as a percentage of Net Auction Sales. Auction commission revenues are recorded net of commissions owed to third parties, which are principally the result of situations when the buyer's premium is shared with a consignor or with the counterparty in an auction guarantee risk and reward sharing arrangement. Additionally, in certain situations, auction commissions are shared with third parties who introduce us to consignors who sell property at auction or otherwise facilitate the sale of property at auction.
Auction commission revenues increased $46.7 million (8%) in 2017 principally due to a 7% increase in Net Auction Sales. The comparison to the prior year is also impacted by changes in foreign currency exchange rates, which reduced auction commission revenue by approximately $10 million in 2017. Excluding the impact of changes in foreign currency exchange rates, auction commission revenue increased $56.7 million (9%). See below for a more detailed discussion of Net Auction Sales and Auction Commission Margin.
Net Auction Sales—Net Auction Sales increased $260.7 million (7%) in 2017 principally due to a stronger art market, which resulted in significantly higher sales of Impressionist, Modern and Contemporary Art. The higher level of sales in these collecting categories was partially offset by a decrease in sales of Asian Art and Jewelry, as well as changes in foreign currency exchange rates which reduced Net Auction Sales by $71.6 million in 2017. Excluding the impact of changes in foreign currency exchange rates, Net Auction Sales increased by $332.3 million (9%).
Auction Commission Margin—Auction Commission Margin represents total auction commission revenues as a percentage of Net Auction Sales. Typically, Auction Commission Margin is higher for lower value works of art or collections, while higher valued property earns a lower Auction Commission Margin. Accordingly, Auction Commission Margin may be impacted by the mix of property sold in a period. Auction Commission Margin may also be adversely impacted by arrangements whereby we share our buyer's premium with a consignor in order to secure a high-value consignment, as well as by our use of auction guarantees. For example, when issuing an auction guarantee, we may enter into a risk and reward sharing arrangement with a counterparty whereby our financial exposure under the auction guarantee is reduced in exchange for sharing our buyer's premium. Also, in situations when guaranteed property sells for less than the guaranteed price, our buyer's premium from that sale is used to reduce the loss on the transaction. See Note 19 of Notes to Consolidated Financial Statements for information related to our use of auction guarantees.
In 2017, Auction Commission Margin improved slightly from 17.1% to 17.2%, reflecting recent changes to our buyer's premium rate structure and a shift in sales mix towards higher valued property.

26



Private Sale Commission Revenues—Private sale commission revenues are earned through the direct brokering of purchases and sales of art. Private sales are initiated either by a client wishing to sell property with us acting as their exclusive agent in the transaction, or by a prospective buyer who is interested in purchasing a certain work of art privately. Because private sales are individually negotiated, non-recurring transactions, the volume and value of transactions completed can vary from period to period, with associated variability in revenues.
Private sale commissions increased $13.8 million (26%) in 2017 due to a higher level of transaction volume during the year, particularly with respect to higher valued property.
Other Agency Commissions and Fees, net—Other agency commissions and fees, net includes: (i) our share of overage or shortfall related to guaranteed property offered or sold at auction; (ii) commissions and other fees earned on sales of art brokered by third parties; (iii) fees charged to consignors for property withdrawn prior to auction, (iv) fees charged for catalogue production and property management; (v) catalogue subscription revenues; and (vi) advertising revenues.
Other agency commissions and fees, net improved $7.6 million (65%) in 2017 principally due to better results from our portfolio of auction guarantees.
Agency Direct Costs—Agency direct costs include expenses incurred in the fulfillment of our integrated auction services and, to a much lesser extent, expenses associated with private sale exhibitions and transactions. A large portion of auction direct costs relate to sale marketing expenses such as catalogue production and distribution, advertising and promotion costs, and traveling exhibition costs. Auction direct costs also include the cost of shipping property, sale venue costs, and other direct costs such as debit and credit card processing fees. The level of auction direct costs incurred in a period is generally dependent upon the volume and composition of our auction sale offerings. For example, direct costs attributable to auctions of single-owner or other high-value collections are typically higher than those associated with standard various-owner auctions, mainly due to higher promotional costs for catalogues, special events, and traveling exhibitions, as well as higher shipping expenses.
Agency direct costs increased $9.2 million (11%) in 2017, which is largely consistent with the increase in Consolidated Sales during the current year.
Inventory Sales and Cost of Inventory Sales—Agency segment inventory sales include amounts earned from the sale of (i) artworks that have been obtained as a result of the failure of guaranteed property to sell at auction, (ii) artworks that have been purchased opportunistically, including property acquired for sale at auction, and (iii) other objects obtained incidental to the auction process (e.g., as a result of buyer default). Agency segment cost of inventory sales includes (i) the net book value of inventory sold, (ii) commissions and fees owed to third parties who help facilitate the sale of inventory, and (iii) writedowns associated with our periodic assessment of inventory valuation.
The table below presents a summary of Agency segment inventory activities for the years ended December 31, 2017 and 2016, as well as a comparison between the two years (in thousands of dollars):
 
 
 
 
 
Variance
 
2017
 
2016
 
$
 
%
Inventory sales
$
167,628

 
$
54,829

 
$
112,799

 
*

Cost of inventory sales
(173,160
)
 
(75,574
)
 
(97,586
)
 
*

Gross loss
$
(5,532
)
 
$
(20,745
)
 
$
15,213

 
73
%
Legend:
* Represents a variance in excess of 100%.    
The lower loss associated with Agency segment inventory activities is attributable to a lower level of inventory writedowns, as well as a number of profitable sales completed during 2017. The higher overall level of inventory sales and inventory cost of sales in 2017 is largely due to the sale at auction of a Fancy Vivid Pink Diamond for $71.2 million, which resulted in a gain of approximately $0.4 million (see Note 11 of Notes to Consolidated Financial Statements).


27



Sotheby's Financial Services
Overview—SFS income before taxes decreased $3.6 million (10%) in 2017 primarily due to non-recurring collateral release fees earned in the prior year and a lower level of facility fees attributable to a lower loan portfolio balance. Also unfavorably impacting the comparison to the prior year is a $0.7 million charge recorded in 2017 as a result of a reduction in the borrowing capacity of the SFS Credit Facility (see "Liquidity and Capital Resources" below).
SFS Financial Data Table—The table below presents a summary of SFS income before taxes and related loan portfolio metrics as of and for the years ended December 31, 2017 and 2016, as well as a comparison between the two years (in thousands of dollars):
 
 
 
 
 
 
Variance
 
 
2017
 
2016
 
$ / %
 
%
Revenues:
 
 
 
 
 
 
 
 
Client paid revenues (a)
 
$
50,937

 
$
52,716

 
$
(1,779
)
 
(3
%)
Intersegment revenues (b)
 
9,168

 
8,518

 
650

 
8
%
Total finance revenues
 
60,105

 
61,234

 
(1,129
)
 
(2
%)
Expenses:
 
 
 
 
 
 
 
 
Cost of finance revenues (c)
 
19,312

 
17,738

 
1,574

 
9
%
Marketing
 
164

 
162

 
2

 
1
%
Salaries and related (d)
 
5,024

 
4,599

 
425

 
9
%
General and administrative
 
3,547

 
2,565

 
982

 
38
%
Depreciation and amortization
 
244

 
119

 
125

 
*

Total SFS expenses
 
28,291

 
25,183

 
3,108

 
12
%
SFS operating income
 
31,814

 
36,051

 
(4,237
)
 
(12
%)
Net interest expense
 

 

 

 
N/A

Non-operating income (expense)
 
481

 
(144
)
 
625

 
N/A

SFS income before taxes
 
$
32,295

 
$
35,907

 
$
(3,612
)
 
(10
%)
Loan Portfolio Metrics:
 
 
 
 
 
 
 
 
Loan Portfolio Balance (e)
 
$
590,609

 
$
675,109

 
$
(84,500
)
 
(13
%)
Average Loan Portfolio (f)
 
$
637,759

 
$
646,135

 
$
(8,376
)
 
(1
%)
Credit Facility Borrowings (g)
 
$
196,500

 
$
565,000

 
$
(368,500
)
 
(65
%)
Average Credit Facility Borrowings (h)
 
$
479,367

 
$
534,433

 
$
(55,066
)
 
(10
%)
Finance Revenue Percentage (i)
 
9.4
%
 
9.5
%
 
(0.1
%)
 
N/A

Client Paid Interest Revenue Percentage (j)
 
7.3
%
 
6.7
%
 
0.6
%
 
N/A

Weighted Average Cost of Borrowings (k)
 
3.9
%
 
3.3
%
 
0.6
%
 
N/A


28



Legend:
 
 
 
*
Represents a variance in excess of 100%.
(a)
Includes interest, facility fees, and collateral release fees earned from clients.
(b)
Principally includes fees charged to the Agency segment to compensate SFS for generating auction and private sale consignments through the sale of term loan collateral. In addition, this line item includes interest and fees earned from the Agency segment for loans issued with favorable terms as an accommodation to the Agency segment in order to secure a consignment or enhance a client relationship.
(c)
Includes borrowing costs related to the SFS Credit Facility, including interest expense, commitment fees, and the
amortization of amendment and arrangement fees.
(d)
We do not allocate salaries and related costs to our cost of revenue, marketing expense, and general and administrative expense line items, as many of our employees perform duties that could be categorized across more than one of these line items.
(e)
Represents the period end net loan portfolio balance.
(f)
Represents the average loan portfolio outstanding during the period.
(g)
Represents the period end balance of borrowings outstanding under the SFS Credit Facility.
(h)
Represents average borrowings outstanding during the period under the SFS Credit Facility.
(i)
Represents the annualized percentage of total client paid and intersegment finance revenues in relation to the Average
Loan Portfolio. The comparison of Finance Revenue Percentage to the prior year is significantly influenced by non-recurring collateral release fees earned in the prior year and a lower level of facility fees in the current year attributable to the lower loan portfolio balance.
(j)
Represents the annualized percentage of total client paid interest revenue in relation to the Average Loan Portfolio. The increase in the Client Paid Interest Revenue Percentage versus the prior year is attributable to higher LIBOR rates in effect during the year.
(k)
Represents the annualized cost of Credit Facility Borrowings, excluding the impact of a $0.7 million charge recorded in 2017 as a result of the reduction in the borrowing capacity in the SFS Credit Facility. The increase in the Weighted Average Cost of Borrowings versus the prior year is attributable to higher LIBOR rates in effect during the year.
Marketing Expenses
Marketing expenses are costs related to the promotion of the Sotheby's brand and include digital and print advertising, client relationship development, Sotheby's lifestyle magazines, and certain sponsorship agreements. In 2017, marketing expenses increased $5.7 million (29%) primarily due to higher spending related to digital initiatives, including costs to live stream our auctions, and higher sponsorship and client relationship development costs. To a lesser extent, costs incurred to promote the opening of a new office in Dubai and the relocation of our Geneva salesroom also contributed to the increase.


29



Salaries and Related Costs
For the years ended December 31, 2017 and 2016, salaries and related costs consisted of the following (in thousands of dollars):
 
 
 
 
 
Variance
 
2017
 
2016
 
$
 
%
Full-time salaries
$
153,707

 
$
143,577

 
$
10,130

 
7
%
Incentive compensation expense
59,562

 
41,035

 
18,527

 
45
%
Employee benefits and payroll taxes
57,095

 
42,444

 
14,651

 
35
%
Share-based payment expense
23,479

 
15,935

 
7,544

 
47
%
Contractual severance agreements, net

 
7,354

 
(7,354
)
 
(100
%)
Acquisition earn-out compensation

 
35,000

 
(35,000
)
 
(100
%)
Other compensation expense (a)
20,052

 
22,314

 
(2,262
)
 
(10
%)
Total salaries and related costs
$
313,895

 
$
307,659

 
$
6,236

 
2
%
Legend:
(a) Other compensation expense typically includes the cost of temporary labor and overtime, as well as amortization expense related to certain retention-based, new-hire and other employment arrangements.
Full-Time Salaries—Full-time salaries increased $10.1 million (7%) in 2017 principally due to base salary increases and headcount reinvestments.
Incentive Compensation—Incentive compensation consists of the accrual for annual cash incentive bonuses, as well as cash payments awarded to employees for brokering certain eligible private sale and other transactions. Payments made under our annual cash incentive bonus plan are aligned with performance against our annual financial plan. In 2017, incentive compensation expense increased $18.5 million (45%), reflecting improved performance against plan targets relative to the prior year.
Share-Based Payment Expense—Share-based payment expense relates to the amortization of equity compensation awards such as performance share units, market-based share units, restricted stock units, and restricted shares. The amount of compensation expense recognized for share-based payments is based, in part, on our estimate of the number of units or shares ultimately expected to vest as a result of employee service. In addition, performance share units vest only if we achieve established profitability targets (for awards granted prior to 2016) or certain ROIC targets (for awards granted beginning in 2016). The amount of compensation expense recognized for such performance-based awards is dependent upon our quarterly assessment of the likelihood of achieving these future profitability or ROIC targets. If, as a result of our assessment, we project that a greater number of performance share units will vest than previously anticipated, a life-to-date adjustment to increase compensation expense is recorded in the period such determination is made. Conversely, if, as a result of our assessment, we project that a lower number of performance share units will vest than previously anticipated, a life-to-date adjustment to decrease compensation expense is recorded in the period such determination is made. See Note 21 of Notes to Consolidated Financial Statements for more detailed information related to our share-based compensation programs.
Share-based payment expense increased by $7.5 million (47%) in 2017, reflecting an increase in our estimate of the number of performance share units ultimately expected to vest relative to the prior year.
Employee Benefits and Payroll Taxes—Employee benefits include the cost of our retirement plans and health and welfare programs, as well as certain employee severance costs. Our material retirement plans include defined contribution pension plans for our employees in the U.S. and the U.K., as well as a deferred compensation plan for certain U.S. employees (the "DCP") and a defined benefit pension plan in the U.K. (the "U.K. Pension Plan"). 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 became participants in a defined contribution plan. 
Generally, the amount of employee benefit costs recognized in a period is dependent upon headcount and overall compensation levels, as well as our financial performance. Additionally, the level of expense related to the U.K. Pension Plan is significantly influenced by service costs, interest rates, investment performance in the debt and equity markets, and actuarial assumptions. Also, the amount of expense recorded in a period for the DCP is dependent upon changes in the fair value of the associated liability resulting from gains and losses in deemed participant investments.

30



In 2017, employee benefits and payroll taxes increased $14.7 million (35%), principally due to newly added staff, higher overall compensation levels, and increased employee severance costs, as well as a $2.2 million decrease in the net credit associated with the U.K. Pension Plan, as discussed in more detail below. The increase in employee benefits and payroll taxes is also, in part, attributable to an increase in payroll taxes associated with a higher value of share-based payment awards vesting during the current year and higher DCP costs as a result of an improvement in the performance of deemed participant investments. On a consolidated basis, the higher level of DCP costs are largely offset by market gains in the trust assets related to the DCP, which are reflected in our Consolidated Income Statements within non-operating income (expense).
As discussed above, in 2017, the net credit associated with the U.K. Pension Plan decreased by $2.2 million, from $6.9 million to $4.7 million. This decrease is primarily due to a lower expected rate of return on plan assets and an increase in the required amortization of prior year actuarial losses. The lower expected rate of return is the result of a change in asset allocation strategy in the first quarter of 2017, which has reduced risk by investing a higher proportion of plan assets in debt securities. In 2018, we expect the net credit associated with the U.K. Pension Plan to decrease by another $2.3 million, from $4.7 million to $2.4 million, primarily due to a lower expected rate of return on plan assets resulting from the continued shift of plan assets to lower risk investments. See statement on Forward Looking Statements.
See Note 8 of Notes to Consolidated Financial Statements for additional information on the U.K. Pension Plan. See Note 27 of Notes to Consolidated Financial Statements for information regarding the adoption of a new accounting standard that will impact the presentation of the net periodic pension cost associated with the U.K. Pension Plan beginning on January 1, 2018.
Contractual Severance Agreements—In the first and third quarters of 2016, we entered into contractual severance agreements with certain former senior employees that provide cash severance benefits and the ability to continue to vest in share-based payment awards after termination of employment. In 2016, salaries and related costs include net charges of $7.4 million associated with these arrangements.
Acquisition Earn-Out Compensation—On January 11, 2016, we acquired AAP, a firm that provides a range of art-related services, in exchange for initial cash consideration of $50 million. In connection with this acquisition, we also agreed to make future earn-out payments to the former principals of AAP not to exceed $35 million in the aggregate, contingent on the achievement of a level of cumulative financial performance within the Impressionist, Modern and Contemporary Art collecting categories, as well as from AAP's art advisory business. Progress against the cumulative financial target (the "Target") was to be measured at the end of each calendar year during the four-year performance period following the acquisition, after adjusting the Target to reflect the annual growth or contraction of the auction market for Impressionist, Modern and Contemporary Art, when compared to the year ended December 31, 2015. Amounts owed pursuant to the earn-out arrangement are compensation expense for accounting purposes and are classified within salaries and related costs in our Consolidated Income Statements.
For the year ended December 31, 2016, we recognized $35 million of compensation expense associated with the AAP earn-out arrangement reflecting the full achievement of the Target as a result of our improved market share in the Contemporary Art collecting category, as well as an improvement in auction commission margins, during the initial annual period. The $35 million owed under the earn-out arrangement is being paid in four annual increments of $8.75 million in the first quarter of each year beginning in 2017 and through 2020.
See Note 3 of Notes to Consolidated Financial Statements for additional information regarding the acquisition of AAP and the related earn-out arrangement.
General and Administrative Expenses
General and administrative expenses include professional fees, facilities-related expenses (such as rental costs and building maintenance), and travel and entertainment costs, as well as other indirect expenses. In 2017, general and administrative expenses increased $11.6 million (7%) largely as a result of higher levels of legal fees, facilities-related costs, and travel and entertainment, as well as a $1.5 million charge associated with an uncollectible Agency segment loan (see Note 4 of Notes to Consolidated Financial Statements). These factors are partially offset by a lower level of legal claims and client goodwill gestures.
Depreciation and Amortization Expense
Depreciation and amortization expense increased $2.2 million (10%) in 2017 primarily due to a $1.9 million accelerated depreciation charge recorded in the fourth quarter of 2017 for certain building improvements and other fixed assets that will be removed from service in 2018 in connection with the planned York Property enhancement program. See Item 2, "Properties" for additional information regarding the York Property enhancement program. See Note 6 of Notes to Consolidated Financial Statements.

31



Net Interest Expense
Net interest expense increased $2 million (7%) in 2017 due to a higher interest rate related to the York Property Mortgage and $1 million of incremental interest expense associated with the refinancing of our $300 million 5.25% Senior Notes due 2022 (the "2022 Notes”) with the proceeds of newly issued $400 million 4.875% Senior Notes due 2025 (the “ 2025 Notes”). The incremental interest expense associated with the refinancing is principally due to the fact that the 2022 Notes remained outstanding until their contractual redemption date on January 11, 2018. See Note 9 of Notes to Consolidated Financial Statements.
Income Tax Expense
Our effective income tax rate for 2017 is 17.9%, compared to 26.8% in the prior year. The decrease in our effective income tax rate is primarily due to a decrease in U.S. taxes owed on our foreign earnings and the reversal in 2017 of a liability for a previously uncertain tax position for which the statute of limitations has expired. These factors are partially offset by a change in the jurisdictional mix of pre-tax earnings, which resulted in a lower portion of our income coming from jurisdictions with a statutory tax rate that is lower than the 35% rate that was in effect in the U.S. during those periods. To a lesser extent, the change in our effective income tax rate between 2017 and 2016 is impacted by provisional net income tax expense of $1.2 million recorded in the fourth quarter of 2017 related to the U.S. Tax Cuts and Jobs Tax Act, as discussed in more detail below. (See Note 17 of Notes to Consolidated Financial Statements for additional information on Uncertain Tax Positions.)
U.S. Tax Reform—The U.S. Tax Cuts and Jobs Act was enacted into law on December 22, 2017. The Act includes significant changes to the U.S. corporate income tax system that are effective on January 1, 2018, including, among other things, (i) a reduction of the U.S. corporate income tax rate from 35% to 21%, (ii) the transition to a modified territorial tax system from a worldwide tax system, (iii) limitations on the deductibility of interest expense and executive compensation, (iv) the imposition of the Base Erosion Anti-Abuse Tax (“BEAT”), a new minimum tax on international payments meant to reduce the ability of multinational companies to erode the U.S. tax base through deductible payments to related parties, and (v) the creation of two new categories of income: (a) foreign-derived intangible income (“FDII”), which is income derived from the sale of property or services to a foreign person which may be taxed at a rate lower than 21%, and (b) global intangible low taxed income (“GILTI”), which is certain income earned by foreign subsidiaries that must be included in the income of the U.S. shareholder. In addition, the Act imposes a one-time transition tax in the current year on the mandatory redeemed repatriation of certain unremitted foreign earnings as of December 31, 2017.
Soon after the Act was enacted into law, the SEC issued SAB 118, which allows companies to record the income tax effects of the Act as a provisional amount based on reasonable estimates for those tax effects. The provisional amount is subject to adjustment as companies complete their analysis of the Act, and collect and prepare the necessary data, and interpret any additional guidance issued by the U.S. Treasury Department, IRS, the FASB, and other standard-setting and regulatory bodies. Any such adjustments may be made within a subsequent measurement period, which should not extend beyond one year from the enactment date.
As of December 31, 2017, we have not completed our accounting for the income tax effects of the Act. However, in accordance with SAB 118, we recorded a provisional net income tax expense of approximately $1.2 million in the fourth quarter of 2017 based on reasonable estimates for those tax effects, consisting of the following:
Non-cash income tax expense of $19.8 million due to a reduction in the value of our net deferred tax assets, primarily due to the change in the U.S. corporate tax rate from 35% to 21% and the potential limitation of certain future business deductions;
Income tax expense of $40.4 million to record a liability for the one-time mandatory transition tax on certain unremitted and untaxed earnings of our foreign subsidiaries; and
A non-cash income tax benefit of $59 million to reverse previously recognized deferred tax liabilities related to the earnings of our foreign subsidiaries that were not deemed to be indefinitely reinvested.
At December 31, 2017, our Consolidated Balance Sheets reflect a provisional income tax payable of $34.6 million (net of foreign tax credits) primarily for the one-time mandatory transition tax on certain unremitted foreign earnings discussed above. We intend to elect to settle this liability in installments over eight years, as allowed by the Act. Accordingly, we have included approximately $32 million of the liability within long-term liabilities on our Consolidated Balance Sheets as of December 31, 2017.

32


We are still evaluating the effects that BEAT, FDII, GILTI, and the other provisions of the Act will have on our Consolidated Financial Statements in future periods. As we complete our analysis of the Act, collect and prepare the necessary data, and interpret any additional guidance issued by the U.S. Treasury Department, the IRS, the FASB, and other standard-setting and regulatory bodies, we may make adjustments to the provisional amounts recorded in the fourth quarter of 2017. These adjustments may impact our provision for income taxes and effective income tax rate in the period in which the adjustments are determined. Our accounting for the income tax effects of the Act will be completed during the measurement period, which should not extend beyond one year from the enactment date.
Taking into account the effects of the Act and our projected jurisdictional mix of earnings, we estimate that our effective income tax rate, excluding discrete items, for the year ending December 31, 2018 will be in the range of 25% to 27%. As discussed above, we are still evaluating the effects of BEAT, FDII, GILTI and the other provisions of the Act, which could have an impact on the effective income tax rate in the future. Accordingly, this estimate is subject to change. See statement on Forward Looking Statements.
Equity in Earnings of Investees
In 2017, our equity in the earnings of our equity method investees decreased $0.8 million primarily due to lower earnings from RM Sotheby's, partially offset by improved results from Acquavella Modern Art. See Note 5 of Notes to Consolidated Financial Statements for additional information regarding our equity method investments.
Impact of Changes in Foreign Currency Exchange Rates
For the year ended December 31, 2017, changes in foreign currency exchange rates had a net unfavorable impact of approximately $5.6 million on our operating income, with revenues unfavorably impacted by $14.1 million and expenses favorably impacted by $8.5 million.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015
Consolidated Results of Operations
Overview—In 2016, our net income was $74.1 million, or $1.27 per diluted share, representing an increase of $30.4 million when compared to the prior year when we reported net income of $43.7 million, or $0.63 per diluted share. The comparison to 2015 was most significantly influenced by a $65.7 million income tax charge recorded in 2015 related to the repatriation of foreign earnings. Excluding this and other charges in both years, Adjusted Net Income* was $99.6 million, or Adjusted Diluted EPS* of $1.71, which was $43.5 million (30%) lower than Adjusted Net Income* of $143.1 million, or Adjusted Diluted EPS* of $2.07, in 2015.
The lower level of Adjusted Net Income* in 2016 was principally due to a decline in the global art market when compared to the prior year, which resulted in a $1.5 billion (29%) decrease in Net Auction Sales and an associated $111.4 million (15%) decrease in auction commission revenue. The impact of the decline in Net Auction Sales was somewhat mitigated by an increase in Auction Commission Margin from 14.3% to 17.1%, as well as a lower level of incentive and share-based compensation and a lower effective tax rate.




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


33



Consolidated Financial Data Table—The table below presents a summary of our consolidated results of operations and related statistical metrics for the years ended December 31, 2016 and 2015, as well as a comparison between the two years (in thousands of dollars, except per share data):
 
 
 
 
 
Variance
 
2016
 
2015
 
$ / %
 
%
Revenues:
 

 
 

 
 

 
 

Agency commissions and fees
$
671,833

 
$
791,920

 
$
(120,087
)
 
(15
%)
Inventory sales
62,863

 
108,699

 
(45,836
)
 
(42
%)
Finance
52,716

 
50,489

 
2,227

 
4
%
Other
17,965

 
10,386

 
7,579

 
73
%
Total revenues
805,377

 
961,494

 
(156,117
)
 
(16
%)
Expenses:
 
 
 
 
 
 
 
Agency direct costs
73,324

 
91,919

 
(18,595
)
 
(20
%)
Cost of inventory sales
81,782

 
111,090

 
(29,308
)
 
(26
%)
Cost of finance revenues
17,738

 
15,780

 
1,958

 
12
%
Marketing
19,695

 
19,332

 
363

 
2
%
Salaries and related (a)
307,659

 
302,825

 
4,834

 
2
%
General and administrative
161,356

 
159,148

 
2,208

 
1
%
Depreciation and amortization
21,817

 
19,481

 
2,336

 
12
%
Voluntary separation incentive programs, net (b)
(610
)
 
36,938

 
(37,548
)
 
N/A

CEO separation and transition costs (c)

 
4,232

 
(4,232
)
 
(100
%)
Restructuring charges, net (d)

 
(972
)
 
972

 
100
%
Total expenses
682,761

 
759,773

 
(77,012
)
 
(10
%)
Operating income
122,616

 
201,721

 
(79,105
)
 
(39
%)
Net interest expense (e)
(29,016
)
 
(30,969
)
 
1,953

 
6
%
Non-operating income (expense)
3,134

 
(1,453
)
 
4,587

 
N/A

Income before taxes
96,734

 
169,299

 
(72,565
)
 
(43
%)
Income tax expense
25,957

 
131,145

 
(105,188
)
 
(80
%)
Equity in earnings of investees
3,262

 
5,327

 
(2,065
)
 
(39
%)
Net income
74,039

 
43,481

 
30,558

 
70
%
Less: Net loss attributable to noncontrolling interest
(73
)
 
(246
)
 
173

 
(70
%)
Net income attributable to Sotheby's
$
74,112

 
$
43,727

 
$
30,385

 
69
%
Diluted earnings per share - Sotheby's common shareholders
$
1.27

 
$
0.63

 
$
0.64

 
*

Statistical Metrics:
 

 
 

 
 

 
 
Aggregate Auction Sales (f)
$
4,247,873

 
$
5,949,030

 
$
(1,701,157
)
 
(29
%)
Net Auction Sales (g)
$
3,556,090

 
$
5,016,738

 
$
(1,460,648
)
 
(29
%)
Private Sales (h)
$
583,410

 
$
673,119

 
$
(89,709
)
 
(13
%)
Consolidated Sales (i)
$
4,894,146

 
$
6,720,384

 
$
(1,826,238
)
 
(27
%)
Effective income tax rate
26.8
%
 
77.5
%
 
(50.7
%)
 
N/A

Non-GAAP Financial Measures:
 
 
 
 
 
 
 
Adjusted Expenses (j)
$
541,497

 
$
579,454

 
$
(37,957
)
 
(7
%)
Adjusted Operating Income (j)
$
164,360

 
$
255,170

 
$
(90,810
)
 
(36
%)
Adjusted Net Income (j)
$
99,616

 
$
143,131

 
$
(43,515
)
 
(30
%)
Adjusted Diluted EPS (j)
$
1.71

 
$
2.07

 
$
(0.36
)
 
(17
%)
Adjusted Effective Income Tax Rate (j)
23.0
%
 
34.8
%
 
(11.8
%)
 
N/A

EBITDA (j)
$
150,902

 
$
225,322

 
$
(74,420
)
 
(33
%)
Adjusted EBITDA (j)
$
192,646

 
$
278,771

 
$
(86,125
)
 
(31
%)

34



Legend:
 *
Represents a variance in excess of 100%.
(a)
We do not allocate salaries and related costs to our cost of revenue, marketing expense, and general and
administrative expense line items, as many of our employees perform duties that could be categorized across more than one of these line items.
(b)
See Note 22 of Notes to Consolidated Financial Statements for information on the Voluntary Separation Incentive Programs enacted in the fourth quarter of 2015.
(c)
See Note 23 of Notes to Consolidated Financial Statements for information on CEO Separation and Transition Costs.

(d)
See Note 24 of Notes to Consolidated Financial Statements for information on Restructuring Charges.

(e)
Represents interest expense less interest income.
(f)
Represents the total hammer (sale) price of property sold at auction plus buyer’s premium, excluding amounts
related to the sale of our inventory at auction, which are reported within inventory sales.
(g)
Represents the total hammer (sale) price of property sold at auction, excluding amounts related to the sale of our inventory at auction, which are reported within inventory sales.
(h)
Represents the total purchase price of property sold in private sales that we have brokered, including our
commissions.
(i)
Represents the sum of Aggregate Auction Sales, Private Sales, and inventory sales.
(j)
See "Non-GAAP Financial Measures" below for a description of this non-GAAP financial measure and a reconciliation to the most comparable GAAP amount.
Agency Segment
Overview—In 2016, Agency segment income before taxes decreased by $75.4 million (54%), from $139.9 million to $64.6 million, as a result of a decline in the global art market, most notably in the Impressionist, Modern and Contemporary Art collecting categories, which resulted in a significantly lower level of Net Auction Sales (29%) and auction commission revenues (15%). Also contributing to the decrease in Agency segment income before taxes was a higher level of inventory losses. Somewhat mitigating the unfavorable comparison to 2015 was an increase in Auction Commission Margin from 14.3% to 17.1% and a lower level of auction direct costs.



35



Agency Segment Financial Data Table—The table below presents a summary of Agency segment income before taxes and related statistical metrics for the years ended December 31, 2016 and 2015, as well as a comparison between the two years (in thousands of dollars).
 
 
 
 
 
 
Variance
 
 
2016
 
2015
 
$ / %
 
%
Revenues:
 
 
 
 
 
 
 
 
Agency commissions and fees:
 
 

 
 

 
 

 
 

Auction commissions
 
$
607,770

 
$
719,152

 
$
(111,382
)
 
(15
%)
Private sale commissions
 
52,463

 
61,256

 
(8,793
)
 
(14
%)
Other Agency commissions and fees, net
 
11,600

 
11,512