10-K 1 bid-12312011x10k.htm BID-12.31.2011-10K


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, 2011.
 
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
___________________________________________________________________
(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 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 Act during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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, or a smaller reporting company (as defined in Rule 12b-2 of the Act). Large accelerated filer þ Accelerated filer o Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company 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, 2011, the aggregate market value of the 67,206,102 shares of Common Stock held by non-affiliates of the registrant was $2,923,465,437 based upon the closing price ($43.50) on the New York Stock Exchange composite tape on such date for the Common Stock.
As of February 22, 2012, there were outstanding 67,503,459 shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s proxy statement for the 2011 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
Overview
Sotheby’s (or, “the Company”) is one of the world’s two largest auctioneers of authenticated fine and decorative art, jewelry and collectibles (collectively, “art” or “works of art” or “artwork” or “property”). In 2011, Sotheby’s accounted for approximately $5 billion, or 51%, of the total aggregate auction sales of the two major auction houses within the global auction market.
Sotheby’s operations are organized under three segments: Auction, Finance and Dealer. Sotheby’s Auction segment functions principally as an agent by offering works of art for sale at auction and by brokering private sales of artwork. Sotheby’s also operates as a dealer in works of art through its Dealer segment, conducts art-related financing activities through its Finance segment and is engaged, to a lesser extent, in brand licensing activities. A more detailed explanation of the activities of each of Sotheby’s segments, as well as its brand licensing activities, is provided below.
Sotheby’s was initially incorporated in Michigan in August 1983. In October 1983, the Company acquired Sotheby Parke Bernet Group Limited, which was then a publicly held company listed on the International Stock Exchange of the United Kingdom and which, through its predecessors, had been engaged in the auction business since 1744. In 1988, Sotheby’s issued shares of common stock to the public. In June 2006, Sotheby’s reincorporated in the State of Delaware. Sotheby's common stock ("Common Stock") is listed on the New York Stock Exchange (the “NYSE”) and trades under the symbol “BID.” As successor to the business that began in 1744, Sotheby’s is the oldest company listed on the NYSE.
Auction Segment
Description of Business
The sale of works of art in the international art market is primarily effected through the major auction houses, numerous art dealers, smaller auction houses and also directly between collectors. Although art dealers and smaller auction houses generally do not report sales figures publicly, Sotheby’s believes that art dealers account for the majority of the volume of transactions in the international art market.
Sotheby’s Auction segment functions principally as an agent by offering works of art for sale at auction and by brokering private art sales. Sotheby’s principal role as an agent is to stimulate buyer interest through professional marketing techniques and to match sellers and buyers through the auction or private sale process. Prior to offering a work of art for sale, Sotheby’s experts perform significant due diligence activities to authenticate and determine the ownership history of the property being sold.
In its role as auctioneer, Sotheby’s represents sellers of artworks by accepting property on consignment and by matching sellers to buyers through the auction process. Sotheby’s invoices the buyer for the purchase price of the property (including the commission owed by the buyer), collects payment from the buyer and remits to the seller the net sale proceeds after deducting its commissions, expenses and applicable taxes and royalties. Sotheby’s commissions include those paid by the buyer (“buyer’s premium”) and those paid by 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 2011, 2010 and 2009, auction commission revenue accounted for 84%, 86%, and 82%, respectively, of Sotheby’s consolidated revenues.
Under the standard terms and conditions of its auction sales, Sotheby’s is not obligated to pay consignors for property that has not been paid for by buyers. If a buyer defaults on payment, the sale may be cancelled, and the property will be returned to the consignor. Alternatively, the consignor may reoffer the property at a future Sotheby's auction or negotiate a private sale with Sotheby's acting as its agent. However, on a limited basis and subject to approval under Sotheby’s policy, the consignor may be paid the net sale proceeds before payment is collected from the buyer and/or the buyer may be allowed to take possession of the property before making payment. In situations when the buyer takes possession of the property before making payment, Sotheby’s is liable to the seller for the net sale proceeds whether or not the buyer makes payment.
From time to time in the ordinary course of its business, Sotheby’s will guarantee to consignors a minimum sale price in connection with the sale of property at auction (an “auction guarantee”). In the event that the property sells for less than the guaranteed price, Sotheby’s must perform under the auction guarantee by funding the difference between the sale price at auction and the amount of the auction guarantee. Sotheby’s is generally entitled to a share of the excess proceeds (the “overage”) if the property under the auction guarantee sells above the guaranteed price. If the property does not sell, the amount of the auction guarantee must be paid, but Sotheby’s has the right to recover such amount through the future sale of the property. In these situations, the guaranteed property is recorded as Inventory on Sotheby's balance sheet at the lower of cost

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(i.e., the amount paid under the auction guarantee) or management’s estimate of the property's net realizable value (i.e., expected sale price upon disposition). The sale proceeds ultimately realized by Sotheby’s in these situations may equal, exceed or be less than the amount recorded as Inventory on Sotheby's balance sheet.
Sotheby’s may reduce its financial exposure under auction guarantees through risk and reward sharing arrangements, which include:
Contractual arrangements under which a counterparty contractually commits to bid a predetermined price on the guaranteed property (an “irrevocable bid”). If the irrevocable bid is the winning bid, the counterparty purchases the property at the predetermined price plus the applicable buyer’s premium, which is the same amount that any other successful bidder would pay at that price. If the irrevocable bid is not the winning bid, the counterparty is generally entitled to receive a share of the auction commission earned on the sale and/or a share of any overage.
Contractual arrangements under which a counterparty contractually commits to fund: (i) a share of the difference between the sale price at auction and the amount of the auction guarantee if the property sells for less than the guaranteed price or (ii) a share of the guaranteed price if the property does not sell while taking ownership of a proportionate share of the unsold property. In exchange for accepting a share of the financial exposure under the auction guarantee, the counterparty is entitled to receive a share of the auction commission earned and/or a share of any overage if the property sells.
The counterparties to these auction guarantee risk and reward sharing arrangements are typically major international art dealers or major art collectors. Sotheby’s could be exposed to losses in the event any of these counterparties do not perform according to the terms of these contractual arrangements.
(See Notes D, E and R of Notes to Consolidated Financial Statements.)
Seasonality
The worldwide art auction market has two principal selling seasons, which generally occur in the second and fourth quarters of the year. Accordingly, Sotheby’s auction business is seasonal, with peak revenues and operating income generally occurring in those quarters. Consequently, first and third quarter results have historically reflected a lower volume of auction activity when compared to the second and fourth quarters and, typically, a net loss due to the fixed nature of many of Sotheby’s operating expenses. (See Note V of Notes to Consolidated Financial Statements.)
The Auction Market and Competition
Competition in the international art market is intense. A fundamental challenge facing any auctioneer or art dealer is to obtain high quality and valuable property for sale either as agent or as principal. Sotheby's primary global auction competitor is Christie’s International, PLC (“Christie’s”), a privately held, French-owned, auction house. To a much lesser extent, Sotheby’s also faces competition from smaller auction houses such as Bonhams and Phillips de Pury & Company, as well as regional auction houses and a variety of art dealers across all collecting categories. In the Chinese art market, Sotheby's also competes with Beijing Poly International Auction Co. Ltd., China Guardian Auctions Co. Ltd. and Beijing Hanhai Auction Co. Ltd.
The owner of a work of art wishing to sell has four principal options: (i) sale or consignment to, or private sale by, an art dealer; (ii) consignment to, or private sale by, an auction house; (iii) private sale to a collector or museum without the use of an intermediary; or (iv) for certain categories of property (in particular, collectibles) consignment to, or private sale through, an internet-based service. The more valuable the property, the more likely it is that the owner will consider more than one option and will solicit proposals from more than one potential purchaser or agent, particularly if the seller is a fiduciary representing an estate or trust. A complex array of factors may influence the seller’s decision. These factors, which are not ranked in any particular order, include:
The level and breadth of expertise of the art dealer or auction house with respect to the property;
The extent of the prior relationship, if any, between the art dealer or auction house and its staff and the seller;
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 client’s desire for privacy;
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 availability and terms of financial options offered by auction houses including auction guarantees, short-term

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financing and auction commission sharing arrangements;
The level of pre-sale estimates;
The desirability of a public auction in order to achieve the maximum possible price (a particular concern for fiduciary sellers, such as trustees and estate executors);
The amount of commission charged by art dealers or auction houses to sell a work on consignment;
The cost, style and extent of pre-sale marketing and promotion to be undertaken by an art dealer or auction house;
Reputation and recommendations by third parties consulted by the seller;
The desire of clients to conduct business with a publicly traded company; and
The availability and extent of related services, such as tax or insurance appraisals.
It is not possible to measure with any particular accuracy the entire international art market or to reach any conclusions regarding overall competition because privately owned art dealers and auction firms frequently do not publicly report annual totals for auction sales, revenues or profits, and the amounts reported may not be verifiable.
Auction Regulation
Regulation of the auction business varies from jurisdiction to jurisdiction. In many jurisdictions, Sotheby’s is subject to laws and regulations that are not directed solely toward the auction business, including, but not limited to, import and export regulations, antitrust laws, cultural property ownership laws, data protection and privacy laws, anti-money laundering laws, copyright and resale royalty laws, and laws and regulations involving sales, use, value-added and other indirect taxes. In addition, Sotheby’s is 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 do not impose a material impediment to Sotheby’s business, but do affect the market generally. A material adverse change in such regulations, such as the Equity for Visual Artists bill introduced in the U.S. Congress imposing a 7% resale royalty only on sales of art through large auction houses, could materially affect Sotheby's business. Additionally, export and import laws and cultural property ownership laws could affect the availability of certain kinds of property for sale at Sotheby’s principal auction locations or could increase the cost of moving property to such locations. In addition, failure to comply with local laws and regulations could subject Sotheby’s to civil and/or criminal penalties in such jurisdictions. Sotheby’s has a Compliance Department which, amongst other activities, develops and updates compliance policies and audits, monitors, and provides training to its employees on compliance with many of these laws and regulations.
Finance Segment
Description of Business
Sotheby’s Finance segment provides certain collectors and art dealers with financing secured by works of art that Sotheby's either has in its possession or permits borrowers to possess. The Finance segment generally makes two types of secured loans: (i) advances secured by consigned property to borrowers who are contractually committed, in the near term, to sell the property at auction (a “consignor advance”); and (ii) general purpose term loans secured by property not presently intended for sale (a “term loan”). A consignor advance allows a seller to receive funds upon consignment for an auction that will typically occur up to one year in the future, while preserving for the benefit of the seller the potential of the auction process. Term loans allow Sotheby's to establish or enhance mutually beneficial relationships with borrowers and may generate future auction consignments or may be used to facilitate certain auction or private purchases. On rare occasions, in order to attract future consignments, Sotheby's also makes unsecured loans to clients.
The collection of secured loans can be adversely impacted by a decline in the art market in general or in the value of the particular collateral. In addition, in situations when there are competing claims on the collateral and/or when a borrower becomes subject to bankruptcy or insolvency laws, Sotheby’s ability to realize on its collateral may be limited or delayed.
Sotheby’s target loan-to-value (“LTV”) ratio, which is defined as the principal loan amount divided by the low auction estimate of the collateral, is 50% or lower. However, loans are sometimes made at an initial LTV higher than 50%. In addition, as a result of the periodic revaluation of loan collateral, the LTV ratio of certain loans may increase above the 50% target due to decreases in the low auction estimates of the collateral. The revaluation of loan collateral is performed by Sotheby’s specialists on an annual basis or more frequently if there is a material change in circumstances related to the loan or the disposal plans for the collateral. Management believes that the LTV ratio is the critical credit quality indicator for Finance segment secured loans. As of December 31, 2011 and 2010, the aggregate LTV ratio of Finance segment secured loans was 42% and 45%, respectively. As of December 31, 2011, Finance segment secured loans with an LTV ratio above 50% totaled $134.3 million and the

5


collateral related to these loans had a low auction estimate of $225.2 million. As of December 31, 2010, Finance segment secured loans with an LTV ratio above 50% totaled $133 million and the collateral related to these loans had a low auction estimate of $191 million.
Finance segment loans are predominantly variable interest rate loans; however, short-term, interest-free advances with maturities typically ranging between three and six months are provided to certain consignors in order to secure high-value property for auctions and can represent a significant portion of the client loan portfolio as of the end of certain quarterly reporting periods in advance of peak selling seasons.
The activities of the Finance segment, which are conducted through Sotheby’s wholly-owned subsidiaries, have in recent years been funded through the operating cash flows of the Auction segment. Sotheby's may supplement the funding of the Finance segment with credit facility borrowings, but has not borrowed under its credit facility during the last three years. (See “Liquidity and Capital Resources” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”)
(See Notes D and E of Notes to Consolidated Financial Statements.)
The Finance Market and Competition
A considerable number of traditional lending sources offer conventional loans at a lower cost to borrowers than the average cost of loans offered by Sotheby’s Finance segment. Additionally, many traditional lenders offer borrowers a variety of integrated financial services such as wealth management services, which are not offered by Sotheby’s. Few lenders, however, are willing to accept works of art as sole collateral as they do not possess the ability to both appraise and sell works of art within a vertically integrated organization. Sotheby’s believes that through a combination of its art expertise and skills in international law and finance, it has the ability to tailor attractive financing packages for clients who wish to obtain immediate access to liquidity from their art assets.
Dealer Segment
Description of Business
Sotheby’s Dealer segment principally includes the activities of Noortman Master Paintings (or “NMP”), an art dealer that sells works of art from inventory directly to private collectors and museums and, from time-to-time, acts as a broker in private purchases and sales of art.
NMP was acquired by Sotheby's on June 7, 2006 paying initial consideration in the form of 1,946,849 shares of Common Stock (the “Initial Consideration”). Pursuant to the terms of the acquisition, if NMP failed to achieve a minimum level of financial performance during the five years following the closing of the transaction, up to 20% of the Initial Consideration would be returned to Sotheby's. The minimum level of financial performance was not achieved by NMP as of May 31, 2011 and, as a result, 147,341 shares of Sotheby's Common Stock were returned to Sotheby's.
In the third quarter of 2011, following the fifth anniversary of the acquisition of NMP and the expiration of the related financial performance targets, management initiated a plan to restructure NMP’s business and sales strategy. Historically, NMP has principally specialized in sales of Dutch and Flemish Old Master Paintings, as well as French Impressionist and Post-Impressionist paintings, with a large number of paintings held in inventory at various price points. However, as a result of the restructuring of its business and sales strategy, NMP is greatly reducing its inventory of lower valued Old Master Paintings and shifting its focus to a select group of high-valued works of art. Accordingly, NMP sold a collection of lower valued works at various auction houses in the fourth quarter of 2011. In the ordinary course of NMP’s business, these objects would have been held for a longer period and sold in privately negotiated transactions. As a result of this new strategy and due in part to a general weakening of the private dealer market for certain categories of Old Master Paintings, as well as a shift in the collecting tastes of NMP’s clients, inventory writedowns of $8.4 million were recorded in 2011, of which $5.7 million were recorded in the third quarter of 2011.
To a lesser extent, Dealer segment activities also include the investment in and resale of artworks directly by Sotheby’s and the activities of certain equity investees, including Acquavella Modern Art (or “AMA”). (See Note G of Notes to Consolidated Financial Statements.)
The Dealer Market and Competition
The Dealer segment operates in the same markets as Sotheby’s Auction segment and is impacted to varying degrees by many of the same competitive factors (as discussed above under “The Auction Market and Competition”). The most prominent competitive factors impacting the Dealer segment, which are not ranked in any particular order, include: (i) reputation and relationships and personal interaction between the buyer or seller and the art dealer; (ii) access to, and participation in, art fairs;

6


(iii) the level of specialized expertise of the art dealer; (iv) the ability of the art dealer to locate and purchase quality works of art for resale; and (v) the ability of the art dealer to finance purchases of art.
Brand Licensing Activities
Prior to 2004, Sotheby’s engaged in the marketing and brokerage of luxury residential real estate sales through Sotheby’s International Realty (or “SIR”). In 2004, Sotheby’s sold SIR to a subsidiary of Realogy Corporation (or “Realogy”), formerly Cendant Corporation. In conjunction with the sale, Sotheby’s 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 2011, 2010 and 2009, Sotheby’s earned $3.9 million, $3.1 million and $2.4 million, respectively, in license fee revenue related to the Realogy License Agreement.
The Sotheby’s name is also licensed for use in connection with the art auction business in Australia, art education services in the U.S. and the United Kingdom (“U.K.”) and print management services. Management will consider additional opportunities to license the Sotheby’s brand in businesses where appropriate.
Strategic Initiatives
Continued Focus on Sotheby’s Most Valuable Relationships
Sotheby’s focus on the high-end of the art market has been an important contributor to its success. Accordingly, management is continuing to dedicate significant time, energy and resources to broadening and extending the breadth and depth of Sotheby’s relationships with major clients. These efforts are part of a multi-year strategy to invest in those areas which serve Sotheby’s major clients best.
Over the past several years, Sotheby’s has made substantial investments in information technology designed to improve client service. A portfolio of enterprise systems anchored by SAP has been deployed across the organization, which has enhanced the quality of information and the processing of sales and inventory tracking, as well as data management. In 2010, Sotheby’s implemented a systems enhancement to significantly reengineer and improve Sotheby’s post-sale client service. In particular, enhancements were made to facilitate the shipment and tracking of client purchased property, and Sotheby's reorganized its staff so that clients have a single point of contact for post sale inquiries. Also, in 2010, the sothebys.com website was enhanced with several important features including BIDnow™ (an online bidding feature), mobile and IPHONE/IPAD† website access, improved e-catalogue features, Chinese language e-catalogues and a new retail wine website. The BIDnow™ feature has satisfied a demand from clients for online bidding capabilities and its impact in certain categories such as wine, jewelry and books has been dramatic.
In 2011, management made further significant technology investments, including a re-launch of the sothebys.com website. The new website provides clients with a variety of new and innovative tools, such as recommendations, related lots, favorites, foreign language translations, enhanced account management, and new custom proprietary content. Sotheby's also launched a custom catalogue app design for the IPAD† in the fourth quarter of 2011. Additionally, Sotheby's is leveraging social media channels with a new presence on FACEBOOK†, YOUTUBE† and TWITTER†.
Client relationships are a key driver of Sotheby’s success and its clients expect a consistently high level of service. Management believes these initiatives will have a meaningful positive impact on the future of Sotheby’s business.
IPHONE, IPAD, FACEBOOK, YOUTUBE and TWITTER are third-party marks over which Sotheby's does not make any claims.

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Continue to Develop Sotheby's Presence in China and Other Emerging Markets
In recent years, Sotheby's has focused on developing its presence in China and the growth in activity from buyers in this region has been dramatic. As demonstrated in the following table, over the past five years, auction and related revenues attributable to Sotheby's Hong Kong has increased substantially and has become an increasingly significant contributor to Sotheby's financial results (in thousands of dollars):
 
 
2011
 
2010
 
2009
 
2008
 
2007
 
 
 
 
 
 
 
 
 
 
 
Auction and related revenues attributable to Sotheby's Hong Kong
 

$156,361

 

$111,651

 

$50,061

 

$52,331

 

$59,550

As a percentage of Sotheby's consolidated auction and related revenues
 
18.8%
 
14.4%
 
10.3%
 
7.6%
 
6.5%
Management is continuing to focus on developing Sotheby's presence in China by deepening its relationships with Chinese art collectors in a number of ways, including:
The implementation of regional marketing initiatives such as the publishing of Hong Kong sales catalogues in Chinese, the launching of a Chinese language website that includes e-catalogues for sales of Asian Art and Sotheby's major Impressionist and Contemporary sales and the hosting of various traveling exhibitions, including the Modern Masters private selling exhibition of western art in Beijing and several other events promoting Asian Art.
Investing in new staff with the requisite skills to service Asian clients at Sotheby's Hong Kong, New York and London locations, as well as to support the growth of the Chinese art market.
The expansion of Sotheby's facilities in Hong Kong to accommodate growth opportunities in the Chinese art market.
Conducting a greater number of auctions and private selling events in Hong Kong. Typically, Sotheby's major Hong Kong auctions are held in early April and early October. Beginning in 2012, the premises expansion discussed above will enable Sotheby's to conduct more auctions in Hong Kong throughout the year, in addition to its traditional auctions held in April and October. (See statement on Forward Looking Statements.)
The exploration of a number of ideas for partnerships and/or licensing opportunities in order to sell art at auction and/or privately in mainland China.
In addition to Sotheby’s progress in China, investments have also been made in emerging markets such as Russia, the Middle East and South America, with offices opened in Moscow and Doha, Qatar in 2008 and Brazil in 2011.
Enhance Private Sales Initiatives
Private sales have become increasingly important to Sotheby's overall financial performance with private sale commission revenues totaling $67.8 million in 2011, a 53% increase when compared to 2010 and a 24% increase when compared to the previous peak of the art market in 2007, as management continues to maintain a greater focus on this revenue stream. Over the past two years, Sotheby's has hosted a number of new and innovative private sale exhibitions and, in 2011, Sotheby's completed the construction of a dedicated private sale exhibition gallery, the S|2 Gallery, at its York Avenue headquarters in New York.
Financial and Geographical Information about Segments
See Note D of Notes to Consolidated Financial Statements for financial and geographical information about Sotheby’s segments.

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Employees
As of December 31, 2011, Sotheby’s had 1,446 employees with 588 located in North America; 503 in the U.K.; 225 in Continental Europe; and 130 in Asia. Sotheby’s regards its relations with substantially all of its employees as good. The table below provides a breakdown of Sotheby’s employees by segment as of December 31, 2011 and 2010.
    
December 31
 
2011
 
2010
Auction
 
1,271

 
1,215

Finance
 
7

 
7

Dealer
 
10

 
8

All Other
 
158

 
150

Total
 
1,446

 
1,380

Employees classified within “All Other” principally relate to Sotheby’s central corporate and information technology departments.
On June 30, 2011, the collective bargaining agreement applicable to 42 property handlers employed at Sotheby's New York City office expired. During the process of negotiations with the union representing the property handlers, the union made statements to the media threatening a strike. In order to avoid the impact of the union's threatened strike during the upcoming sales season and in support of Sotheby's bargaining proposals, Sotheby's locked out members of the bargaining unit on July 29, 2011. Although management cannot predict the ultimate outcome of the negotiations and any associated work disruption, Sotheby's is committed to a good faith bargaining process and resolution of this matter. In the interim, Sotheby's ability to conduct business at its New York City office could be disrupted by the lockout, though management has contingency plans in place to minimize any potential disruption that could be caused by the lockout. The union has also initiated a broader campaign seeking to pressure Sotheby's management and its Board of Directors and to influence Sotheby's clients and suppliers to support the union and cease doing business with Sotheby's. It is impossible to predict the impact of this union campaign, but to-date, the campaign has not had a material impact on Sotheby's business.
Website Address
Sotheby’s makes available free of charge its annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K through a hyperlink from its website, http://investor.shareholder.com/bid/sec.cfm, a website maintained by an unaffiliated third-party service. Such reports are made available on the same day that they are electronically filed with or furnished to the Securities and Exchange Commission (the "SEC"). 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
Sotheby's operating results and liquidity are significantly influenced by a number of risk factors, many of which are not within its control. These factors, which are not ranked in any particular order, are discussed below.
The global economy and the financial markets and political conditions of various countries may negatively affect Sotheby's business and clients, as well as the supply of and demand for works of art.
The international 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 Sotheby's 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. Sotheby's 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. Accordingly, weakness in those economies and financial markets can adversely affect the supply of and demand for works of art and Sotheby's business. Furthermore, global political conditions may also influence the enactment of legislation that could adversely impact Sotheby's business.
Government laws and regulations may restrict or limit Sotheby's business.
Many of Sotheby's activities are subject to laws and regulations including, but not limited to, import and export regulations, cultural property ownership laws, data protection and privacy laws, anti-money laundering laws, antitrust laws, copyright and resale royalty laws, and laws and regulations involving sales, use, value-added and other indirect taxes. In addition, Sotheby's is 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 the worldwide business of

9



Sotheby's, but do affect the market generally. A material adverse change in such regulations, such as the Equity for Visual Artists bill introduced in the U.S. Congress imposing a 7% resale royalty on sales of art through large auction houses, could affect Sotheby's business. Additionally, export and import laws and cultural property ownership laws could affect the availability of certain kinds of property for sale at Sotheby's principal auction locations or could increase the cost of moving property to such locations.
Foreign currency exchange rate movements can significantly increase or decrease Sotheby's results of operations.
Sotheby's has operations throughout the world, with approximately 62% of its revenues earned outside of the U.S. in 2011. Revenues and expenses relating to Sotheby's foreign operations are translated using weighted average monthly exchange rates during the period in which they are recognized. Accordingly, fluctuations in foreign currency exchange rates, particularly for the Pound Sterling and the Euro, can significantly increase or decrease Sotheby's results of operations.
Competition in the international art market is intense and may adversely impact Sotheby's results of operations.
Sotheby's competes 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 Sotheby's ability to obtain valuable consignments for sale, as well as the commission margins achieved on such consignments.
Sotheby's cannot be assured of the amount and quality of property consigned for sale at auction, which may cause significant variability in its financial results.
The amount and quality of property consigned for sale is influenced by a number of factors not within Sotheby's control. Many major consignments, and specifically single-owner sale consignments, often become available as a result of the death or financial or marital difficulties of the owner, all of which are unpredictable and may cause significant variability in Sotheby's financial results from period to period.
The demand for art is unpredictable, which may cause significant variability in Sotheby's financial results.
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, all of which are difficult to predict and which may adversely impact the ability of Sotheby's to obtain and sell consigned property, potentially causing significant variability in Sotheby's financial results from period to period.
The loss of key personnel could adversely impact Sotheby's ability to compete.
Sotheby's is largely a service business in which the ability of its employees to develop and maintain relationships with potential sellers and buyers of works of art is essential to its success. Moreover, Sotheby's business is unique, making it important to retain key specialists and members of management. Accordingly, Sotheby's business is highly dependent upon its success in attracting and retaining qualified personnel.
Sotheby's ability to conduct business at its New York City office could be disrupted by a work stoppage involving unionized employees.
On June 30, 2011, the collective bargaining agreement applicable to 42 property handlers employed at Sotheby's New York City office expired. During the process of negotiations with the union representing the property handlers, the union made statements to the media threatening a strike. In order to avoid the impact of the union's threatened strike during the autumn 2011 sales season and in support of Sotheby's bargaining proposals, Sotheby's locked out members of the bargaining unit on July 29, 2011. Although management cannot predict the ultimate outcome of the negotiations and any associated work disruption, Sotheby's is committed to a good faith bargaining process and resolution of this matter. In the interim, Sotheby's ability to conduct business at its New York City office could be disrupted by the lockout, though management has implemented contingency plans to minimize any potential disruption that could be caused by the lockout. The union has also initiated a broader campaign seeking to pressure Sotheby's management and its Board of Directors and to influence Sotheby's clients and suppliers to support the union and cease doing business with Sotheby's. It is impossible to predict the impact of this union campaign, but to-date, the campaign has not had a material impact on Sotheby's business.
The strategic initiatives being implemented by Sotheby's may not succeed.
Sotheby's current core strategic initiatives are focused on extending the breadth and depth of its relationships with major clients, developing a presence in China and other emerging markets, and enhancing its ability to conduct private sales. Over the past several years, Sotheby's has made substantial investments in information technology to provide clients with access to on-line bidding, improve post-sale client service, and enhance the sothebys.com website. In addition, Sotheby's has

10



hosted new and innovative private sale exhibitions, and, in 2011, completed the construction of a dedicated private sale exhibition gallery, the S|2 Gallery, at its York Avenue headquarters in New York. Sotheby's has also implemented a restructuring plan whereby it has streamlined certain European selling operations to allow global management to focus resources on growing markets, especially China, and other strategic priorities.
Sotheby's future operating results are dependent in part on management's success in implementing these initiatives. Furthermore, the inability of Sotheby's to successfully implement these initiatives could result in, among other things, the loss of clients, the impairment of assets, and inefficiencies from operating in new and emerging markets. Sotheby's short-term operating results could also be unfavorably impacted by the costs associated with the implementation of its strategic plans.
(See Item 1 above under "Strategic Initiatives" and statement on Forward Looking Statements.)
A breach of the security measures protecting Sotheby's global network of information systems may occur.
Sotheby's is dependent on a global network of information systems to conduct its business. A breach of the security measures protecting Sotheby's information systems could adversely impact its operations, reputation and brand.
Sotheby's business continuity plans may not be effective in addressing the impact of unexpected events that could impact its business.
Sotheby's inability to successfully implement its business continuity plans in the wake of an unexpected event, such as an act of God or a terrorist attack occurring near one of its major selling and/or sourcing offices and/or any other unexpected event, could disrupt its ability to operate and adversely impact its operations.
Sotheby's relies on a small number of clients who make a significant contribution to its revenues, profitability and operating cash flows.
Sotheby's relies on a small number of clients who make a significant contribution to its revenues, profitability and operating cash flows. Accordingly, Sotheby's revenues, profitability and operating cash flows are highly dependent upon its ability to develop and maintain relationships with this small group of clients, as well as the financial strength of these clients.
On a limited basis and subject to approval under Sotheby's policy, Sotheby's will pay the consignor before payment is collected from the buyer and/or allows the buyer to take possession of the property before payment is received. In these situations, Sotheby's is exposed to losses in the event the buyer does not make payment.
Under the standard terms and conditions of its auction sales, Sotheby's is not obligated to pay consignors for property that has not been paid for by buyers. However, on a limited basis and subject to approval under Sotheby's policy, the consignor may be paid the net sale proceeds before payment is collected from the buyer while retaining possession of the property. In such situations, if the buyer does not make payment, Sotheby's will take title to the property, but could be exposed to losses if the value of the property declines. In other certain limited instances and subject to approval under Sotheby's policy, Sotheby's allows the buyer to take possession of the property before making payment. In these situations, Sotheby's is liable to the seller for the net sale proceeds whether or not the buyer makes payment and would incur losses in the event of buyer default.
Sotheby's 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 it operates and in which its clients reside.
Sotheby's operates in 40 countries and has a worldwide client base that has grown in recent years due in part to a dramatic increase in the activity of buyers from emerging markets, and 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. Sotheby's 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 Sotheby's ability to enforce its rights as a creditor in jurisdictions where the applicable laws and regulations may be less defined, particularly in emerging markets.
Demand for art-related financing is unpredictable, which may cause variability in Sotheby's financial results.
Sotheby's 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 financial results of Sotheby's Finance segment are subject to variability from period to period.


11



The ability of Sotheby's to realize proceeds from the sale of collateral for Finance segment loans may be limited or delayed.
In situations when there are competing claims on the collateral for Finance segment loans and/or when a borrower becomes subject to bankruptcy or insolvency laws, Sotheby's ability to realize proceeds from the sale of its collateral may be limited or delayed.
The value of art is subjective and often fluctuates, exposing Sotheby's to losses in the value of its inventory and loan collateral and significant variability in its financial results.
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. Accordingly, Sotheby's is at risk both as to the realizable value of art held in inventory and as to the realizable value of art pledged as collateral for client loans.
In estimating the realizable value of art, management relies on the opinions of Sotheby's specialists, who consider the following complex array of factors when valuing art: (i) whether the artwork is expected to be offered at auction or sold privately, in the ordinary course of Sotheby's business; (ii) the supply and demand for works of art, taking into account economic conditions and changing trends in the art market as to which collecting categories and artists are most sought after; and (iii) recent sale prices achieved in the art market for comparable works of art within a particular collecting category and/or by a particular artist.
If management determines that the estimated realizable value of a specific artwork held in inventory is less than its carrying value, a loss is recorded to reflect management's revised estimate of realizable value. In addition, if the estimated realizable value of the art pledged as collateral for a client loan is less than the corresponding loan balance, management assesses 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. These factors may cause significant variability in Sotheby's financial results from period to period.
Sotheby's could be exposed to losses as a result of various claims and lawsuits incidental to the ordinary course of its business.
Sotheby's becomes involved in various claims and lawsuits incidental to the ordinary course of its business. Management is required to assess the likelihood of any adverse judgments or outcomes in these matters, as well as potential ranges of probable losses. A determination of the amount of losses, if any, to be recorded 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 for such contingencies may change in the future due to new developments in each matter or a change in settlement strategy.
Sotheby's could be exposed to losses in the event of title or authenticity claims arising from sales or auctions of works of art.
The assessment of works of art offered for sale or auction can involve potential claims regarding title and authenticity. Items sold by Sotheby's 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 Sotheby's auction sale catalogues. The authentication of works of art is based on scholarship and research, but necessarily requires a degree of judgment from Sotheby's art experts. In the event of a title or authenticity claim against Sotheby's, Sotheby's may have recourse against the seller of the property and may have the benefit of insurance, but a claim could nevertheless expose Sotheby's to losses and to reputational risk.
Auction guarantees create the risk of loss resulting from the potential inaccurate valuation of art.
As discussed above, the art market is not a highly liquid trading market and, as a result, the valuation of art is inherently subjective. Accordingly, Sotheby's is at risk with respect to management's ability to estimate the likely selling prices of works of art offered with auction guarantees. If management's judgments about the likely selling prices of works of art offered with auction guarantees prove to be inaccurate, there could be a significant adverse impact on Sotheby's results of operations, financial condition and liquidity.
Sotheby's could be exposed to losses in the event of nonperformance by its counterparties in auction guarantee risk and reward sharing arrangements.
In certain situations, Sotheby's reduces its financial exposure under auction guarantees through risk and reward sharing arrangements. Sotheby's counterparties to these risk and reward sharing arrangements are typically major international art dealers or major art collectors. Sotheby's could be exposed to losses in the event any of these counterparties do not perform according to the terms of these contractual arrangements.

12



Sotheby's Convertible Notes have early conversion features that, if triggered, could reduce its liquidity in the short-term.
Sotheby's 3.125% Convertible Notes have a stated maturity date of June 15, 2013, but may be exercised during any fiscal quarter if the closing price of Sotheby's Common Stock exceeds $44.20 per share (i.e., 130% of the conversion price of the Convertible Notes) for at least 20 trading days in the period of 30 consecutive trading days at the end of the previous quarter (the “Stock Price Trigger”). It is Sotheby's current intent and policy to settle up to the principal amount of the Convertible Notes in cash. The Stock Price Trigger was not met during the fourth quarter of 2011 and, as a result, the Convertible Notes will not be convertible for the fiscal quarter beginning on January 1, 2012 and ending on March 31, 2012. However, if the Convertible Notes were to become exercisable during any fiscal quarter subsequent to March 31, 2012, and if any holders of the Convertible Notes elected to exercise during such periods, Sotheby's liquidity would be reduced.
Future costs and obligations related to the Sotheby's U.K. Pension Plan are dependent on unpredictable factors, which may cause significant variability in employee benefit costs.
Future costs and obligations related to Sotheby's defined benefit pension plan in the U.K. are heavily influenced by changes in interest rates, investment performance in the debt and equity markets and actuarial assumptions, each of which is unpredictable and may cause significant variability in Sotheby's employee benefit costs.
 
Tax matters may cause significant variability in Sotheby's financial results.
Sotheby's operates in many tax jurisdictions throughout the world and the provision for income taxes involves a significant amount of management judgment regarding interpretation of relevant facts and laws in the jurisdictions in which Sotheby's operates. Sotheby's effective income tax rate can vary significantly between periods due to a number of complex factors including, but not limited to: (i) future changes in applicable laws; (ii) projected levels of taxable income; (iii) pre-tax income being lower than anticipated in countries with lower statutory rates or higher than anticipated in countries with higher statutory rates; (iv) increases or decreases to valuation allowances recorded against deferred tax assets; (v) tax audits conducted by various tax authorities; (vi) adjustments to income taxes upon finalization of income tax returns; (vii) the ability to claim foreign tax credits; (viii) the repatriation of non-U.S. earnings for which Sotheby's has not previously provided for income taxes; and (ix) tax planning.
Sotheby's 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 clients to purchase or sell works of art through Sotheby's. Additionally, Sotheby's unique business and global client base may also expose Sotheby's to complicated and uncertain sales, use, value-added and other indirect tax analyses, which could lead to claims from tax authorities.
Insurance coverage for artwork may become more difficult to obtain, exposing Sotheby's to losses for artwork in Sotheby's possession.
Sotheby's maintains insurance coverage for the works of art it owns and for works of art consigned to it by its clients, which are stored at Sotheby's facilities around the world. An inability to adequately insure such works of art due to limited capacity of the global art insurance market in the future could have an adverse impact on Sotheby's business.


ITEM 1B: UNRESOLVED STAFF COMMENTS
None.


13



ITEM 2: PROPERTIES
Sotheby’s North American Auction, Dealer and Finance operations, as well as its corporate offices, are headquartered at 1334 York Avenue, New York, New York (the “York Property”). The York Property contains approximately 439,000 square feet of building area and is home to Sotheby’s sole North American Auction salesroom and principal North American exhibition space. Sotheby’s purchased the York Property on February 6, 2009 for $370 million (see Note K of Notes to Consolidated Financial Statements). Prior to this purchase, Sotheby’s occupied the York Property subject to a 20-year lease which was entered into in conjunction with a sale-leaseback transaction in February 2003. Sotheby’s also leases office and exhibition space in several other major cities throughout the U.S.
Sotheby’s U.K. operations (primarily Auction) are centered at New Bond Street, London, where the main salesrooms, exhibition space and administrative offices are located. Almost the entire New Bond Street complex is either owned or held under various freehold and long-term lease arrangements. In April 2010, Sotheby’s signed a lease for a new warehouse in London, which it began to occupy in January 2011 after the construction of the facility was completed.
Below is a table summarizing Sotheby’s ownership, freehold and lease arrangements related to its London properties as of December 31, 2011 (in thousands of dollars, except for square footage):
 
Square
Footage
 
Net Book Value of Land
 
Net Book Value of Building and Building Improvements
 
Net Book Value of Leasehold Improvements
 
Total Net Book Value of London Premises
Owned property
10,907

 
$
5,601

 
$
2,375

 
$

 
$
7,976

Freeholds (a)
84,563

 

 

 
21,637

 
21,637

Leases with a remaining term greater than 10 Years (b)
106,896

 

 

 
12,580

 
12,580

All other leases (c)
29,257

 

 

 
1,978

 
1,978

Total
231,623

 
$
5,601

 
$
2,375

 
$
36,195

 
$
44,171

(a)
Freeholds are occupancy arrangements in which there is no rent paid and the arrangement has no termination date.
(b)
Consists mostly of a lease for the warehouse discussed above, which has approximately 52,000 square feet and has an initial term that expires in 2030. Also includes a lease for approximately 26,000 square feet that expires in 2034 and a lease for approximately 30,000 square feet that expires in 2060.
(c)
Includes various leased office space elsewhere in London.
In order to accommodate growth opportunities in Hong Kong, management is significantly expanding its Hong Kong facilities located at One Pacific Place. In June 2011, Sotheby's signed leases for additional space which will include salesrooms, exhibition space and administrative offices that will more than double the size of the existing premises to 34,000 square feet. Total capital expenditures for this office expansion are expected to be approximately $8 million in 2012, with the project scheduled for completion in the first half of 2012. (See statement on Forward Looking Statements.)
Sotheby’s also leases space primarily for Auction operations in various locations throughout Continental Europe, including salesrooms in Geneva and Zurich, Switzerland; Milan, Italy and Paris, France. In addition, Sotheby’s leases gallery space for Noortman Master Paintings in Amsterdam, The Netherlands and London, England.
Management believes Sotheby’s worldwide premises are adequate for the current conduct of its business. However, management continually analyzes Sotheby’s worldwide premises for both its current and future business needs as part of its ongoing efforts to manage infrastructure and other overhead costs. Where appropriate, management will continue to make any necessary changes to address Sotheby’s premises requirements.


14



ITEM 3: LEGAL PROCEEDINGS
Sotheby’s becomes involved in various claims and lawsuits incidental to the ordinary course of its business, including the matter described below. Management is required to assess the likelihood of any adverse judgments or outcomes in these matters, as well as potential ranges of probable losses. A determination of the amount of losses, if any, to be recorded 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 for such contingencies may change in the future due to new developments in each matter or a change in settlement strategy. Management does not believe that the outcome of any of these pending claims or proceedings will have a material adverse effect on Sotheby’s consolidated results of operations, financial condition and/or cash flows.
Estate of Robert Graham, et al. v. Sotheby's, Inc. is a purported class action commenced in the United States District Court for the Central District of California in October 2011 on behalf of U.S. artists (and their estates) whose artworks were sold by Sotheby's in the State of California or at auction by California sellers and for which a royalty was allegedly due under the California Resale Royalties Act (the “Resale Royalties Act”). Plaintiffs seek unspecified damages, punitive damages and injunctive relief for alleged violations of the Resale Royalties Act and the California Unfair Competition Law. In January 2012, Sotheby’s filed a motion to dismiss the action on the grounds, among others, that the Resale Royalties Act violates the United States Constitution and is pre-empted by the United States Copyright Act of 1976. In February 2012, the plaintiffs filed their response to Sotheby's motion to dismiss. It is currently not possible to make an estimate of the amount or range of loss that could result from an unfavorable outcome of this matter. Sotheby's believes that there are meritorious defenses to the claims asserted by plaintiffs, and they are being vigorously defended.

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not used.


15



PART II

ITEM 5: MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Market Information
The principal market for Sotheby’s Common Stock is the NYSE (symbol: BID). As of February 15, 2012, there were 1,251 holders of record of Sotheby’s Common Sock. The quarterly price ranges on the NYSE of Sotheby’s common stock during 2011 and 2010 were as follows:
        
 
2011
 
2010
 
High
 
Low
 
High
 
Low
Quarter Ended
 
 
 
 
 
 
 
March 31
$
52.95

 
$
38.23

 
$
32.23

 
$
21.76

June 30
$
55.67

 
$
37.17

 
$
46.52

 
$
22.20

September 30
$
48.90

 
$
27.53

 
$
37.42

 
$
22.06

December 31
$
37.61

 
$
25.00

 
$
47.80

 
$
35.07

Sotheby’s is party to a credit agreement with an international syndicate of lenders led by General Electric Capital Corporation that contains a financial covenant restricting quarterly dividend payments to the lesser of $0.10 per share or $8 million. However, the maximum level of quarterly dividend payments may be increased depending upon the achievement of a certain Fixed Charge Coverage Ratio in any period. (See “Liquidity and Capital Resources” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note K of Notes to Consolidated Financial Statements for more detailed information related to this credit agreement.)
The following table summarizes dividends declared and paid for each of the quarterly periods in 2011 and 2010 (in thousands of dollars, except per share amounts):
        
 
2011
 
2010
 
Per Share
 
Amount
 
Per Share
 
Amount
Quarter Ended
 
 
 
 
 
 
 
March 31
$
0.05

 
$
3,451

 
$
0.05

 
$
3,348

June 30
$
0.05

 
$
3,420

 
$
0.05

 
$
3,350

September 30
$
0.05

 
$
3,425

 
$
0.05

 
$
3,351

December 31
$
0.08

 
$
4,555

 
$
0.05

 
$
3,571

Total
$
0.23

 
$
14,851

 
$
0.20

 
$
13,620

On November 7, 2011, Sotheby’s Board of Directors approved a 60% increase to the quarterly dividend rate (from $0.05 per share to $0.08 per share) and declared a quarterly dividend of $0.08 per share (approximately $5.4 million) that was paid to shareholders of record as of December 1, 2011 on December 15, 2011. On February 28, 2012, Sotheby’s Board of Directors declared a quarterly dividend of $0.08 per share (approximately $5.4 million), to be paid on March 15, 2012 to shareholders of record as of March 9, 2012.
The declaration and payment of future dividends to shareholders remains at the discretion of Sotheby’s Board of Directors and is dependent upon many factors, including Sotheby’s financial condition, cash flows, legal requirements and other factors as the Board of Directors deem relevant. It is the intention of Sotheby’s to continue to pay quarterly dividends at a rate of at least $0.08 per share, subject to Board approval and depending on economic, financial, market and other conditions at the time. (See statement on Forward Looking Statements.)

16



Equity Compensation Plans
The following table provides information as of December 31, 2011 related to shares of Sotheby’s common stock that may be issued under its existing equity compensation plans, including the Sotheby’s 1997 Stock Option Plan (the “Stock Option Plan”), the Sotheby’s Restricted Stock Unit Plan (the “Restricted Stock Unit Plan”) and the Sotheby’s Amended and Restated Stock Compensation Plan for Non-Employee Directors (the “Directors Stock Plan”):
 
 
(A)
 
(B)
 
(C)
Plan Category (1)
 
Number of
Securities to be
Issued Upon
Exercise of
Outstanding
Options, Warrants
and Rights (2)
 
Weighted Average
Exercise Price of
Outstanding Options,
Warrants and Rights (3)
 
Number of Securities
Remaining Avaliable for
Future Issuance Under
Equity Compensation Plans (4)
 
 
(In thousands, except per share data)
Equity compensation plans approved by shareholders
 
2,382

 
$
21.94

 
1,697

Equity compensation plans not approved by shareholders
 

 

 

Total
 
2,382

 
$
21.94

 
1,697

_____________________________________________________________
(1)
See Note O of Notes to Consolidated Financial Statements for a description of the material features of Sotheby’s equity compensation plans.

(2)
Includes 1,989,185 shares awarded under the Restricted Stock Unit Plan for which vesting is contingent upon future employee service and/or Sotheby’s achievement of certain profitability targets and 392,500 stock options for which vesting is contingent upon future employee service.

(3)
The weighted-average exercise price includes the exercise price of stock options and does not take into account 1,989,185 shares awarded under the Restricted Stock Unit Plan, which have no exercise price.

(4)
Includes 1,582,951 shares available for future issuance under the Restricted Stock Unit Plan, 35,350 shares available for issuance under the Stock Option Plan and 78,307 shares available for issuance under the Directors Stock Plan.

17



Performance Graph
The following graph compares the cumulative total shareholder return on Sotheby’s common stock for the five-year period from December 31, 2006 to December 31, 2011 with the cumulative return of the Standard & Poor’s MidCap 400 Stock Index (“S&P MidCap 400”) and Sotheby’s Peer Group (“the Peer Group”). The Peer Group consists of Nordstrom, Inc., Saks Holdings, Inc., Tiffany & Co. and Movado, Inc. Management believes the members of the Peer Group to be purveyors of luxury goods appealing to a segment of the population consistent with Sotheby’s own clientele as no other auction house of comparable market share or capitalization is publicly traded.
The graph reflects an investment of $100 in Sotheby’s common stock, the S&P MidCap 400, which includes Sotheby’s, and its Peer Group, respectively, on December 31, 2006, and a reinvestment of dividends at the average of the closing stock prices at the beginning and end of each quarter.

Comparison of Five-Year Cumulative Total Return Among
Sotheby’s, the Peer Group Index and the S&P MidCap 400
as of December 31, 2011
 
 
12/31/2006
 
12/31/2007
 
12/31/2008
 
12/31/2009
 
12/31/2010
12/31/2011
Sotheby’s
 
$
100.00

 
$
124.25

 
$
29.77

 
$
77.32

 
$
155.81

$
99.41

Peer Group
 
$
100.00

 
$
99.60

 
$
36.92

 
$
67.03

 
$
95.43

$
104.14

S&P MidCap 400
 
$
100.00

 
$
107.98

 
$
68.80

 
$
94.50

 
$
119.69

$
117.63


18



ITEM 6: SELECTED FINANCIAL DATA
Year ended December 31
 
2011
 
2010
 
2009
 
2008
 
2007
 
 
(Thousands of dollars, except per share data)
Key Performance Indicator:
 
 

 
 

 
 

 
 

 
 

Net Auction Sales (1)
 
$
4,240,573

 
$
3,644,764

 
$
1,912,589

 
$
4,189,735

 
$
4,625,914

Statement of Operations Data:
 
 

 
 

 
 

 
 

 
 

Auction and related revenues
 
$
791,738

 
$
731,021

 
$
448,768

 
$
616,625

 
$
833,128

Finance revenues
 
12,038

 
9,685

 
9,073

 
14,183

 
17,025

Dealer revenues
 
21,790

 
29,092

 
22,339

 
55,596

 
62,766

License fee revenues
 
5,228

 
3,682

 
3,270

 
3,438

 
2,960

Other revenues
 
1,042

 
829

 
1,508

 
1,717

 
1,843

Total revenues
 
$
831,836

 
$
774,309

 
$
484,958

 
$
691,559

 
$
917,722

Net interest expense
 
$
(37,496
)
 
$
(45,080
)
 
$
(40,351
)
 
$
(31,652
)
 
$
(14,166
)
Net income (loss)
 
$
171,416

 
$
160,950

 
$
(6,528
)
 
$
26,456

 
$
213,139

Basic earnings (loss) per share
 
$
2.52

 
$
2.37

 
$
(0.10
)
 
$
0.39

 
$
3.22

Diluted earnings (loss) per share
 
$
2.46

 
$
2.34

 
$
(0.10
)
 
$
0.38

 
$
3.20

Cash dividends declared per share
 
$
0.23

 
$
0.20

 
$
0.30

 
$
0.60

 
$
0.50

Balance Sheet Data:
 
 

 
 

 
 

 
 

 
 

Working capital
 
$
728,984

 
$
573,020

 
$
525,892

 
$
662,993

 
$
490,740

Total assets
 
$
2,399,414

 
$
2,178,628

 
$
1,586,123

 
$
1,662,968

 
$
2,020,104

Long-term debt, net (2)
 
$
464,552

 
$
472,862

 
$
512,939

 
$
461,663

 
$
268,874

Shareholders’ equity
 
$
903,667

 
$
771,508

 
$
576,985

 
$
572,093

 
$
604,017

(1)
Represents the hammer (sale) price of property sold at auction.
(2)
Includes the York Property capital lease obligation of $167.2 million and $169 million as of December 31, 2008 and 2007, respectively. Sotheby's purchased the York Property on February 6, 2009. Sotheby's financed this purchase, in part, through the assumption of an existing $235 million mortgage (see Note K of Notes to Consolidated Financial Statements).


19



ITEM 7:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Seasonality
The worldwide art auction market has two principal selling seasons, which generally occur in the second and fourth quarters of the year. Accordingly, Sotheby's auction business is seasonal, with peak revenues and operating income generally occurring in those quarters. Consequently, first and third quarter results have historically reflected a lower volume of auction activity when compared to the second and fourth quarters and, typically, a net loss due to the fixed nature of many of Sotheby's operating expenses.
Use of Non-GAAP Financial Measures
GAAP refers to generally accepted accounting principles in the United States of America. Included in Management's Discussion and Analysis of Financial Condition and Results of Operations (or “MD&A”) are financial measures presented in accordance with GAAP and also on a non-GAAP basis. EBITDA, EBITDA Margin and Net Liquidity, as presented in MD&A under “Key Performance Indicators,” are supplemental financial measures that are not required by or presented in accordance with GAAP.
EBITDA and EBITDA Margin should not be considered as an alternative to net income or any other performance measures derived in accordance with GAAP or as an alternative to cash flows from operating activities as a measure of Sotheby's liquidity. Net Liquidity should not be considered as an alternative to cash and cash equivalents as reported in accordance with GAAP.
Sotheby's defines EBITDA as net income, excluding income tax expense, interest expense, interest income and depreciation and amortization expense. Sotheby's defines EBITDA Margin as EBITDA as a percentage of total revenues. Management cautions users of Sotheby's financial statements that amounts presented in accordance with its definitions of EBITDA and EBITDA Margin may not be comparable to similar measures disclosed by other companies, because not all companies and analysts calculate such measures in the same manner. Management believes that EBITDA and EBITDA Margin provide important supplemental measures of Sotheby's performance and that these measures may be used by securities analysts, investors, financial institutions and other interested parties in the evaluation of Sotheby's. Management also utilizes EBITDA in analyzing Sotheby's performance and in the determination of annual incentive compensation. A reconciliation of EBITDA to net income derived in accordance with GAAP is presented below in “Reconciliation of Non-GAAP Financial Measures.”
Sotheby's defines Net Liquidity as the amount of cash and cash equivalents that would remain assuming all accounts receivable were collected and all consignor payables and current accrued liabilities were paid as of each balance sheet date. This measure, among others, is used by management to assess the amount of available short-term liquidity, excluding available borrowings under Sotheby's revolving credit facility, in consideration of the fact that Sotheby's is predominantly an agency business that collects and remits cash on behalf of its clients. A reconciliation of Net Liquidity to cash and cash equivalents reported in accordance with GAAP is presented below in “Reconciliation of Non-GAAP Financial Measures.”
Critical Accounting Estimates
The preparation of financial statements and related disclosures in conformity with GAAP requires management to make judgments, assumptions and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Actual results may ultimately differ from management’s original estimates as future events and circumstances sometimes do not develop as expected. Note B of Notes to Consolidated Financial Statements describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. In addition, management believes that the following are its most critical accounting estimates, which are not ranked in any particular order, which may affect Sotheby’s financial condition and/or results of operations.
(1)
Valuation of Art—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. Accordingly, certain amounts reported in Sotheby's financial statements and accompanying notes are dependent upon management's estimates of the realizable value of art held in inventory and art pledged as collateral for Finance segment loans.
If management determines that the estimated realizable value of a specific artwork held in inventory is less than its carrying value, a loss is recorded to reflect management's revised estimate of realizable value. (See Note F of Notes to Consolidated Financial Statements for detailed information related to Sotheby's inventory balances.)
If the estimated realizable value of the art pledged as collateral for a client loan is less than the corresponding loan balance, management assesses 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.

20



(See Note E of Notes to Consolidated Financial Statements for detailed information related to Finance segment loans.)
In estimating the realizable value of art, management relies on the opinions of Sotheby's specialists, who consider the following complex array of factors when valuing art:
whether the artwork is expected to be offered at auction or sold privately, in the ordinary course of Sotheby's business;
the supply and demand for works of art, taking into account economic conditions and changing trends in the art market as to which collecting categories and artists are most sought after; and
recent sale prices achieved in the art market for comparable works of art within a particular collecting category and/or by a particular artist.
Due to the inherent subjectivity involved in estimating the realizable value of art, management's judgments about the estimated realizable value of art held in inventory and the estimated realizable value of art pledged as collateral for client loans may prove, with the benefit of hindsight, to be different than the amount ultimately realized upon the sale of the art.
(See Notes E and F of Notes to Consolidated Financial Statements.)
(2)
Legal and Other Contingencies—Sotheby's is subject to legal proceedings, lawsuits and other claims. Management is required to assess the likelihood of any adverse judgments or outcomes in these matters, as well as potential ranges of probable losses. A determination of the amount of losses, if any, to be recorded 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 for such contingencies may change in the future due to new developments in each matter or a change in settlement strategy. (See Note Q of Notes to Consolidated Financial Statements.)
(3) Pension Obligations—The pension obligations related to Sotheby's U.K. defined benefit pension plan (the “U.K. Pension Plan”) are based on an actuarial valuation. Inherent in this valuation are key assumptions and estimates, including the discount rate, expected long-term rate of return on plan assets, future expectations of inflation, expected future compensation increases, mortality assumptions and other factors, which are updated on at least an annual basis. In developing these assumptions and estimates, management considers current market conditions, market indices and other relevant data.
The discount rate assumption represents the approximate weighted average rate at which the obligations of the U.K. Pension Plan could be effectively settled and is based on a hypothetical portfolio of high-quality corporate bonds with maturity dates approximating the length of time remaining until individual benefit payment dates. The discount rate used to calculate the $5.5 million net pension benefit in 2011 related to the U.K. Pension Plan was 5.5%. A hypothetical increase or decrease of 0.1% in this assumption would result in a decrease or increase in net annual pension cost of approximately $0.1 million. As of the date of the most recent actuarial valuation (December 31, 2011), the discount rate used to calculate the $270.7 million benefit obligation related to the U.K. Pension Plan was 4.8%. A hypothetical increase or decrease of 0.1% in this assumption would result in a decrease or increase in the benefit obligation of approximately $5.2 million.
The assumption for the expected long-term rate of return on plan assets is based on expected future appreciation, as well as dividend and interest yields available in equity and bond markets as of the measurement date and weighted according to the composition of invested plan assets. The expected long-term rate of return on plan assets used to calculate the $5.5 million net pension benefit in 2011 related to the U.K. Pension Plan was 7.7%. A hypothetical increase or decrease of 0.25% in this assumption would result in a decrease or increase in net annual pension cost of approximately $0.8 million.
The assumption for future average annual compensation increases is established after considering historical salary data for Sotheby's U.K. employees and current economic data for inflation, as well as management's expectations for future salary growth. The assumption for future average annual compensation increases used to calculate the $5.5 million net pension benefit in 2011 related to the U.K. Pension Plan was 5.5%. A hypothetical increase or decrease of 0.25% in this assumption would result in an increase or decrease in net annual pension cost of approximately $0.2 million. As of the date of the most recent actuarial valuation (December 31, 2011), the assumption for future annual compensation increases used to calculate the $270.7 million benefit obligation related to the U.K. Pension Plan was 5.0%. A hypothetical increase or decrease of 0.25% in this assumption would result in an increase or decrease in the benefit obligation of approximately $1.6 million.
The mortality assumptions used in the actuarial valuation represent the approximate mortality rates for plan members based upon standardized data tables used by actuaries in the U.K. that include allowances for longer future life expectancies. A hypothetical 5% decrease or increase in life expectancies would result in a decrease or increase in net pension cost of approximately $0.2 million. Additionally, a hypothetical 5% decrease or increase in life expectancies would result in a decrease or increase in the benefit obligation of approximately $2.9 million.

21



As of December 31, 2010, the accumulated net gain for the U.K. Pension Plan that had not yet been recognized in Sotheby's statements of operations was $6.5 million, net of taxes. In 2011, the U.K. Pension Plan incurred an after-tax net loss of $28 million largely due to the reduction in the discount rate used to measure plan liabilities from 5.5% to 4.8% at December 31, 2011, which resulted from a decrease in bond yields during the year. The impact of the lower discount rate used to measure plan liabilities was partially offset by a lower assumed rate of inflation.
As of December 31, 2011, the accumulated net loss for the U.K. Pension Plan that has not yet been recognized in Sotheby's statements of operations was $20.4 million, net of taxes. Net gains and losses related to the U.K. Pension Plan are reflected net of taxes on Sotheby's balance sheets within accumulated other comprehensive income (loss). If the amount recorded in accumulated other comprehensive income (loss) exceeds 10% of the greater of the market-related value of the U.K. Pension Plan's assets or benefit obligation, that amount is systematically recognized as a component of future net pension expense or benefit over the average remaining service period of active employees expected to receive benefits under the plan, which was estimated to be approximately 13.5 years as of December 31, 2011.
(See Note P of Notes to Consolidated Financial Statements for additional information related to the U.K. Pension Plan, as well as Sotheby's other material pension arrangements.)
(4)
Income Taxes—The provision for income taxes involves a significant amount of management judgment regarding interpretation of relevant facts and laws in the jurisdictions in which Sotheby's operates. Future changes in applicable laws, projected levels of taxable income and tax planning could change the effective tax rate and the tax balances recorded.
As of December 31, 2011, Sotheby's had net deferred tax assets of $59.3 million, primarily resulting from deductible temporary differences which will reduce taxable income in future periods over a number of years. Included in this net deferred tax asset is a valuation allowance of $6.0 million to reduce Sotheby's deferred tax assets to the amount that is more likely than not to be realized. In assessing the need for the valuation allowance, management considers, among other things, projections of future taxable income and ongoing prudent and feasible tax planning strategies. If management's projections of future taxable income and other positive evidence considered in evaluating the need for a valuation allowance prove, with the benefit of hindsight, to be inaccurate, it will be more difficult to support the realization of these deferred tax assets. As a result, an additional valuation allowance may be required, which would have an adverse impact on Sotheby's results. Conversely, should management determine that Sotheby's will be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would have a favorable impact on Sotheby's results in the period such determination was made.
Additionally, liabilities are recorded to address potential exposures involving uncertain tax positions that Sotheby's has taken, or expects to take, on income tax returns that could be challenged by taxing authorities. These potential exposures result from the varying applications of statutes, rules, regulations and interpretations. Inherent in Sotheby's liabilities for uncertain tax positions are assumptions based on past experiences and judgments about potential actions by taxing jurisdictions. The cost of the ultimate resolution of these matters may be greater or less than the liability that Sotheby's has recorded.
(See discussion of “Income Tax Expense” below, as well as Notes L and M of Notes to Consolidated Financial Statements.)
(5)
Share-Based Payments—Sotheby's grants share-based payment awards as compensation to certain employees. Certain of these awards vest only if Sotheby's achieves pre-established profitability targets. The amount and timing of compensation expense recognized for such performance-based awards is dependent upon management's assessment of the likelihood and timing of achieving these profitability targets. Accordingly, if the projections of future profitability used by management in its assessment prove, with the benefit of hindsight, to be inaccurate, the amount and timing of future compensation expense related to share-based payments could materially change. (See Note O of Notes to Consolidated Financial Statements for additional information related to Sotheby's share-based payments.)


22




RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
This discussion should be read in conjunction with Note D (“Segment Reporting”) of Notes to Consolidated Financial Statements.
Overview
In 2011, Sotheby’s had the second most profitable year in its history, with net income of $171.4 million, a 7% increase in comparison to 2010. These results reflect the growth of the global art market in the first half of 2011, with full year Net Auction Sales of $4.2 billion, a level that is comparable to the art market's most recent peak years between 2007 and 2008. This improvement in Sotheby's results was driven by a 7% increase in revenues attributable to growth in both auction and private sale commission revenues. Importantly, this was achieved with a significantly lower risk profile, as Sotheby's continued to be highly selective in its use of auction guarantees and only issued auction guarantees in tandem with risk and reward sharing arrangements that greatly reduced its financial exposure, but also contributed to the significant decrease in auction commission margin. Offsetting the growth in revenues was a higher level of operating expenses due in part to increased compensation costs, a higher level of direct costs of services consistent with the volume and composition of auction sales and the cost of investments in strategic initiatives. Sotheby's 2011 results were also favorably impacted by a $13.6 million tax benefit recognized in 2011 due to the reversal of a valuation allowance against certain of Sotheby's deferred tax assets and a $7.6 million decrease in net interest expense.
See the discussion below for greater detail on the significant factors impacting Sotheby’s 2011 results and the comparison to the prior year.
Outlook
Uncertainty and volatility in the global economic environment contributed to mixed auction results in the fourth quarter of 2011, as well as to the challenging climate for consignments for certain first quarter 2012 auctions. The first quarter is traditionally a loss quarter for Sotheby's (see "Seasonality" above), although in the first quarter of 2011, Sotheby's reported net income of $2.4 million, primarily as a result of exceptionally strong auction sales that included several significant single-owner sales. Sotheby's will have fewer of these unique revenue opportunities in the first quarter of 2012, and, in tandem with a higher expense base due, in part, to strategic investments, it is expected that Sotheby's will incur a net loss in the first quarter of 2012. (See statement on Forward Looking Statements.)

However, management is encouraged by the strength of the global art market, as evidenced by the level of quality consignments already secured for second quarter 2012 auctions, as well as the potential consignment opportunities that remain in the market. Management is focused on maximizing auction commission margins; nevertheless, the environment for high-value consignments is very competitive, with such consignments typically earning significantly lower auction commission margins. Management is mindful of the potential volatility of the global art market in the current economic environment and is committed to maintaining a rational cost structure, while continuing with measured investments in the strategic initiatives that are vital to Sotheby's future. (See statement on Forward Looking Statements.)


23



Results of Operations for the Years Ended December 31, 2011 and 2010
The table below presents a summary of Sotheby’s results of operations for 2011 and 2010, as well as a comparison between the two periods (in thousands of dollars):
 
 
 
 
 
Favorable/(Unfavorable)
 
2011
 
2010
 
$ Change
 
% Change
Revenues:
 

 
 

 
 

 
 

Auction and related revenues
$
791,738

 
$
731,021

 
$
60,717

 
8.3
 %
Finance revenues
12,038

 
9,685

 
2,353

 
24.3
 %
Dealer revenues
21,790

 
29,092

 
(7,302
)
 
(25.1
)%
License fee revenues
5,228

 
3,682

 
1,546

 
42.0
 %
Other revenues
1,042

 
829

 
213

 
25.7
 %
Total revenues
831,836

 
774,309

 
57,527

 
7.4
 %
Expenses **
560,365

 
500,311

 
(60,054
)
 
(12.0
)%
Operating income
271,471

 
273,998

 
(2,527
)
 
(0.9
)%
Net interest expense
(37,496
)
 
(45,080
)
 
7,584

 
16.8
 %
Extinguishment of debt, net
(1,529
)
 
(6,291
)
 
4,762

 
75.7
 %
Other (expense) income
(1,057
)
 
2,952

 
(4,009
)
 
*

Income before taxes
231,389

 
225,579

 
5,810

 
2.6
 %
Equity in earnings of investees, net of taxes
59

 
644

 
(585
)
 
(90.8
)%
Income tax expense
60,032

 
65,273

 
5,241

 
8.0
 %
Net income
$
171,416

 
$
160,950

 
$
10,466

 
6.5
 %
Key performance indicators:
 

 
 

 
 

 


Aggregate Auction Sales (a)
$
4,986,639

 
$
4,287,176

 
$
699,463

 
16.3
 %
Net Auction Sales (b)
$
4,240,573

 
$
3,644,764

 
$
595,809

 
16.3
 %
Private Sales (c)
$
814,581

 
$
494,505

 
$
320,076

 
64.7
 %
Consolidated Sales (d)
$
5,823,010

 
$
4,810,773

 
$
1,012,237

 
21.0
 %
Auction Commission Margin (e)
16.6
%
 
18.3
%
 
N/A

 
(9.6
)%
Direct Costs as a percentage of Net Auction Sales
1.6
%
 
1.7
%
 
N/A

 
(5.9
)%
Average Loan Portfolio (f)
$
219,785

 
$
181,585

 
$
38,200

 
21.0
 %
EBITDA (g)
$
286,596

 
$
288,323

 
$
(1,727
)
 
(0.6
)%
EBITDA Margin (g) (h)
34.5
%
 
37.2
%
 
N/A

 
(7.3
)%
Net Liquidity (g) (i)
$
508,481

 
$
307,173

 
$
201,308

 
65.5
 %
 
 
Legend:
*
Represents a change in excess of 100%.
**
Expenses for 2011 include net restructuring charges of $4.8 million.
(a)
Represents the hammer (sale) price of property sold at auction plus buyer’s premium.
(b)
Represents the hammer (sale) price of property sold at auction.
(c)
Represents the total purchase price of property sold in private sales brokered by Sotheby’s.
(d)
Represents the sum of Aggregate Auction Sales, Private Sales and Dealer revenues.
(e)
Represents total auction commission revenues as a percentage of Net Auction Sales.
(f)
Represents the average loan portfolio of Sotheby's Finance segment.
(g)
See “Use of Non-GAAP Financial Measures” above and “Reconciliation of Non-GAAP Financial Measures” below.
(h)
Represents EBITDA as a percentage of total revenues.
(i)
Represents the amount of cash and cash equivalents that would remain assuming all accounts receivable were collected and that all consignor payables, accounts payable and current accrued liabilities were paid as of each balance sheet date.

24



Revenues
In 2011 and 2010, revenues consisted of the following (in thousands of dollars):
    
 
 
 
 
 
 
Favorable/(Unfavorable)
 
 
2011
 
2010
 
$ Change
 
% Change
Auction and related revenues:
 
 

 
 

 
 

 
 

Auction commission revenues
 
$
701,776

 
$
667,033

 
$
34,743

 
5.2
 %
Private sale commission revenues
 
67,848

 
44,240

 
23,608

 
53.4
 %
Principal activities
 
125

 
(1,890
)
 
2,015

 
**

Other auction and related revenues*
 
21,989

 
21,638

 
351

 
1.6
 %
Total auction and related revenues
 
791,738

 
731,021

 
60,717

 
8.3
 %
Other revenues:
 
 

 
 

 
 

 
 

Finance revenues
 
12,038

 
9,685

 
2,353

 
24.3
 %
Dealer revenues
 
21,790

 
29,092

 
(7,302
)
 
(25.1
)%
License fee revenues
 
5,228

 
3,682

 
1,546

 
42.0
 %
Other
 
1,042

 
829

 
213

 
25.7
 %
Total other revenues
 
40,098

 
43,288

 
(3,190
)
 
(7.4
)%
Total revenues
 
$
831,836

 
$
774,309

 
$
57,527

 
7.4
 %
* Principally includes fees charged to clients for catalogue production and insurance, catalogue subscription revenues, advertising revenues and commissions earned on private sales brokered by third-parties.
** Represents a change in excess of 100%.
Auction and Related Revenues
In 2011, auction and related revenues improved $60.7 million (8%) almost entirely due to a higher level of auction and private sale commissions, as well as improved results from principal activities. The comparison to the prior year is also favorably impacted by changes in foreign currency exchange rates which increased auction and related revenues by $22.3 million. See the discussion below for a more detailed explanation of the factors contributing to the improvement in auction and related revenues.
          Auction Commission Revenues—In its role as auctioneer, Sotheby’s represents sellers of artworks by accepting property on consignment and by matching sellers to buyers through the auction process. Sotheby’s invoices the buyer for the purchase price of the property (including the commission owed by the buyer), collects payment from the buyer and remits to the seller the net sale proceeds after deducting its commissions, expenses and applicable taxes and royalties. Sotheby’s commissions include those paid by the buyer (“buyer’s premium”) and those paid by the seller (“seller’s commission”) (collectively, “auction commission revenue”), both of which are calculated as a percentage of Net Auction Sales.
In 2011, auction commission revenues improved $34.7 million (5%) due to a 16% increase in Net Auction Sales, partially offset by a decline in Auction Commission Margin from 18.3% to 16.6%. The comparison to the prior year is also favorably impacted by changes in foreign currency exchange rates which increased auction commission revenues by $20.2 million. See “Net Auction Sales” and “Auction Commission Margin” below for a more detailed discussion of these key performance indicators.
Net Auction Sales—In 2011, Net Auction Sales increased $595.8 million (16%), reflecting a surge in activity from buyers and sellers from emerging markets, especially China, and significantly higher single-owner sale results. More specifically, the increase in Net Auction Sales is primarily attributable to the following factors:
An increase of $343.9 million (68%) in worldwide sales of Asian Art due in part to several unprecedented sales of single-owner collections conducted in Hong Kong, including The Meiyingtang Collection of Chinese Porcelain ($139.2 million) and The Mei Yun Tang Collection of Paintings by Chang Dai-chien ($76.4 million). Recurring various-owner sales of Asian Art also performed well in 2011, with an increase of $172.4 million (52%).
An increase of $115.2 million (7%) in sales of Impressionist Art and Contemporary Art. This increase was driven by the single-owner sale Looking Closely - A Private Collection ($128.5 million).

25



The favorable impact of changes in foreign currency exchange rates, which increased Net Auction Sales by $115.2 million.
Auction Commission Margin—Auction Commission Margin represents total auction commission revenues as a percentage of Net Auction Sales. Typically, the Auction Commission Margin is higher for lower value works of art or collections, while higher valued property earns a lower Auction Commission Margin. For example, in salesrooms in the U.S., the buyer’s premium rate structure is 25% on the first $50,000 of hammer (sale) price; 20% on the portion of hammer price above $50,000 up to and including $1 million; and 12% on any remaining amount above $1 million.
In certain situations, Auction Commission Margin is adversely impacted by arrangements whereby Sotheby's buyer's premium is shared with a consignor. In such situations, Sotheby's may share its buyer's premium with a consignor in order to secure a high value consignment without issuing an auction guarantee.
Auction Commission Margin may also be adversely impacted by the use of auction guarantees. For example, when issuing an auction guarantee, Sotheby's may enter into a risk and reward sharing arrangement with a counterparty whereby Sotheby's financial exposure under the auction guarantee is reduced in exchange for sharing its auction commission. Also, in situations when the guaranteed property sells for less than the guaranteed price, all or a portion of Sotheby's auction commissions are used to reduce the principal loss on the transaction. (See Note R of Notes to Consolidated Financial Statements for additional information on Sotheby's use of auction guarantees.)
In 2011, Auction Commission Margin decreased 10% (from 18.3% to 16.6%) because of continued competitive pressures to win high value consignments, which resulted in a higher level of auction commissions shared with consignors and a lower level of seller's commission revenues.
Private Sale Commission Revenues—In 2011, private sale commission revenues improved by $23.6 million (53%) due to increased sales of high value property. For example, in 2011, the number of private sale transactions brokered by Sotheby's with an aggregate sale price in excess of $5 million increased by approximately 70%. Private sales continue to be a strategic focus for management and have become increasingly important to Sotheby’s overall financial performance with private sale commission revenues increasing by 24% over the 5 year period since the previous peak of the art market in 2007.
Principal Activities—Auction segment principal activities consist of gains and losses related to auction guarantees including: (i) Sotheby's share of overage or shortfall related to guaranteed property offered or sold at auction, (ii) subsequent writedowns to the carrying value of guaranteed property that initially failed to sell at auction and (iii) subsequent recoveries and losses on the sale of guaranteed property that initially failed to sell at auction. Auction segment principal activities also include gains and losses related to the sale of other Auction segment inventory, as well as writedowns to the carrying value of such inventory, which principally consists of objects obtained as a result of purchaser defaults in situations when Sotheby's has paid the consignor.
In 2011, principal activities improved $2.0 million primarily due to a lower level of inventory writedowns and better results from the sale of guaranteed property that previously failed to sell at auction, partially offset by a lower share of overage earned from guaranteed property initially offered at auctions in 2011 than earned in 2010.
Finance Revenues
In 2011, Finance revenues increased $2.4 million (24%) due to a higher average loan portfolio balance, which was largely attributable to a $55 million client loan made in the fourth quarter of 2010, and higher interest rates earned on client loans in 2011. (See Note E of Notes to Consolidated Financial Statements).
(Note: For the purposes of MD&A, Finance revenues do not include intercompany revenues earned by the Finance segment from the Auction segment, which are eliminated in consolidation. See Note D of Notes to Consolidated Financial Statements.)
Dealer Revenues and Cost of Sales
Dealer revenues consist of revenues earned from the sale of Dealer inventory, which includes property owned by Noortman Master Paintings ("NMP") and artworks purchased for investment purposes. To a lesser extent, Dealer revenues also include commissions earned by NMP through the brokering of private art sales. Dealer cost of sales includes the net book value of Dealer inventory sold during the period and any writedowns to the carrying value of Dealer inventory.

26



The table below summarizes Dealer revenues, cost of sales and gross (loss) profit for 2011 and 2010 (in thousands of dollars):
    
 
 
 
 
 
Favorable/(Unfavorable)
 
2011
 
2010
 
$ Change
 
% Change
Dealer revenues
$
21,790

 
$
29,092

 
$
(7,302
)
 
(25.1
)%
Dealer cost of sales
(23,738
)
 
(24,889
)
 
1,151

 
4.6
 %
Dealer gross (loss) profit
$
(1,948
)
 
$
4,203

 
$
(6,151
)
 
*

* Represents a change in excess of 100%
In the third quarter of 2011, following the fifth anniversary of the acquisition of NMP and the expiration of the related financial performance targets (see Note O of Notes to Consolidated Financial Statements), management initiated a plan to restructure NMP’s business and sales strategy. Historically, NMP has principally specialized in sales of Dutch and Flemish Old Master Paintings, as well as French Impressionist and Post-Impressionist paintings, with a large number of paintings held in inventory at various price points. However, as a result of the restructuring of its business and sales strategy, NMP is greatly reducing its inventory of lower valued Old Master Paintings and shifting its focus to a select group of high-valued works of art. Accordingly, NMP sold a collection of lower valued works at various auction houses in the fourth quarter of 2011. In the ordinary course of NMP’s business, these objects would have been held for a longer period and sold in privately negotiated transactions. As a result of the new strategy described above and due in part to a general weakening of the private dealer market for certain categories of Old Master Paintings, as well as a shift in the collecting tastes of NMP’s clients, inventory writedowns of $8.4 million were recorded in 2011, of which $5.7 million were recorded in the third quarter of 2011. In 2010, Dealer inventory writedowns totaled $3.1 million.
In 2011, Dealer segment results were also impacted by a significantly lower gross profit earned on NMP sales principally attributable to the weakening of the private dealer market for certain categories of Old Master Paintings, as well as a shift in the collecting tastes of NMP’s clients.
Expenses
In 2011 and 2010, expenses consisted of the following (in thousands of dollars):
 
 
 
 
 
Favorable / (Unfavorable)
 
2011
 
2010
 
$ Change
 
% Change
Direct costs of services
$
69,507

 
$
60,940

 
$
(8,567
)
 
(14.1
)%
Dealer cost of sales
23,738

 
24,889

 
1,151

 
4.6
 %
Marketing expenses
15,059

 
12,207

 
(2,852
)
 
(23.4
)%
Salaries and related costs
268,530

 
253,271

 
(15,259
)
 
(6.0
)%
General and administrative expenses
161,097

 
132,566

 
(28,531
)
 
(21.5
)%
Depreciation and amortization expense
17,604

 
16,492

 
(1,112
)
 
(6.7
)%
Restructuring charges, net
4,830

 
(54
)
 
(4,884
)
 
*

Total expenses
$
560,365

 
$
500,311

 
$
(60,054
)
 
(12.0
)%
* Represents a change in excess of 100%
Direct Costs of Services
Direct costs of services consists largely of sale specific marketing costs such as auction catalogue production and distribution expenses, sale advertising and promotion expenses, and traveling exhibition costs. Also included in direct costs of services are sale-related shipping expenses. The level of direct costs incurred in any period is generally dependent upon the volume and composition of Sotheby’s auction offerings. For example, direct costs attributable to single-owner or other high-value collections are typically higher than those associated with standard various-owner sales, mainly due to higher promotional costs for catalogues, special events and traveling exhibitions, as well as higher shipping expenses.
In 2011, direct costs of services increased $8.6 million (14%) primarily due to a higher volume of auction offerings and, in particular, a higher level of single-owner sales, which contributed $3.2 million to the overall increase. Additionally, direct costs of services increased due to fees associated with the broader usage of debit and credit cards by buyers from China. In 2011, direct costs of services were also unfavorably impacted by changes in foreign currency exchange rates, which contributed

27



$1.7 million to the increase over the prior year. Partially offsetting the overall increase in direct costs of services is an unexpected recovery of $0.9 million recognized in the second quarter of 2011 related to a property damage loss initially incurred in the first quarter of 2010.
Marketing Expenses
Marketing expenses are costs related to the promotion of the Sotheby’s brand and consist of costs related to Sotheby’s corporate marketing activities, client service initiatives and strategic sponsorships of cultural institutions. In 2011, marketing expenses increased by $2.9 million (23%) due to increased sponsorships of museums and other cultural institutions, as well as a higher level of costs incurred to support certain strategic initiatives, including brand promotion activities in China and other emerging markets and the enhancement of the sothebys.com website.
Salaries and Related Costs
In 2011 and 2010, salaries and related costs consisted of the following (in thousands of dollars):
    
 
 
 
 
 
Favorable / (Unfavorable)
 
2011
 
2010
 
$ Change
 
% Change
Full-time salaries
$
127,959

 
$
114,040

 
$
(13,919
)
 
(12.2
)%
Incentive compensation expense
68,035

 
68,199

 
164

 
0.2
 %
Share-based payments
18,918

 
20,250

 
1,332

 
6.6
 %
Payroll taxes
20,722

 
19,051

 
(1,671
)
 
(8.8
)%
Employee benefits
14,858

 
17,171

 
2,313

 
13.5
 %
Other compensation expense *
18,038

 
14,560

 
(3,478
)
 
(23.9
)%
Total salaries and related costs
$
268,530

 
$
253,271

 
$
(15,259
)
 
(6.0
)%
    
Key Performance Indicator:
 

 
 

 
 
 
 

Salaries and related costs as a % of revenues
32.3
%
 
32.7
%
 
N/A
 
1.3
%
*
Principally includes expense related to the cost of temporary labor and overtime, and certain employment arrangements.
In 2011, salaries and related costs increased $15.3 million (6%) due to higher full-time salaries and temporary labor costs (which are classified in the table above within other compensation expense), partially offset by lower employee benefit costs and share-based payments. See below for a detailed discussion of the significant factors contributing to the overall increase in salaries and related costs.
Full-Time Salaries—In 2011, full-time salaries increased $13.9 million (12%) due to strategic headcount and salary increases and the unfavorable impact of changes in foreign currency exchange rates, which contributed $3 million to the increase.
Other Compensation Expense—Other compensation expense typically includes the cost of temporary labor and overtime, as well as the amortization of expense related to certain employment arrangements. In 2011, other compensation expense increased $3.5 million (24%) primarily due to higher temporary labor costs in New York and London. The higher temporary labor costs in New York are primarily attributable to the $1.5 million cost of temporary labor required as a result of the lockout of unionized property handlers in the third and fourth quarters of 2011, which was entirely offset by savings in full-time salaries, employee benefits and payroll taxes resulting from the lockout. (See Part I, Item 1A, “Risk Factors,” for more detailed information on Sotheby’s lockout of its unionized property handlers.)
Payroll Taxes—In 2011, payroll taxes increased $1.7 million (9%) primarily due to higher full-time salaries, as discussed above, as well as a higher value of share-based payment awards vesting during the first quarter of 2011.
Incentive Compensation—The amount of incentive compensation expense recorded in a period is largely dependent upon the level of Sotheby’s earnings, as measured by EBITDA, and is ultimately paid at the discretion of the Compensation Committee of the Board of Directors only after assessing Sotheby’s full year financial results. In addition, incentive compensation includes amounts specifically awarded to employees for the brokering of certain eligible private sale transactions. In 2011, incentive compensation is flat when compared to the prior year, which is consistent with the comparable level of EBITDA in the periods.

28



Employee Benefits—Employee benefits include the cost of Sotheby’s retirement plans and health and welfare programs, as well as non-restructuring related employee severance costs. Sotheby’s material retirement plans include defined benefit and defined contribution pension plans for employees in the U.K. and defined contribution and deferred compensation plans for U.S. employees.
Generally, the amount of employee benefit costs is dependent upon headcount and overall compensation levels, as well as Sotheby’s financial performance. Additionally, the level of expense related to Sotheby’s U.K. Pension Plan is significantly influenced by interest rates, investment performance in the debt and equity markets and actuarial assumptions. Also, the expense recorded for Sotheby’s Deferred Compensation Plan (the “DCP”) is dependent upon changes in the fair value of the DCP liability during a period, which result from gains and losses in deemed participant investments. Gains in deemed participant investments increase the DCP liability and, therefore, increase employee benefit costs. Losses in deemed participant investments decrease the DCP liability and, therefore, decrease employee benefit costs.
In 2011, employee benefit costs decreased $2.3 million (13%) largely as a result of market losses in deemed participant investments associated with the DCP, which reduced employee benefits costs by $3.1 million. On a consolidated basis, the cost reductions related to the DCP liability are offset by market losses in the trust assets related to the DCP liability, which are reflected within other (expense) income.
Also contributing to the decrease in employee benefit costs in 2011 is an increase of $1.8 million in the net pension credit related to the U.K. Pension Plan as a result of favorable changes in the market-based assumptions used to determine the net pension credit between the periods. In 2012, the net pension credit related to the U.K. Pension Plan is expected to decrease by approximately $2.9 million when compared to 2011, primarily as a result of updated market-based assumptions used in determining the net pension credit, in particular, the expected long-term rate of return which is decreasing from 7.7% to 6.3%. (See statement on Forward Looking Statements.)
In 2011, the overall decrease in employee benefits is partially offset by $1.6 million in non-restructuring related severance costs incurred in 2011, for which there were no comparable costs in the prior year. In addition, the comparison to the prior year is unfavorably impacted by higher employee benefit costs associated with the increase in full-time salaries discussed above.
Share-Based Payments—Share-based payments consist of amortization expense related to performance-based equity compensation awards, restricted stock, restricted stock units and stock options. Equity compensation awards are typically granted annually each February and the value of each annual award is generally dependent upon Sotheby’s financial results for the year prior to the grant date. The amount of compensation expense recognized for share-based payments is based on management’s estimates of the number of shares ultimately expected to vest. In addition, for performance-based equity compensation awards, the amount and timing of expense recognition is significantly impacted by management’s assessment of the likelihood and timing of achieving certain profitability targets. (See Note O of Notes to Consolidated Financial Statements for more detailed information related Sotheby’s share-based compensation programs.)
In 2011, expense related to share-based payments decreased $1.3 million (7%) principally as a result of management’s reassessment of the likelihood and timing of achieving the profitability targets for certain performance-based equity awards. In 2012, expense related to share-based payments is expected to increase approximately $5 million when compared to 2011. (See statement on Forward Looking Statements.)
General and Administrative Expenses
In 2011, general and administrative expenses increased $28.5 million (22%) primarily due to the following factors:
A $9.2 million (22%) increase in professional fees, primarily attributable to a higher level of consulting fees in support of Sotheby's strategic initiatives, including the development of Sotheby's presence in emerging markets such as China and the enhancement of Sotheby's website.
A $4.9 million charge recorded in the fourth quarter of 2011 related to a sales tax liability identified during the period (see Note Q of Notes to Consolidated Financial Statements).
A $4 million (17%) increase in travel and entertainment expenses in response to consignment opportunities throughout the year.
A $2.9 million (7%) increase in facilities-related expenses, due in part to $1.1 million in security costs incurred to minimize the business disruption associated with protests by Sotheby's unionized property handlers in New York (see Part I, Item 1, "Description of Business" and 1A, "Risk Factors," for more detailed information on the lockout of Sotheby's unionized employees). The increase in facilities-related expenses is also partially attributable to a $0.8

29



million increase in rent expense primarily due to the expansion of Sotheby's premises in Hong Kong.
A $2.3 million increase in bad debt expense due to losses from uncollectible Auction segment receivables in the U.K. and the U.S.
A $2.2 million increase in litigation claims and client goodwill gestures.
A $3 million increase due to unfavorable changes in foreign currency exchange rates.
Restructuring Plans and Related Charges
In 2011, Sotheby’s recorded net Restructuring Charges of approximately $4.8 million. In 2010 , Sotheby’s recorded a benefit to net Restructuring Charges of approximately $0.1 million.
On June 27, 2011, the Executive Committee of Sotheby’s Board of Directors approved a restructuring plan (the “2011 Restructuring Plan”) impacting Sotheby’s operations in Italy and the Netherlands. The 2011 Restructuring Plan streamlined Sotheby’s European selling operations, with a renewed emphasis on relationships with key clients and the sourcing of important collections. The 2011 Restructuring Plan has also allowed Sotheby’s global management to focus resources on growing markets, especially China, and other strategic priorities. In the Netherlands, the 2011 Restructuring Plan resulted in the cessation of all local auction sales. In Italy, Sotheby’s significantly reduced its auction sales calendar, but plans to continue to conduct auctions of Contemporary and Modern Art. Sotheby’s streamlined European operations will continue to source property to its other selling locations throughout the world, as well as pursue private sale opportunities.
The 2011 Restructuring Plan will ultimately reduce staff by 24, which represents approximately 46% of Sotheby’s current headcount in Italy and the Netherlands and 2% of its global headcount. The 2011 Restructuring Plan also allowed Sotheby’s to completely exit its leased Amsterdam salesroom, replacing it with a smaller local office, and significantly reduce the cost associated with its Milan premises.
The charges associated with the 2011 Restructuring Plan consist of $2.8 million in lease termination costs related to the Amsterdam salesroom and $2 million in employee termination benefits and other restructuring related charges. Accrued restructuring costs of $0.8 million are recorded within Accounts Payable and Accrued Liabilities on Sotheby's December 31, 2011 balance sheet. Total cash expenditures related to the 2011 Restructuring Plan are expected to be approximately $5 million, a substantial portion of which were made in the fourth quarter of 2011, with the remaining payments to be made in 2012.
Following its implementation, beginning in 2012, the 2011 Restructuring Plan is expected to result in reductions to Net Auction Sales, Revenues and Expenses of approximately $50 million, $10 million and $7 million, respectively, when compared to 2010. Accordingly, the 2011 Restructuring Plan is not expected to result in incremental profitability in 2012 as compared to 2010 and in fact, these actions would have had a dilutive impact of approximately $3 million on 2010 pre-tax income. However, 2010 results for the Netherlands included Net Auction Sales and Revenues of $19 million and $3 million, respectively, related to unique sales of single-owner collections not likely to be repeated in the near term. Accordingly, excluding restructuring charges, these actions are not expected to have a dilutive impact on Sotheby’s future results.
(See statement on Forward Looking Statements and Note J of Notes to Consolidated Financial Statements.)
Net Interest Expense
In 2011, net interest expense decreased $7.6 million (17%) primarily due to Sotheby's repurchase of $48.3 million of its 7.75% Senior Notes in the fourth quarter of 2010, which resulted in a $3.7 million reduction in interest expense. Additionally, net interest expense also decreased due to lower credit facility related fees (see Note K of Notes to Consolidated Financial Statements). Also impacting the comparison of net interest expense to the prior year is $2.2 million of interest income recognized in the first quarter of 2011 as a result of the resolution of a legal matter related to a delinquent client account.
Extinguishment of Debt, Net
On December 21, 2010, Sotheby’s repurchased an aggregate principal amount of $48.3 million of its 7.75% Senior Notes for a purchase price of $53.1 million (representing 110% of the aggregate principal amount repurchased). This repurchase resulted in a loss of approximately $6.3 million, including fees, which was recognized in the fourth quarter of 2010.
On April 1, 2011, the trustee for the Convertible Notes notified bondholders that the Convertible Notes would be convertible at their option for a period beginning on April 1, 2011 and ending on June 30, 2011 as a result of the closing price of Sotheby's Common Stock exceeding $44.20 for 20 trading days in the 30 consecutive trading days ending on March 31, 2011. In June 2011, Sotheby's received conversion requests totaling a principal amount of $18.1 million from holders of the

30



Convertible Notes. The conversion obligation of $22.5 million related to these conversion requests, which consisted of $18.1 million related to principal and approximately $4.4 million related to the conversion premium, was settled entirely in cash in August 2011. Sotheby's simultaneously received $4.4 million in cash to fund the conversion premium through its exercise of a portion of the Convertible Note Hedges (see discussion below). In the third quarter of 2011, Sotheby's recognized a $1.5 million loss representing the write-off of a proportionate amount of the unamortized discount and deferred transaction costs related to the Convertible Notes redeemed.
(See Note K of Notes to Consolidated Financial Statements.)
Other (Expense) Income
Sotheby's results in 2011 include other expense of $1.1 million as compared to other income of $3.0 million in 2010. The unfavorable comparison versus the prior year is largely the result of the investment performance of the trust assets related to the DCP liability, which resulted in a loss of $1.3 million in 2011 and a gain of $1.8 million in 2010. On a consolidated basis, gains and losses in the trust assets related to the DCP are largely offset by corresponding adjustments to employee benefits costs (see “Salaries and Related Expenses” above).
Income Tax Expense
Sotheby's effective income tax rate was approximately 26% in 2011, compared to approximately 29% in 2010. The 2011 effective income tax rate was favorably impacted by the reversal of a $13.6 million valuation allowance against certain state and local deferred tax assets. The 2010 effective income tax rate was favorably impacted by the reversal of $5.9 million of federal tax reserves in connection with the expiration of the statute of limitations. Sotheby's effective income tax rate was also influenced in each year by the level and mix of earnings and losses by taxing jurisdiction in combination with the applicable differences between U.S. and foreign tax rates. Accordingly, changes in the jurisdictional mix of pre-tax income could result in pre-tax income being higher or lower than the current and prior year in countries with lower statutory tax rates, which could cause Sotheby's effective income tax rate to fluctuate. The impact of such changes could be meaningful in countries with statutory income tax rates that are significantly lower than the U.S. statutory income tax rate of 35%. This is particularly true in countries where Sotheby's has significant auction operations, including the U.K., Hong Kong and Switzerland, where the statutory income tax rates are approximately 26%, 17%, and 23%, respectively. In 2011, pre-tax income in the U.K., Hong Kong and Switzerland was $82.8 million, $63.8 million, and $21.5 million, respectively, which cumulatively comprised 90% of foreign pre-tax income and 73% of consolidated pre-tax income. In 2010, pre-tax income in the U.K., Hong Kong and Switzerland was $87.3 million, $47.1 million, and $18.5 million, respectively, which cumulatively comprised 81% of foreign pre-tax income and 68% of consolidated pre-tax income. (See Notes L and M of Notes to Consolidated Financial Statements for a more detailed discussion of Income Taxes and Uncertain Tax Positions. In addition, see Item 1A, “Risk Factors.”)
Impact of Changes in Foreign Currency Exchange Rates
In 2011, changes in foreign currency exchange rates had a net favorable impact of approximately $10.5 million on Sotheby's results, as summarized in the following table (in thousands of dollars):
 
 
Favorable/(Unfavorable)
Total revenues
 
$
23,431

Total expenses
 
(12,971
)
Operating income
 
10,460

Net interest expense and other
 
42

Impact of changes in foreign currency exchange rates
 
$
10,502


31



Reconciliation of Non-GAAP Financial Measures
The following is a reconciliation of net income to EBITDA for 2011 and 2010 (in thousands of dollars):
    
 
2011
 
2010
Net income
$
171,416

 
$
160,950

Income tax expense
60,032

 
65,273

Income tax expense related to earnings from equity investees
48

 
528

Interest income
(4,002
)
 
(1,739
)
Interest expense
41,498

 
46,819

Depreciation and amortization expense
17,604

 
16,492

EBITDA
$
286,596

 
$
288,323

The following is a reconciliation of cash and cash equivalents to Net Liquidity as of December 31, 2011 and 2010 (in thousands of dollars):
December 31
 
2011
 
2010
Cash and cash equivalents
 
$
890,633

 
$
483,663

Add: Restricted cash
 
28,143

 
18,812

Add: Accounts receivable
 
553,502

 
681,800

Subtract: Due to consignors
 
(774,535
)
 
(675,586
)
Subtract: Accounts payable and other accrued liabilities
 
(189,262
)
 
(201,516
)
Net Liquidity
 
$
508,481

 
$
307,173


RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2010 AND 2009
This discussion should be read in conjunction with Note D (“Segment Reporting”) of Notes to Consolidated Financial Statements.
Overview
In 2010, Sotheby’s reported net income of $161 million, representing the second most profitable year in its history. These results represented a dramatic improvement in comparison to 2009 when Sotheby’s reported a net loss of ($6.5) million. This improvement was primarily due to higher auction commission revenues resulting from a 91% increase in Net Auction Sales attributable to the recovery of the global art market, which was aided, in part, by the increased buying activity of clients from emerging markets. Sotheby’s revenue growth and return to substantial profitability in 2010 was achieved with a lower risk profile than in the previous peak years of 2006 and 2007, as the Company was highly selective in its use of auction guarantees and only issued such guarantees in tandem with risk sharing arrangements that very significantly reduced its financial exposure to guarantees. Sotheby’s 2010 results reflected increased incentive compensation, due to the substantial improvement in earnings, as well as a higher level of direct costs of services, consistent with the level and composition of auction offerings during the period. See the discussion below for greater detail on the significant factors impacting Sotheby’s 2010 results and the comparison to 2009.

32



Results of Operations for the Years Ended December 31, 2010 and 2009
The table below presents a summary of Sotheby’s results of operations for 2010 and 2009, as well as a comparison between the two periods (in thousands of dollars):
 
 
 
 
 
Favorable/(Unfavorable)
 
2010
 
2009
 
$ Change
 
% Change
Revenues:
 

 
 

 
 

 
 

Auction and related revenues
$
731,021

 
$
448,768

 
$
282,253

 
62.9
 %
Finance revenues
9,685

 
9,073

 
612

 
6.7
 %
Dealer revenues
29,092

 
22,339

 
6,753

 
30.2
 %
License fee revenues
3,682

 
3,270

 
412

 
12.6
 %
Other revenues
829

 
1,508

 
(679
)
 
(45.0
)%
Total revenues
774,309

 
484,958

 
289,351

 
59.7
 %
Expenses **
500,311

 
431,824

 
(68,487
)
 
(15.9
)%
Operating income
273,998

 
53,134

 
220,864

 
*

Net interest expense
(45,080
)
 
(40,351
)
 
(4,729
)
 
(11.7
)%
Extinguishment of debt, net
(6,291
)
 
1,039

 
(7,330
)
 
*

Write-off of credit facility amendment fees

 
(3,750
)
 
3,750

 
100.0
 %
Other income
2,952

 
5,323

 
(2,371
)
 
(44.5
)%
Income before taxes
225,579

 
15,395

 
210,184

 
*

Equity in earnings of investees, net of taxes
644

 
239

 
405

 
*

Income tax expense
65,273

 
22,162

 
(43,111
)
 
*

Net income (loss)
$
160,950

 
$
(6,528
)
 
$
167,478

 
*

Key performance indicators:
 

 
 

 
 

 
 

Aggregate Auction Sales (a)
$
4,287,176

 
$
2,278,525

 
$
2,008,651

 
88.2
 %
Net Auction Sales (b)
$
3,644,764

 
$
1,912,589

 
$
1,732,175

 
90.6
 %
Private Sales (c)
$
494,505

 
$
472,603

 
$
21,902

 
4.6
 %
Consolidated Sales (d)
$
4,810,773

 
$
2,773,467

 
$
2,037,306

 
73.5
 %
Auction Commission Margin (e)
18.3
%
 
20.7
%
 
N/A

 
(11.6
)%
Direct Costs as a percentage of Net Auction Sales
1.7
%
 
2.3
%
 
N/A

 
26.4
 %
Average Loan Portfolio (f)
$
181,585

 
$
154,619

 
$
26,966

 
17.4
 %
EBITDA (g)
$
288,323

 
$
77,674

 
$
210,649

 
*

EBITDA Margin (g) (h)
37.2
%
 
16.0
%
 
N/A

 
*

 
 
Legend:
*
Represents a change in excess of 100%.
**
Expenses for 2009 include net restructuring charges of $12.2 million.
(a)
Represents the hammer (sale) price of property sold at auction plus buyer’s premium.
(b)
Represents the hammer (sale) price of property sold at auction.
(c)
Represents the total purchase price of property sold in private sales brokered by Sotheby’s.
(d)
Represents the sum of Aggregate Auction Sales, Private Sales and Dealer revenues.
(e)
Represents total auction commission revenues as a percentage of Net Auction Sales.
(f)
Represents the average loan portfolio of the Sotheby's Finance segment.
(g)
See “Use of Non-GAAP Financial Measures” above and “Reconciliation of Non-GAAP Financial Measures” below.
(h)
Represents EBITDA as a percentage of total revenues.



33



Revenues
In 2010 and 2009, revenues consisted of the following (in thousands of dollars):
 
 
 
 
 
 
Favorable/(Unfavorable)
Year Ended December 31
 
2010
 
2009
 
$ Change
 
% Change
Auction and related revenues:
 
 

 
 

 
 

 
 

Auction commission revenues
 
$
667,033

 
$
396,772

 
$
270,261

 
68.1
 %
Private sale commission revenues
 
44,240

 
37,462

 
6,778

 
18.1
 %
Principal activities
 
(1,890
)
 
(5,735
)
 
3,845

 
67.0
 %
Other auction and related revenues*
 
21,638

 
20,269

 
1,369

 
6.8
 %
Total auction and related revenues
 
731,021

 
448,768

 
282,253

 
62.9
 %
Other revenues:
 
 

 
 

 
 

 
 

Finance revenues
 
9,685

 
9,073

 
612

 
6.7
 %
Dealer revenues
 
29,092

 
22,339

 
6,753

 
30.2
 %
License fee revenues
 
3,682

 
3,270

 
412

 
12.6
 %
Other
 
829

 
1,508

 
(679
)
 
(45.0
)%
Total other revenues
 
43,288

 
36,190

 
7,098

 
19.6
 %
Total revenues
 
$
774,309

 
$
484,958

 
$
289,351

 
59.7
 %
* Principally includes fees charged to clients for catalogue production and insurance, catalogue subscription revenues, advertising revenues and commissions earned on private sales brokered by third-parties.
Auction and Related Revenues
In 2010, auction and related revenues improved $282.3 million (63%) due to a significant increase in auction commission revenues and, to a much lesser extent, a higher level of private sale commissions and a lower level of principal activity losses. See the discussion below for a more detailed explanation of the factors contributing to the significant improvement in auction and related revenues.
Auction Commission Revenues—In 2010, auction commission revenues improved $270.3 million (68%) due to a substantial increase in Net Auction Sales, partially offset by a decline in Auction Commission Margin. See “Net Auction Sales” and “Auction Commission Margin” below for a more detailed discussion of these key performance indicators.
Net Auction Sales—In 2010, Net Auction Sales increased $1.7 billion (91%) due to the recovery of the global art market in 2010, which resulted in a greater volume of property sold and the achievement of higher average selling prices across almost all collecting categories. Specifically, the increase in 2010 Net Auction Sales was attributable to the following factors:
An $828 million (108%) increase in various-owner sales of Impressionist and Contemporary Art. In these sales, more works of art were offered and higher prices were achieved than in 2009.
A $240 million (159%) increase in sales of Asian Art conducted in Hong Kong, primarily attributable to higher average selling prices achieved in recurring sales throughout 2010. Also favorably impacting the comparison to 2009 were two single-owner sales of Chinese Ceramics (the Qing Imperial Porcelain from J.T. Tai and Co. and An Important Private Collection of Qing Historical Works of Art) that totaled $84 million and for which there were no comparable sales in 2009.
A $156 million (146%) increase in single-owner sales conducted in the U.S. and Europe with 2010 results including the sales of Antiquities From the Collection of the Late Clarence Day, the Hesketh Collection of Books and Manuscripts, the British American Tobacco Artventure Collection and the Collection of Patricia Kluge, amongst others.
A $182 million (113%) increase in sales of jewelry, which included substantial improvements in recurring sales in Switzerland ($75 million), Hong Kong ($51 million) and the U.S. ($44 million), with a significant portion of the increase ($100 million) resulting from fourth quarter sales. In particular, fourth quarter results include the sale of a superb pink diamond for $38.2 million in Switzerland, for which there was no comparable item sold in 2009.
Smaller increases in recurring various-owner sales in other collecting categories, most notably in 19th Century Paintings ($67 million), Old Master Paintings ($47 million) and sales of Islamic Art in the U.K. ($38 million).

34



Auction Commission Margin—In 2010, Sotheby’s was highly selective in its use of auction guarantees and issued auction guarantees only when it was able to enter into risk and reward sharing arrangements to significantly reduce its financial exposure. In 2010, Auction Commission Margin decreased 12% (from 20.7% to 18.3%) almost entirely due to a lower average buyer’s premium rate achieved on 2010 sales when compared to 2009 sales, resulting from a change in sales mix, as a significantly higher portion of Net Auction Sales were at the high-end of Sotheby’s business. Specifically, in 2010, there was a 105% increase in the number of lots sold with a hammer (sale) price over $1 million, the price point at which the buyer’s premium rate decreases from 20% to 12%. To a lesser extent, Auction Commission Margin was adversely impacted by competitive pressures, which resulted in a lower seller’s commission rate and a higher level of shared auction commissions.
The following table provides a comparison between 2010 and 2009 of the volume and value of lots sold with a hammer (sale) price over $1 million (in thousands of dollars, except for lot volume):
Year Ended December 31
 
2010
 
2009
 
$ Change
 
% Change
Lots with a hammer (sale) price of greater than $1 million
 
530

 
259

 
271

 
105
%
Total hammer (sale) price
 
$
2,030,545

 
$
743,943

 
$
1,286,602

 
173
%
Private Sale Commissions—In 2010, private sale commissions increased $6.8 million (18%) when compared to 2009 primarily due to improved commission margins as well as a higher volume of property sold.
Principal Activities—In 2010, principal activity losses included $5.6 million in writedowns of Auction segment inventory primarily related to guaranteed property that failed to sell at auction in prior periods, substantially offset by Sotheby’s share of overages earned on guaranteed property sold in the fourth quarter of 2010. The favorable comparison of principal activities to 2009 was principally due to the overages earned on these transactions.
Finance Revenues
In 2010, Finance revenues increased $0.6 million (7%) primarily due to $0.7 million of interest income recognized in the first quarter of 2010 that was previously considered to be uncollectible. The overall increase in Finance revenues was partially offset by lower rates of return on the loan portfolio, which in 2010, included a higher proportion of short-term, interest-free advances to consignors (with maturities typically ranging between 3 and 6 months) that were issued during the first nine months of 2010 in order to secure high-value property for auctions. However, fourth quarter Finance revenues increased $0.9 million, due in part to an interest-bearing $55 million client loan that was made in October 2010.
(Note: For the purposes of Management’s Discussion and Analysis, Finance revenues do not include intercompany revenues earned by the Finance segment from the Auction segment, which are eliminated in consolidation. See Note D of Notes to Consolidated Financial Statements.)
Dealer Revenues and Cost of Sales
The table below summarizes Dealer revenues, cost of sales and gross profit (loss) for 2010 and 2009 (in thousands of dollars):
    
 
 
 
 
 
Favorable/(Unfavorable)
 
2010
 
2009
 
$ Change
 
% Change
Dealer revenues
$
29,092

 
$
22,339

 
$
6,753

 
30.2
 %
Dealer cost of sales
(24,889
)
 
(24,516
)
 
(373
)
 
(1.5
)%
Dealer gross profit (loss)
$
4,203

 
$
(2,177
)
 
$
6,380

 
N/A


In 2010, Dealer segment results improved significantly primarily due to the performance of Noortman Master Paintings, which reported more profitable inventory sales and a higher level of commissions earned from the brokering of private art sales. Also impacting the comparison to 2009 was a $1.6 million decrease in inventory writedowns in 2010 (from $4.7 million to $3.1 million).

35



Expenses
In 2010 and 2009, expenses consisted of the following (in thousands of dollars):
 
 
 
 
 
Favorable / (Unfavorable)
 
2010
 
2009
 
$ Change
 
% Change
Direct costs of services
$
60,940

 
$
43,429

 
$
(17,511
)
 
(40.3
)%
Dealer cost of sales
24,889

 
24,516

 
(373
)
 
(1.5
)%
Marketing expenses
12,207

 
10,541

 
(1,666
)
 
(15.8
)%
Salaries and related costs
253,271

 
196,269

 
(57,002
)
 
(29.0
)%
General and administrative expenses
132,566

 
123,350

 
(9,216
)
 
(7.5
)%
Depreciation and amortization expense
16,492

 
21,560

 
5,068

 
23.5
 %
Restructuring charges, net
(54
)
 
12,159

 
12,213

 
*

Total expenses
$
500,311

 
$
431,824

 
$
(68,487
)
 
(15.9
)%
* Represents a change in excess of 100%
Direct Costs of Services
In 2010, direct costs of services increased $17.5 million (40%), which was consistent with the level and composition of Sotheby’s auction offerings in the year. For example, in 2010, there was a $6.3 million increase in costs to promote a substantially higher level of single-owner sales, as discussed above under “Net Auction Sales,” and a $2.2 million increase in traveling exhibition costs, due in part to traveling exhibitions for property offered in Sotheby’s Impressionist and Contemporary Art sales in response to heightened interest from buyers in emerging markets. Also contributing to the higher level of direct costs was a $1.5 million increase in property loss and damage claims. Despite the overall increase when compared to 2009, direct costs of services as a percentage of Net Auction Sales decreased from 2.3% in 2009 to 1.7% in 2010.
Marketing Expenses
In 2010, marketing expenses increased by $1.7 million (16%) principally due to higher costs to promote the Sotheby’s brand in emerging markets and a higher level of museum sponsorships.
Salaries and Related Costs
In 2010 and 2009, salaries and related costs consisted of the following (in thousands of dollars):
 
 
 
 
 
Favorable / (Unfavorable)
 
2010
 
2009
 
$ Change
 
% Change
Full-time salaries
$
114,040

 
$
114,467

 
$
427

 
0.4
 %
Incentive compensation expense
68,199

 
18,255

 
(49,944
)
 
**

Share-based payments
20,250

 
20,750

 
500

 
2.4
 %
Payroll taxes
19,051

 
14,369

 
(4,682
)
 
(32.6
)%
Employee benefits
17,171

 
17,679

 
508

 
2.9
 %
Other*
14,560

 
10,749

 
(3,811
)
 
(35.5
)%
Total salaries and related costs
$
253,271

 
$
196,269

 
$
(57,002
)
 
(29.0
)%
Key Performance Indicator:
 

 
 

 
 
 
 

Salaries and related costs as a % of revenues
32.7
%
 
40.5
%
 
N/A
 
19.2
%
*
Principally includes expense related to the cost of temporary labor and overtime, and certain employment arrangements.
 
 
**
Represents a change in excess of 100%.
In 2010, salaries and related costs increased $57 million (29%), almost entirely due to a higher level of incentive compensation. See below for a detailed discussion of the significant factors contributing to the overall increase in salaries and related costs.

36



Incentive Compensation—The substantial increase in incentive compensation expense in 2010 was due to the significant improvement in Sotheby’s earnings.
Payroll Taxes—In 2010, payroll taxes increased $4.7 million (33%) primarily due to higher incentive compensation expense, as discussed above.
Full-Time Salaries—In 2010, full-time salaries remained relatively flat as the impact of headcount reductions resulting from restructuring initiatives implemented throughout 2009 was offset by strategic salary and headcount increases in 2010, as well as the impact of one-time unpaid employee furloughs and temporary pay reductions for certain senior employees that were implemented in 2009 in response to a downturn in the international art market. (See “Restructuring Plans and Related Charges” below.)
Other Compensation—The increase in other compensation was due to non-refundable cash payments made in connection with employment arrangements entered into in 2010, as well a $1.8 million (25%) increase in temporary employee and overtime costs.
Employee Benefits—In 2010, employee benefit costs decreased $0.5 million (3%) primarily due to lower gains from deemed participant investments related to the DCP, which reduced employee benefit costs by $1.9 million. The cost reduction related to the DCP was largely offset by a corresponding reduction in the value of the trust assets held by Sotheby’s to fund the DCP liability, the impact of which was reflected below operating income within other income (expense). Also contributing to the decrease in employee benefit costs was an increase of $1.4 million in the net pension credit related to the U.K. Pension Plan. This increase was attributable to differences in the market-based assumptions used to determine the net pension credit between the periods.
The factors discussed above impacting employee benefits were almost entirely offset by a higher level of contributions to Sotheby’s U.S. retirement plans, which was primarily due to increased profit-sharing and incentive compensation related accruals associated with the substantial improvement in Sotheby’s financial performance, when compared to 2009. The impact of these costs was partially offset by a decrease in the rate of contributions to the U.S. retirement plans as a result of a May 2009 amendment to the Sotheby’s, Inc. Retirement Savings Plan, which reduced matching contributions by 50%.
Share-Based Payments—In 2010, share-based payments decreased $0.5 million (2%), principally due to lower expense related to prior years’ equity awards almost entirely offset by $2.5 million in expense related to stock options granted to certain senior executives in February 2010. Prior to this grant, no stock options had been awarded by Sotheby’s since 2005.
General and Administrative Expenses
In 2010, general and administrative expenses increased $9.2 million (8%) to $132.6 million, primarily due to the following factors:
A $6.8 million (42%) increase in travel and entertainment expenses in response to a higher level of consignment opportunities.
A $3.5 million increase in bad debt expense primarily attributable to an unusually high level of recoveries occurring in 2009.
Smaller individual increases in various other general and administrative expenses aggregating to $2.3 million.
The overall increase in general and administrative expenses was partially offset by a decrease in facility related costs ($1.5 million) as 2009 results included rent and moving expenses related to Sotheby’s former middle-market salesroom in London, which was vacated in June 2009. Also partially offsetting the overall increase in general and administrative expenses was a $1 million decrease in authenticity claims, goodwill gestures and other litigation-related matters and a $0.9 million decrease in professional fees primarily due to lower costs associated with Sotheby’s previously outsourced tax compliance function.
Depreciation and Amortization Expense
In 2010, depreciation and amortization expense decreased $5.1 million (24%) principally due to a lower level of recurring capital spending in 2010 and 2009 than in prior years, as well as certain tangible and intangible assets becoming fully depreciated and amortized in 2009. In 2010 and 2009, a substantial portion of capital spending was devoted to assets that were not placed into service until the second half of 2010 and the first quarter of 2011.

37



Restructuring Plans and Related Charges
In 2010, Sotheby’s recorded a benefit to net Restructuring Charges of approximately $0.1 million. In 2009, Sotheby’s recorded net Restructuring Charges of approximately $12.2 million. See below for brief descriptions of the 2008 Restructuring Plan and 2009 Restructuring Plan.
2008 Restructuring Plan—Due to a downturn in the international art market, on December 1, 2008 and February 26, 2009, Sotheby’s Board of Directors approved restructuring actions impacting the Auction segment, as well as certain corporate departments. These restructuring actions (collectively, the “2008 Restructuring Plan”) were the result of a strategic review of Sotheby’s operations conducted by management between November 2008 and February 2009. The 2008 Restructuring Plan resulted in a 15% decrease in global headcount, a reduction in Sotheby’s selling activities and leased premises in Amsterdam and the vacating of other premises principally in the U.K.
The 2008 Restructuring Plan included $2.1 million of facility related costs associated with exiting certain leased facilities in the Netherlands and the U. K. These facility related Restructuring Charges, which were recognized in 2009, represented the future rental costs (net of estimated sub-lease income) that Sotheby’s remained obligated to pay subsequent to the cease use date for each facility.
2009 Restructuring Plan—In March and April 2009, in response to a continued downturn in the international art market, management conducted a further strategic review of Sotheby’s operations, and on April 27, 2009, the Executive Committee of the Board of Directors approved additional restructuring actions (the “2009 Restructuring Plan”). The 2009 Restructuring Plan impacted all areas of Sotheby’s global operations through additional significant cost reductions that resulted from a further 5% decrease in global headcount.
In total, the 2008 Restructuring Plan and the 2009 Restructuring Plan resulted in aggregate annual cost savings of approximately $25 million when compared to 2008. The aggregate annual cost savings was almost entirely due to the headcount reductions discussed above.
(See Note J of Notes to Consolidated Financial Statements.)
Net Interest Expense
In 2010, net interest expense increased $4.7 million (12%) primarily due to a $4.1 million decrease in interest income related to previously delinquent client accounts that were determined to be collectible. To a lesser extent, the increase in net interest expense was due to a higher level of discount amortization related to Sotheby’s 3.125% Convertible Notes and higher amortization of arrangement and amendment fees related to Sotheby’s revolving credit facility.
Extinguishment of Debt, Net
On January 27, 2009, Sotheby’s repurchased an aggregate principal amount of $2.8 million of its 7.75% Senior Notes for a purchase price of $1.6 million (representing 59% of the aggregate principal amount repurchased). This repurchase resulted in a non-cash gain of approximately $1 million, net of fees, which was recognized in the first quarter of 2009.
On December 21, 2010, Sotheby’s repurchased an aggregate principal amount of $48.3 million of its 7.75% Senior Notes for a purchase price of $53.1 million (representing 110% of the aggregate principal amount repurchased). This repurchase resulted in a loss of approximately $6.3 million, including fees, which was recognized in the fourth quarter of 2010.
Other Income
The comparison of other income to 2009 was significantly impacted by a gain of approximately $4 million related to the sale of Sotheby’s Australia. The majority of this gain was the result of the realization of the cumulative translation adjustment related to this entity. There was no comparable event in 2010.
Write-Off of Credit Facility Amendment Fees
On August 31, 2009, Sotheby’s terminated its senior secured revolving credit facility with Bank of America, N.A. (the “BofA Credit Agreement”). As a result, Sotheby’s recorded a $2.5 million non-cash charge in the third quarter of 2009 to write-off the remaining balance of arrangement and amendment fees related to the BofA Credit Agreement. Additionally, as a result of amendments to the BofA Credit Agreement made in the first half of 2009, Sotheby’s recorded a $1.3 million non-cash charge in the second quarter of 2009 to write-off a portion of arrangement and amendment fees related to this facility.

38



Income Tax Expense
Sotheby’s effective tax rate was approximately 29% in 2010, compared to approximately 144% in 2009. In 2009, the effective tax rate was unusually high due to the recording of a valuation allowance of $18.2 million against certain state, local, and foreign deferred tax assets and loss carryforwards for which there was no comparable item in 2010. The 2009 effective tax rate was also impacted by the relative impact of book to tax differences (i.e., non-deductible expenses) on significantly lower pre-tax results in various taxing jurisdictions as compared to 2010. In 2010, the effective tax rate was affected by the release of certain federal tax reserves of $5.9 million in conjunction with the expiration of the statute of limitations. The rate in 2010 was also significantly influenced by the level and mix of 2010 earnings and losses by taxing jurisdiction and foreign tax rate differentials as well as the mix of income earned at tax rates lower than the U.S. tax rate. (See Notes L and M of Notes to Consolidated Financial Statements for a more detailed discussion of Income Taxes and Uncertain Tax Positions. In addition, see Item 1A, “Risk Factors.”)
Reconciliation of Non-GAAP Financial Measures
The following is a reconciliation of net income (loss) to EBITDA for 2010 and 2009 (in thousands of dollars):
    
 
2010
 
2009
Net income (loss)
$
160,950

 
$
(6,528
)
Income tax expense
65,273

 
22,162

Income tax expense related to earnings from equity investees
528

 
129

Interest income
(1,739
)
 
(5,357
)
Interest expense
46,819

 
45,708

Depreciation and amortization expense
16,492

 
21,560

EBITDA
$
288,323

 
$
77,674


FINANCIAL CONDITION AS OF DECEMBER 31, 2011
This discussion should be read in conjunction with Sotheby’s Consolidated Statements of Cash Flows. In 2011, total cash and cash equivalents increased $407 million to $890.6 million primarily due to the factors discussed below.
Cash Provided by Operating Activities—The amount of cash provided or used by Sotheby's operating activities in a period is generally a reflection of the volume of Net Auction Sales, the timing of auction sale settlements (see Note E of Notes to Consolidated Financial Statements), the amount and timing of payments made to vendors, the amount and timing of compensation-related payments and the amount and timing of the collection and/or payment of tax-related amounts. Net cash provided by operating activities of $403 million in 2011 is principally attributable to the cash flows associated with Sotheby’s profitable results during the period and net cash inflows of $191.5 million associated with the timing of the settlement of auction sales, due in part to the collection of receivables related to certain high-value fourth quarter sales in 2011 for which payment to the consignor was made in 2012. These cash inflows are partially offset by net income tax payments of $56.6 million and the funding of 2010 incentive compensation-related payments in February 2011.
Cash Provided by Investing Activities—Net cash provided by investing activities of $50.1 million in 2011 is principally attributable to net cash inflows related to the collection of client loans totaling $76.3 million, as settlements of loan and auction guarantee advances to consignors exceeded new loans issued during the period. This net cash inflow is partially offset by capital expenditures of $17.1 million made during 2011, a portion of which were made to support certain strategic initiatives, including the further enhancement of the sothebys.com website and investments made to enhance Sotheby's private sale exhibition space.
Cash Used by Financing Activities—Net cash used by financing activities of $45.1 million in 2011 is principally due to the settlement of Convertible Note redemptions ($18.1 million, net of proceeds received from the exercise of the Convertible Note Hedges, as discussed in Note K of Notes to Consolidated Financial Statements), the funding of employee tax obligations upon the vesting of share-based payments during the period ($18.6 million) and dividend payments of $14.9 million. These financing cash outflows are partially offset by $7 million in excess tax benefits resulting from the vesting and exercise of share-based payments during the period. Due to the appreciation of Sotheby's stock price, such share-based payments vested at values higher than what was recorded as expense in Sotheby's statements of operations, resulting in a higher tax deduction for Sotheby's. (See Note O of Notes to Consolidated Financial Statements.)



39



CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The following table summarizes Sotheby’s material contractual obligations and commitments as of December 31, 2011 (in thousands of dollars):
 
Payments Due by Period
 
Total
 
Less Than
One Year
 
1 to 3 Years
 
3 to 5 Years
 
After 5
Years
York Property Mortgage (1)
 

 
 

 
 

 
 

 
 

Principal payments
$
230,502

 
$
2,976

 
$
7,068

 
$
220,458

 
$

Interest payments
43,693

 
11,694

 
24,940

 
7,059

 
 
Sub-total
274,195

 
14,670

 
32,008

 
227,517

 

Unsecured debt (2)
 

 
 

 
 

 
 

 
 

Principal payments
261,839

 

 
181,868

 
79,971

 

Interest payments
30,251

 
11,881

 
15,253

 
3,117

 

Sub-total
292,090

 
11,881

 
197,121

 
83,088

 

 
 
 
 
 
 
 
 
 
 
Other commitments:
 

 
 

 
 

 
 

 
 

Operating lease obligations (3)
110,868

 
15,390

 
26,772

 
25,226

 
43,480

Employment arrangements (4)
20,585

 
9,385