10-K 1 bid1231201510k_xbrl2015.htm 10-K 10-K


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, 2015.
 
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 Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange 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, 2015, the aggregate market value of the 62,219,489 shares of Common Stock held by non-affiliates of the registrant was $2,814,809,682 based upon the closing price ($45.24) on the New York Stock Exchange composite tape on such date for the Common Stock.
As of February 24, 2016, there were outstanding 61,942,422 shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s proxy statement for the 2016 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 a global art business whose operations are organized under two segments: Agency and Finance. The Agency segment earns commissions by matching buyers and sellers of authenticated fine art, decorative art, jewelry, wine and collectibles (collectively, "art" or "works of art" or "artwork" or "property") through the auction or private sale process. To a much lesser extent, Agency segment activities also include the sale of artworks that are principally acquired incidental to the auction process and the activities of RM Sotheby's, an equity investee that operates as an auction house for investment-quality automobiles (see "Investment in RM Sotheby's" below). The Finance segment earns interest income through art-related financing activities by making loans that are secured by works of art. See Note 3 of Notes to Consolidated Financial Statements for information regarding a change in Sotheby's segment reporting that became effective in the second quarter of 2015.
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 and is the only publicly traded investment opportunity in the art market.
Agency Segment
Description of Business
Through its Agency segment, Sotheby's accepts property on consignment, stimulates buyer interest through professional marketing techniques, and matches sellers, also known as consignors, to buyers through the auction or private sale process. Prior to offering a work of art for sale, Sotheby's specialists perform significant due diligence activities to authenticate and determine the ownership history of the property being sold.
Following an auction or private sale, Sotheby's invoices the buyer for the purchase price of the property (including any commission owed by the buyer), collects payment from the buyer, and remits to the consignor the net sale proceeds after deducting its commissions, expenses and applicable taxes and royalties. Sotheby's auction 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. Sotheby's private sale commissions are stipulated in a legally binding agreement between Sotheby's and the seller, which outlines the terms of the arrangement including the desired sale price and the amount or rate of commission to be earned. In certain situations, Sotheby's may also execute a legally binding agreement with the buyer stipulating the terms of the private sale transaction. In 2015, 2014, and 2013, auction commission revenues accounted for approximately 75%, 81%, and 81%, respectively, of Sotheby's consolidated revenues. In 2015, 2014, and 2013, private sale commission revenues accounted for approximately 6%, 6%, and 10%, respectively, of Sotheby's consolidated revenues.
Under Sotheby's standard auction payment terms, payments from buyers are due no more than 30 days from the sale date and payments to consignors are due 35 days from the sale date. For private sales, payment from the buyer is typically due on the sale date, with the net sale proceeds due to the consignor shortly thereafter. Extended payment terms are sometimes provided to an auction or private sale buyer. For auctions, the extent to which extended payment terms are provided to buyers can vary considerably from selling season to selling season. Extended payment terms typically extend the payment due date to a date that is no longer than one year from the sale date. In limited circumstances, the payment due date may be extended to a date that is beyond one year from the sale date. When providing extended payment terms, Sotheby's attempts to match the timing of cash receipt from the buyer with the timing of payment to the consignor, but is not always successful in doing so. All extended payment term arrangements are approved by management under Sotheby's internal corporate governance policy.

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Under the standard terms and conditions of its auction and private sales, Sotheby's is not obligated to pay the consignor for property that has not been paid for by the buyer. If a buyer defaults on payment, the sale may be cancelled, and the property will be returned to the consignor. Alternatively, the consignor may reoffer the property at a future Sotheby's auction or negotiate a private sale with Sotheby's acting as its agent. In certain instances and subject to management approval under Sotheby's internal corporate governance policy, the consignor may be paid the net sale proceeds before payment is collected from the buyer and/or the buyer may be allowed to take possession of the property before making payment. In situations when the buyer takes possession of the property before making payment, Sotheby's is liable to the seller for the net 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 a consignor a minimum sale price in connection with the sale of property at auction (an "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. 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. If the property does not sell, the amount of the auction guarantee must be paid, but Sotheby's takes ownership of the unsold property and may recover the amount paid through its future sale. Depending on the mix of items subject to a guarantee, in advance of peak selling seasons, a small number of guaranteed items may represent a substantial portion of the aggregate amount of outstanding auction guarantees.
Sotheby's may reduce its financial exposure under auction guarantees through contractual risk and reward sharing arrangements. Such auction guarantee risk and reward sharing arrangements include irrevocable bids and partner sharing arrangements. An irrevocable bid is an arrangement under which a counterparty commits to bid a predetermined price on the guaranteed property. If the irrevocable bid is 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. In a partner sharing arrangement, a counterparty commits to fund: (i) a share of the difference between the sale price at auction and the amount of the auction guarantee if the property sells for less than the minimum guaranteed price or (ii) a share of the minimum guaranteed price if the property does not sell while taking ownership of a proportionate share of the unsold property. In exchange for accepting a share of the financial exposure under the auction guarantee, the counterparty in a partner sharing arrangement is generally entitled to receive a share of the auction commission earned if the property sells and/or a share of any overage.
The counterparties to Sotheby's 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.
Although irrevocable bid and partner sharing arrangements may be used to reduce the risk associated with auction guarantees, Sotheby's may also enter into auction guarantees without securing such arrangements. In these circumstances, Sotheby's could be exposed to auction guarantee losses and/or deterioration in auction commission margins if the underlying property fails to sell at the minimum guaranteed price. Furthermore, in such situations, Sotheby's liquidity could be reduced.
See "Auction Commission Margin" under Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for a complete discussion of the factors impacting auction commission margin. See Note 4 of Notes to Consolidated Financial Statements for additional information about auction and private sale receivables. See Note 16 of Notes to Consolidated Financial Statements for additional information about auction guarantees.
Investment in RM Sotheby's
On February 18, 2015, Sotheby's acquired a 25% ownership interest in RM Auctions, an auction house for investment-quality automobiles, for $30.7 million. Following this investment, RM Auctions is now known as RM Sotheby's. In addition to the initial 25% ownership interest, Sotheby's has governance participation and a comprehensive partnership agreement to work together to drive growth in the business. Over time, Sotheby's will have opportunities to increase its ownership stake as the partnership evolves and grows. See Note 5 of Notes to Consolidated Financial Statements for additional information about RM Sotheby's.

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Acquisition of Art Agency, Partners
On January 11, 2016, Sotheby's acquired Art Agency, Partners ("AAP"), a firm that provides a range of art-related services to art collectors. Through this acquisition, Sotheby's aims to grow its auction and private sale revenues by enhancing its relationships with art collectors and improving its position in the fine art market, particularly in Impressionist, Modern and Contemporary Art. Also, as a result of this acquisition, Sotheby's will add a new revenue stream by assimilating AAP's existing art advisory services, providing a new avenue for growth. See Note 24 of Notes to Consolidated Financial Statements and statement on Forward Looking Statements.
The Art Market and Competition
The global art market is influenced over time by the overall strength and stability of the global economy, the financial markets of various countries, geopolitical conditions and world events, all of which may impact the willingness of potential buyers and sellers to purchase and sell art. In addition, the amount and quality of art consigned for sale is influenced by other factors not within Sotheby's control, and many consignments often become available as a result of the death or financial or marital difficulties of the owner. These factors cause the supply and demand for works of art to be unpredictable and may lead to significant variability in Sotheby's revenues from period to period.
The sale of works of art in the global art market is primarily effected through the major auction houses, numerous art dealers, smaller auction houses, and also directly between collectors. Competition in the global art market is intense and 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 competitor in the global art market is Christie's International, PLC ("Christie's"), a privately owned auction house. To a much lesser extent, Sotheby's also faces competition from smaller auction houses such as Bonhams and Phillips, 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.
In 2015, 2014, and 2013, Sotheby's and Christie's together totaled approximately $12.3 billion, $12.9 billion, and $11.0 billion, respectively, of Aggregate Auction Sales, of which Sotheby's accounted for $5.9 billion (48%), $6.1 billion (47%), and $5.1 billion (47%), respectively.
It is not possible to measure with any particular accuracy the entire global art market or to reach any conclusions regarding overall competition because privately owned art dealers and auction houses frequently do not publicly report annual totals for auction sales, revenues, or profits, and the amounts reported may not be verifiable. However, Sotheby's believes that art dealers account for the majority of the volume of transactions in the global art market.
The owner of a work of art wishing to sell has four principal options: (i) sale or consignment to an art dealer; (ii) sale or consignment to 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 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: (i) the level and breadth of expertise of the art dealer or auction house with respect to the property; (ii) the extent of the prior relationship, if any, between the art dealer or auction house and its staff and the seller; (iii) 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; (iv) the client's desire for privacy; (v) 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; (vi) the availability and terms of financial inducements offered by auction houses including auction guarantees, short-term financing, and auction commission sharing arrangements; (vii) the level of pre-sale estimates; (viii) the desirability of a public auction in order to achieve the maximum possible price, a particular concern for a seller that is a fiduciary representing an estate or trust; (ix) the amount of commission charged by art dealers or auction houses to sell a work on consignment; (x) the cost, style, and extent of pre-sale marketing and promotion to be undertaken by an art dealer or auction house; (xi) the reputation of the art dealer or auction house and recommendations by third parties consulted by the seller; (xii) the desire of clients to conduct business with a publicly traded company; and (xiii) the availability and extent of related services, such as tax or insurance appraisals.




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While financial inducements such as auction commission sharing arrangements and auction guarantees may lead to a higher level of auction consignments, they adversely impact auction commission margins, and auction guarantees introduce the possibility of incurring a loss on the transaction and reduced liquidity if the underlying property fails to sell at the minimum guaranteed price. To mitigate the risk of a decline in auction commission margins, from time-to-time, Sotheby's adjusts its commission rate structures. In addition, as discussed above, Sotheby's may reduce its financial exposure under auction guarantees through contractual risk and reward sharing arrangements.
Seasonality
The worldwide art auction market has two principal selling seasons, which generally occur in the second and fourth quarters of the year. In the aggregate, second and fourth quarter Net Auction Sales represented 78%, 79%, and 83% of total Net Auction Sales in 2015, 2014, and 2013, respectively, with auction commission revenues comprising approximately 75%, 81%, and 81%, of Sotheby's total revenues, respectively, in those years. Accordingly, Sotheby's financial results are seasonal, with peak revenues and operating income generally occurring in the second and fourth quarters. Consequently, first and third quarter results have historically reflected lower revenues when compared to the second and fourth quarters and, typically, a net loss due to the fixed nature of many of Sotheby's operating expenses. Management believes that investors should focus on results for six and twelve month periods, which better reflect the business cycle of the art auction market. See Note 25 of Notes to Consolidated Financial Statements for Sotheby's quarterly results for the years ended December 31, 2015 and 2014.
Regulation of the Art Market
Regulation of the art market varies from jurisdiction to jurisdiction. In many jurisdictions, Sotheby's is subject to laws and regulations that are not directed solely toward the art market, 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, laws and regulations involving sales, use, value-added and other indirect taxes, and regulations related to the use of real estate. 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 Sotheby's, but do affect the art market generally. A material adverse change in such regulations, such as the American Royalties Too Act of 2014 introduced in the U.S. Congress, which would impose a 5% resale royalty (with a cap of $35,000) on sales of art through larger 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, increase the cost of moving property to such locations, or expose Sotheby's to legal claims or government inquiries. 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
The 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: (1) advances secured by consigned property where the borrowers are contractually committed, in the near term, to sell the property through the Agency segment (a "consignor advance"); and (2) general purpose term loans secured by property not presently intended for sale (a "term loan").
Consignor advances allow sellers to receive funds upon consignment for an auction or private sale that will typically occur up to one year in the future and normally have short-term maturities. Term loans allow Sotheby's to establish or enhance mutually beneficial relationships with borrowers and may generate future auction or private sale consignments and/or purchases. In certain situations, term loans are also made to refinance accounts receivable generated by clients' auction and private sale purchases. Term loans normally have initial maturities of up to two years and typically carry a variable market rate of interest.
Prior to 2014, the lending activities of the Finance segment were funded primarily by the operating cash flows of the Agency segment, with the ability to supplement those cash flows with revolving credit facility borrowings. In January 2014, in order to reduce the Finance segment's cost of capital and enhance returns, Sotheby's established a separate capital structure for the Finance segment through which client loans are predominantly funded with borrowings drawn from a dedicated revolving credit facility. The establishment of the Finance segment's dedicated revolving credit facility has allowed Sotheby's to finance a substantial portion of the Finance segment loan portfolio with debt. Cash balances are also used to fund a portion of the Finance segment loan portfolio, as appropriate.


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The collection of secured loans can be adversely impacted by a decline in the art market in general or in the value of the collateral, which is concentrated within certain collecting categories. In addition, in situations when there are competing claims on the collateral and/or when a borrower becomes subject to bankruptcy or insolvency laws, Sotheby's ability to realize on its collateral may be limited or delayed.
Management aims to mitigate the risks associated with potential collateral devaluation by targeting a 50% loan-to-value ("LTV") ratio (i.e., the principal loan amount divided by the low auction estimate of the collateral). Loans may also be made with LTV ratios between 51% and 60% as the Finance segment credit facility permits borrowings on loans with an LTV of up to 60%. In rare circumstances, loans are also made at an initial LTV ratio of higher than 60%. In addition, 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, the value of the collateral, the disposal plans for the collateral, or if an event of default occurs.
See "Finance Segment" and "Liquidity and Capital Resources" under Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for information on the financial performance and capital structure of the Finance segment. See Note 4 of Notes to Consolidated Financial Statements for information about Finance segment loans. See Note 7 of Notes to Consolidated Financial Statements for information about the Finance segment's dedicated revolving credit facility.
Finance Segment Market and Competition
Sotheby's Finance segment is uniquely positioned as a niche lender with the ability to tailor attractive financing packages for clients who wish to obtain immediate access to liquidity from their art assets. Through its Finance segment, Sotheby's deploys its unique combination of art expertise, skills in international law and finance, and access to capital.
A considerable number of traditional lending sources offer conventional loans at a lower cost to borrowers than the average cost of loans offered by the Finance segment. Additionally, many traditional lenders offer borrowers a variety of integrated financial services such as wealth management, which are not offered by Sotheby's. Few lenders, however, are willing to accept works of art as sole collateral for loans as they do not have access to market information allowing them to effectively appraise such collateral during the life of the loan. 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.
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 ("SIR"). In 2004, Sotheby's sold SIR to a subsidiary of Realogy Corporation ("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 2015, 2014, and 2013, Sotheby's earned $8.1 million, $7.2 million, and $6 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, and art education services in the United States (the "U.S.") and the United Kingdom (the "U.K."). Management will consider additional opportunities to license the Sotheby's brand in businesses where appropriate.
Financial and Geographical Information about Segments
See Note 3 of Notes to Consolidated Financial Statements for financial and geographical information about Sotheby's segments.

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Employees
As of December 31, 2015, Sotheby's had 1,596 employees, with 625 located in North America and South America, 525 in the U.K., 226 in Continental Europe, and 220 in Asia. Sotheby's regards its relations with its employees as good. The table below provides a breakdown of Sotheby's employees by segment as of December 31, 2015 and 2014.
December 31,
 
2015
 
2014
Agency
 
1,368

 
1,341

Finance
 
11

 
8

All Other
 
217

 
201

Total
 
1,596

 
1,550

Employees classified within "All Other" principally relate to Sotheby's central corporate and information technology departments.
See Note 19 of Notes to Consolidated Financial Statements for information regarding voluntary separation incentive programs announced by Sotheby's in the fourth quarter of 2015 that will result in headcount reductions in 2016.
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 on the Investor Relations page of its website, www.sothebys.com. 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
Before you make an investment decision with respect to Sotheby's Common Stock, you should carefully consider all of the information included in this Form 10-K and the subsequent periodic filings with the SEC. In particular, you should carefully consider the risk factors described below and the risks and uncertainties related to "Forward Looking Statements," any of which could have a material adverse affect on Sotheby's business, results of operations, financial condition and the actual outcome of matters as to which forward looking statements are made in this annual report. The following risk factors, which are not ranked in any particular order, should be read in conjunction with the balance of this annual report, including the Consolidated Financial Statements and related notes included in this report.
The global economy, 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 (including the Middle East). Accordingly, weakness in those economies and financial markets can adversely affect the supply of and demand for works of art and Sotheby's business. Furthermore, global political conditions may also influence the enactment of legislation that could adversely impact Sotheby's business.
Competition in the international art market is intense and may adversely impact Sotheby's business, results of operations, and financial condition.
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, which may cause significant variability in its results of operations.
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 results of operations from period to period.

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The demand for art is unpredictable, which may cause significant variability in Sotheby's results of operations.
The demand for art is influenced not only by overall economic conditions, but also by changing trends in the art market as to which collecting categories and artists are most sought after and by the collecting preferences of individual collectors. These conditions and trends are difficult to predict and may adversely impact the ability of Sotheby's to obtain and sell consigned property, potentially causing significant variability in Sotheby's results of operations from period to period.
Sotheby's relies on a small number of clients who make a significant contribution to its revenues, profitability, and operating cash flows.
Sotheby's is a global art services business that caters to a select group of the world's most discerning art collectors. 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.
Tax matters may cause significant variability in Sotheby's results of operations.
Sotheby's operates in many tax jurisdictions throughout the world and the provision for income taxes involves a significant amount of judgment regarding the interpretation of relevant facts and laws in the jurisdictions in which Sotheby's operates. Sotheby's effective income tax rate and recorded tax balances can significantly change between periods due to a number of complex factors including, but not limited to: (i) future changes in applicable laws, including the European Commission’s investigations on illegal state aid and the Organisation for Economic Cooperation and Development project on Base Erosion and Profit Shifting, which may result in changes to long-standing tax principles; (ii) projected levels of taxable income; (iii) changes in the jurisdictional mix of forecasted and/or actual pre-tax income; (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 the finalization of income tax returns; (vii) the ability to claim foreign tax credits; (viii) estimates of U.S. and foreign cash, (ix) working capital and investment needs, (x) the repatriation of foreign earnings for which Sotheby's has not previously provided income taxes; and (xi) tax planning strategies.
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 is subject to laws and regulations in many countries involving sales, use, value-added and other indirect taxes which are assessed by various governmental authorities and imposed on certain revenue-producing transactions between Sotheby's and its clients. The application of these laws and regulations to Sotheby's unique business and global client base, and the estimation of any related liabilities, is complex and requires a significant amount of judgment. These indirect tax liabilities are generally not those of Sotheby's unless it fails to collect the correct amount of sales, use, value-added, or other indirect taxes. Failure to collect the correct amount of indirect tax on a transaction may expose Sotheby's to claims from tax authorities.
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.
On November 13, 2015, Sotheby's announced a series of regional voluntary separation incentive programs aimed at reducing headcount and associated compensation costs. Employee transitions under these programs commenced on December 31, 2015 and will occur throughout 2016. Sotheby's currently expects that the programs will result in a net reduction of approximately 5% of its global headcount of approximately 1,600 employees prior to the implementation of the Programs. The loss of employees as a result of these programs could adversely impact Sotheby's ability to compete.
The business plans and strategic initiatives being implemented by Sotheby's may not succeed.
Sotheby's future operating results are dependent, in part, on management's success in implementing its business plans and strategic initiatives. The inability of Sotheby's to successfully implement its business plans and strategic initiatives, including the integration of Art Agency, Partners (see Note 24 of Notes to Consolidated Financial Statements), could result in, among other things, the loss of clients and the impairment of assets. Also, Sotheby's short-term operating results and liquidity could be unfavorably impacted by the implementation of its business plans and strategic initiatives.

9



Government laws and regulations may restrict or limit Sotheby's business or impact the value of its real estate assets.
Many of Sotheby's activities are subject to laws and regulations including, but not limited to, import and export regulations, cultural property regulations, data protection and privacy laws, anti-money laundering laws, antitrust laws, copyright and resale royalty laws, laws and regulations involving sales, use, value-added and other indirect taxes, and regulations related to the use of real estate. In addition, 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 Sotheby's, but do affect the art market generally. A material adverse change in such regulations, such as the American Royalties Too Act of 2014 introduced in the U.S. Congress, which would impose a 5% resale royalty (with a cap of $35,000) on sales of art through large auction houses, could affect 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, increase the cost of moving property to such locations, or expose Sotheby's to legal claims or government inquiries.
Sotheby's joint venture and wholly-owned subsidiary in China are foreign-invested enterprises under Chinese law. As such, enforcement of certain of Sotheby's rights within these entities are subject to approval from the Chinese government, which could limit the ability of the entities to operate and succeed.
Sotheby's operates an equity joint venture with Beijing GeHua Art Company in China and, in 2014, established a wholly-owned subsidiary in China after obtaining the license required to operate as a Foreign-Invested Commercial Enterprise. Because these entities are foreign-invested enterprises under Chinese law, enforcement of certain of Sotheby's rights within these entities is subject to approval from the Chinese government. For example, all changes in ownership and constitution of the joint venture will be subject to approval by the Chinese government, including in the event Sotheby's is seeking to terminate the joint venture agreement, exercise its put option, or wind-up the joint venture. Accordingly, Sotheby's ability to successfully operate its business in China could be constrained by the Chinese government and other unforeseen circumstances.
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 an increase in the activity of buyers from emerging markets, in particular, China. The collection of auction receivables related to buyers from emerging markets may be adversely impacted by the buyer's lack of familiarity with the auction process and the buyer's financial condition. 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.
Sotheby's capital allocation and financial policies may impact its liquidity, financial condition, market capitalization and business, and Sotheby's ongoing ability to return capital to its shareholders (and the size and timing of such return) is subject to ongoing business variables.
The actions taken by management based on its review of Sotheby's capital allocation and financial policies may impact its current and future liquidity, financial condition, market capitalization, and business. In addition, the amount and timing of any potential return of capital to shareholders depends on various factors, including the amount of excess cash generated by the business in the future, the ability to continue to finance the Finance segment loan portfolio with debt, the business initiatives contemplated and implemented by management, and the amount of capital that may be required to support Sotheby's future liquidity needs, among other factors.
Foreign currency exchange rate movements can significantly impact Sotheby's results of operations and financial condition.
Sotheby's has operations throughout the world. Approximately 53% of Sotheby's total revenues were earned outside of the U.S. in 2015, including 27% of its total revenues earned in the U.K. Additionally, Sotheby's has significant assets and liabilities denominated in the Pound Sterling, the Euro, and the Swiss Franc. Revenues, expenses, gains, and losses recorded in foreign currencies are translated using the monthly average exchange rates prevailing during the period in which they are recognized. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Accordingly, fluctuations in foreign currency exchange rates, particularly for the Pound Sterling, the Euro, and the Swiss Franc, can significantly impact Sotheby's results of operations and financial condition.

10



Subject to management approval under Sotheby's internal corporate governance policy, Sotheby's may pay a consignor the net sale proceeds from an auction or private sale before payment is collected from the buyer and/or may allow the buyer to take possession of purchased 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 and private sales, Sotheby's is not obligated to pay the consignor for property that has not been paid for by the buyer. However, in certain instances and subject to management approval under Sotheby's internal corporate governance policy, the consignor may be paid the net sale proceeds before payment is collected from the buyer while Sotheby's retains 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 certain other situations and subject to management approval under Sotheby's internal corporate governance policy, the buyer is allowed to take possession of purchased 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. See Note 4 of Notes to Consolidated Financial Statements for information about auction and private sale receivables.
Sotheby's could be exposed to losses in the event of title or authenticity claims.
The assessment of property offered for auction or private sale can involve potential claims regarding title and authenticity. 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 and the terms stated in, and the laws applicable to, agreements governing private sale transactions. The authentication of the items offered by Sotheby's is based on scholarship and research, but necessarily requires a degree of judgment from Sotheby's specialists. 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 market for fine art, decorative art, and jewelry is not a highly liquid trading market and, as a result, the valuation of these items is inherently subjective. Accordingly, Sotheby's is at risk with respect to management's ability to estimate the likely selling prices of property offered with auction guarantees. If management's judgments about the likely selling prices of property offered with auction guarantees prove to be inaccurate, there could be a significant adverse impact on Sotheby's results, financial condition, and liquidity. See Note 16 of Notes to Consolidated Financial Statements for information related to auction guarantees.
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. See Note 16 of Notes to Consolidated Financial Statements for information related to auction guarantees.
Demand for art-related financing is unpredictable, which may cause variability in the operating results of Sotheby's Finance segment.
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 operating results of Sotheby's Finance segment are subject to variability from period to period.
The ability of Sotheby's to realize proceeds from the sale of collateral for Finance segment loans may be delayed or limited.
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.

11



The value of the property held in inventory and the property pledged as collateral for Finance segment loans is subjective and often fluctuates, exposing Sotheby's to losses and significant variability in its results of operations.
The market for fine art, decorative art, and jewelry is not a highly liquid trading market. As a result, the valuation of these items is inherently subjective and their realizable value often fluctuates over time. Accordingly, Sotheby's is at risk both as to the realizable value of the property held in inventory and as to the realizable value of the property pledged as collateral for Finance segment loans. In estimating the realizable value of art held in inventory and art pledged as collateral for Finance segment loans, management considers the following complex array of factors: (i) whether the property is expected to be offered at auction or sold privately, and the timing of any such sale; (ii) the supply and demand for the property, taking into account current art market conditions, as well as changing trends as to which collecting categories and artists are most sought after; (iii) recent sale prices achieved for comparable items within a particular collecting category and/or by a particular artist, (iv) the state of the global economy and financial markets; and (v) management's intent and ability to hold the property in order to maximize the realizable value. If there is evidence that the estimated realizable value of a specific item held in inventory is less than its carrying value, a loss is recorded to reflect management's revised estimate of realizable value. In addition, if the estimated realizable value of the property pledged as collateral for a Finance segment 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 results of operations from period to period.
The low rate of historic losses on the Finance segment loan portfolio may not be indicative of future loan loss experience.
Sotheby's has historically incurred minimal losses on the Finance segment loan portfolio. However, despite management's stringent loan underwriting standards, Sotheby's previous loan loss experience may not be indicative of the future performance of the loan portfolio.
The collateral supporting the Finance segment loan portfolio is concentrated within certain collecting categories. A material decline in these markets could impair Sotheby's ability to collect the principal and interest owed on certain loans and could require repayments of borrowings on such affected loans under Sotheby's revolving credit facility.
The collateral supporting the Finance segment loan portfolio is concentrated within certain collecting categories. Although management believes the Finance segment loan portfolio is sufficiently collateralized due to its current aggregate loan-to-value ratio of 50%, a material decline in these markets could impair Sotheby's ability to collect the principal and interest owed on certain loans. Additionally, the eligibility of individual Finance segment loans included in the borrowing base of Sotheby's revolving credit facility requires a minimum loan-to-value ratio of 60%. A material decline in the value of Finance segment loan collateral could result in an increase in the loan-to-value ratio above 60% for individual loans and could require repayment of a portion of the borrowings associated with such loans.
Sotheby's could be exposed to losses and/or reputational harm as a result of various claims and lawsuits incidental to the ordinary course of its business.
Sotheby's becomes involved in various legal proceedings, lawsuits, and other claims 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 or reasonably possible losses. A determination of the amount of losses, if any, to be recorded or disclosed as a result of these contingencies is based on a careful analysis of each individual exposure with, in some cases, the assistance of outside legal counsel. The amount of losses recorded or disclosed for such contingencies may change in the future due to new developments in each matter or a change in settlement strategy.
Sotheby's could be exposed to reputational harm as a result of wrongful actions by certain third parties.
Sotheby's is involved in various business arrangements and ventures with unaffiliated third parties. Wrongful actions by such parties could harm Sotheby's brand and reputation.

12



A breach of the security measures protecting Sotheby's global network of information systems and those of certain third-party service providers utilized by Sotheby's could adversely impact its operations, reputation and brand.
The protection of client, employee and company data is extremely important to Sotheby's. The regulatory environment surrounding information security and privacy is becoming increasingly demanding and frequently changing in the jurisdictions in which Sotheby's does business. Clients and employees have expectations that Sotheby's will protect their information from cyber-attacks and other security breaches. Sotheby's has implemented systems and processes that are designed to protect personal and company information and to prevent data losses, however, these measures cannot provide absolute security, and Sotheby's systems may be vulnerable to cyber-security breaches such as viruses, break-ins, and similar disruptions from unauthorized intrusions. In addition, Sotheby's is dependent on a global network of information systems to conduct its business and is committed to maintaining a strong infrastructure to secure these systems. As part of its information systems infrastructure, Sotheby's relies increasingly upon third-party service providers to perform services related to its live auction bidding platform, retail wine and other e-commerce, video broadcasting, website content distribution, marketing, and to store, process and transmit information including client, employee and company information. Any failure on Sotheby's part or by these third-party service providers to maintain the security of Sotheby's confidential data and its client and employee personal information could result in business disruption, damage to reputation, financial obligations, lawsuits, sizable fines and costs, and loss of employee and client confidence in Sotheby's, and thus could have a material adverse impact on Sotheby's business and financial condition, and adversely affect results of operations. A significant security breach could require future expenditures to implement additional security measures to protect against new privacy threats or to comply with state, federal and international laws aimed at addressing those threats.
Due to the nature of its business, valuable works of art are exhibited and stored at Sotheby's facilities around the world. Such works of art could be subject to damage or theft, which could have a material adverse effect on Sotheby's business and reputation.
Valuable works of art are exhibited and stored at Sotheby's facilities around the world. Although Sotheby's maintains state of the art security measures at its premises, valuable artworks may be subject to damage or theft. The damage or theft of valuable property despite these security measures could have a material adverse impact on Sotheby's business and reputation.
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, works of art consigned by clients, and all other property that may be in Sotheby's custody, which are exhibited and 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 could, in the future, have a material adverse impact on Sotheby's business.
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 in or 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.
Future costs and obligations related to 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, changes in statutory requirements in the U.K., and actuarial assumptions, each of which is unpredictable and may cause significant variability in Sotheby's employee benefit costs.
ITEM 1B: UNRESOLVED STAFF COMMENTS
None.

13



ITEM 2: PROPERTIES
Sotheby's is headquartered at 1334 York Avenue, New York, New York (the"York Property"). The York Property includes land and approximately 489,000 square feet of building area. The York Property is home to Sotheby's sole North American auction salesroom and principal North American exhibition space, including S|2, a private sale exhibition gallery. The York Property is also home to the U.S. operations of Sotheby's Finance segment and its corporate offices. The York Property was purchased by Sotheby's on February 6, 2009 for $370 million and, 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.
The York Property is subject to a mortgage, which was refinanced on July 1, 2015 with a seven-year, $325 million mortgage that bears interest based on the one-month LIBOR rate plus a spread of 2.25%. Sotheby's has entered into associated interest rate protection agreements to hedge the risk associated with the variability in expected cash outflows related to the monthly one-month LIBOR-indexed interest payments. As of December 31, 2015, the York Property had a net book value of $264 million. See Notes 7 and 18 of Notes to Consolidated Financial Statements for additional information on the York Property Mortgage and the related interest rate protection agreements.
Sotheby's U.K. operations are centered at New Bond Street, London, where the main salesrooms, exhibition spaces and administrative offices are located. As part of a multi-year refurbishment initiative, Sotheby's has invested approximately $10 million in New Bond Street over the past 4 years to enhance exhibition space and construct an S|2 private sales gallery. Almost the entire New Bond Street complex is either owned or held under various long-term lease, freehold, and virtual freehold arrangements. (Freeholds are occupancy arrangements in which the property is owned outright by Sotheby's. Virtual freeholds are occupancy arrangements in which there is a 2,000-year lease with nominal yearly rent payments that cannot be escalated during the term of the lease.) Sotheby's also leases 52,000 square feet for a warehouse facility in Greenford, West London under a lease that expires in 2030.
Below is a table summarizing Sotheby's ownership, freehold, and lease arrangements related to its London properties as of December 31, 2015 (in thousands of dollars, except for square footage):
 
Square
Footage
 
Net Book Value of Land
 
Net Book Value of Buildings and Building Improvements
 
Net Book Value of Leasehold Improvements
 
Total Net Book Value of London Premises
Freeholds and virtual freeholds
96,503

 
$
5,378

 
$
2,001

 
$
25,953

 
$
33,332

Leases with a remaining term greater than 10 years
108,089

 
 
 
 
 
9,404

 
9,404

All other leases
30,309

 
 
 
 
 
2,705

 
2,705

Total
234,901

 
$
5,378

 
$
2,001

 
$
38,062

 
$
45,441

Sotheby's also leases space primarily for Agency segment operations in various locations throughout North America, South America, Continental Europe and Asia, including sales centers in Geneva and Zurich, Switzerland; Milan, Italy; Paris, France; and Hong Kong and Beijing, China.
Management believes Sotheby's worldwide premises are adequate for the current conduct of its business, but continues to evaluate its real estate holdings in New York and London, taking into account the strategic and operating requirements for these locations.
ITEM 3: LEGAL PROCEEDINGS
See Note 14 of Notes to Consolidated Financial Statements for information related to Legal Proceedings.
ITEM 4: MINE SAFETY DISCLOSURES
Not applicable.


14



PART II

ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Market Information
Quarterly Stock Prices—The principal market for Sotheby's Common Stock is the NYSE (symbol: BID). As of February 12, 2016, there were 863 holders of record of Sotheby's Common Stock. The quarterly price ranges on the NYSE of Sotheby's Common Stock for the years ended December 31, 2015 and 2014 were as follows:
 
 
2015
 
2014
 
 
High
 
Low
 
High
 
Low
Quarter Ended
 
 
 
 
 
 
 
 
March 31
 
$
45.41

 
$
39.70

 
$
53.74

 
$
42.41

June 30
 
$
47.28

 
$
40.47

 
$
44.86

 
$
37.89

September 30
 
$
45.74

 
$
31.46

 
$
44.95

 
$
35.00

December 31
 
$
35.40

 
$
25.49

 
$
44.01

 
$
34.74

Cash Dividends—The following table summarizes cash dividends declared and paid to shareholders in each of the quarterly periods in the years ended December 31, 2015 and 2014 (in thousands of dollars, except per share amounts):
 
 
2015
 
2014
 
 
Per Share
 
Amount
 
Per Share
 
Amount
Quarterly Dividends
 
 
 
 
 
 
 
 
1st quarter
 
$
0.10

 
$
6,944

 
$
0.10

 
$
6,944

2nd quarter
 
0.10

 
6,933

 
0.10

 
6,894

3rd quarter
 
0.10

 
6,667

 
0.10

 
6,899

4th quarter
 
0.10

 
6,563

 
0.10

 
6,899

Total
 
0.40

 
27,107

 
0.40

 
27,636

Special Dividends
 
 
 
 
 
 
 
 
1st quarter
 

 

 
4.34

 
300,118

Total dividends
 
$
0.40

 
$
27,107

 
$
4.74

 
$
327,754

In January 2014, Sotheby's declared a special dividend of $300 million ($4.34 per share) payable to shareholders of record as of February 12, 2014. The $300 million special dividend was paid on March 17, 2014 and was funded principally by the repatriation of $250 million of cash from Sotheby's foreign subsidiaries, with the remaining $50 million funded by existing domestic cash balances. In conjunction with this special dividend, dividend equivalents of approximately $11 million were accrued on share-based payments to Sotheby's employees and charged against retained earnings. Through December 31, 2015, approximately $5.8 million of such dividends has been paid to employees, with $2 million paid in March 2015 and $3.8 million paid in March 2014. See Note 12 of Notes to Consolidated Financial Statements for information related to Sotheby's share-based payment programs.
On January 21, 2016, in light of management's recent capital allocation analysis, the Board of Directors decided to eliminate Sotheby's $0.10 per share quarterly cash dividend and allocate the capital instead to repurchase shares of Common Stock. See "Issuer Purchases of Equity Securities" below.
Sotheby's has a credit agreement with an international syndicate of lenders led by General Electric Capital Corporation under which there are no limitations on dividend payments and Common Stock repurchases provided that, both before and after giving effect thereto: (i) there are no events of default, (ii) the aggregate borrowing capacity equals or exceeds $100 million, and (iii) the Liquidity Amount, as defined in the credit agreement, equals or exceeds $200 million. See "Liquidity and Capital Resources" under Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Note 7 of Notes to Consolidated Financial Statements for additional information related to Sotheby's credit agreement.

15




Issuer Purchases of Equity Securities
The following table provides information regarding purchases of Common Stock by Sotheby's during the three months ended December 31, 2015:
Period
 
Total number of shares purchased
 
Average price paid per share
 
Total number of shares purchased as part of Sotheby's publicly announced share repurchase program
 
Approximate dollar value of shares that may yet be purchased under Sotheby's publicly announced share repurchase program
October 2015
 

 
$

 

 
$
125,000,000

November 2015
 
1,038,280

 
$
24.08

 
1,038,280

 
$
125,000,000

December 2015
 

 
$

 

 
$
125,000,000

Fourth Quarter 2015
 
1,038,280

 
 
 
1,038,280

 
 
In January 2014, the Board of Directors authorized a five-year, $150 million Common Stock repurchase program. In March 2014, Sotheby's repurchased 558,171 shares of its Common Stock for an aggregate purchase price of $25 million ($44.79 per share) pursuant to an accelerated share repurchase ("ASR") agreement.
On August 6, 2015, the Board of Directors approved an increase of $125 million to Sotheby's share repurchase authorization. On August 13, 2015, Sotheby's entered into an ASR agreement (the "August 2015 ASR Agreement") pursuant to which it received an initial delivery of 2,667,378 shares of its Common Stock for an initial purchase price of $125 million. The initial shares received by Sotheby's on August 13, 2015 had a value of $100 million, or $37.49 per share. In November 2015, the counterparty to the August 2015 ASR Agreement elected to conclude the agreement, and Sotheby's received an additional 1,038,280 shares of its Common Stock. Accordingly, the August 2015 ASR Agreement resulted in the total repurchase of 3,705,658 shares of Sotheby's Common Stock for an average price of $33.73 per share.
On January 21, 2016, in light of management's recent capital allocation analysis, the Board of Directors approved a $200 million increase to Sotheby's remaining $125 million share repurchase authorization, resulting in an updated total share repurchase authorization of $325 million. Through February 25, 2016, Sotheby's has repurchased 3,998,381 shares of its Common Stock for $90.9 million at an average price of $22.74 per share under this authorization through open market purchases. Management expects to continue to repurchase shares of Common Stock under this authorization through additional open market purchases and/or accelerated share repurchase agreements, subject to the factors described in the following paragraph.
The timing of share repurchases and the actual amount purchased will depend on a variety of factors including the market price of Sotheby's Common Stock, general market and economic conditions, and other corporate considerations. Repurchases may be made pursuant to plans intended to comply with Rule 10b5-1 under the Exchange Act, which could allow Sotheby's to purchase its shares during periods when it otherwise might be prevented from doing so under insider trading laws or because of self-imposed trading blackout periods. The repurchase authorization does not require the purchase of a specific number of shares and is subject to suspension or termination by the Board of Directors at any time.


16



Equity Compensation Plans
The following table provides information as of December 31, 2015 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 Available for
Future Issuance Under
Equity Compensation Plans (4)
 
 
(In thousands, except per share data)
Equity compensation plans approved by shareholders
 
1,864

 
$
22.11

 
3,501

Equity compensation plans not approved by shareholders
 
206

 

 

Total
 
2,070

 
$
22.11

 
3,501

_____________________________________________________________
(1)
See Note 12 of Notes to Consolidated Financial Statements for a description of the material features of Sotheby's equity compensation plans.
(2)
Equity compensation plans approved by shareholders include 1,813,614 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 50,000 vested and outstanding stock options for which vesting was contingent only upon future employee service. Equity compensation plans not approved by shareholders consist of inducement awards granted to Thomas S. Smith, Jr., Sotheby's President and Chief Executive Officer ("CEO"), upon the commencement of his employment on March 31, 2015, consisting of an award of 158,638 shares of restricted stock and 47,070 fully-vested restricted stock units. These awards were not issued pursuant to the Restricted Stock Unit Plan and have not been registered with the SEC. See Note 12 of Notes to Consolidated Financial Statements for a description of these inducement awards.
(3)
The weighted-average exercise price includes the exercise price of stock options, but does not take into account 1,813,614 shares awarded under the Restricted Stock Unit Plan or the 158,638 restricted stock shares and 47,070 fully-vested restricted stock units granted to Mr. Smith upon the commencement of his employment as Sotheby's President and CEO on March 31, 2015.
(4)
Includes 3,227,866 shares available for future issuance under the Restricted Stock Unit Plan, 104,100 shares available for issuance under the Stock Option Plan, and 168,850 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, 2010 to December 31, 2015 with the cumulative return of the Standard & Poor's Global Luxury Index (the "S&P Global Luxury Index"), which is a line-of-business index largely composed of companies whose products and services appeal to a segment of the population consistent with Sotheby's clients, and the Standard & Poor's MidCap 400 Stock Index (the"S&P MidCap 400").
The graph reflects an investment of $100 in Sotheby's Common Stock, the S&P Global Luxury Index, and the S&P MidCap 400 on December 31, 2010, and a reinvestment of dividends at the average of the closing stock prices at the beginning and end of each quarter.
 
 
12/31/10
 
12/31/11
 
12/31/12
 
12/31/13
 
12/31/14
 
12/31/15
Sotheby's
 
$
100.00

 
$
63.80

 
$
76.37

 
$
121.35

 
$
108.34

 
$
65.33

S&P Global Luxury Index
 
$
100.00

 
$
98.23

 
$
124.18

 
$
168.38

 
$
160.71

 
$
151.18

S&P MidCap 400
 
$
100.00

 
$
98.28

 
$
115.84

 
$
154.67

 
$
169.76

 
$
166.10


18



ITEM 6: SELECTED FINANCIAL DATA
Year ended December 31,
 
2015
 
2014
 
2013
 
2012
 
2011
 
 
(Thousands of dollars, except per share data)
Income Statement Data:
 
 

 
 

 
 

 
 

 
 

Revenues:
 
 
 
 
 
 
 
 
 
 
Agency commissions and fees
 
$
791,920

 
$
825,126

 
$
793,639

 
$
717,231

 
$
791,738

Inventory sales
 
108,699

 
69,958

 
30,638

 
26,180

 
21,790

Finance
 
50,489

 
33,013

 
21,277

 
17,707

 
12,038

License fees
 
9,820

 
8,484

 
6,902

 
6,124

 
5,228

Other
 
566

 
1,472

 
1,222

 
1,250

 
1,042

Total revenues
 
$
961,494

 
$
938,053

 
$
853,678

 
$
768,492

 
$
831,836

Net interest expense (a)
 
$
(30,969
)
 
$
(33,306
)
 
$
(39,911
)
 
$
(42,879
)
 
$
(37,496
)
Net income attributable to Sotheby's
 
$
43,727

 
$
117,795

 
$
130,006

 
$
108,292

 
$
171,416

Basic earnings per share
 
$
0.64

 
$
1.69

 
$
1.90

 
$
1.59

 
$
2.52

Diluted earnings per share
 
$
0.63

 
$
1.68

 
$
1.88

 
$
1.57

 
$
2.46

Cash dividends declared per share
 
$
0.40

 
$
4.74

 
$
0.20

 
$
0.52

 
$
0.23

Statistical Metrics:
 
 
 
 
 
 
 
 
 
 
Net Auction Sales (b)
 
$
5,016,738

 
$
5,151,419

 
$
4,338,948

 
$
3,809,656

 
$
4,240,573

Auction Commission Margin (c)
 
14.3
%
 
14.7
%
 
15.9
%
 
16.3
%
 
16.6
%
Private Sales (d)
 
$
673,119

 
$
624,511

 
$
1,179,038

 
$
906,510

 
$
814,581

Adjusted Net Income (e)
 
$
143,131

 
$
142,398

 
$
139,461

 
$
116,553

 
$
175,782

Adjusted Diluted Earnings Per Share (e)
 
$
2.07

 
$
2.03

 
$
2.02

 
$
1.69

 
$
2.52

EBITDA (e)
 
$
241,102

 
$
256,776

 
$
245,066

 
$
220,640

 
$
286,596

Adjusted EBITDA (e)
 
$
294,551

 
$
298,613

 
$
246,438

 
$
235,658

 
$
292,955

Balance Sheet Data:
 
 

 
 

 
 

 
 

 
 

Working capital (f)
 
$
912,156

 
$
610,315

 
$
829,784

 
$
706,244

 
$
728,984

Average Loan Portfolio (g)
 
$
732,814

 
$
583,304

 
$
433,619

 
$
335,898

 
$
219,785

Total assets
 
$
3,274,129

 
$
3,134,820

 
$
2,893,546

 
$
2,575,095

 
$
2,399,414

Credit facility borrowings
 
$
541,500

 
$
445,000

 
$

 
$

 
$

Long-term debt, net
 
$
614,767

 
$
300,000

 
$
515,148

 
$
515,197

 
$
464,552

Total equity
 
$
806,704

 
$
878,238

 
$
1,139,665

 
$
992,826

 
$
903,667

Legend:
(a)
Represents interest expense less interest income.
(b)
Represents the total hammer (sale) price of property sold at auction.
(c)
Represents total auction commission revenues as a percentage of Net Auction Sales.
(d)
Represents the total purchase price of property sold in private sales brokered by Sotheby's, including its commissions.
(e)
See "Non-GAAP Financial Measures" under Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for a description of this non-GAAP financial measure and a reconciliation to the most comparable GAAP amount.
(f)
See Note 23 of Notes to Consolidated Financial Statements for information regarding a change in the balance sheet classification of deferred tax assets and liabilities that was adopted in 2015.
(g)
Represents the average Finance segment loan portfolio outstanding during the period.


19




ITEM 7:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Sotheby's is a global art business whose operations are organized under two segments—Agency and Finance. The Agency segment earns commissions by matching buyers and sellers of authenticated works of art through the auction or private sale process. To a much lesser extent, Agency segment activities also include the sale of artworks that are principally acquired incidental to the auction process and the activities of RM Sotheby's, an equity investee that operates as an auction house for investment-quality automobiles. The Finance segment earns interest income through art-related financing activities by making loans that are secured by works of art. See Note 3 of Notes to Consolidated Financial Statements for information regarding a change in Sotheby's segment reporting that became effective in the second quarter of 2015.
The global art market is influenced over time by the overall strength and stability of the global economy, the financial markets of various countries, geopolitical conditions, and world events, all of which may impact the willingness of potential buyers and sellers to purchase and sell art. In addition, the amount and quality of art consigned for sale is influenced by other factors not within Sotheby's control, and many consignments often become available as a result of the death or financial or marital difficulties of the owner. These factors cause the supply and demand for works of art to be unpredictable and may lead to significant variability in Sotheby's revenues from period to period.
Competition in the international art market is intense. A fundamental challenge facing any auctioneer or art dealer is the sourcing of high quality and valuable property for sale either as agent or as principal. Sotheby's primary global competitor is Christie's, a privately owned auction house. In response to the competitive environment, Sotheby's may offer consignors a variety of financial inducements such as auction commission sharing arrangements and auction guarantees as a means to secure high-value consignments. Although these inducements may lead to a higher level of auction consignments, they adversely impact auction commission margins, and auction guarantees introduce the possibility of incurring a loss on the transaction and reduced liquidity if the underlying property fails to sell at the minimum guaranteed price. To mitigate the risk of a decline in auction commission margins, from time-to-time, Sotheby's adjusts its commission rate structures. In addition, Sotheby's may reduce its financial exposure under auction guarantees through contractual risk and reward sharing arrangements such as irrevocable bids under which a counterparty commits to bid a predetermined price on the guaranteed property. However, Sotheby's could be exposed to losses in the event any of its counterparties do not perform according to the terms of these contractual arrangements.
Sotheby's is a service business in which the ability of its employees to source high-value works of art and develop and maintain relationships with potential sellers and buyers of art is essential to its success. Sotheby's business is highly dependent upon attracting and retaining qualified personnel and employee compensation is its most substantial operating expense. Sotheby's also incurs significant costs to promote and conduct its auctions, as well as general and administrative expenses to support its global operations. While a large portion of Sotheby's expenses are fixed, certain categories of expense are variable. For example, sale marketing costs are dependent upon the volume of auction activity and certain elements of employee compensation are a function of Sotheby's profitability.
Business and Industry Trends
Agency Segment—In late-2009, the global art market began a period of expansion that resulted in some of the most profitable years in Sotheby's history. A significant driver of the expansion of the global art market and Sotheby's profitability during this period was the growth of the Contemporary and Asian art markets, as well as increased demand for art from clients in China and other emerging markets across several collecting categories.
As the global art market expanded, the value of the property sold by Sotheby's increased and the competitive environment between Sotheby's and Christie's intensified. These factors resulted in a decline in auction commission margins over the past few years, with the competitive environment for high-value consignments causing an increase in the use of auction commission sharing arrangements and an increase in the use of auction guarantees, sometimes without the protection of irrevocable bids. To help mitigate the decline in auction commission margins, in March 2013 and again in February 2015, management enacted increases in Sotheby's buyer's premium rate structure. See "Auction Commission Margin" within the discussion of Agency segment results below for additional commentary.
Auction sale results in the fourth quarter of 2015 and to date in 2016 indicate that the global art market is experiencing a period of lower sales and the long-term growth trend in the market appears to be moderating in 2016. See statement on Forward Looking Statements.


20




Finance Segment—In recent years, there has also been an increase in the demand for art-related financing. In response, and in an effort to reduce the Finance segment's cost of capital and enhance returns, in January 2014, Sotheby's established a separate capital structure for the Finance segment through which client loans are predominantly funded with borrowings drawn from a dedicated revolving credit facility. The establishment of the Finance segment's dedicated revolving credit facility has allowed management to finance 79% of the loan portfolio with debt, and has contributed to a 44% increase in the client loan portfolio when compared to December 31, 2013, resulting in a 56% increase in Finance segment gross profit for the year ended December 31, 2015 when compared to 2013.
Seasonality
The worldwide art auction market has two principal selling seasons, which generally occur in the second and fourth quarters of the year. In the aggregate, second and fourth quarter Net Auction Sales represented 78% and 79% of total Net Auction Sales in 2015 and 2014, respectively, with auction commission revenues comprising approximately 75% and 81%, respectively, of Sotheby's total revenues in those years. Accordingly, Sotheby's financial results are seasonal, with peak revenues and operating income generally occurring in the second and fourth quarters. Consequently, first and third quarter results have historically reflected lower revenues when compared to the second and fourth quarters and, typically, a net loss due to the fixed nature of many of Sotheby's operating expenses. Management believes that investors should focus on results for six and twelve month periods, which better reflect the business cycle of the art auction market. See Note 25 of Notes to Consolidated Financial Statements for Sotheby's quarterly results for the years ended December 31, 2015 and 2014.
Critical Accounting Estimates
The preparation of financial statements and related disclosures in accordance with GAAP requires management to make judgments, assumptions, and estimates that affect the amounts reported in Sotheby's 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 1 of Notes to Consolidated Financial Statements describes the significant accounting policies and methods used in the preparation of Sotheby's Consolidated Financial Statements. In addition, management believes that the following are its most critical accounting estimates, which are not ranked in any particular order, that may affect Sotheby's reported financial condition and/or results of operations.
(1)
Valuation of Inventory and Loan Collateral—The art market is not a highly liquid trading market. As a result, the valuation of art is inherently subjective and the realizable value of art often fluctuates over time. If there is evidence that the estimated realizable value of a specific item held by Sotheby's in inventory is less than its carrying value, a loss is recorded to reflect management's revised estimate of realizable value. If the estimated realizable value of the property pledged as collateral for a Finance segment loan is less than the corresponding loan balance, management must assess whether it is necessary to record a loss to reduce the carrying value of the loan, after taking into account the ability of the borrower to repay any shortfall between the value of the collateral and the amount of the loan.
In estimating the realizable value of art held in inventory and art pledged as collateral for Finance segment loans, management considers the following complex array of factors: (i) whether the property is expected to be offered at auction or sold privately, and the timing of any such sale; (ii) the supply and demand for the property, taking into account current art market conditions, as well as changing trends as to which collecting categories and artists are most sought after; (iii) recent sale prices achieved for comparable items within a particular collecting category and/or by a particular artist; (iv) the state of the global economy and financial markets; and (v) management's intent and ability to hold the property in order to maximize the realizable value.
Due to the inherent subjectivity involved in estimating the realizable value of art held in inventory and art pledged as collateral for Finance segment loans, management's estimates of realizable value may prove, with the benefit of hindsight, to be different than the amount ultimately realized upon sale.
See Note 1 of Notes to Consolidated Financial Statements for information related to Sotheby's inventory. See Note 4 of Notes to Consolidated Financial Statements for information related to Finance segment loans.

21




(2) Accounts Receivable—Accounts receivable principally includes amounts due from buyers as a result of auction and private sale transactions. The recorded amount reflects the purchase price of the property, including Sotheby's commission. Under the standard terms and conditions of its auction and private sales, Sotheby's is not obligated to pay the consignor for property that has not been paid for by the buyer. If a buyer defaults on payment, the sale may be cancelled and the property will be returned to the consignor. Management continually evaluates the collectability of amounts due from individual buyers and, if management determines that it is probable that a buyer will default, a cancelled sale is recorded in the period in which that determination is made and the associated accounts receivable balance, including Sotheby's auction commission, is reversed. Historically, cancelled sales have not been material in relation to the aggregate hammer price of property sold at auction.
In certain instances and subject to management approval under Sotheby's internal corporate governance policy, the consignor may be paid the net sale proceeds before payment is collected from the buyer while Sotheby's retains 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 certain other situations and subject to management approval under Sotheby's internal corporate governance policy, the buyer is allowed to take possession of purchased 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.
Management's judgments regarding the collectability of accounts receivable are based on an assessment of the buyer's payment history, discussions with the buyer, and the value of any property held as security against the buyer's payment obligation. Management's judgments with respect to the collectability of amounts due from buyers for auction and private sale purchases may prove, with the benefit of hindsight, to be incorrect. See Note 4 of Notes to Consolidated Financial Statements for information related to accounts receivable.
(3) 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 those related to the discount rate, the expected long-term rate of return on plan assets, future inflation, and mortality, which are reviewed and updated, as appropriate, 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 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 yield curve for a selection of high-quality corporate bonds with maturity dates approximating the length of time remaining until individual benefit payment dates. The discount rate as of December 31, 2014 that was used to calculate the $1.6 million net pension cost recorded in 2015 was 3.5%. 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 $0.5 million. As of December 31, 2015, the discount rate used to calculate the $326.2 million benefit obligation was 3.7%. A hypothetical increase or decrease of 0.1% in this assumption would result in a decrease or increase in the benefit obligation of approximately $6.1 million.
The expected long-term rate of return is weighted according to the composition of invested assets and is based on expected future appreciation, as well as dividend and interest yields currently available in the equity and bond markets. In particular, the expected rate of return for growth assets represents management's best estimate of annualized long-term returns by asset class. The expected rate of return on debt securities is based on interest yields currently available on long-dated U.K. government bonds and highly-rated corporate bonds. The expected long-term rate of return on plan assets used to calculate the $1.6 million net pension cost recorded in 2015 was 5.4%. 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 $0.9 million.
Assumed mortality rates are based upon standardized data tables used by actuaries in the U.K., taking into account the demographics of U.K. Pension Plan members and allowances for longer future life expectancies. A hypothetical 5% increase or decrease in life expectancies would result in an increase or decrease in net pension cost of approximately $0.4 million. Additionally, a hypothetical 5% increase or decrease in life expectancies would result in an increase or decrease in the benefit obligation of approximately $3.3 million.

22



As of December 31, 2015, the accumulated after-tax net loss related to the U.K. Pension Plan that has not yet been recognized in Sotheby's Consolidated Income Statements was ($10) million and is reflected in the Shareholders' Equity section of Sotheby' Consolidated Balance Sheets. Unrecognized pension losses are generally the result of: (i) actual results being different from previous actuarial assumptions (for example, the expected return on plan assets); (ii) changes in actuarial assumptions between balance sheet dates (for example, the discount rate); and/or (iii) curtailment gains. If the unrecognized pre-tax loss reflected in Shareholders' Equity ($18 million) were to exceed 10% of the greater of: (i) the market-related value of plan assets ($381 million) or (ii) the benefit obligation ($326 million), the excess amount would be amortized as a component of future net pension cost over the average expected remaining service period of active plan participants, which is approximately 12.4 years.
Management is currently in consultation with active participants regarding an amendment to the U.K. Pension Plan which would close the plan to accrual of future service costs for these employees. This consultation process is being conducted in accordance with local statutory requirements and the resulting amendment is expected to be enacted in the first quarter of 2016. The ($10) million accumulated after-tax net loss reflected in the Shareholders' Equity section of Sotheby's Consolidated Balance Sheets includes a $17.9 million curtailment gain resulting from this expected plan amendment.
See Note 15 of Notes to Consolidated Financial Statements for additional information related to the U.K. Pension Plan.
(4)
Income Taxes—The provision for income taxes involves a significant amount of management judgment regarding the interpretation of the relevant facts and laws in the many jurisdictions in which Sotheby's operates. Sotheby's effective income tax rate and recorded tax balances can change significantly between periods due to a number of complex factors including, but not limited to: (i) future changes in applicable laws, including the European Commission’s investigations on illegal state aid and the Organisation for Economic Cooperation and Development project on Base Erosion and Profit Shifting, which may result in changes to long-standing tax principles; (ii) projected levels of taxable income; (iii) changes in the jurisdictional mix of forecasted and/or actual pre-tax income; (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 the finalization of income tax returns; (vii) the ability to claim foreign tax credits; (viii) estimates of U.S. and foreign cash, (ix) working capital and investment needs, (x) the repatriation of foreign earnings for which Sotheby's has not previously provided income taxes; and (xi) tax planning strategies.
As of December 31, 2015, Sotheby's had a net deferred tax liability of $32.5 million, which includes gross deferred tax assets of $79.3 million, primarily resulting from deductible temporary differences which will reduce taxable income in future periods over a number of years. To a lesser extent, Sotheby's also has deferred tax assets relating to net operating loss carryforwards, which are partially offset by a valuation allowance of $2.4 million to reduce the deferred tax assets to the amount that management has determined 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 determines that sufficient negative evidence exists (for example, if Sotheby's experiences cumulative three-year losses in a certain jurisdiction), then management will consider recording a valuation allowance against a portion or all of the deferred tax assets in that jurisdiction. If, after recording a valuation allowance, 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 could prove more difficult to support the realization of these deferred tax assets. As a result, an additional valuation allowance could be required, which would have an adverse impact on Sotheby's effective income tax rate and results. Conversely, if, after recording a valuation allowance, management determines that sufficient positive evidence exists in the jurisdiction in which it recorded the valuation allowance (for example, if Sotheby's is no longer in a three-year cumulative loss position in the jurisdiction, and management expects to have future taxable income in that jurisdiction based upon its forecasts and the expected timing of deferred tax asset reversals), management may reverse a portion or all of the valuation allowance in that jurisdiction. In such situations, the adjustment made to the deferred tax asset would have a favorable impact on Sotheby's effective income tax rate and results in the period such determination was made.

23



Due to the global complexity of tax regulation, Sotheby's records liabilities to address potential exposures involving uncertain tax positions that management 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 and interpretations of income tax related statutes, rules, and regulations. As of December 31, 2015, Sotheby’s liability for unrecognized tax benefits, excluding interest and penalties, was $22 million. Management believes that Sotheby's recorded tax liabilities are adequate to cover all open years based on an assessment of the relevant facts and circumstances. This assessment involves assumptions and significant judgments about future events and potential actions by taxing authorities, as well as an evaluation of past experiences. The cost of the ultimate resolution of these matters may be greater or less than the liability that Sotheby's has recorded. To the extent that management's opinion as to the outcome of these matters changes, income tax expense will be adjusted accordingly in the period in which such a determination is made.
See discussion "Income Tax Expense" below, as well as Notes 8 and 9 of Notes to Consolidated Financial Statements.
(5)
Share-Based Payments—Sotheby's grants share-based payment awards as compensation to certain employees. The amount of compensation expense recognized for share-based payments is based on management's estimate of the number of shares ultimately expected to vest as a result of employee service. A substantial portion of the share-based payment awards vest only if Sotheby's achieves established profitability targets. The amount and timing of compensation expense recognized for such performance-based awards is dependent upon management's quarterly assessment of the likelihood and timing of achieving these future profitability targets. Accordingly, if management's projections of future profitability prove, with the benefit of hindsight, to be inaccurate, the amount of life-to-date and future compensation expense related to share-based payments could significantly increase or decrease.
In 2015, Sotheby's granted a share-based payment award to Thomas S. Smith, Jr., its President and Chief Executive Officer, with a single vesting opportunity after a five-year service period contingent upon the achievement of pre-determined levels of Sotheby's stock price appreciation. The compensation expense recognized for this share-based payment is based on management's estimate of the grant date fair value of the award. In developing this estimate, management considered current market conditions, historical data, and other relevant data. See Note 12 of Notes to Consolidated Financial Statements for information related to Sotheby's share-based payment programs.

24



RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2015 AND 2014
This discussion should be read in conjunction with Note 3 of Notes to Consolidated Financial Statements, which provides financial information about Sotheby's segments.
Overview
Sotheby's reported net income of $43.7 million (or $0.63 per diluted share) in 2015, representing a decrease of $74.1 million (63%) when compared to net income in 2014 of $117.8 million (or $1.68 per diluted share). The lower level of net income is due to a number of charges recorded in 2015, including a $65.7 million non-cash income tax charge related to the planned repatriation of foreign earnings and an after-tax charge of $23.6 million related to a series of regional voluntary separation incentive programs, both recognized in the fourth quarter of 2015. Excluding these and other charges, Sotheby's reported Adjusted Net Income* of $143.1 million (or $2.07 per diluted share), is comparable to 2014 Adjusted Net Income* of $142.4 million (or $2.03 per diluted share).
The comparison of Sotheby's net income and Adjusted Net Income* between 2015 and 2014 is also significantly influenced by sales of property from the collection of A. Alfred Taubman (the "Taubman Collection"), which is subject to an auction guarantee. Auction sale results for the Taubman Collection will fall short of the guaranteed amount and, accordingly, Sotheby's will not recognize any net auction commission revenue from this consignment, which contributed to the decline in auction commission margin when compared to the prior year. The comparison between the two years is also impacted by an overall lower level of auction commission revenues, as well as a higher level of auction direct costs (including $6 million attributable to the Taubman Collection) and an increase in inventory writedowns. These factors are largely offset by a lower level of accrued incentive compensation, improved Finance segment results, and a higher level of equity earnings in part attributable to Sotheby's 25% interest in RM Sotheby's, which was acquired in February 2015.
Although Adjusted Net Income* for 2015 is comparable to 2014, Adjusted Diluted Earnings Per Share* of $2.07 reflects an improvement versus 2014 due to 3,705,658 shares of Common Stock repurchased during the year.
Update on Taubman Collection
On September 2, 2015, Sotheby's entered into an arrangement with the Estate of A. Alfred Taubman (the "Estate") under which Sotheby's is selling works of art from the Taubman Collection. Robert S. Taubman, a director of Sotheby's, is a trustee and beneficiary of the Estate. In connection with this arrangement, Sotheby's provided an auction guarantee of $509 million, which takes into account items withdrawn by the Estate prior to sale. Through February 24, 2016, total aggregate proceeds (i.e., the hammer price plus buyer's premium) from sales of Taubman Collection property were $470 million. The results of these sales, combined with the estimated value of items which were taken into inventory after failing to sell at auction ($33 million) and the estimated aggregate proceeds of the remaining property to be offered at future auctions ($3 million), result in a projected loss on the auction guarantee of approximately $3 million, which was recognized in the fourth quarter of 2015. The remaining outstanding auction guarantee attributable to the Taubman Collection as of February 24, 2016 is $3.4 million, relating to property scheduled to be offered at auction in 2016.







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




25



Outlook
First Quarter of 2016
Sotheby’s financial results are seasonal, with peak revenues and operating income generally occurring in the second and fourth quarters. Consequently, first and third quarter results have historically reflected lower revenues when compared to the second and fourth quarters and, typically, a net loss due to the fixed nature of many of Sotheby’s operating expenses.  However, Sotheby’s reported unusually strong results and a profitable quarter for the three months ended March 31, 2015, attributable to the single-owner Bear Witness sale of Contemporary Art in London, and strong various-owner sales of Impressionist and Contemporary Art in London and Asian Art in New York. Through the first two months of 2016, Aggregate Auction Sales have decreased by approximately 33%, when compared to the same period in 2015. Accordingly, management anticipates a significant net loss in the first quarter of 2016. See statement on Forward Looking Statements.
Full Year 2016
Auction sale results in the fourth quarter of 2015 and to date in 2016 indicate that the global art market is experiencing a period of lower sales in comparison to the first half of 2015. Accordingly, it is unlikely that Net Auction Sales and revenues in 2016 will equal the levels achieved in 2015 and 2014. See statement on Forward Looking Statements.
























26



Results of Operations for the Years Ended December 31, 2015 and 2014
The table below presents a summary of Sotheby's consolidated results of operations and related statistical metrics for the years ended December 31, 2015 and 2014, as well as a comparison between the current and prior year periods (in thousands of dollars, except per share data):
 
 
 
 
 
Variance
 
2015
 
2014
 
$ / %
 
%
Revenues:
 

 
 

 
 

 
 

Agency commissions and fees
$
791,920

 
$
825,126

 
$
(33,206
)
 
(4
%)
Inventory sales
108,699

 
69,958

 
38,741

 
55
%
Finance
50,489

 
33,013

 
17,476

 
53
%
License fees
9,820

 
8,484

 
1,336

 
16
%
Other
566

 
1,472

 
(906
)
 
(62
%)
Total revenues
961,494

 
938,053

 
23,441

 
2
%
Expenses:
 
 
 
 
 
 
 
Agency direct costs
91,919

 
86,524

 
5,395

 
6
%
Cost of inventory sales
111,090

 
68,037

 
43,053

 
63
%
Cost of Finance revenues
15,780

 
8,740

 
7,040

 
81
%
Marketing
19,332

 
16,566

 
2,766

 
17
%
Salaries and related
302,825

 
310,934

 
(8,109
)
 
(3
%)
General and administrative
159,148

 
158,796

 
352

 
%
Depreciation and amortization
19,481

 
20,575

 
(1,094
)
 
(5
%)
Voluntary separation incentive programs (a)
36,938

 

 
36,938

 
N/A

CEO separation and transition costs (b)
4,232

 
7,591

 
(3,359
)
 
(44
%)
Restructuring charges (net) (c)
(972
)
 
14,238

 
(15,210
)
 
N/A

Special charges (net) (d)

 
20,008

 
(20,008
)
 
(100
%)
Total expenses
759,773

 
712,009

 
47,764

 
7
%
Operating income
201,721

 
226,044

 
(24,323
)
 
(11
%)
Net interest expense (e)
(30,969
)
 
(33,306
)
 
2,337

 
7
%
Other (expense) income
(1,453
)
 
283

 
(1,736
)
 
N/A

Income before taxes
169,299

 
193,021

 
(23,722
)
 
(12
%)
Equity in earnings of investees
5,327

 
732

 
4,595

 
*

Income tax expense
131,145

 
75,761

 
55,384

 
73
%
Net income
43,481

 
117,992

 
(74,511
)
 
(63
%)
Less: Net (loss) income attributable to noncontrolling interest
(246
)
 
197

 
(443
)
 
N/A

Net income attributable to Sotheby's
$
43,727

 
$
117,795

 
$
(74,068
)
 
(63
%)
Diluted earnings per share - Sotheby's common shareholders
$
0.63

 
$
1.68

 
$
(1.05
)
 
(63
%)
Statistical Metrics:
 

 
 

 
 

 


Aggregate Auction Sales (f)
$
5,949,030

 
$
6,075,345

 
$
(126,315
)
 
(2
%)
Net Auction Sales (g)
$
5,016,738

 
$
5,151,419

 
$
(134,681
)
 
(3
%)
Private Sales (h)
$
673,119

 
$
624,511

 
$
48,608

 
8
%
Consolidated Sales (i)
$
6,720,384

 
$
6,740,114

 
$
(19,730
)
 
%
Adjusted Expenses (j)
$
579,454

 
$
593,395

 
$
(13,941
)
 
(2
%)
Adjusted Operating Income (j)
$
255,170

 
$
267,881

 
$
(12,711
)
 
(5
%)
Adjusted Net Income (j)
$
143,131

 
$
142,398

 
$
733

 
1
%
Adjusted Diluted Earnings Per Share (j)
$
2.07

 
$
2.03

 
$
0.04

 
2
%
EBITDA (j)
$
241,102

 
$
256,776

 
$
(15,674
)
 
(6
%)
Adjusted EBITDA (j)
$
294,551

 
$
298,613

 
$
(4,062
)
 
(1
%)
EBITDA Margin (j)
25.1
%
 
27.4
%
 
(2.3
%)
 
N/A

Adjusted EBITDA Margin (j)
30.6
%
 
31.8
%
 
(1.2
%)
 
N/A

Effective income tax rate (k)
77.5
%
 
39.2
%
 
38.3
%
 
N/A


27



Legend:
 *
Represents a change in excess of 100%.
(a)
Consists of charges associated with the voluntary separation incentive programs implemented by Sotheby's in the fourth quarter of 2015. See "Voluntary Separation Incentive Programs" below for additional information.
(b)
Consists of compensation-related charges and other costs associated with the resignation of William F. Ruprecht as Sotheby's President and Chief Executive Officer and the subsequent hiring of Thomas S. Smith, Jr. as his replacement. See "CEO Separation and Transition Costs" below for additional information.
(c)
Consists of charges for employee termination benefits and lease termination costs associated with the 2014 Restructuring Plan. See "Restructuring Charges (net)" below for additional information.
(d)
Consists of expenses directly associated with issues related to shareholder activism and the resulting proxy contest with Third Point LLC ("Third Point"). See "Special Charges (net)" below for additional information.
(e)
Represents interest expense less interest income.
(f)
Represents the total hammer (sale) price of property sold at auction plus buyer's premium.
(g)
Represents the total hammer (sale) price of property sold at auction.
(h)
Represents the total purchase price of property sold in private sales brokered by Sotheby's, including its commissions.
(i)
Represents the sum of Aggregate Auction Sales, Private Sales, and Inventory Sales. For the purposes of this calculation, when applicable, amounts that are associated with the sale of Sotheby's inventory at auction and included in Aggregate Auction Sales are eliminated.
(j)
See "Non-GAAP Financial Measures" below for a description of this non-GAAP financial measure and a reconciliation to the most comparable GAAP amount.
(k)
The effective income tax rate in 2015 is significantly impacted by non-cash income tax expense of $65.7 million related to the planned repatriation of foreign earnings. See "Income Tax Expense" and "Liquidity and Capital Resources" below for additional information.


28



Agency Segment
The Agency segment earns commissions by matching buyers and sellers, also known as consignors, of authenticated works of art through the auction or private sale process. To a much lesser extent, Agency segment activities also include the sale of artworks that are principally acquired incidental to the auction process. See Note 3 of Notes to Consolidated Financial Statements for information regarding a change in Sotheby's segment reporting that became effective in the second quarter of 2015. All prior period segment information has been updated to reflect this change.
The table below presents a summary of Agency segment gross profit and related statistical metrics for the years ended December 31, 2015 and 2014, as well as a comparison between the current and prior year periods (in thousands of dollars):
 
 
 
 
 
 
Variance
 
 
2015
 
2014
 
$ / %
 
%
Agency commissions and fees:
 
 

 
 

 
 

 
 

Auction commissions
 
$
719,152

 
$
758,213

 
$
(39,061
)
 
(5
%)
Private sale commissions
 
61,256

 
60,183

 
1,073

 
2
%
Auction guarantees (net)
 
(11,567
)
 
(15,462
)
 
3,895

 
25
%
Other
 
23,079

 
22,192

 
887

 
4
%
Total Agency commissions and fees
 
791,920

 
825,126

 
(33,206
)
 
(4
%)
Inventory sales
 
100,110

 
60,167

 
39,943

 
66
%
Total Agency segment revenues
 
892,030

 
885,293

 
6,737

 
1
%
Agency direct costs:
 
 
 
 
 


 


Auction direct costs
 
85,182

 
79,677

 
5,505

 
7
%
Private sale expenses
 
6,737

 
6,847

 
(110
)
 
(2
%)
Total Agency direct costs
 
91,919


86,524

 
5,395

 
6
%
Cost of inventory sales
 
103,256

 
59,313

 
43,943

 
74
%
Total Agency direct costs and cost of inventory sales
 
195,175

 
145,837

 
49,338

 
34
%
Intersegment costs:
 
 
 
 
 
 
 
 
Interest (a)
 
$
4,856

 
$
6,796

 
(1,940
)
 
(29
%)
Facility fees (b)
 
2,065

 
2,209

 
(144
)
 
(7
%)
Consignment fees (c)
 
7,838

 
5,272

 
2,566

 
49
%
Total intersegment costs
 
14,759

 
14,277

 
482

 
3
%
Agency segment gross profit (d)
 
$
682,096

 
$
725,179

 
$
(43,083
)
 
(6
%)
Statistical Metrics:
 
 
 
 
 
 
 
 
Aggregate Auction Sales (e)
 
$
5,949,030

 
$
6,075,345

 
$
(126,315
)
 
(2
%)
Net Auction Sales (f)
 
$
5,016,738

 
$
5,151,419

 
$
(134,681
)
 
(3
%)
Items sold at auction with a hammer (sale) price greater than $1 million
 
727

 
743

 
(16)

 
(2
%)
Total hammer (sale) price of items sold at auction with a hammer price greater than $1 million
 
$
3,273,638

 
$
3,188,811

 
$
84,827

 
3
%
Items sold at auction with a hammer (sale) price greater than $2 million
 
385

 
408

 
(23)

 
(6
%)
Total hammer (sale) price of items sold at auction with a hammer (sale) price greater than $2 million
 
$
2,828,520

 
$
2,720,525

 
$
107,995

 
4
%
Items sold at auction with a hammer (sale) price greater than $3 million
 
250

 
276

 
(26)

 
(9
%)
Total hammer (sale) price of items sold at auction with a hammer (sale) price greater than $3 million
 
$
2,499,581

 
$
2,396,255

 
$
103,326

 
4
%
Auction Commission Margin (g)
 
14.3
%
 
14.7
%
 
(0.4
%)
 
N/A

Auction direct costs as a percentage of Net Auction Sales
 
1.70
%
 
1.55
%
 
0.15
%
 
N/A

Private Sales (h)
 
$
673,119

 
$
624,511

 
$
48,608

 
8
%

29



Legend:
(a)
Represents interest charged by the Finance segment for secured loans issued with an interest rate below the Finance segment's target rate. Such loans are issued by the Finance segment as an accommodation to the Agency segment in order to secure a consignment or enhance a client relationship.
(b)
Represents fees charged by the Finance segment for secured loans where the facility fee owed by the borrower is either reduced or waived as an accommodation to the Agency segment in order to secure a consignment or enhance a client relationship.
(c)
Represents fees charged by the Finance segment for term loan collateral sold at auction or privately through the Agency segment. Such fees are paid to compensate the Finance segment for generating auction and private sale consignments. The Finance segment began charging these fees effective January 1, 2015. Prior period segment results are presented on a comparable basis.
(d)
The calculation of Agency segment gross profit does not include the impact of salaries and related costs, general and administrative expenses, and depreciation and amortization expense. However, these items are deducted in the determination of segment income before taxes as reported in Note 3 of Notes to Consolidated Financial Statements.
(e)
Represents the total hammer (sale) price of property sold at auction plus buyer's premium.
(f)
Represents the total hammer (sale) price of property sold at auction.
(g)
Represents total auction commission revenues as a percentage of Net Auction Sales.
(h)
Represents the total purchase price of property sold in private sales brokered by Sotheby's, including its commissions.

Overview—Agency segment gross profit decreased by $43.1 million (6%) in 2015 largely due to changes in foreign currency exchange rates, which contributed $28.4 million to the overall decrease. Excluding the impact of foreign currency exchange rate changes, Agency segment gross profit decreased by $14.7 million (2%). The comparison of Agency segment gross profit between the two years is significantly influenced by sales of property from the Taubman Collection in the fourth quarter of 2015. The Taubman Collection is subject to an auction guarantee and although it totaled $383 million of Net Auction Sales in the fourth quarter of 2015, sale results will fall short of the guaranteed amount and Sotheby's will not recognize any net auction commission revenue from this consignment, causing a decline in Auction Commission Margin from 14.7% to 14.3%. Also contributing to the decrease in Agency segment gross profit in 2015 is a lower level of recurring various-owner Net Auction Sales, as well as a higher level of auction direct costs (including $6 million attributable to the Taubman Collection) and an increase in inventory writedowns. See below for a detailed discussion of the significant factors impacting the comparison between the two years.
Auction Commission Revenues—In its role as auctioneer, Sotheby's accepts property on consignment and matches 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 auction 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. Auction commission revenues are recorded net of commissions owed to third parties, which are principally the result of situations when the buyer's premium is shared with a consignor or with the counterparty in an auction guarantee risk and reward sharing arrangement. Additionally, in certain situations, auction commissions are shared with third parties who introduce Sotheby's to consignors who sell property at auction or otherwise facilitate the sale of property at auction.
Auction commission revenues decreased $39.1 million (5%) in 2015 largely due to changes in foreign currency exchange rates, which contributed $28.4 million to the overall decrease. Excluding the impact of foreign currency exchange rate changes, auction commission revenues decreased $10.7 million (1%) due to a decrease in Auction Commission Margin from 14.7% to 14.3% and a lower level of recurring various-owner Net Auction Sales. See below for a more detailed discussion of Net Auction Sales and Auction Commission Margin.


30



Net Auction Sales—The table below presents a summary of Net Auction Sales for the years ended December 31, 2015 and 2014, as well as a comparison between the current and prior year periods (in millions of dollars):
 
 
 
 
 
 
Variance
 
 
2015
 
2014
 
$
 
%
Impressionist and Modern Art
 
$
1,569.3

 
$
1,245.8

 
$
323.5

 
26
%
Contemporary Art
 
1,525.8

 
1,430.5

 
95.3

 
7
%
Asian Art
 
630.2

 
675.2

 
(45.0
)
 
(7
%)
Jewelry
 
504.1

 
500.7

 
3.4

 
1
%
Old Master and British Paintings and Drawings
 
223.5

 
307.7

 
(84.2
)
 
(27
%)
Other fine art, decorative art and collectibles
 
737.4

 
991.6

 
(254.2
)
 
(26
%)
Sub-total
 
5,190.3

 
5,151.5

 
38.8

 
1
%
Impact of foreign currency exchange rate changes
 
(173.5
)
 
N/A

 
(173.5
)
 
N/A

Total
 
$
5,016.8

 
$
5,151.5

 
$
(134.7
)
 
(3
%)
Net Auction Sales decreased $134.7 million (3%) in 2015 due to changes in foreign currency exchange rates, which contributed $173.5 million to the overall decrease. Excluding the impact of foreign currency exchange rate changes, Net Auction Sales increased $38.8 million (1%). The comparison of Net Auction Sales between the two years is significantly influenced by sales of property from the Taubman Collection at various auctions in the fourth quarter of 2015, which totaled $383 million across various collecting categories, most prominently in Impressionist and Modern Art ($237 million) and Contemporary Art ($121 million). Excluding sales of property from the Taubman Collection, the comparison of Net Auction Sales between the two periods is unfavorably impacted by a lower level of auction sales across the majority of Sotheby's collecting categories, most notably occurring in the fourth quarter of 2015.
Auction Commission Margin—Auction Commission Margin represents total auction commission revenues as a percentage of Net Auction Sales. Typically, Auction Commission Margin is higher for lower value works of art or collections, while higher valued property earns a lower Auction Commission Margin. Accordingly, Auction Commission Margin may be adversely impacted by the mix of property sold in a period. Auction Commission Margin may also be adversely impacted by arrangements whereby Sotheby's shares its buyer's premium with a consignor in order to secure a high-value consignment, as well as by Sotheby's 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 buyer's premium. Also, in situations when guaranteed property sells for less than the guaranteed price, Sotheby's buyer's premium from that sale is used to reduce the loss on the transaction. See Note 16 of Notes to Consolidated Financial Statements for information related to Sotheby's use of auction guarantees.
In order to enhance revenue and strengthen Auction Commission Margin, on February 1, 2015, Sotheby's enacted a new buyer's premium rate structure that is generally 25% on the first $200,000 of hammer (sale) price; 20% on the portion of hammer (sale) price above $200,000 up to and including $3 million; and 12% on any remaining amount above $3 million. The hammer (sale) price thresholds in other currencies have been adjusted in a commensurate manner. The previous buyer's premium rate structure, which was in effect since March 15, 2013, was 25% on the first $100,000 of hammer (sale) price; 20% on the portion of hammer (sale) price above $100,000 up to and including $2 million; and 12% on any remaining amount above $2 million.
Auction Commission Margin decreased from 14.7% to 14.3% in 2015 and was significantly influenced by sales of property from the Taubman Collection. The Taubman Collection is subject to an auction guarantee and although it totaled $383 million of Net Auction Sales in the fourth quarter of 2015, sale results will fall short of the guaranteed amount and Sotheby's will not recognize any net auction commission revenue from this consignment. The comparison of Auction Commission Margin between the two years is also influenced by an unfavorable change in sales mix, as a higher value of property was sold in the upper price bands of Sotheby's buyer's premium rate structure in 2015. These factors are partially offset by the change in the buyer's premium rate structure enacted on February 1, 2015, as discussed above, which added $44 million in incremental buyer's premium revenues in 2015.
Private Sale Commission Revenues—Private sale commission revenues are earned through the direct brokering of purchases and sales of art. Private sales are initiated either by a client wishing to sell property with Sotheby's acting as its exclusive agent in the transaction, or by a prospective buyer who is interested in purchasing a certain work of art privately. Because private sales are individually negotiated, non-recurring transactions, the volume and value of transactions completed can vary from period to period, with associated variability in revenues.

31



Private sale commissions increased $1.1 million (2%) in 2015 due to an increased number of high-value transactions completed during the year, partially offset by foreign currency exchange rate changes. Excluding the $2.5 million unfavorable impact of foreign currency exchange rate changes, private sale commission revenues increased $3.6 million (6%) when compared to 2014.
Agency Direct Costs—The table below presents a summary of Agency direct costs for the years ended December 31, 2015 and 2014, as well as a comparison between the current and prior year periods (in thousands of dollars):
 
 
 
 
 
 
Variance
 
 
2015
 
2014
 
$ / %
 
%
Auction direct costs:
 
 
 
 
 
 
 
 
Sale marketing
 
$
38,120

 
$
34,979

 
$
3,141

 
9
%
Shipping
 
12,971

 
13,208

 
(237
)
 
(2
%)
Sale venue
 
15,402

 
14,522

 
880

 
6
%
Other
 
18,689

 
16,968

 
1,721

 
10
%
Total auction direct costs
 
85,182

 
79,677

 
5,505

 
7
%
Private sale expenses
 
6,737


6,847

 
(110
)
 
(2
%)
Total Agency direct costs
 
$
91,919

 
$
86,524

 
$
5,395

 
6
%
Statistical Metric:
 
 
 
 
 
 
 
 
Auction direct costs as a % of Net Auction Sales
 
1.70
%
 
1.55
%
 
0.15
%
 
N/A

Auction Direct Costs—A large portion of auction direct costs relate to sale marketing expenses such as catalogue production and distribution, advertising and promotion costs, and traveling exhibition costs. Auction direct costs also include the cost of shipping property, sale venue costs, and other direct costs such as debit and credit card processing fees. The level of auction direct costs incurred in a period is generally dependent upon the volume and composition of Sotheby's auction sale offerings. For example, direct costs attributable to auctions of single-owner or other high-value collections are typically higher than those associated with standard various-owner auctions, mainly due to higher promotional costs for catalogues, special events, and traveling exhibitions, as well as higher shipping expenses.
In 2015, changes in foreign currency exchange rates reduced auction direct costs by $2.7 million. Excluding foreign currency exchange rate changes, auction direct costs increased $8.2 million (10%), primarily due to approximately $6 million of costs incurred to promote and conduct the Taubman Collection sales, and, to a lesser extent, the higher cost of promoting and conducting Sotheby's recurring various-owner Impressionist and Modern Art and Contemporary Art sales.
Inventory Sales and Cost of Inventory Sales - Agency segment inventory sales include proceeds earned from the sale of (i) artworks that have been obtained as a result of the failure of guaranteed property to sell at auction, (ii) artworks that have been purchased opportunistically, including property acquired for sale at auction, and (iii) other objects obtained incidental to the auction process (e.g., as a result of buyer default).
The table below presents a summary of Agency segment inventory activities for the years ended December 31, 2015 and 2014, as well as a comparison between the current and prior year periods (in thousands of dollars):
 
 
 
 
 
Variance
 
2015
 
2014
 
$
 
%
Inventory sales
$
100,110

 
$
60,167

 
$
39,943

 
66
%
Cost of inventory sales
(103,256
)
 
(59,313
)
 
(43,943
)
 
74
%
Gross (loss) profit
$
(3,146
)
 
$
854

 
$
(4,000
)
 
N/A

The increase in Agency segment Inventory Sales and Cost of Inventory Sales in 2015 is primarily due to two paintings acquired and sold at auction in 2015, which together yielded approximately $55 million in Inventory Sales and Cost of Inventory Sales. The unfavorable variance in Agency segment inventory gross (loss) profit is due to a higher level of inventory writedowns in 2015 when compared to the prior year.


32



Finance Segment
The 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 where the borrowers are contractually committed, in the near term, to sell the property through the Agency segment (a "consignor advance"); and (ii) general purpose term loans secured by property not presently intended for sale (a "term loan"). See Note 4 of Notes to Consolidated Financial Statements for information about Finance segment loans.
The lending activities of the Finance segment are predominantly funded with borrowings drawn from a dedicated revolving credit facility. Cash balances are also used to fund a portion of the Finance segment loan portfolio, as appropriate. See Note 7 of Notes to Consolidated Financial Statements for information related to the Finance segment's dedicated revolving credit facility.
The table below presents a summary of Finance segment gross profit and related statistical metrics for the years ended December 31, 2015 and 2014, as well as a comparison between the current and prior year periods (in thousands of dollars):
 
 
 
 
 
 
Variance
 
 
2015
 
2014
 
$ / %
 
%
Finance revenues:
 
 
 
 
 
 
 
 
Client paid revenues:
 
 
 
 
 
 
 
 
Interest
 
$
42,771

 
$
29,477

 
$
13,294

 
45
%
Facility and other fees
 
7,718

 
3,536

 
4,182

 
*

Total client paid revenues
 
50,489

 
33,013

 
17,476

 
53
%
Intersegment revenues:
 
 
 
 
 
 
 
 
Interest (a)
 
4,856

 
6,796

 
(1,940
)
 
(29
%)
Facility fees (b)
 
2,065

 
2,209

 
(144
)
 
(7
%)
Consignment fees (c)
 
7,838

 
5,272

 
2,566

 
49
%
Total intersegment revenues
 
14,759

 
14,277

 
482

 
3
%
Total Finance revenues
 
65,248

 
47,290

 
17,958

 
38
%
Cost of Finance revenues (d)
 
15,780

 
8,740

 
7,040

 
81
%
Finance segment gross profit (e)
 
$
49,468

 
$
38,550

 
$
10,918

 
28
%
Loan Portfolio Metrics:
 
 
 
 
 
 
 
 
Loan Portfolio Balance (f)
 
$
682,258

 
$
644,441

 
$
37,817

 
6
%
Average Loan Portfolio (g)
 
$
732,814

 
$
583,304

 
$
149,510

 
26
%
Credit Facility Borrowings (h)
 
$
541,500

 
$
445,000

 
$
96,500

 
22
%
Average Credit Facility Borrowings (i)
 
$
541,004

 
$
306,448

 
$
234,556

 
77
%
Average Equity in Loan Portfolio (j)
 
$
191,810

 
$
276,856

 
$
(85,046
)
 
(31
%)
Finance Segment Leverage Ratio (k)
 
79.4
%
 
69.1
%
 
10.3
%
 
N/A

Finance Revenue Margin (l)
 
8.9
%
 
8.1
%
 
0.8
%
 
N/A

Finance Segment LTM Return on Equity (m)
 
14.7
%
 
N/A

 
N/A

 
N/A


33



Legend:
 
 
 
*
Represents a change in excess of 100%.
(a)
Represents interest earned from the Agency segment for secured loans issued with an interest rate below the Finance segment's target rate. Such loans are issued by the Finance segment as an accommodation to the Agency segment in order to secure a consignment or enhance a client relationship.
(b)
Represents fees earned from the Agency segment for secured loans where the facility fee owed by the borrower is either reduced or waived as an accommodation to the Agency segment in order to secure a consignment or enhance a client relationship.
(c)
Represents fees earned from the Agency segment for Finance segment term loan collateral sold at auction or privately through the Agency segment. Such fees are paid to compensate the Finance segment for generating auction and private sale consignments. The Finance segment began charging these fees effective January 1, 2015. Prior period segment results are presented on a comparable basis.
(d)
Includes borrowing costs related to the Finance segment's dedicated revolving credit facility, including interest expense, commitment fees, and the amortization of amendment and arrangement fees.
(e)
The calculation of Finance segment gross profit does not include the impact of salaries and related costs, general and administrative expenses, depreciation and amortization expense, and intercompany charges from Sotheby's global treasury function. However, these items are deducted in the determination of segment income before taxes as reported in Note 3 of Notes to Consolidated Financial Statements.
(f)
Represents the period end net loan portfolio balance.
(g)
Represents the average loan portfolio outstanding during the period.
(h)
Represents the period end balance of borrowings outstanding under the Finance segment's dedicated revolving credit facility.
(i)
Represents average borrowings outstanding during the period under the Finance segment's dedicated revolving credit facility.
(j)
Calculated as Average Loan Portfolio less Average Credit Facility Borrowings.
(k)
Calculated as Credit Facility Borrowings divided by Loan Portfolio Balance.
(l)
Represents the annualized margin of total client paid and intersegment Finance revenues in relation to the Average Loan Portfolio.
(m)
Represents the return on Finance segment net income, excluding allocated corporate overhead costs, over the last twelve months ("LTM") in relation to the Average Equity in Loan Portfolio during that period. For the purposes of this calculation, income taxes are provided using the Finance segment's effective income tax rate for the year ended December 31, 2015. On a pro-forma basis, assuming the current period-end Finance Segment Leverage Ratio of 79.4%, the Finance segment LTM Return on Equity for the year ended December 31, 2015, would be 19.3%. This metric is not applicable for the LTM period ended December 31, 2014, as the financing of the Finance segment loan portfolio with debt did not begin until February 2014.
The improvement in Finance segment gross profit in 2015 is a reflection of the higher Average Loan Portfolio, which can be attributed to the increased ability to fund loans through revolving credit facility borrowings, the relatively low nominal interest rate environment, and the improved global reach of Sotheby's art-financing business, all of which allowed Sotheby's to fund a number of significant new term loans during the first half of the year. The overall improvement in Finance segment gross profit is partially offset by a higher cost of revolving credit facility borrowings due to an increase in the Average Loan Portfolio and a higher Finance Segment Leverage Ratio as the process of financing loans with debt began in February 2014.
Marketing Expenses
Marketing expenses are costs related to the promotion of the Sotheby's brand and include digital and print advertising, client relationship development, Sotheby's lifestyle magazines, and strategic sponsorships of and charitable donations to cultural institutions. Marketing expenses increased $2.8 million (17%) in 2015 as a result of costs incurred to enhance Sotheby's brand preeminence and accessibility.

34



Salaries and Related Costs
The table below presents a summary of salaries and related costs for the years ended December 31, 2015 and 2014, as well as a comparison between the current and prior year periods (in thousands of dollars):
 
 
 
 
 
Variance
 
2015
 
2014
 
$ / %
 
%
Full-time salaries
$
146,130

 
$
150,110

 
$
(3,980
)
 
(3
%)
Incentive compensation expense
44,456

 
63,672

 
(19,216
)
 
(30
%)
Leadership transition severance costs
13,251

 

 
13,251

 
N/A

Share-based payment expense
28,632

 
23,470

 
5,162

 
22
%
Payroll taxes
20,472

 
23,631

 
(3,159
)
 
(13
%)
Employee benefits
30,331

 
29,651

 
680

 
2
%
Other compensation expense
19,553

 
20,400

 
(847
)
 
(4
%)
Total salaries and related costs
$
302,825

 
$
310,934

 
$
(8,109
)
 
(3
%)
Statistical Metric:
 

 
 

 
 

 
 

Salaries and related costs as a % of revenues
31.5
%
 
33.1
%
 
(1.6
%)
 
N/A

In 2015, changes in foreign currency exchange rates reduced salaries and related costs by $13.7 million when compared to 2014. Excluding the impact of foreign currency exchange rate changes, salaries and related costs increased $5.6 million (2%) in 2015. See below for a detailed discussion of the significant factors impacting the comparison of the various elements of salaries and related costs between 2015 and 2014.
Full-Time Salaries—Full-time salaries decreased $4 million (3%) in 2015 due to changes in foreign currency exchange rates ($6.6 million) and savings achieved as a result of the restructuring plan enacted in July 2014 (see "Restructuring Charges (Net)" below), partially offset by base salary increases and headcount reinvestments in the current year. Excluding the impact of foreign currency exchange rates, full-time salaries increased $2.7 million (2%) in 2015.
Incentive Compensation—Incentive compensation principally includes the accrued expense associated with cash payments to be made under Sotheby's incentive compensation program in the first quarter of every year. The amount of incentive compensation awarded under this program is determined by the Compensation Committee of the Board of Directors after assessing Sotheby's annual earnings, as measured by Adjusted EBITDA*. In addition, incentive compensation includes amounts awarded to employees for brokering certain eligible private sale transactions under a formula established by the Compensation Committee, and, to a much lesser extent, amounts awarded to employees with respect to Sotheby's other selling activities. The decrease in incentive compensation expense in 2015 is principally due to management's recommendation to reduce the pool of available incentive compensation relative to Adjusted EBITDA*, which was approved by the Compensation Committee in February 2016.
Leadership Transition Severance Costs—In 2015, Sotheby's incurred severance costs of $13.3 million associated with the termination of certain executive officers, including its former Chief Financial Officer and former Chief Operating Officer, in conjunction with Sotheby's recent leadership transition.








________________________
* See "Non-GAAP Financial Measures" below for a description of this non-GAAP financial measure.

35




Share-Based Payment Expense—Share-based payment expense relates to the amortization of equity compensation awards such as performance share units, market-based share units, restricted stock units, restricted stock, and stock options. Equity compensation awards are generally granted annually in the first quarter of the year. The amount of compensation expense recognized for share-based payments is based on management's estimate of the number of units ultimately expected to vest as a result of employee service. In addition, for performance share units, the amount and timing of expense recognition is significantly impacted by management's quarterly assessment of the likelihood and timing of achieving the underlying profitability targets.
Share-based payment expense increased by $5.2 million (22%) in 2015 largely due to the accelerated recognition of $2.9 million of compensation expense pursuant to the terms of severance agreements with Sotheby's former Chief Financial Officer and former Chief Operating Officer, as well as higher amortization of CEO share-based payment awards. See Note 12 of Notes to Consolidated Financial Statements for more detailed information related to Sotheby's share-based compensation programs.
Payroll Taxes—The decrease of $3.2 million (13%) in payroll taxes in 2015 is primarily due to changes in foreign currency exchange rates ($1.8 million) and the lower level of incentive compensation expense.
Employee Benefits—Employee benefits include the cost of Sotheby's retirement plans and health and welfare programs, as well as certain employee severance costs. Sotheby's material retirement plans include defined benefit and defined contribution pension plans for its employees in the U.K. and defined contribution and deferred compensation plans for its U.S. employees.
Generally, the amount of employee benefit costs recognized in a period is dependent upon headcount and overall compensation levels, as well as Sotheby's financial performance. Additionally, the level of expense related to Sotheby's defined benefit pension plan in the U.K. is significantly influenced by interest rates, investment performance in the debt and equity markets, and actuarial assumptions. Also, the amount recorded in a period for Sotheby's Deferred Compensation Plan (the "DCP") is dependent upon changes in the fair value of the DCP liability resulting 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. On a consolidated basis, cost increases (decreases) related to the DCP liability are largely offset by market gains (losses) in the trust assets related to the DCP liability, which are reflected in the Consolidated Income Statements within other (expense) income.
Employee benefit costs increased $0.7 million (2%) in 2015 primarily due to higher pension costs in the U.K., including an increase of $2.3 million related to the defined benefit pension plan and $0.7 million related to defined contribution plan profit share accruals, which commenced in the U.K. in the current year. Also unfavorably impacting the comparison to 2014 are higher non-restructuring related severance costs. These factors are almost entirely offset by a decrease of $2.3 million in DCP expense as a result of a decline in the performance of deemed participant investments, as well as lower health and welfare costs in the U.S., the lower level of incentive compensation, and changes in foreign currency exchange rates.
For the year ending December 31, 2016, the net pension benefit attributable to the U.K. defined benefit pension plan is expected to be approximately $8 million, as compared to a net pension cost of $1.6 million in 2015. The forecasted net pension benefit in 2016 is primarily due to the expected closure of the plan to future salary accruals in the first quarter of 2016. (See statement on Forward Looking Statements.)

36



General and Administrative Expenses
The table below presents a summary of general and administrative expenses for the years ended December 31, 2015 and 2014, as well as a comparison between the current and prior year periods (in thousands of dollars):
 
 
 
 
 
 
Variance
 
 
2015
 
2014
 
$
 
%
Professional fees:
 
 
 
 
 


 


Operations
 
$
25,137

 
$
25,321

 
$
(184
)
 
(1
%)
Legal and compliance
 
13,700

 
14,261

 
(561
)
 
(4
%)
Other (a)
 
14,402

 
14,703

 
(301
)
 
(2
%)
Total professional fees
 
53,239

 
54,285

 
(1,046
)
 
(2
%)
Facilities-related expenses
 
42,666

 
44,590

 
(1,924
)
 
(4
%)
Travel and entertainment
 
27,566

 
27,633

 
(67
)
 
%
Telecommunication and technology
 
9,487

 
9,077

 
410

 
5
%
Insurance
 
6,270

 
6,190

 
80

 
1
%
Other indirect expenses
 
19,920

 
17,021

 
2,899

 
17
%
Total general and administrative expenses
 
$
159,148

 
$
158,796

 
$
352

 
%
(a) Other professional fees include business consulting costs incurred to assist management in the analysis and development of business and operational strategies, Board of Director fees, and costs related to various administrative areas.
In 2015, changes in foreign currency exchange rates reduced general and administrative expenses by $6.5 million. Excluding foreign currency exchange rate changes, general and administrative expenses increased $6.9 million (4%) in 2015. See below for a detailed discussion of the significant factors impacting the comparison of the various elements of general and administrative expenses between 2015 and 2014.
Professional fees (Operations)—Sotheby's incurs professional fees to outsource certain business functions such as catalogue production and its client contact management center, as well as for assistance with personnel recruiting, website maintenance and development, and other activities. This category of professional fees was relatively unchanged in 2015 when compared to 2014, as savings from negotiated rate reductions related to certain outsourced functions were offset by higher website consulting costs and personnel recruiting costs.
Professional fees (Legal and Compliance)—Sotheby's incurs professional fees related to legal, audit and other compliance-related activities. This category of professional fees decreased $0.6 million (4%) in 2015 primarily due to recoveries of legal fees mainly resulting from a favorable court ruling.
Facilities-related expenses—Facilities-related expenses principally include rent expense, real estate taxes and other costs related to the operation, security and maintenance of Sotheby's worldwide premises. Facilities-related expenses decreased $1.9 million (4%) in 2015 due to changes in foreign currency exchange rates, which contributed $2.4 million to the overall decrease.
Travel and entertainment—Travel and entertainment includes costs related to business travel by Sotheby's staff and client entertainment. Travel and entertainment expenses were unchanged in 2015 when compared to 2014 due to changes in foreign currency exchange rates, which reduced the level of reported expense by $1.2 million. Excluding foreign currency exchange rate changes, travel and entertainment expenses increased $1.1 million (4%) in 2015.
Other indirect expenses—Other indirect expenses include costs related to client goodwill gestures and claims, uncollectible accounts and other miscellaneous indirect costs. Other indirect expenses increased $2.9 million (17%) in 2015 primarily due to a charge recognized in the second quarter for an authenticity claim related to property sold through Sotheby's several years ago. This charge is recorded net of a related insurance recovery recognized in the fourth quarter of 2015.


37



Voluntary Separation Incentive Programs
On November 13, 2015, Sotheby's announced a series of regional voluntary separation incentive programs (the "Programs") aimed at reducing headcount and associated compensation costs. The Programs were offered to Sotheby's employees in jurisdictions where it was practical to do so. Employees who elected to participate in the Programs were accepted only upon approval by Sotheby's management.
In the fourth quarter of 2015, Sotheby's recognized a charge of $36.9 million as a result of the Programs, consisting of $33.8 million in cash severance benefits and $3.1 million in accelerated equity compensation expense related to awards that will continue to vest after termination of employment subject to Sotheby's achievement of the underlying profitability targets, when applicable. The liability related to the $33.8 million in cash severance benefits is recorded on the December 31, 2015 Consolidated Balance Sheet within Accounts Payable and Accrued Liabilities and includes $4.7 million related to 2015 incentive compensation that would have been paid to participants had they not participated in the Programs. This liability is expected to be settled through cash payments made principally in the first half of 2016.
Employee transitions under the Programs commenced on December 31, 2015 and will occur throughout 2016. Management currently expects that the Programs will result in a net reduction of approximately 5% of its global headcount of approximately 1,600 employees prior to the implementation of the Programs. (See statement on Forward Looking Statements.)
CEO Separation and Transition Costs
CEO Separation and Transition Costs consist of compensation-related charges of $7.6 million recognized in the fourth quarter of 2014, related to the resignation of William F. Ruprecht as Sotheby's President and Chief Executive Officer, and charges of $4.2 million recognized in the first quarter of 2015, associated with the subsequent hiring of Thomas S. Smith, Jr. as his replacement.
The charges recognized in the fourth quarter of 2014 consist of the accrual of a $4 million cash severance benefit and $3.6 million in accelerated equity compensation expense triggered by the terms of Mr. Ruprecht's employment agreement.
The charges recognized in the first quarter of 2015 principally relate to compensation of $3.1 million owed to Mr. Smith to replace incentive compensation that he expected to receive from his previous employer, consisting of a fully-vested restricted stock unit award with a fair value of $2 million granted on March 31, 2015 and a $1.1 million cash payment that was made in September 2015. There was no required service period associated with this compensation. The CEO Separation and Transition Costs recognized in the first quarter of 2015 also include approximately $1.1 million in recruitment and other professional fees associated with the CEO hiring process.
Restructuring Charges (Net)
On July 16, 2014, the Board of Directors approved a restructuring plan (the "2014 Restructuring Plan") principally impacting Sotheby's operations in the U.S. and the U.K. The 2014 Restructuring Plan resulted in net Restructuring Charges of $14.2 million recognized in 2014, consisting of $13.9 million in employee termination benefits and $0.3 million in lease exit costs. In 2015, Sotheby's recognized a benefit of $1 million in Restructuring Charges (net) as a result of adjustments to the initial accrual for employee termination benefits. The headcount reductions resulting from the 2014 Restructuring Plan were completed in the third quarter of 2015 and the associated liability has been fully settled.


38



Special Charges (Net)
In 2014, Sotheby's recognized Special Charges (net) of $20 million related to third party advisory, legal, and other professional service fees directly associated with issues related to shareholder activism, the resulting proxy contest with Third Point, and the litigation concerning Sotheby's former shareholder rights plan and the change in control provision in its credit agreement. The amount recognized in 2014 is net of a $4.6 million insurance recovery pertaining to certain professional services fees incurred in defense of the litigation concerning the former shareholder rights plan and the change in control provision in Sotheby's credit agreement.
Included in Special Charges (net) in 2014 is a $10 million charge related to the reimbursement by Sotheby's of Third Point's documented, out-of-pocket expenses incurred in connection with the proxy contest and the litigation concerning Sotheby's former shareholder rights plan. This reimbursement is part of a support agreement Sotheby's entered into with Third Point, Daniel S. Loeb, Olivier Reza, Harry J. Wilson and other entities affiliated with Third Point (together with Third Point, the "Third Point Entities") on May 4, 2014 pursuant to which Sotheby's and Third Point settled the previously pending proxy contest for the election of directors (the "Support Agreement"). Pursuant to the Support Agreement, on May 4, 2014, Mr. Loeb, Mr. Reza, and Mr. Wilson (the "Third Point Nominees") were appointed to Sotheby's Board of Directors. The Support Agreement also contains various other terms and provisions, including with respect to standstill and voting commitments entered into by Third Point, Third Point's withdrawal of the litigation concerning Sotheby's former shareholder rights plan, and the accelerated expiration of Sotheby's former shareholder rights plan.
Net Interest Expense
Net interest expense decreased $2.3 million (7%) in 2015 almost entirely due to the July 2015 refinancing of the mortgage on Sotheby's headquarters at 1334 York Avenue in New York. See Note 7 of Notes to Consolidated Financial Statements for information on the refinancing of the mortgage on 1334 York Avenue.
Other (Expense) Income
In 2015, other expense of approximately ($1) million consists primarily of a $2.7 million DCP market loss associated with the underlying trust assets, partially offset by a $1.6 million death benefit recognized in the fourth quarter of 2015 under a corporate-owned life insurance policy related to the DCP.
Other income of approximately $0.3 million in 2014 consists of net gains realized on certain foreign currency denominated transactions and a $0.3 million market gain on DCP trust assets, almost entirely offset by a $2.1 million loss related to the cumulative translation adjustment that was recognized upon the liquidation of a foreign subsidiary.
Income Tax Expense
Sotheby's effective income tax rate was 77.5% in 2015, compared to 39.2% in 2014. The increase in the effective income tax rate is primarily due to income tax expense of $65.7 million recorded in the fourth quarter of 2015 to recognize a deferred tax liability for incremental taxes associated with accumulated foreign earnings relating to years prior to 2014 that are no longer deemed to be indefinitely reinvested outside of the U.S. (see “Repatriation of Foreign Earnings” below). In 2015 and 2014, income tax expense of approximately $14.2 million and $18.6 million, respectively, was recorded to recognize deferred tax liabilities for incremental taxes associated with Sotheby’s foreign earnings in those years that were not deemed to be indefinitely reinvested outside of the U.S.
The effective income tax rate for the current year also includes income tax expense of approximately $4 million to write-down certain deferred tax assets as a result of New York City tax legislation enacted in April 2015. The legislation reduced the amount of Sotheby’s taxable income apportioned to New York City, thereby reducing Sotheby’s state and local effective income tax rate. This income tax expense was recorded discretely in the second quarter of 2015 and reduced the value of certain deferred tax assets to the amount that will be recognized in the future as a result of the reduction of the New York City effective income tax rate. The effective income tax rate for 2014 included income tax expense of approximately $3.9 million related to the write-down of certain deferred tax assets as a result of the New York State 2014-2015 Budget Act that was enacted in 2014.


39


Repatriation of Foreign Earnings—In prior periods, based on Sotheby’s projections and planned uses of U.S. and foreign earnings, management had intended that approximately $400 million of accumulated foreign earnings relating to years prior to 2014 would be indefinitely reinvested outside of the U.S. As a result, Sotheby’s did not record deferred income taxes on these earnings in its financial statements. Due to the resignation of William F. Ruprecht as Sotheby’s President and Chief Executive Officer in November 2014 and the subsequent hiring of Thomas S. Smith, Jr. as his replacement in March 2015, and the resulting reevaluation of the Company's strategic priorities, the Board of Directors and management reassessed Sotheby’s U.S. and foreign cash needs in the fourth quarter of 2015. As a result of this reassessment and in consideration of the recent expansion of Sotheby's Common Stock repurchase program (see Note 11 of Notes to Consolidated Financial Statements), as well as the need for cash in the U.S. to fund other corporate strategic initiatives, in the fourth quarter of 2015, it became apparent that these foreign earnings will instead be repatriated to the U.S. in the foreseeable future. Consequently, in the fourth quarter of 2015, Sotheby's recognized a non-cash income tax charge of $65.7 million (net of foreign tax credits) for the deferred income taxes on these foreign earnings. The specific timing of the repatriation of these foreign earnings and cash payment of the associated taxes is currently being evaluated.
Management will continue to evaluate its projections and planned uses of U.S. and foreign earnings to determine whether foreign earnings in periods subsequent to 2015 will be indefinitely reinvested outside of the U.S. If management concludes that such earnings will not be required to fund U.S. operations or commitments and will be indefinitely reinvested outside of the U.S., Sotheby’s effective income tax rate would decrease in 2016 and future years when compared to 2015 and 2014. See statement on Forward Looking Statements.
Equity in Earnings of Investees
Sotheby's equity method investments include a 25% ownership interest in RM Sotheby's, which was acquired on February 18, 2015, and a 50% ownership interest in Acquavella Modern Art ("AMA"). In 2015, equity in earnings of investees increased by $4.6 million when compared to 2014 due to the earnings contributed by RM Sotheby's ($2.5 million) and an increase in earnings from AMA ($2.1 million). See Note 5 of Notes to Consolidated Financial Statements for additional information on Sotheby's equity method investees.
Impact of Changes in Foreign Currency Exchange Rates
For the year ended December 31, 2015, foreign currency exchange rate changes had a net unfavorable impact of approximately $6.7 million on Sotheby's operating income, with revenues unfavorably impacted by $32.5 million and expenses favorably impacted by $25.8 million.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013
This discussion should be read in conjunction with Note 3 of Notes to Consolidated Financial Statements, which provides financial information about Sotheby's segments.
Overview
Sotheby's reported operating income of $226 million in 2014, representing a $3.5 million (2%) increase when compared to 2013, as 2014 results include $41.8 million in charges associated with shareholder activism, restructuring, and CEO transition. Excluding these items, Sotheby's reported Adjusted Operating Income* of $267.9 million in 2014, representing a $43.9 million (20%) improvement over 2013. Also favorably impacting the comparison to 2013 are a number of cost reduction initiatives that were implemented by management in 2014. These initiatives resulted in a lower ratio of auction direct costs as a percentage of Net Auction Sales, savings in general and administrative and marketing expenses, and also helped contain full-time salary costs.
Sotheby's reported net income of $117.8 million in 2014, representing a $12.2 million (9%) decrease when compared to 2013, as 2014 results include the impact of the charges noted in the previous paragraph. Excluding these items, Sotheby's reported Adjusted Net Income* of $142.4 million in 2014, representing an $11.6 million (9%) improvement over 2013. As discussed in more detail below under "Income Tax Expense," the comparison of Sotheby's after-tax results for 2014 to the prior year was significantly influenced by the effective income tax rate for the period, which increased from 30% to approximately 39%.
See below for a detailed discussion of the significant factors impacting Sotheby's 2014 results and the comparison to 2013.
_______________________
* See "Non-GAAP Financial Measures" below for a description of this non-GAAP financial measure and a reconciliation to the most comparable GAAP amount.

40





Results of Operations for the Years Ended December 31, 2014 and 2013
The table below presents a summary of Sotheby's consolidated results of operations and related statistical metrics for the years ended December 31, 2014 and 2013, as well as a comparison between the two years (in thousands of dollars, except per share data):
 
 
 
 
 
Variance
 
2014
 
2013
 
$ / %