The following table summarizes Sotheby’s material contractual obligations and commitments as of September 30, 2009:
From time to time in the ordinary course of its business, Sotheby’s will guarantee to consignors a minimum price in connection with the sale of property at auction (an “auction guarantee”). In the event that the property sells for less than the minimum guaranteed price, Sotheby’s must perform under the auction guarantee by funding the difference between the sale price at auction and the amount of the auction guarantee. Sotheby’s is generally entitled to a share of the excess proceeds if the property under the auction guarantee sells above a minimum price. If the property does not sell, the amount of the guarantee must be paid, but Sotheby’s has the right to recover such amount through the future sale of the property. The sale proceeds ultimately realized by Sotheby’s may exceed the amount of any losses previously recognized on the auction guarantee or could be less than the initial carrying value of the property.
Sotheby’s is obligated under the terms of certain auction guarantees to advance a portion of the guaranteed amount prior to the auction. In certain other situations, Sotheby’s reduces its financial exposure under auction guarantees through risk and reward sharing arrangements with partners. The counterparties to these risk and reward sharing arrangements are typically major international art dealers or major art collectors. Sotheby’s could be exposed to credit-related losses in the event of nonperformance by these counterparties.
As of September 30, 2009, Sotheby’s had outstanding auction guarantees of $5.3 million, the property relating to which had pre-sale low and high estimates (1) of $5 million and $7 million, respectively. As a result of risk and reward sharing arrangements, Sotheby’s financial exposure under its outstanding auction guarantees was reduced by $5 million. As of September 30, 2009, the carrying amount of the liability representing the estimated fair value of Sotheby’s obligation to perform under its outstanding auction guarantees totaled $14 thousand.
| |
(1) | Pre-sale estimates are not always accurate predictions of auction sale results or the fair value of the guaranteed property. |
In response to the downturn in the international art market that began after September 15, 2008, as well as the current challenging economic environment, Sotheby’s has substantially reduced its use of auction guarantees for sales occurring in 2009 when compared to 2008. Sotheby’s expects to continue to significantly limit its use of auction guarantees for the foreseeable future. (See statement on Forward Looking Statements.)
Lending Commitments
Sotheby’s enters into legally binding arrangements to lend, primarily on a collateralized basis and subject to certain limitations and conditions, to potential consignors and other individuals who have collections of fine art or other objects. Unfunded commitments to extend additional credit were $3 million on September 30, 2009, of which $1 million is committed to an employee of Sotheby’s.
DERIVATIVE FINANCIAL INSTRUMENTS
In most cases, Sotheby’s utilizes forward exchange contracts to hedge cash flow exposures related to foreign currency risks, which primarily arise from short-term foreign currency denominated intercompany balances and, to a lesser extent, foreign currency denominated client payable balances and foreign currency denominated future auction guarantee obligations. Such forward exchange contracts are typically short-term with settlement dates less than one year from their inception. Additionally, on rare occasions, Sotheby’s purchases foreign currency option contracts to hedge foreign currency risks associated with amounts payable to consignors as a result of the sale of property at auction.
Exposures related to Sotheby’s foreign currency risks are centrally managed by its global treasury function. Sotheby’s outstanding forward exchange contracts and foreign currency option contracts, if any, are not designated as hedging instruments and are recorded in the Condensed Consolidated Balance Sheets at their fair values (see Note 20 of Notes to Condensed Consolidated Financial Statements). Changes in the fair value of these derivative financial instruments are recognized in the Condensed Consolidated Statements of Operations within Other Income (Expense).
As of September 30, 2009, Sotheby’s had a total of $85.7 million in notional value forward exchange contracts. Notional amounts do not quantify risk or represent assets or liabilities of Sotheby’s, but are used in the calculation of cash settlements under such contracts. Sotheby’s is exposed to credit-related losses in the event of nonperformance by the three counterparties to its forward exchange contracts, but Sotheby’s does not expect any counterparties to fail to meet their obligations given their high short-term (A1/P1) credit ratings.
As of September 30, 2009, December 31, 2008 and September 30, 2008, Sotheby’s Condensed Consolidated Balance Sheets included liabilities of $0.2 million, $2.6 million and $2.6 million, respectively, recorded within Accounts Payable and Accrued Liabilities reflecting the aggregate fair value of Sotheby’s outstanding derivative instruments on those dates.
CONTINGENCIES
For information related to Contingencies, see Note 14 of Notes to Condensed Consolidated Financial Statements.
UNCERTAIN TAX POSITIONS
For information related to Uncertain Tax Positions, see Note 19 of Notes to Condensed Consolidated Financial Statements.
50
FINANCIAL CONDITION AS OF SEPTEMBER 30, 2009
This discussion should be read in conjunction with Sotheby’s Condensed Consolidated Statements of Cash Flows (see Part I, Item 1, “Financial Statements”). For the nine months ended September 30, 2009, total cash and cash equivalents decreased approximately $137 million to $116.5 million primarily due to the factors discussed below.
Cash Used by Operating Activities—Net cash used by operating activities of $63.4 million for the nine months ended September 30, 2009 is principally attributable to of Sotheby’s net loss for the period and a $68 million decrease in accounts payable and accrued liabilities. These cash decreases were partially offset by an increase of $32.4 million in net amounts collected from clients and, to a lesser extent, sales of inventory.
In October and November 2009, Sotheby’s sold inventory with an aggregate carrying value of approximately $25 million. As a result, Sotheby’s inventory balance as of December 31, 2009 is expected to be in the range of $140 million, which would represent a decrease of approximately $45 million when compared to December 31, 2008. (See Statement on Forward Looking Statements.)
Cash Used by Investing Activities—Net cash used by investing activities of $55.9 million for the nine months ended September 30, 2009 is principally due to the $85 million payment made in conjunction with the York Property purchase in February 2009 (see “York Property” above) and the funding of other capital expenditures ($10.8 million). These cash outflows are partially offset by a $23.7 million decrease in restricted cash and a $16.9 million net decrease in client loans.
Cash Used by Financing Activities—Net cash used by financing activities of $18.5 million for the nine months ended September 30, 2009 is principally due to $17 million in dividend payments in 2009 and $1.6 million in repurchases of 7.75% Senior Notes in January 2009.
Non-Cash Investing and Financing Activities—On February 6, 2009, Sotheby’s purchased the York Property, financed in part through the assumption of an existing $235 million mortgage. (See “York Property” above.)
LIQUIDITY AND CAPITAL RESOURCES
Cash and Cash Equivalents—As of September 30, 2009, Sotheby’s had cash and cash equivalents of approximately $116.5 million, which are invested on a short-term basis in the highest rated AAA U.S. Treasury money market funds and the highest rated overnight time deposits with major banks.
Revolving Credit Facility—On August 31, 2009, Sotheby’s and certain of its wholly-owned subsidiaries (collectively, the “Borrowers”), entered into a credit agreement (the “Credit Agreement”) with General Electric Capital Corporation (“GE Capital”), as Agent, GE Capital Markets, Inc. and HSBC Bank PLC, as Joint Lead Arrangers and Joint Bookrunners, and the lenders named therein (collectively, the “Lenders”).
The Credit Agreement has a maturity date of August 31, 2012 and provides for a $200 million revolving credit facility (the “Revolving Credit Facility”), with a sub-limit of $50 million for U.K. based borrowings. The borrowings available under the Credit Agreement are limited by a borrowing base, which is summarized in the following paragraph. Borrowings under the Revolving Credit Facility may be used for general corporate purposes. In addition, up to $10 million of the Revolving Credit Facility may be used to issue letters of credit. As of September 30, 2009, there were no outstanding borrowings under the Revolving Credit Facility, and the borrowing availability was approximately $140 million, as calculated under the borrowing base. In addition, Sotheby’s did not have any letters of credit outstanding as of September 30, 2009.
Borrowings under the Revolving Credit Facility are limited by a borrowing base, which is equal to 85% of Eligible Art Loans (as defined in the Credit Agreement), plus 30% of Eligible Art Inventory (as defined in the Credit Agreement), plus 15% of Consolidated Net Tangible Assets (as defined in the Credit Agreement), subject to certain reserves.
Borrowings under the Revolving Credit Facility are available in either Dollars (to Borrowers located in the U.S. (“U.S. Borrowers”)) or Pounds Sterling (to Borrowers located in England (“U.K. Borrowers”)). The U.S. Borrowers and, subject to certain limitations, the U.K. Borrowers, are jointly and severally liable for all obligations under the Credit Agreement. In addition, certain subsidiaries of the Borrowers guaranty the obligations of the Borrowers under the Credit Agreement. The obligations under the Credit Agreement are secured by liens on all or substantially all of the personal property of the Borrowers and the guarantors.
Borrowings are, at the Borrowers’ option, either Dollar Index Rate Loans (for U.S. Borrowers only) or LIBOR Loans. Dollar Index Rate Loans bear interest from the applicable borrowing date at a rate per annum equal to (a) the highest of (i) the “Prime Rate” as quoted inThe Wall Street Journal, (ii) the Federal Funds Rateplus 3%, or (iii) the LIBOR Rate based upon the offered rate for deposits in such currency for a period equal to such interest period on the Reuters Screen LIBOR01 Page plus 1.0%,plus (b) the Applicable Margin, as defined in the Credit Agreement and which is generally 3.0% to 3.5% based upon the level of outstanding borrowings under the Revolving Credit Facility. The LIBOR Rate for Dollars or Sterling, as the case may be, for an interest period is equal to (x) the highest of (i) the offered rate for deposits in such currency for a period equal to such interest period on the Reuters Screen LIBOR01 Page, (ii) if the interest period is less than three months, the offered rate for deposits in such currency on the Reuters Screen for an Interest Period of three months, and (iii) 2%, plus (y) the Applicable Margin, as defined in the Credit Agreement, and which is generally 4.0% to 4.5% based upon the level of outstanding borrowings under the Revolving Credit Facility.
The Credit Agreement contains certain customary affirmative and negative covenants including, but not limited to, limitations on capital expenditures, limitations on net outstanding auction guarantees, limitations on the use of proceeds from the credit extensions, limitations on the ability to merge, liquidate, consolidate, dispose of assets or capital stock, and limitations on material changes to the nature of the business. The Credit Agreement also restricts quarterly dividend payments to the lesser of $0.05 per share or $4 million. The maximum level of quarterly dividend payments may be increased depending on the Fixed Charge Coverage Ratio covenant, as defined in the Credit Agreement. Management believes that Sotheby’s is in compliance with the current covenants and terms under the Credit Agreement.
51
The Credit Agreement also contains the following financial covenants, which are only applicable during certain compliance periods (as defined in the Credit Agreement):
| | |
| • | A minimum Fixed Charge Coverage Ratio (as defined in the Credit Agreement), which requires Sotheby’s to maintain sufficient level of specifically defined cash flows to cover certain debt and equity related cash requirements. |
| | |
| • | A minimum EBITDA (as defined in the Credit Agreement), which requires Sotheby’s to maintain certain minimum levels of specifically defined operating cash flows. |
As applicable during certain compliance periods (as defined in the Credit Agreement), the financial covenants discussed above will first be effective for the twelve month period ending December 31, 2009 and therefore are not applicable to Sotheby’s as of September 30, 2009.
Sotheby’s incurred total fees related to the Credit Agreement of approximately $7.5 million, which are being amortized on a straight-line basis to interest expense over the three-year term of the facility. Additionally, commitment fees of 1.00% per annum are being charged to Sotheby’s for undrawn amounts committed under the Revolving Credit Facility.
52
In connection with entry into the Credit Agreement, on August 31, 2009, Sotheby’s terminated its senior secured revolving credit facility with Bank of America, N.A. (the “BofA Credit Agreement”). The BofA Credit Agreement had a maturity date of September 7, 2010 and provided for borrowings of up to $150 million, subject to a borrowing base. As a result of this termination, Sotheby’s recorded a non-cash $2.5 million charge in the third quarter of 2009 to write-off the remaining balance of arrangement and amendment fees related to the BofA Credit Agreement. Additionally, as a result of amendments to the BofA Credit Agreement made in the first half of 2009, Sotheby’s recorded a non-cash $1.3 million charge in the second quarter of 2009 to partially write-off previous arrangement and amendment fees related to the BofA Credit Agreement.
Liquidity Requirements—Sotheby’s generally relies on operating cash flows supplemented by borrowings to meet its liquidity requirements.
Sotheby’s short-term operating needs and capital requirements include the funding of working capital, the funding of notes receivable and consignor advances, the funding of other short-term commitments to consignors, the funding of capital expenditures and the payment of any dividends, as well as the short-term commitments to be funded on or before September 30, 2010, included in the table of contractual obligations and commitments above.
Sotheby’s long-term operating needs and capital requirements include the funding of working capital, the funding of notes receivable and consignor advances, the funding of capital expenditures, as well as the funding of Sotheby’s presently anticipated long-term contractual obligations and commitments outlined in the table of contractual obligations and commitments above.
Management believes that operating cash flows, cash balances and borrowings available under the Credit Agreement will be adequate to meet Sotheby’s anticipated short-term and long-term commitments, operating needs and capital requirements through the August 31, 2012 expiration of the Credit Agreement. (See statement on Forward Looking Statements.)
DIVIDENDS
The following table summarizes dividends per share and dividends declared and paid for the periods indicated (in thousands, except per share amounts):
| | | | | | | |
Quarter Ended | | Dividends
Per Share | | Dividends Declared
and Paid | |
| |
| |
| |
| | | | | | | |
March 31, 2009 | | $ | 0.15 | | $ | 10,231 | |
June 30, 2009 | | $ | 0.05 | | $ | 3,399 | |
September 30, 2009 | | $ | 0.05 | | $ | 3,399 | |
| | | | |
|
| |
Total through September 30, 2009 | | | | | $ | 17,029 | |
| | | | |
|
| |
On November 3, 2009, Sotheby’s Board of Directors declared a quarterly dividend of $0.05 per share (approximately $3.4 million) to be paid on December 15, 2009 to shareholders of record as of December 1, 2009. The declaration and payment of future dividends to shareholders remains at the discretion of Sotheby’s Board of Directors and will depend on many factors, including Sotheby’s financial condition, cash flows, legal requirements and other factors as the Board of Directors deem relevant.
Management will continue to assess Sotheby’s quarterly dividend based upon future operating results and capital requirements (See statement on Forward Looking Statements.)
FUTURE IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2008, the FASB issued FSP No. FAS 132(R)-1, “Employers’ Disclosures about Post Retirement Benefit Plan Assets,” which is codified under ASC 715-20 (Compensation-Retirement Benefits-Defined Benefit Plans) and requires expanded disclosures about plan assets in employers’ defined benefit pension or other post-retirement plans regarding how investment decisions are made, the major categories of plan assets, the input and valuation techniques used to measure the fair value of plan assets and concentrations of risk within plan assets. Although earlier application is permitted, these expanded disclosures are not required until Sotheby’s annual report for the year ending December 31, 2009. The new disclosure requirements do not apply to interim financial statements. Management is evaluating the impact of complying with these new disclosure requirements on Sotheby’s consolidated financial statements.
In April 2009, the FASB issued FSP No. FAS 107 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” which is codified under ASC 825 (Financial Instruments) and requires publicly traded companies to disclose on an interim and annual basis the fair value and related carrying amounts of their financial instruments, as well as the
53
methods and significant assumptions used to estimate fair value and any changes to such methods and assumptions. Sotheby’s adopted these new disclosure requirements as of June 30, 2009, as applicable. See Note 10 of Notes to Condensed Consolidated Financial Statements.
In April 2009, the SEC Staff issued Staff Accounting Bulletin (“SAB”) No. 111. SAB No. 111 amends and replaces SAB Topic 5.M. in the SAB Series entitled“Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities.” SAB No. 111 maintains the SEC Staff’s previous views related to equity securities and amends Topic 5.M. to exclude debt securities from its scope. Sotheby’s adopted SAB No. 111 in the second quarter of 2009. The adoption of SAB No. 111 has not had an impact on Sotheby’s results or financial position in 2009.
In April 2009, the FASB issued FSP No. 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies,” which is now codified under ASC 805 (Business Combinations). This standard amends and clarifies previous accounting principles regarding business combinations to address application issues raised by preparers, auditors, and members of the legal profession on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. This standard was effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The adoption of this standard has not impacted Sotheby’s results of operations or financial condition in 2009 as there have been no business combinations on or after its effective date.
In May 2009, the FASB issued SFAS No. 165, “Subsequent Events,” which is now codified under ASC 855 (Subsequent Events). This standard establishes the general principles of accounting for, and disclosure of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This standard also requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for selecting that date. Sotheby’s adopted this standard, effective for the period ended June 30, 2009. The adoption of this standard has not impacted Sotheby’s results of operations or financial position in 2009. Sotheby’s management has conducted its evaluation of subsequent events through November 5, 2009, which is the date on which the Condensed Consolidated Financial Statements contained within this filing were issued. See Notes 14 and 17 of Notes to Condensed Consolidated Financial Statements for subsequent events impacting Sotheby’s.
In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140.” This pronouncement has not yet been incorporated into the Codification. This standard eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets and requires additional disclosures in order to enhance information reported to users of financial statements by providing greater transparency about transfers of financial assets, including securitization transactions, and an entity’s continuing involvement in and exposure to the risks related to transferred financial assets. This standard is effective for fiscal years beginning after November 15, 2009. Sotheby’s will adopt this standard as of January 1, 2010. Management is evaluating the potential impact this standard may have on Sotheby’s consolidated financial statements.
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R).” This pronouncement has not yet been incorporated into the Codification. This standard changes how companies determine whether an entity that is insufficiently capitalized or is controlled through voting (or similar rights) should be consolidated. This standard will become effective for Sotheby’s on January 1, 2010. Management is evaluating the impact of adopting this standard on Sotheby’s consolidated financial statements.
In June 2009, the SEC Staff issued SAB No. 112. SAB No. 112 amends or rescinds portions of the SEC Staff’s interpretive guidance included in the SAB Series in order to make the relevant interpretive guidance consistent with ASC 805 (Business Combinations). Sotheby’s adopted this standard in the second quarter of 2009. The adoption of SAB No. 112 has not impacted Sotheby’s results of operations or financial position in 2009.
In August 2009, the FASB issued ASU No. 2009-05, “Fair Value Measurements and Disclosures (Topic 820), Measuring Liabilities at Fair Value.” ASU No. 2009-05 amends principles regarding the fair value measurement of liabilities and requires the use of either quoted prices of an identical liability when traded as an asset, quoted prices for similar liabilities or similar liabilities when traded as assets or other valuation techniques such as an income present value approach or a market current replacement approach. Sotheby’s will adopt ASU No. 2009-05 upon its effective date in the fourth quarter of 2009. Management is evaluating the potential impact it may have on Sotheby’s consolidated financial statements.
In September 2009, the FASB issued ASU No. 2009-06, “Income Taxes (Topic 740), Implementation Guidance on Accounting for Uncertainty in Income Taxes and Disclosure Amendments for Nonpublic Entities.” ASU No. 2009-06 provides implementation guidance regarding: (1) income taxes attributable to owners; (2) the determination of the taxable status of an entity, including its status as a pass-through or tax-exempt entity and (3) the evaluation of the tax positions of all entities within a related group regardless of the tax status of the reporting entity. In addition, ASU No. 2009-06 eliminates the tabular reconciliation disclosure requirement for the total amount of unrecognized tax benefits for the periods presented. ASU No. 2009-06 applies to entities that are currently applying the standards for accounting for uncertainties in income taxes and is
54
effective for interim and annual financial statements for periods ending after September 15, 2009. Sotheby’s adopted ASU No. 2009-06 in the third quarter of 2009. The adoption of ASU No. 2009-06 did not have an impact on Sotheby’s results of operations or financial position for the period ended September 30, 2009. See Note 19 of Notes to Condensed Consolidated Financial Statements.
In September 2009, the FASB issued ASU No. 2009-12, “Fair Value Measurements and Disclosures (Topic 820), Investments in Certain Entities that Calculate Net Asset Value per Share (or Its Equivalent).” ASU No. 2009-12 amends principles regarding the fair value measurements of investments in entities that calculate fair value using a net asset value per share approach and permits the measurement of the fair value of an investment on the basis of the entities’ net asset value per share. In addition, ASU No. 2009-12 requires disclosures, by major category, about the attributes of such investments, to include any restrictions to redeem, unfunded commitments, and underlying investment strategies. ASU No. 2009-12 is effective for interim and annual periods ending after December 15, 2009. Early adoption is permitted. Sotheby’s will adopt ASU No. 2009-12 in the fourth quarter of 2009. Management is evaluating the potential impact of ASU No. 2009-12 on Sotheby’s consolidated financial statements.
In October 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition (Topic 605), Multiple-Deliverable Revenue Arrangements, a consensus of the FASB Emerging Issues Task Force.” ASU No. 2009-13 establishes a selling price hierarchy for the determination of the applicable value of separate deliverables within a multi-deliverable arrangement. The relative selling price hierarchy replaces the fair value methodology and establishes allocations based on entity-specific assumptions rather than broad market fair value criteria. In addition, ASU No. 2009-13 expands the required disclosures to include a description of the arrangement, the specific factors used to determine the selling price for the deliverable and the timing of revenue recognition as a result of the arrangement. ASU No. 2009-13 is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. Management is evaluating the potential impact of ASU No. 2009-13 on Sotheby’s consolidated financial statements.
In October 2009, the FASB issued ASU No. 2009-15, “Accounting for Own Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing.” ASU No. 2009-15 provides accounting and disclosure guidance for share lending arrangements issued in contemplation of convertible debt issuance. A share-lending arrangement is an agreement between the entity (share lender) and an investment bank (share borrower) and is intended to facilitate the ability of investors to hedge the conversion option of the issued convertible debt. The share lending agreement must be measured at fair value. Specific disclosures are required in any period in which the share lending arrangement is outstanding. ASU No. 2009-15 is effective for fiscal years beginning on or after December 15, 2009, and interim periods within those fiscal years for arrangements outstanding as of the beginning of those fiscal years. Early adoption is not permitted. Management is evaluating the potential impact of ASU No. 2009-15 on Sotheby’s consolidated financial statements.
FORWARD LOOKING STATEMENTS
This Form 10-Q contains certain forward looking statements; as such term is defined in Section 21E of the Securities Exchange Act of 1934, as amended, relating to future events and the financial performance of Sotheby’s. Such statements are only predictions and involve risks and uncertainties, resulting in the possibility that the actual events or performance will differ materially from such predictions. Major factors which management believes could cause the actual results to differ materially from the predicted results in the forward looking statements include, but are not limited to, the factors listed below under Part I, Item 1A, “Risk Factors,” which are not ranked in any particular order.
55
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Sotheby’s continually evaluates its market risk associated with its financial instruments and derivative financial instruments (see above) during the course of its business. As of September 30, 2009, Sotheby’s financial instruments include its:
| | |
| • | Cash and cash equivalents |
| | |
| • | Restricted cash |
| | |
| • | Notes receivable and consignor advances (see Note 5 of Notes to Condensed Consolidated Financial Statements) |
| | |
| • | Trust assets related to the deferred compensation liability (see Note 11 of Notes to Condensed Consolidated Financial Statements) |
| | |
| • | York Property Mortgage (see Note 10 of Notes to Condensed Consolidated Financial Statements) |
| | |
| • | 7.75% Senior Notes (see Note 10 of Notes to Condensed Consolidated Financial Statements) |
| | |
| • | 3.125% Convertible Notes (see Note 10 of Notes to Condensed Consolidated Financial Statements) |
| | |
| • | Deferred compensation liability (see Note 11 of Notes to Condensed Consolidated Financial Statements) |
Management believes that its interest rate risk is minimal as a hypothetical 10% increase or decrease in interest rates is immaterial to Sotheby’s cash flow, earnings and fair value related to its financial instruments. (See statement on Forward Looking Statements.)
As of September 30, 2009, a hypothetical 10% strengthening or weakening of the U.S. dollar relative to all other currencies would result in a decrease or increase in cash flow of approximately $11.3 million.
(See “Derivative Instruments” above and Note 18 of Notes to Condensed Consolidated Financial Statements.)
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of September 30, 2009, Sotheby’s has carried out an evaluation, under the supervision and with the participation of Sotheby’s management, including Sotheby’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of Sotheby’s disclosure controls and procedures. Based upon that evaluation, Sotheby’s Chief Executive Officer and Chief Financial Officer have concluded that Sotheby’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) were effective as of September 30, 2009.
Changes in Internal Control over Financial Reporting
There was no change in Sotheby’s internal control over financial reporting that occurred during Sotheby’s most recent fiscal quarter that materially affected, or is reasonably likely to materially affect, Sotheby’s internal control over financial reporting.
56
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Sotheby’s is involved from time to time in claims, proceedings and litigation, including the matters described below:
Sotheby’s Inc. v. Halsey Minor is an action commenced by a subsidiary of Sotheby’s in September 2008 in the U.S. District Court for the Southern District of New York, seeking to collect approximately $18 million for three paintings that Mr. Minor purchased in auctions conducted by Sotheby’s in the spring of 2008. Mr. Minor filed a counterclaim in that action alleging that Sotheby’s had failed to disclose that the consignor of one of those paintings had an outstanding loan from Sotheby’s and asserting that the sale should, therefore, be rescinded or the price of the painting reduced. In October 2008, Mr. Minor commenced a separate action in the U.S. District Court for the Northern District of California seeking recovery for alleged losses on behalf of a purported class of purchasers of properties that were subject to alleged undisclosed loans from Sotheby’s. That action also asserted breaches of fiduciary duties arising from alleged art consulting advice provided to Mr. Minor by a Sotheby’s employee. The California action that Mr. Minor had commenced against Sotheby’s has been dismissed. In April 2009, Mr. Minor filed a motion in the New York action seeking to amend his answer and counterclaim to (i) broaden his rescission claim to cover an additional painting, (ii) add claims for alleged breach of fiduciary duty and alleged violations of a New York State consumer protection statute and (iii) seek injunctive relief. In May 2009, Sotheby’s opposed that motion and, in addition, moved for summary judgment against certain of Mr. Minor’s claims. In July 2009, Sotheby’s moved for summary judgment against the remainder of Mr. Minor’s claims, and Mr. Minor moved for summary judgment in favor of certain of his claims. In October 2009, the Magistrate Judge assigned to this action issued an opinion and order denying Mr. Minor’s motion for leave to file an amended answer and counterclaim to the extent that Mr. Minor sought to assert claims for breach of fiduciary duty and violations of the New York State consumer protection statute. While it is not possible to predict the outcome of litigation, management believes that there are meritorious defenses to the claims asserted in the counterclaim to the New York action and that they will not have a material adverse effect on Sotheby’s consolidated results of operations, financial condition and/or cash flows. This counterclaim is being vigorously defended.
Italian Antitrust Matter—In October 2008, the Italian Antitrust Authority commenced an investigation of Italian auction houses and an Italian auction house trade association seeking evidence of practices that reduce competition, particularly in respect of the sale of modest value works of art. Sotheby’s subsidiary, Sotheby’s Italia S.r.l., fully cooperated with the investigation and has been advised by the Italian Antitrust Authority that the investigation has been completed and did not result in any findings of anticompetitive practices.
Sotheby’s becomes involved in various other claims and lawsuits incidental to the ordinary course of its business. While it is not possible to predict the outcome of litigation, management does not believe that the outcome of any of these pending claims or proceedings will have a material adverse effect on Sotheby’s consolidated results of operations, financial condition and/or cash flows.
(See statement on Forward Looking Statements.)
ITEM 1A. RISK FACTORS
Sotheby’s operating results and liquidity are significantly influenced by a number of risk factors, many of which are not within its control. These factors, which are not ranked in any particular order, are discussed below:
The supply of and demand for works of art can be adversely impacted by weakness in various worldwide economies and financial markets.
The art market in which Sotheby’s operates is influenced over time by the overall strength of various worldwide economies and financial markets, although this correlation may not be immediately evident. Sotheby’s business can be particularly influenced by the economies of the U.S., the U.K., and the major countries or territories of Continental Europe and Asia. Accordingly, weakness in those economies can adversely affect the supply and demand of works of art and Sotheby’s business.
Interest rates may negatively impact Sotheby’s cost of borrowings, if any.
Fluctuations in interest rates influence the cost of borrowings, if any, under Sotheby’s senior secured credit facility, which is used periodically to finance working capital needs and, in particular, the Finance segment’s client loan portfolio.
57
Government laws and regulations may restrict or limit Sotheby’s business.
Many of Sotheby’s activities are subject to laws and regulations including, but not limited to, import and export regulations, cultural property ownership laws, data protection and privacy laws, anti-money laundering laws, antitrust laws and value added sales taxes. In addition, Sotheby’s is subject to local auction regulations, such as New York City Auction Regulations Subchapter M of Title 6 §§ 2-121–2-125, et. seq. Such regulations do not impose a material impediment to the worldwide business of Sotheby’s, but do affect the market generally, and a material adverse change in such regulations could affect the business. Additionally, export and import laws and cultural property ownership laws could affect the availability of certain kinds of property for sale at Sotheby’s principal auction locations or could increase the cost of moving property to such locations.
Global political conditions and world events may negatively affect Sotheby’s business and customers.
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. Global political conditions may also influence the enactment of legislation that could adversely affect Sotheby’s business.
Foreign currency exchange rate movements can significantly increase or decrease Sotheby’s results of operations.
Sotheby’s has operations throughout the world, with approximately 68% of its revenues earned outside of the U.S. in 2008. Accordingly, fluctuations in exchange rates can significantly increase or decrease Sotheby’s results of operations.
Competition in the art market is intense and may adversely impact Sotheby’s ability to obtain valuable consignments for sale and the commission margins achieved on such consignments.
Sotheby’s competes with both 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 the commission margins that Sotheby’s earns for services provided to its clients.
Sotheby’s cannot be assured of the amount and quality of property being consigned for sale at auction, which may cause significant variability in its financial results.
The amount and quality of property being 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. This, plus the ability of Sotheby’s to sell such property, can cause significant variability in Sotheby’s financial results from period to period.
The demand for fine arts, decorative arts, and collectibles is unpredictable, which may cause significant variability in Sotheby’s financial results.
The demand for fine arts, decorative arts, and collectibles is influenced not only by overall economic conditions, but also by changing trends in the art market as to which collecting categories and artists are most sought after and by the collecting preferences of individual collectors, all of which can be unpredictable and cause significant variability in Sotheby’s financial results from period to period.
The loss of key personnel could adversely impact Sotheby’s ability to compete.
Sotheby’s business 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 both complex and unique, making it important to retain key specialists and members of management. Accordingly, Sotheby’s business is highly dependent upon its success in attracting and retaining qualified personnel.
Sotheby’s relies on a small number of clients who make a significant contribution to Sotheby’s revenues and profitability.
Sotheby’s relies on a small number of important clients who make a significant contribution to its revenues and profitability. Accordingly, Sotheby’s success is highly dependent upon its ability to develop and maintain relationships with this small group of important clients.
Demand for art-related financing is unpredictable, which may cause significant variability in the financial results of Sotheby’s Finance segment.
Sotheby’s Finance segment is 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.
58
The strategic initiatives and restructuring plans that Sotheby’s is relying on to improve profitability may not succeed.
Management is implementing certain strategic initiatives, as well as restructuring plans. Sotheby’s future operating results are dependent in part on management’s success in implementing these plans. Implementation of Sotheby’s strategic plans and its restructuring plans could unfavorably impact its short-term operating results. (See “Restructuring Plans and Related Charges” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and statement on Forward Looking Statements.)
The value of artwork is subjective and often fluctuates, exposing Sotheby’s to losses in the value of its inventory and loan collateral and significant variability in its financial results.
The art market is not a highly liquid trading market. As a result, the valuation of artwork is inherently subjective and the realizable value of artwork often fluctuates over time. Accordingly, Sotheby’s is at risk both as to the value of art held as inventory and as to the value of artworks pledged as collateral for Finance segment loans.
In determining the estimated realizable value of artworks, management relies upon the opinions of Sotheby’s specialists, who consider the following complex array of factors when valuing artworks: (i) whether the work is expected to be offered at auction or sold privately, (ii) the current and expected future demand for works of art, taking into account changing trends in the art market as to which collecting categories and artists are most sought after, and (iii) recent sale prices achieved in the art market for comparable works within a particular collecting category and/or by a particular artist.
When management determines that the estimated realizable value of specific artworks held in inventory is less than the carrying value, Sotheby’s records a loss in the Auction or Dealer segment to reduce the carrying value of the specific artwork to the lower of its cost or management’s estimate of realizable value. In addition, in the event that the estimated realizable value of the artworks pledged as collateral for Finance segment loans declines and becomes less than the corresponding loan balance, management is required to assess whether it is necessary to record a loss to reduce the carrying value of a specific loan, after taking into account the ability of the borrower to repay Sotheby’s for any shortfall in the value of the collateral when compared to the amount of the loan. These factors may cause significant variability in Sotheby’s financial results from period to period.
Auction guarantees create risk of loss from inaccurate valuation of artworks.
As discussed above, the art market is not a highly liquid trading market and, as a result, the valuation of artwork is inherently subjective. Accordingly, Sotheby’s is at risk with respect to its ability to estimate the likely selling prices of works of art offered with auction guarantees. Accordingly, if management’s judgments about the likely selling prices of works of art offered with auction guarantees, prove to be inaccurate, there could be a significant adverse impact on Sotheby’s results of operations, financial condition and liquidity.
Sotheby’s could be exposed to credit-related 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 with partners. 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 credit-related losses in the event of nonperformance by these counterparties.
Future costs and obligations related to the Sotheby’s U.K. Pension Plan are dependent on unpredictable factors, which may cause significant variability in employee benefit costs.
Future costs and obligations related to Sotheby’s defined benefit pension plan in the U.K. are heavily influenced by changes in interest rates, investment performance in the debt and equity markets and actuarial assumptions, each of which is unpredictable and may cause significant variability in Sotheby’s employee benefit costs.
Tax matters may cause significant variability in Sotheby’s financial results.
Sotheby’s operates in many tax jurisdictions throughout the world and the provision for income taxes involves a significant amount of management judgment regarding interpretation of relevant facts and laws in the jurisdictions in which Sotheby’s operates. Accordingly, Sotheby’s effective income tax rate can vary significantly between periods due to a number of complex factors including, but not limited to (i) future changes in applicable laws, (ii) projected levels of taxable income, (iii) pre-tax income being lower than anticipated in countries with lower statutory rates or higher than anticipated in countries with higher statutory rates, (iv) increases to valuation allowances recorded against deferred tax assets, (v) tax audits conducted by various tax authorities, (vi) adjustments to income taxes upon finalization of income tax returns, (vii) the ability to claim foreign tax credits, (viii) the repatriation of non-U.S. earnings for which Sotheby’s has not previously provided for income taxes, and (ix) tax planning.
59
Similarly, Sotheby’s clients reside in various tax jurisdictions throughout the world. To the extent that there are changes to tax laws in any of these jurisdictions, such changes could adversely impact the ability and/or willingness of Sotheby’s clients to purchase or sell works of art.
Insurance coverage for artwork may become more difficult to obtain, exposing Sotheby’s to losses for artwork in Sotheby’s possession.
Sotheby’s maintains insurance coverage for the works of art it owns and for works of art consigned to it by its clients, which are stored at Sotheby’s facilities around the world. An inability to adequately insure such works of art due to limited capacity of the global art insurance market in the future could have an adverse impact on Sotheby’s business.
A charge to earnings would be required if the values of Sotheby’s goodwill, amortizable intangible assets or other long-lived assets become impaired.
Sotheby’s is required under generally accepted accounting principles to test goodwill for impairment at least annually and to review amortizable intangible assets and other long-lived assets for impairment when events or changes in circumstance indicate the carrying value may not be recoverable. Factors that could lead to impairment of goodwill include a decline in Sotheby’s stock price and market capitalization, a significant adverse change in the business climate and declines in the financial condition of Sotheby’s auction business. Factors that could lead to impairment of intangible assets include a significant adverse change in the business climate and declines in the financial condition of operations related to the intangible asset. Factors that are considered when evaluating other long-lived assets for impairment include a current expectation that it is more likely than not that the long-lived asset will be sold significantly before the end of its useful life, a significant decrease in the market price of the long-lived asset and a significant change in the extent or manner in which the long-lived asset is being used. The evaluation whether a long-lived asset is impaired requires significant judgment, including judgments made by management about future cash flows, which are dependent on internal forecasts. Changes in the estimates and assumptions used by management in its internal forecasts could materially affect the determination of impairment. If management determines that the value of any of its goodwill, amortizable intangible assets or other long-lived assets is impaired, Sotheby’s would be required to record a charge in its financial statements during the period, negatively impacting its results of operations.
60
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
| | | |
| (a) | Exhibits |
| | | |
| | 10.1 | Credit Agreement dated as of August 31, 2009, among Sotheby’s (a Delaware corporation), Sotheby’s Inc., Sotheby’s Financial Services, Inc., Sotheby’s Financial Services California, Inc., Oberon, Inc., Theta, Inc., Sotheby’s Ventures, LLC, Oatshare Limited, Sotheby’s (a company registered in England) and Sotheby’s Financial Services Limited, as Borrowers and General Electric Capital Corporation, as Agent and a Lender, GE Capital Markets, Inc. and HSBC Bank PLC, as Joint Lead Arrangers and Joint Bookrunners and Other Credit Parties and Lenders Hereto, incorporated by reference to Exhibit 10.1 to Sotheby’s Form 8-K dated September 1, 2009. |
| | | |
| | 31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | | |
| | 31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | | |
| | 32.1 | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | | |
| | 32.2 | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | | |
| (b) | Reports on Form 8-K |
| | | |
| | (i) | On August 8, 2009, Sotheby’s filed a current report on Form 8-K under Item 2.02, “Results of Operations and Financial Condition” and Item 9.01, “Financial Statements and Exhibits.” |
| | | |
| | (ii) | On September 1, 2009, Sotheby’s filed a current report on Form 8-K under Item 1.01, “Entry into a Material Definitive Agreement,” Item 1.02, “Termination of a Material Definitive Agreement,” Item 2.03, “Creation of a Direct Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement of a Registrant,” Item 7.01, “Regulation FD Disclosure,” and Item 9.01, “Financial Statements and Exhibits.” |
61
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | |
| SOTHEBY’S |
| | |
| By: | /s/ Kevin M. Delaney |
| |
|
| | Kevin M. Delaney |
| | Senior Vice President, |
| | Controller and Chief |
| | Accounting Officer |
| | |
| Date: November 5, 2009 |
62
Exhibit Index
| | |
Exhibit
No. | | Description |
10.1 | | Credit Agreement dated as of August 31, 2009, among Sotheby’s (a Delaware corporation), Sotheby’s Inc., Sotheby’s Financial Services, Inc., Sotheby’s Financial Services California, Inc., Oberon, Inc., Theta, Inc., Sotheby’s Ventures, LLC, Oatshare Limited, Sotheby’s (a company registered in England) and Sotheby’s Financial Services Limited, as Borrowers and General Electric Capital Corporation, as Agent and a Lender, GE Capital Markets, Inc. and HSBC Bank PLC, as Joint Lead Arrangers and Joint Bookrunners and Other Credit Parties and Lenders Hereto, incorporated by reference to Exhibit 10.1 to the Sotheby’s Form 8-K dated September 1, 2009. |
| | |
31.1 | | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
31.2 | | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
32.1 | | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | |
32.2 | | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
63
