For the three and six months ended June 30, 2005 and 2004, salaries and related costs consisted of the following (in thousands of dollars):
* Represents a change in excess of 100%.
For the three and six months ended June 30, 2005, salaries and related costs increased $3.7 million, or 8%, to $53.3 million, and $4.3 million, or 5%, to $92.8 million, respectively, when compared to the same periods in the prior year. These increases are primarily attributable to higher incentive bonus costs and increased employee benefit costs, as well as the impact of limited full-time salary increases in 2005 and higher stock compensation expenses. The overall increase in salaries and related costs for both periods was partially offset by lower costs related to the Option Exchange program, primarily related to the one-time $2.2 million cash payment made to employees upon acceptance of the Exchange Offer in 2004, for which there was no comparable event in 2005. See discussion below for a more detailed explanation of each of these factors.
Employee Benefit Costs—For the three and six months ended June 30, 2005, employee benefit costs increased $1.3 million, or 33%, and $1.8 million, or 21%, respectively, when compared to the same periods in the prior year. The higher level of employee benefit costs for the periods was primarily due to increases of $0.5 million and $1.1 million, respectively, in costs related to the Company’s U.K. defined benefit pension plan (see Note 8 of Notes to Consolidated Financial Statements under Part I, Item 1 “Financial Statements”). To a lesser extent, the increases in employee benefit costs were attributable to incremental profit-sharing costs related to the Company’s U.S. pension plans, reflecting the Company’s financial performance for the first half of 2005. In the prior periods, certain contributions to the Company’s U.S. pension plans were determined as a fixed percentage of an employee’s eligible compensation rather than via a profit-sharing formula. Also unfavorably impacting the comparison to the prior periods were increased health and welfare benefit costs in the U.K. For the six months ended June 30, 2005, the overall increase in employee benefit costs was partially offset by $0.6 million in severance costs incurred in the first quarter of 2004 related to headcount reductions in Continental Europe, for which there was no comparable event in the current period.
Full-Time Salaries—For the three and six months ended June 30, 2005, full-time salaries increased $0.9 million, or 4%, to $24.9 million, and $1.6 million, or 3%, to $50.6 million, respectively, when compared to the same periods in the prior year. These increases were principally due to limited salary increases taking effect in 2005 and the unfavorable impact of foreign currency translations ($0.4 million and $0.9 million for the three and six months ended June 30, 2005, respectively); partially offset by savings achieved as a result of certain headcount reductions taking effect in 2004.
Stock Compensation Expense—For the three and six months ended June 30, 2005 and 2004, stock compensation expense related to restricted stock shares granted pursuant to the Sotheby’s Holdings, Inc. 2003 Restricted Stock Plan (excluding shares issued in conjunction with the Exchange Offer discussed below) increased $0.8 million and $1.3 million, respectively, when compared to the same periods in the prior year. These increases are primarily due to incremental stock compensation expense associated with a grant of 276,000 shares of restricted stock on February 7, 2005. The amortization of stock compensation expense related to restricted stock shares granted pursuant to the Sotheby’s Holdings, Inc. 2003 Restricted Stock Plan (excluding shares issued in conjunction with the Exchange Offer discussed below) is expected to be approximately $3.9 million for the year ended December 31, 2005.
Option Exchange Program—In February 2003, the Compensation Committee approved an exchange offer of cash or restricted stock for certain stock options held by eligible employees under the 1997 Stock Option Plan (the “Exchange Offer”). The Exchange Offer was tendered during the first half of 2004.
Compensation expense related to the Exchange Offer decreased $0.9 million, or 49%, and $1.4 million, or 35%, for the three and six months ended June 30, 2005, respectively, when compared to the same periods in the prior year. For the three months ended June 30, 2005, the decrease in compensation expense related to the Exchange Offer is principally attributable to lower amortization of stock compensation expense related to the issuance of approximately 1.1 million shares as a result of the Exchange Offer, the expense relating to which is being amortized over a graded four-year vesting period. For the six months ended June 30, 2005, the comparison of compensation expense related to the Exchange Offer to the prior year was also significantly influenced by $2.2 million of expense recognized in the first quarter of 2004 representing the full cash payment made to employees upon acceptance of the Exchange Offer on March 31, 2004, for which there is no comparable event in 2005; partially offset by the higher amortization of stock compensation expense in 2005 due to the timing of the Exchange Offer restricted stock grant in 2004.
The amortization of stock compensation expense related to the Exchange Offer is expected to be approximately $4.6 million, $2.5 million and $1.2 million for the years ended December 31, 2005, 2006 and 2007, respectively.
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General and Administrative Expenses
For the three and six months ended June 30, 2005, general and administrative expenses increased $6 million, or 25%, to $30.6 million, and $7.6 million, or 15%, to $57.8 million, respectively, when compared to the same periods in the prior year. For the three and six months ended June 30, 2005, the overall increase in general and administrative expenses is largely attributable to the following factors:
| • | An insurance recovery of approximately $4 million recorded in the second quarter of 2004, for which there was no comparable event in the first half of 2005. |
| • | Increases of $0.6 million and $1.2 million, respectively, in property taxes related to the Company’s headquarters building at 1334 York Avenue in New York as a result of a tax reassessment that became effective on July 1, 2004. |
| • | Increases of $0.7 million and $1.2 million, respectively, in travel and entertainment costs principally due to the higher level of travel for pursuing business opportunities during 2005. |
| • | Increases of $0.2 million and $1.2 million, respectively, in professional fees principally related to the timing of the Company’s compliance efforts for Section 404 of the Sarbanes-Oxley Act. |
| • | Increases of $0.9 million and $2 million, respectively, in other professional fees partially due to fees incurred as a result of outsourcing management of the Company’s catalogue production operations in the U.S. |
| • | Increases in facility-related costs of $0.4 million and $0.8 million, respectively. |
For the three and six months ended June 30, 2005, general and administrative costs were favorably influenced by a decrease in client goodwill gestures and authenticity claims of approximately $0.8 million, when compared to the same periods in the prior year.
For the six months ended June 30, 2005, general and administrative expenses were also favorably influenced by $2.1 million of transaction costs incurred in the first quarter of 2004 related to consummation of the Company’s agreement with Cendant to license the Sotheby’s International Realty trademark. There were no comparable fees incurred in the current period.
Net Interest Expense
For the three and six months ended June 30, 2005, net interest expense decreased $1.5 million, or 19%, and $2.8 million, or 18%, respectively, when compared to the same periods in the prior year. The improvement over the prior year is largely attributable to increases of $1.1 million and $2.1 million, respectively, in interest income resulting from significantly higher balances of cash and short-term investments, as well as higher interest rates in part due to a change in investment composition. To a lesser extent, the decrease in net interest expense versus the prior periods is attributable to lower credit facility related costs, as the Company had no outstanding credit facility borrowings during the current year, as well as lower amortization of the discount related to antitrust matters (see Note 11 of Notes to Consolidated Financial Statements in Part I, Item 1, “Financial Statements”).
Income Tax Expense
The effective tax rate for continuing operations was approximately 33% for the three and six months ended June 30, 2005, compared to approximately 34% for the same periods in the prior year. The change in the effective rate was primarily due to permanent adjustments resulting from a current year tax benefit on stock options exercised, exempt interest income and certain other one-time adjustments which were partially offset by non deductible payments related to the antitrust settlement and other disallowable expenses.
The American Jobs Creation Act of 2004 (the “Act”), signed into law in October 2004, allows the Company to repatriate up to $500 million of permanently reinvested foreign earnings in 2005 and 2006 at an effective tax rate of 5.25%. The Company has not yet completed its evaluation of the possible effect of the Act on its plan for repatriation of foreign earnings. Accordingly, the Company has not adjusted its income tax expense or deferred tax liability as of June 30, 2005 to reflect the possible effect of the new repatriation provision. Income tax expense, if any, associated with any repatriation under the Act will be provided in the Company’s financial statements in the reporting period in which the Company's evaluation is completed and the required management approvals have been obtained. (See statement on Forward Looking Statements and “Future Impact of Recently Issued Accounting Standards” below.)
Discontinued Operations
For information related to Discontinued Operations, see Note 3 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”.
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FINANCIAL CONDITION AS OF JUNE 30, 2005
This discussion should be read in conjunction with the Company’s Consolidated Statements of Cash Flows (see Part I, Item 1, “Financial Statements”).
For the six months ended June 30, 2005, total cash and cash equivalents related to the Company’s continuing and discontinued operations decreased $46.6 million primarily due to the factors discussed below.
Net cash used by operations was $51.1 million for the six months ended June 30, 2005 and was due in part to:
| • | The funding of a $15 million discretionary contribution to the Company’s U.K. defined benefit pension plan in May 2005 (see Note 8 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”). |
| • | The funding of $12 million of the fine payable to the DOJ in February 2005 (see Note 11 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”). |
| • | A $9.6 million net increase in inventory due to property relating to auction guarantees that did not sell at auction during the spring auction season ($5.8 million) and investments made in certain properties during the first half of 2005 ($5.3 million). |
Net cash used by operations was also significantly influenced by a $122 million decrease in amounts due to consignors, partially offset by a $35.2 million decrease in accounts receivable, both principally resulting from the timing and settlement of auction sales in the fourth quarter of 2004 and the first half of 2005. The impact of these net cash outflows from operations was also partially offset by the Company’s income from continuing operations of $32.7 million during the period, as well as the collection of $12.5 million in cash due from the Company’s partner in an auction guarantee.
Net cash provided by investing activities was $2.1 million for the six months ended June 30, 2005 and was largely due to $301.3 million in proceeds received from the maturity of short-term investments during the period and, to a lesser extent the collection of $90.6 million in client loans, a $3.6 million decrease in restricted cash and $2.7 million in distributions received from an equity investee. These investing cash inflows were almost entirely offset by the funding of $297.6 million in short-term investments, the funding of $94.1 million in new client loans and $4.4 million in capital expenditures.
Net cash provided by financing activities was $2.8 million for the six months ended June 30, 2005 and was almost entirely attributable to proceeds received from the exercise of stock options.
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CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The following table summarizes the Company’s material contractual obligations and commitments as of June 30, 2005:
| | Payments Due by Period |
| | Total | | Less Than
One Year | | 1 to 3
Years | | 3 to 5
Years | | After
5 Years |
| | (Thousands of dollars) |
Long-term debt (1): | | | | | | | | | | | | | | | | | |
Principal payments | | | $ | 100,000 | | | | $ | – | | | | $ | – | | | | $ | 100,000 | | | | $ | – | |
Interest payments | | | | 26,927 | | | | | 6,875 | | | | | 13,750 | | | | | 6,302 | | | | | – | |
Sub-total | | | | 126,927 | | | | | 6,875 | | | | | 13,750 | | | | | 106,302 | | | | | – | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Other commitments: | | | | | | | | | | | | | | | | | | | | | | | | | |
York Property capital lease | | | | 397,948 | | | | | 18,633 | | | | | 38,574 | | | | | 40,575 | | | | | 300,166 | |
Operating lease obligations | | | | 86,197 | | | | | 14,046 | | | | | 24,581 | | | | | 15,330 | | | | | 32,240 | |
DOJ antitrust fine (2) | | | | 15,000 | | | | | 15,000 | | | | | – | | | | | – | | | | | – | |
Employment agreements (3) | | | | 3,525 | | | | | 3,525 | | | | | – | | | | | – | | | | | – | |
Sub-total | | | | 502,670 | | | | | 51,204 | | | | | 63,155 | | | | | 55,905 | | | | | 332,406 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | | $ | 629,597 | | | | $ | 58,079 | | | | $ | 76,905 | | | | $ | 162,207 | | | | $ | 332,406 | |
(1) | Represents the aggregate outstanding principal and semi-annual interest payments due on the Company’s long-term debt. (See Note 7 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”) |
(2) | Represents the remaining fine payable to the Antitrust Division of the U.S. Department of Justice (the “DOJ”). (See Note 11 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”) |
(3) | Represents the remaining commitment for future salaries as of June 30, 2005 related to employment agreements with a number of employees, excluding incentive bonuses. (See Note 9 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”) |
The vendor’s commission discount certificates (the “Discount Certificates”) that were distributed in conjunction with the settlement of certain civil litigation related to the investigation by the DOJ (see Note 11 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”) are fully redeemable in connection with any auction that is conducted by the Company or Christie’s International, PLC (“Christie’s”) in the U.S. or in the U.K. The Discount Certificates may be used to satisfy consignment charges involving vendor’s commission, risk of loss and/or catalogue illustration. The Discount Certificates will expire on May 14, 2008 and cannot be redeemed subsequent to that date; however, any unused Discount Certificates may be redeemed for cash at their face value at any time between May 15, 2007 and May 14, 2008. As of June 30, 2005, the outstanding face value of unused Discount Certificates that the Company could be required to redeem was $54.6 million.
(See “Off-Balance Sheet Arrangements” below for information on auction guarantees and lending commitments.)
OFF-BALANCE SHEET ARRANGEMENTS
Auction Guarantees
From time to time in the ordinary course of business, the Company will guarantee to consignors a minimum price in connection with the sale of property at auction. The Company must perform under its auction guarantee only
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in the event that the property sells for less than the minimum price and, therefore, the Company must pay 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 the Company has the right to recover such amount through future sale of the property. Generally, the Company is entitled to a share of the excess proceeds if the property under the auction guarantee sells above a minimum price. In addition, the Company is obligated under the terms of certain guarantees to advance a portion of the guaranteed amount prior to the auction. In certain situations, the Company reduces its financial exposure under auction guarantees through sharing arrangements with unaffiliated third parties.
As of June 30, 2005, the Company had outstanding auction guarantees totaling $21.5 million, the property relating to which had a mid-estimate sales price (1) of $33 million. The property related to such auction guarantees is being offered at auctions during the second half of 2005. As of June 30, 2005, $5 million of the guaranteed amount had been advanced by the Company and is recorded within Notes Receivable and Consignor Advances in the Consolidated Balance Sheets (see Note 5 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”)
As of August 1, 2005, the Company had outstanding auction guarantees totaling $48.2 million, the property relating to which had a mid-estimate sales price (1) of $61.5 million. The property related to such auction guarantees is being offered at auctions during the fourth quarter of 2005. As of August 1, 2005, $18.5 million of the guaranteed amount had been advanced by the Company.
| (1) | The mid-estimate sales price is calculated as the average of the low and high pre-sale auction estimates for the property under the auction guarantee. Pre-sale estimates are not always accurate predictions of auction sale results. |
Lending Commitments
In certain situations, the Company’s Finance segment 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 approximately $9 million at June 30, 2005. (See Note 9 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”)
DERIVATIVE INSTRUMENTS
The Company utilizes forward exchange contracts to manage exposures related to foreign currency risks, which primarily arise from short-term foreign currency denominated intercompany balances. Generally, such intercompany balances are centrally managed by the Company’s global treasury function. The Company’s objective for holding derivative instruments is to minimize foreign currency risks using the most effective methods to eliminate or reduce the impacts of these exposures.
The forward exchange contracts entered into by the Company are used as economic cash flow hedges of the Company’s exposure to short-term foreign currency denominated intercompany balances. Such forward exchange contracts are typically short-term with settlement dates no more than one month from their inception. These contracts are not designated as hedging instruments under Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, and are recorded in the Consolidated Balance Sheets at fair value, which is based on referenced market rates. Changes in the fair value of the Company’s forward exchange contracts are recognized currently in earnings and are generally offset by the revaluation of the underlying intercompany balances in accordance with SFAS No. 52, “Foreign Currency Translation.”
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CONTINGENCIES
Legal Actions—The Canadian Competition Bureau is continuing to conduct an investigation regarding anti-competitive practices relating to commissions charged by the Company and Christie’s for auction services during the period 1993 to 2000. The Company also becomes involved, from time to time, in various claims and lawsuits incidental to the ordinary course of its business.
Management does not believe that the outcome of any of the pending claims or proceedings described above will have a material adverse effect on the Company’s business, results of operations, financial condition and/or liquidity.
Gain Contingency—During the third quarter of 2004, the Company signed an agreement for the sale of land and buildings at Billingshurst, West Sussex in the U.K. (the “Sussex Property”). The completion of the sale is conditional upon the receipt of planning permission for redevelopment of part of the site. The Company had previously disclosed in its 2004 Form 10-K and Form 10-Q for the period ended March 31, 2005 that, if completed, the sale of the Sussex Property would result in a pre-tax gain in the range of approximately $5 to $6 million. However, subsequent to the date of those filings as a result of discussions with the planning authorities and the developer based on recent events, the structure of the planned sale is being amended. Consequently, the amount of the expected proceeds or gain from the sale, if any, cannot be reasonably estimated at this time. The Company expects this contingency to be resolved some time in 2005 or 2006.
(See Note 9 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”)
LIQUIDITY AND CAPITAL RESOURCES
On March 4, 2004, the Company entered into a new senior secured credit agreement with General Electric Capital Corporation (the “GE Capital Credit Agreement”). The GE Capital Credit Agreement is available through March 4, 2007 and provides for borrowings of up to $200 million provided by an international syndicate of lenders.
Borrowings under the GE Capital Credit Agreement are available for the funding of the Company’s ordinary working capital requirements and general corporate needs. The Company paid arrangement fees of $3 million related to the GE Capital Credit Agreement, which are being amortized to interest expense over the three-year term of the agreement. The Company’s obligations under the GE Capital Credit Agreement are secured by substantially all of the assets of the Company, as well as the assets of its subsidiaries in the U.S. and the U.K.
The GE Capital Credit Agreement contains financial covenants requiring the Company not to exceed $15 million in annual capital expenditures, not to make dividend payments and to have a quarterly fixed charge coverage ratio of not less than 1.0. The GE Capital Credit Agreement also has certain non-financial covenants and restrictions. The Company is in compliance with its covenants.
At the option of the Company, borrowings under the GE Capital Credit Agreement generally bear interest equal to: (i) 1.25% plus the higher of the Prime Rate or the Federal Funds Rate plus 0.5%, or (ii) LIBOR plus 2.5%. Pursuant to the GE Capital Credit Agreement, on a quarterly basis, the applicable interest rate charged for borrowings is adjusted up or down depending on the Company’s performance under a quarterly fixed charge coverage ratio test.
As of June 30, 2005, the Company had no outstanding borrowings under the GE Capital Credit Agreement.
The Company generally relies on operating cash flows supplemented by borrowings, when necessary, to meet its liquidity requirements. The Company currently believes that operating cash flows, current cash and short-term investment balances and borrowings available under the GE Capital Credit Agreement will be adequate to meet its short-term and long-term commitments, operating needs and capital requirements through March 4, 2007. Subsequent to March 4, 2007, management anticipates that the Company will extend or renew the GE Capital Credit Agreement or obtain other forms of long-term financing. Additionally, as a result of the current level of cash balances, short-term investments and borrowings available under the GE Capital Credit Agreement, the Company has considerably more liquidity and financial flexibility than it has had in the recent past. It is the Company’s present intention to use this additional liquidity to expand its loan portfolio. (See statement on Forward Looking Statements.)
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The Company’s short-term operating needs and capital requirements include peak seasonal working capital requirements, other short-term commitments to consignors, the potential funding of the Company’s client loan portfolio and the funding of capital expenditures, as well as the short-term commitments to be funded prior to July 1, 2006 included in the table of contractual obligations above.
The Company’s long-term operating needs and capital requirements include peak seasonal working capital requirements, the potential funding of the Company’s client loan portfolio and the funding of capital expenditures beyond the next twelve months and through March 4, 2007, as well as the funding of the Company’s long-term contractual obligations and commitments included in the table of contractual obligations above through March 4, 2007.
In addition to the short-term and long-term operating needs and capital requirements described above, the Company is obligated to fund the redemption of the Discount Certificates distributed in conjunction with the settlement of certain civil litigation related to the investigation by the DOJ (see Note 11 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”). As discussed above, the Discount Certificates are fully redeemable in connection with any auction that is conducted by the Company or Christie’s in the U.S. or the U.K. The Discount Certificates may be used to satisfy consignment charges involving vendor’s commission, risk of loss and/or catalogue illustration. The Discount Certificates will expire on May 14, 2008 and cannot be redeemed subsequent to that date; however, any unused Discount Certificates may be redeemed for cash at their face value at any time between May 15, 2007 and May 14, 2008. As of June 30, 2005, the outstanding face value of unused Discount Certificates that the Company could be required to redeem was approximately $54.6 million.
FACTORS AFFECTING OPERATING RESULTS AND LIQUIDITY
Operating results from the Company’s Auction and Finance segments, as well as the Company’s liquidity, are significantly influenced by a number of factors, many of which are not within the Company’s control. These factors, which are not ranked in any particular order, include:
| • | The overall strength of the international economy and financial markets and, in particular, the economies of the U.S., the U.K., and the major countries or territories of Continental Europe and Asia (principally Japan and China); |
| • | Interest rates, particularly with respect to the Finance segment’s client loan portfolio and the Company’s credit facility borrowings; |
| • | The impact of political conditions in various nations on the international economy and financial markets; |
| • | Government laws and regulations which the Company is subject to, including, but not limited to, import and export regulations, cultural patrimony laws and value added taxes; |
| • | The effects of foreign currency exchange rate movements; |
| • | The outcome of any pending legal claims or proceedings; |
| • | The seasonality of the Company’s auction business; |
| • | Competition with other auctioneers and art dealers, specifically in relation to the following factors: |
| (a) | The level and breadth of expertise of the dealer or auction house with respect to the property; |
| (b) | The extent of the prior relationship, if any, between the seller and the firm; |
| (c) | The reputation and historic level of achievement by a firm in attaining high sale prices in the property’s specialized category; |
| (d) | The desire for privacy on the part of sellers and buyers; |
| (e) | The amount of cash offered by a dealer, auction house or other purchaser to purchase the property outright; |
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| (f) | The level of auction guarantees or the terms of other financial options offered by auction houses or dealers; |
| (g) | The level of pre-sale estimates offered by auction houses; |
| (h) | The desirability of a public auction in order to achieve the maximum possible price; |
| (i) | The amount of commission proposed by dealers or auction houses to sell a work on consignment; |
| (j) | The cost, style and extent of presale marketing and promotion to be undertaken by a firm; |
| (k) | Recommendations by third parties consulted by the seller; |
| (l) | Relationships and personal interaction between the seller and the firm’s staff; and |
| (m) | The availability and extent of related services, such as tax or insurance appraisal and short-term financing; |
| • | The amount of quality property being consigned to art auction houses (and, in particular, the number of single-owner sale consignments), as well as the ability of the Company to sell such property, both of which factors can cause auction and related revenues to be highly variable from period-to-period; |
| • | The demand for fine arts, decorative arts and collectibles; |
| • | The success of the Company in attracting and retaining qualified personnel, who have or can develop relationships with certain potential sellers and buyers; |
| • | The success of the Company in retaining key members of management; |
| • | The demand for art-related financing; |
| • | The uncertainty in future costs related to the Company’s U.K. defined benefit pension plan, as well as the impact of any decline in the equity markets or unfavorable changes in interest rates on plan assets and obligations; |
| • | The impact of the variability in taxable income between the various jurisdictions where the Company does business on its effective tax rate; and |
| • | The ability of the Company to utilize its deferred tax assets. |
FUTURE IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123(R), “Share-Based Payment.” SFAS No. 123(R) requires the recognition of compensation expense equal to the fair value of stock options or other share-based payments. Under SFAS No. 123(R), the Company would have been required to implement the standard as of July 1, 2005. In April 2005, the Securities and Exchange Commission (the “SEC”) announced the adoption of a new rule that amended the compliance date for SFAS No. 123(R). The new rule will allow the Company to implement SFAS No. 123(R) as of January 1, 2006. The Company will adopt SFAS No. 123(R) using the modified prospective method, which will result in the amortization of stock compensation expense related to unvested stock options outstanding on the date of adoption, as well as any stock options granted subsequent to that date. The Company expects the adoption of SFAS No. 123(R) to result in the recording of compensation expense in the range of $0.5 million to $1.2 million in 2006 related to unvested stock options outstanding on the date of adoption.
The Company has adopted the provisions of FASB Staff Position (“FSP”) No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004.” According to FSP No. 109-2, the Company is allowed time beyond the financial reporting period of enactment to evaluate the effects of the Act on its plan for repatriation of foreign earnings for purposes of applying SFAS No. 109, “Accounting for Income Taxes.” The Company has not yet completed its evaluation of the possible effect of the Act on its plan for repatriation of foreign earnings. Accordingly, the Company has not adjusted its income tax expense or deferred tax liability as of June 30, 2005 to reflect the possible effect of the new repatriation provision. Income tax expense, if any, associated with any repatriation under the Act will be provided in the Company's financial statements in the reporting period in which the Company’s evaluation is completed and the required management approvals have been obtained. (See statement on Forward Looking Statements.)
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which changes the requirements for the accounting and reporting of a change in accounting principle and error corrections. SFAS No. 154 applies to all voluntary changes in accounting principle, as well as to changes required by an accounting pronouncement that does not include specific transition provisions. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Starting in 2006, the Company will apply the provisions of SFAS No. 154 on a prospective basis when applicable.
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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 the Company. 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 the Company 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 above under “Factors Affecting Operating Results and Liquidity”, which are not ranked in any particular order.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company continually evaluates its market risk associated with its financial instruments and forward exchange contracts during the course of its business. The Company’s financial instruments include cash and cash equivalents, restricted cash, short-term investments, notes receivable, consignor advances, long-term debt, the fine payable to the DOJ and the settlement liability related to the Discount Certificates issued in connection with certain civil litigation related to the investigation by the DOJ.
At June 30, 2005, 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 $11.4 million. Excluding the potential impact of this hypothetical strengthening or weakening of the U.S. dollar, the market risk of the Company’s financial instruments has not changed significantly as of June 30, 2005 from that set forth in the Company’s Form 10-K for the year ended December 31, 2004.
At June 30, 2005, the Company had $54.6 million of notional value forward exchange contracts outstanding. Notional amounts do not quantify risk or represent assets or liabilities of the Company, but are used in the calculation of cash settlements under such contracts. The Company is exposed to credit-related losses in the event of nonperformance by the two counterparties to its forward exchange contracts, but the Company does not expect any counterparties to fail to meet their obligations given their high credit ratings.
ITEM 4: CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of June 30, 2005, the Company has carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) were effective as of June 30, 2005.
Changes in Internal Control over Financial Reporting
There was no change in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
The Canadian Competition Bureau is continuing to conduct an investigation regarding anti-competitive practices relating to commissions charged by the Company and Christie’s for auction services during the period 1993 to 2000.
The Company also becomes involved, from time to time, in various claims and lawsuits incidental to the ordinary course of its business.
Management does not believe that the outcome of any of the pending claims or proceedings described above will have a material adverse effect on the Company’s business, results of operations, financial condition and/or liquidity.
(See Note 9 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”)
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
| 10.1 | Amendment No. 1 to Trademark License Agreement dated as of May 2, 2005 by and among SPTC Delaware, LLC (as an assignee of SPTC, Inc.) and Sotheby’s Holdings, Inc. and Cendant Corporation and Sotheby’s International Realty Licensee Corporation (formerly known as Monticello Licensee Corporation) |
| 10.2 | Amendment No. 2 to Trademark License Agreement dated as of May 2, 2005 by and among SPTC Delaware, LLC (as an assignee of SPTC, Inc.) and Sotheby’s Holdings, Inc. and Cendant Corporation and Sotheby’s International Realty Licensee Corporation (formerly known as Monticello Licensee Corporation) |
| 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 |
| (i) | On April 18, 2005, the Company filed a current report on Form 8-K under Item 1.01, “Entry into a Material Definitive Agreement,” and Item 9.01, “Financial Statements and Exhibits.” |
| (ii) | On May 10, 2005, the Company filed a current report on Form 8-K under Item 1.01, “Entry into a Material Definitive Agreement,” and Item 9.01, “Financial Statements and Exhibits.” |
| (iii) | On May 12, 2005, the Company 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.” |
| (iv) | On June 30, 2005, the Company filed a current report on Form 8-K under Item 5.02, “Departure of Director or Principal Officers; Election of Directors; Appointment of Principal Officers.” |
37
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 HOLDINGS, INC. |
| | By: |
/s/ Michael L. Gillis
|
| | | Michael L. Gillis
Senior Vice President,
Controller and Chief
Accounting Officer |
| | | |
| | Date: | August 8, 2005 |
38
Exhibit Index
Exhibit No. | Description |
| |
10.1 | Amendment No. 1 to Trademark License Agreement dated as of May 2, 2005 by and among SPTC Delaware, LLC (as an assignee of SPTC, Inc.) and Sotheby’s Holdings, Inc. and Cendant Corporation and Sotheby’s International Realty Licensee Corporation (formerly known as Monticello Licensee Corporation. |
| |
10.2 | Amendment No. 2 to Trademark License Agreement dated as of May 2, 2005 by and among SPTC Delaware, LLC (as an assignee of SPTC, Inc.) and Sotheby’s Holdings, Inc. and Cendant Corporation and Sotheby’s International Realty Licensee Corporation (formerly known as Monticello Licensee Corporation. |
| |
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 |
39
