Sotheby's (BID) 10-Q 2006 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2006

Commission File Number 1-9750

Sotheby’s

(Exact name of registrant as specified in its charter)

Delaware	38-2478409
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
1334 York Avenue New York, New York	10021
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code:(212) 606-7000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yesx No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Act). Large accelerated filer o Accelerated filerx Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes o No x

As of July 28, 2006, there were outstanding 63,656,511 shares of Common Stock, par value $0.10 per share, of the registrant.

TABLE OF CONTENTS

		PAGE
PART I:	FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Income Statements for the Three and Six Months Ended June 30, 2006 and 2005	3
	Consolidated Balance Sheets as of June 30, 2006, December 31, 2005 and June 30, 2005	4
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2006 and 2005	5
	Notes to Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	44
Item 4.	Controls and Procedures	44
PART II:	OTHER INFORMATION
Item 1.	Legal Proceedings	45
Item 1A.	Risk Factors	45
Item 4.	Submission Of Matters To A Vote Of Security Holders	47
Item 6.	Exhibits and Reports on Form 8-K	47
SIGNATURE		48
EXHIBIT INDEX		49

SOTHEBY’S
CONSOLIDATED INCOME STATEMENTS
(UNAUDITED)
(Thousands of dollars, except per share data)

	Three Months Ended						Six Months Ended
	June 30, 2006			June 30, 2005			June 30, 2006			June 30, 2005
Revenues:
Auction and related revenues	$	243,511		$	175,558		$	335,235		$	247,733
Finance revenues		3,550			1,768			6,982			2,976
License fee revenues		722			448			1,192			624
Other revenues		516			578			905			1,134
Total revenues		248,299			178,352			344,314			252,467
Expenses:
Direct costs of services		23,228			19,029			36,111			29,270
Salaries and related costs		70,338			53,326			114,342			92,879
General and administrative expenses		31,155			30,618			63,208			57,837
Depreciation and amortization expense		5,292			5,570			10,663			11,217
Total expenses		130,013			108,543			224,324			191,203
Operating income		118,286			69,809			119,990			61,264
Interest income		1,109			1,632			1,628			3,241
Interest expense		(8,370	)		(8,000	)		(16,900	)		(16,142	)
Other expense		(816	)		(218	)		(570	)		(213	)
Income from continuing operations before taxes		110,209			63,223			104,148			48,150
Equity in earnings of investees, net of taxes		402			130			509			480
Income tax expense		38,232			20,859			36,214			15,874
Income from continuing operations		72,379			42,494			68,443			32,756
Discontinued operations:
Loss from discontinued operations before taxes		(1,419	)		(736	)		(1,486	)		(698	)
Income tax benefit		(488	)		(219	)		(513	)		(198	)
Loss from discontinued operations		(931	)		(517	)		(973	)		(500	)
Net Income	$	71,448		$	41,977		$	67,470		$	32,256
Basic earnings per share:
Income from continuing operations	$	1.21		$	0.68		$	1.17		$	0.52
Loss from discontinued operations		(0.02	)		(0.01	)		(0.02	)		(0.01	)
Basic earnings per share	$	1.20		$	0.67		$	1.15		$	0.51
Diluted earnings per share:
Income from continuing operations	$	1.17		$	0.67		$	1.14		$	0.51
Loss from discontinued operations		(0.02	)		(0.01	)		(0.02	)		(0.01	)
Diluted earnings per share:	$	1.16		$	0.66		$	1.12		$	0.50
Basic and diluted weighted average shares outstanding:
Basic		59,740			62,841			58,437			62,718
Diluted		61,608			63,783			60,221			63,884

See accompanying Notes to Consolidated Financial Statements

3

SOTHEBY’S
CONSOLIDATED BALANCE SHEETS
(Thousands of dollars)

	June 30, 2006 (UNAUDITED)			December 31, 2005			June 30, 2005 (UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents	$	92,767		$	124,956		$	100,454
Restricted cash		16,151			7,679			9,376
Short-term investments		—			—			106,343
Accounts receivable, net of allowance for doubtful accounts of $5,876, $5,345 and $5,317		587,619			354,741			368,280
Notes receivable and consignor advances, net of allowance for credit losses of $977, $792 and $1,757		95,575			85,272			45,727
Inventory (see Note 3)		100,172			45,087			39,915
Deferred income taxes		9,861			15,055			—
Income tax receivable		199			—			—
Prepaid expenses and other current assets		60,086			54,166			57,337
Total Current Assets		962,430			686,956			727,432
Non-Current Assets:
Notes receivable		44,896			56,678			47,513
Fixed assets, net of accumulated depreciation and amortization of $144,934, $135,651 and $127,919		221,746			225,434			227,454
Goodwill (see Note 3)		53,129			13,447			13,500
Investments		26,132			25,871			26,368
Deferred income taxes		45,707			46,033			68,422
Other assets		6,036			6,333			3,527
Total Assets	$	1,360,076		$	1,060,752		$	1,114,216
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Due to consignors	$	482,763		$	376,079		$	342,620
Accounts payable and accrued liabilities		169,488			131,354			110,270
Deferred revenues		5,913			5,186			4,244
Accrued income taxes		20,272			8,918			13,329
Deferred income taxes		32			42			5,712
York Property capital lease obligation		1,538			1,438			753
Deferred gain on sale of York Property		1,129			1,129			1,129
Settlement liabilities		46,015			21,099			18,211
Total Current Liabilities		727,150			545,245			496,268
Long-Term Liabilities:
Long-term debt, net of unamortized discount of $255, $299 and $341		99,745			99,701			99,659
Credit facility borrowings		10,000			34,542			—
Settlement liabilities		—			40,794			45,299
York Property capital lease obligation		169,817			170,606			171,355
Deferred gain on sale of York Property		17,681			18,245			18,809
Other liabilities		40,893			25,343			18,615
Total Liabilities		1,065,286			934,476			850,005
Commitments and contingencies (see Note 9)
Shareholders’ Equity (see Notes 17 and 18):
Common Stock, $0.10 par value		6,298			5,777			6,416
Authorized shares at June 30, 2006—200,000,000
Issued and outstanding shares at June 30, 2006—63,079,837
Issued and outstanding shares at December 31, 2005—57,847,878 of Class A
Issued and outstanding shares at June 30, 2005—46,330,942 of Class A and 17,882,727 of Class B
Additional paid-in capital		157,710			69,808			236,619
Retained earnings		137,213			69,741			40,395
Deferred compensation expense		—			(7,876	)		(11,233	)
Accumulated other comprehensive loss		(6,431	)		(11,174	)		(7,986	)
Total Shareholders’ Equity		294,790			126,276			264,211
Total Liabilities and Shareholders’ Equity	$	1,360,076		$	1,060,752		$	1,114,216

See accompanying Notes to Consolidated Financial Statements

4

SOTHEBY’S
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(Thousands of dollars)

	Six Months Ended
	June 30, 2006			June 30, 2005
Operating Activities:
Net income*	$	67,470		$	32,256
Adjustments to reconcile net income to net cash used by operating activities:
Depreciation and amortization expense		10,663			11,217
Equity in earnings of investees		(509	)		(480	)
Deferred income tax expense		17,441			4,356
Stock compensation expense		6,453			4,427
Impact of consolidating variable interest entity		3,493			268
Defined benefit pension expense		3,220			2,501
Asset provisions		2,200			3,093
Amortization of discount related to antitrust matters		1,400			2,048
Excess tax benefits from stock-based compensation		(8,584	)		—
Other		447			623
Changes in assets and liabilities (net of effects from acquisition - see Note 3):
(Increase) decrease in accounts receivable		(232,370	)		35,167
Increase in inventory		(10,874	)		(9,644	)
Increase in prepaid expenses and other current assets		(5,815	)		(1,994	)
Decrease in other long-term assets		428			36
Funding of settlement liabilities		(17,425	)		(14,330	)
Increase (decrease) in due to consignors		109,940			(122,029	)
Increase in income tax receivable and deferred income tax assets		(3,887	)		—
Increase in accrued income taxes and deferred income tax liabilities		13,527			68
Increase in accounts payable and accrued liabilities and other liabilities		174			1,591
Net cash used by operating activities		(42,608	)		(50,826	)
Investing Activities:
Funding of notes receivable and consignor advances		(162,105	)		(94,063	)
Collections of notes receivable and consignor advances		165,772			90,576
Purchases of short-term investments		—			(297,618	)
Proceeds from maturities of short-term investments		—			301,275
Capital expenditures		(4,507	)		(4,356	)
Distributions from equity investees		575			2,713
(Increase) decrease in restricted cash		(8,165	)		3,550
Net cash (used) provided by investing activities		(8,430	)		2,077
Financing Activities:
Proceeds from revolving credit facility borrowings		353,838			—
Repayments of revolving credit facility borrowings		(379,992	)		—
Repayment of acquiree bank debt (see Note 3)		(9,531	)		—
Decrease in York Property capital lease obligation		(689	)		(61	)
Proceeds from exercise of employee stock options		45,692			2,822
Excess tax benefits from stock-based compensation		8,584			—
Net cash provided by financing activities		17,902			2,761
Effect of exchange rate changes on cash and cash equivalents		947			(581	)
Decrease in cash and cash equivalents		(32,189	)		(46,569	)
Cash and cash equivalents at beginning of period		124,956			147,023
Cash and cash equivalents at end of period	$	92,767		$	100,454
* Net loss from discontinued operations	$	(973	)	$	(500	)

Supplemental information on noncash investing and financing activities:

On June 7, 2006, the Company acquired Noortman Master Paintings B.V. for initial consideration of 1,946,849 shares of Sotheby’s Stock (see Note 3).

See accompanying Notes to Consolidated Financial Statements

5

SOTHEBY’S
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1.	Basis of Presentation
	The Consolidated Financial Statements included herein have been prepared by Sotheby’s (or, together with its subsidiaries, the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted from this report, as is permitted by such rules and regulations; however, the Company believes that the disclosures are adequate to make the information presented not misleading. It is suggested that these condensed financial statements be read in conjunction with the financial statements and notes thereto included in the Company’s 2005 Annual Report on Form 10-K.
	Shareholders’ Equity and Deferred Tax Assets-The June 30, 2005 balances of Shareholders’ Equity and deferred tax assets have been restated to $264.2 million and $68.4 million, respectively, to properly reflect the deferred tax assets of foreign subsidiaries. The amounts as originally reported incorrectly accrued a deferred tax benefit for foreign currency translation losses, which is recorded in Accumulated Other Comprehensive Loss, a component of Shareholders’ Equity. The restatement resulted in a reduction of deferred tax assets and a corresponding reduction in Shareholders’ Equity of $3.5 million as of June 30, 2005. The original amounts reported for Shareholders’ Equity and deferred tax assets as of June 30, 2005 were $267.7 million and $71.9 million, respectively. Accordingly, the Company’s comprehensive income for the three and six months ended June 30, 2005 has also been restated to $37.2 million and $23.2 million, respectively, to properly reflect the deferred tax assets of foreign subsidiaries. The amounts as originally reported incorrectly accrued a deferred tax benefit for foreign currency translation losses. The restatement resulted in a decrease in comprehensive income of $1.6 million and $3 million for the three and six months ended June 30, 2005, respectively. The original amounts reported for comprehensive income were $38.8 million and $26.2 million for the three and six months ended June 30, 2005, respectively. (See Note 12)
	Discontinued Operations- In the fourth quarter of 2004, the Company committed to a plan to discontinue its real estate brokerage business in Australia and license the Sotheby’s International Realty trademark and certain related trademarks in Australia. Previously, the Company had expected to consummate a license agreement related to such trademarks some time in 2006, but such an agreement could not be reached on terms acceptable to the Company. As a result, management has decided to continue operating the Company’s real estate brokerage business in Australia. Accordingly, the operating results of this business, which previously had been reported as discontinued operations in the Consolidated Income Statements since the fourth quarter of 2004, have been reclassified into the Company’s results from continuing operations for all periods presented. The Australia real estate brokerage business, which is the only remaining component of the Company’s former Real Estate segment, is not material to the Company’s results of operations, financial condition or liquidity.
	Special Charges-Prior to the first quarter of 2005, expenses related to the investigation by the Antitrust Division of the United States Department of Justice (the “DOJ”), other governmental investigations and the related civil litigation were classified as Special Charges in the Consolidated Income Statements. Beginning in the first quarter of 2005, such expenses, consisting principally of settlement administration costs and legal fees, are being classified within General and Administrative Expenses for all periods presented as they are no longer significant to the Company’s results. In the second quarter of 2006, the Company recorded a $2.2 million benefit to General and Administrative Expenses for the recovery of settlement administration costs related to the International Antitrust Litigation to be received by the end of 2006. The majority of such expenses was incurred prior to the first quarter of 2005 and was recorded within Special Charges in the Consolidated Income Statements (see Note 11).
	Statement of Cash Flows-Certain amounts in the Consolidated Statement of Cash Flows for the six months ended June 30, 2005 have been reclassified to present separately the impact of consolidating the assets and liabilities of a variable interest entity within net cash used by operating activities.
	In the opinion of the management of the Company, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the financial statements included herein have been made.

6

2.	Seasonality of Business
	The worldwide art auction market has two principal selling seasons, spring and autumn. Accordingly, the Company’s auction business is seasonal, with peak revenues and operating income generally occurring in the second and fourth quarters of each year. Consequently, first and third quarter results of the Auction segment typically reflect lower Aggregate Auction Sales (as defined below) when compared to the second and fourth quarters and, accordingly, a net loss due to the fixed nature of many of the Company’s operating expenses. “Aggregate Auction Sales” represents the hammer price of property sold at auction by the Company plus buyer’s premium.
	The table below demonstrates that approximately 80% of the Company’s Aggregate Auction Sales occur during the second and fourth quarters of the year.

	Percentage of Annual Aggregate Auction Sales
	2005			2004			2003
January - March		13	%		9	%		12	%
April - June		35	%		41	%		34	%
July - September		10	%		7	%		7	%
October - December		42	%		43	%		47	%
		100	%		100	%		100	%

3.	Acquisition
	On June 7, 2006, the Company and Arcimboldo S.A., a private limited liability company incorporated under the laws of Luxembourg, (“Arcimboldo”) entered into a sale and purchase agreement (the “Purchase Agreement”), pursuant to which the Company acquired all the issued and outstanding shares of capital stock of Noortman Master Paintings B.V., a company incorporated under the laws of the Netherlands (“NMP”), one of the world’s leading art dealers. NMP is based in Maastricht, the Netherlands. Robert C. Noortman is the sole shareholder of Arcimboldo and has guaranteed the obligations of Arcimboldo under the Purchase Agreement. The acquisition of NMP offers the Company growth opportunities by adding a pre-eminent art dealer. NMP’s results are included in the Company’s Consolidated Income Statements beginning on June 1, 2006 and are not material to the periods covered by this report. Consequently, such results are included in All Other for segment reporting purposes for the three and six months ended June 30, 2006 (see Note 4). Beginning in the third quarter of 2006, NMP’s results will be reported in a new segment, if material.
	Pursuant to the Purchase Agreement, the Company paid initial consideration (the “Initial Consideration”) in the form of 1,946,849 shares of Sotheby’s Class A Limited Voting Common Stock (“Sotheby’s Shares”), which had a fair value of approximately $41.4 million. The fair value of the Sotheby’s Shares issued as Initial Consideration is based on the actual number of shares issued using the closing price of Sotheby’s Shares on the New York Stock Exchange of $25.30 per share on June 6, 2006 reduced by $7.9 million to reflect the fair value of certain restrictions on the future transfer of the Sotheby’s Shares issued as Initial Consideration, as discussed in more detail below. The fair value of these restrictions was determined by an independent valuation expert. In addition to the Initial Consideration, the Company acquired NMP subject to approximately $25.6 million of indebtedness, consisting of a $16.1 million long-term non-interest bearing note payable to Arcimboldo over a period of three years and $9.5 million of bank debt that was repaid upon the closing of the transaction, as well as the settlement of a $11.7 million payable to Sotheby's (as discussed in more detail below). The present value of the note payable to Arcimboldo is $14.6 million. The $1.5 million discount on the note payable is being amortized to interest expense over the three-year term. The first payment of $2.6 million under the note payable was made on July 26, 2006.
	An additional 486,712 Sotheby’s Shares (the “Additional Consideration”) have been issued and placed in escrow, to be released only if NMP achieves certain targeted performance criteria specified in the Purchase Agreement during the five years following the closing of the transaction and if Mr. Noortman continues to be employed by the Company. Based on the closing price of Sotheby’s Shares on the New York Stock Exchange of $27.63 per share on July 31, 2006, the Additional Consideration has a value of approximately $13.4 million. The Additional Consideration is being held in escrow pursuant to an escrow agreement dated June 7, 2006, among the parties to the Purchase Agreement and LaSalle Bank N.A.

7

          If NMP fails to achieve a minimum level of financial performance during the five years following the closing of the transaction, up to 20% of the Initial Consideration will be transferred back to the Company.

          The Purchase Agreement also provides for certain restrictions on the transfer of Sotheby’s Shares received by Arcimboldo, as discussed above. Subject to certain limited exclusions, Arcimboldo may not transfer any of the Sotheby’s Shares that it received as Initial Consideration for a period of two years after the closing, and may not transfer 20% of the Sotheby’s Shares that it received as Initial Consideration for a period of five years after the closing.

          The Company, Arcimboldo and Mr. Noortman also made customary warranties and covenants in the Purchase Agreement, including certain post-closing business covenants of the Company and certain non-competition and non-solicitation covenants of Arcimboldo and Mr. Noortman for a period of five years following closing. Mr. Noortman also entered into a seven-year employment agreement with NMP.

          The Company is in the process of valuing the NMP assets acquired and liabilities assumed. The fair value of the art-related assets acquired is being estimated by a team of qualified art experts. The fair value of all other NMP assets and liabilities is being estimated considering a number of factors, including independent appraisals. The Company expects to complete the allocation of the purchase price during the third quarter of 2006. The table below, which is presented in thousands of dollars, summarizes the preliminary allocation of the purchase price to the NMP assets acquired and liabilities assumed. This allocation is subject to revision upon completion of the Company’s valuation procedures.

Purchase price:
Fair value of Initial Consideration	$	41,374
Settlement of payable due to Sotheby's		11,745		*
Direct acquisition costs		1,416
Total purchase price	$	54,535
Allocation of purchase price:
Accounts receivable	$	13,424
Inventory		47,186
Fixed assets		658
Prepaid expenses and other current assets		293
Other long-term assets		89
Goodwill		39,542		**
Accounts payable and accrued liabilities		(20,395	)
Other current liabilities		(1,309	)
Note payable to Arcimboldo		(14,590	)	***
Bank debt		(9,531	)
Other non-current liabilities		(832	)
Total purchase price	$	54,535

*	Reflects amounts due to Sotheby’s for property purchased by NMP at auction prior to the date of acquisition.
**	Represents the excess of the purchase price over the net assets acquired based on the Company’s preliminary purchase price allocation. Upon completion of the Company’s valuation procedures, a portion of this amount will be allocated to NMP’s inventory, fixed assets and identifiable intangible assets, if any.
***	The current portion of the note payable to Arcimboldo ($4.6 million) is recorded in the June 30, 2006 Consolidated Balance Sheet within “Accounts Payable and Accrued Liabilities.” The non-current portion of the note payable to Arcimboldo ($10 million) is recorded in the June 30, 2006 Consolidated Balance Sheet within “Other Liabilities.”

8

4.	Segment Reporting
	The Company’s continuing operations are organized under two business segments – Auction and Finance. The Auction segment is an aggregation of operations in North America, Europe and Asia as they have similar economic characteristics and they are similar in service, customers and the way in which the service is provided.
	The Company’s discontinued real estate brokerage business, which almost entirely comprised its former Real Estate segment, is not included in this presentation. In the second quarter of 2006, management decided to continue to operate the Company’s real estate brokerage business in Australia, which had previously been reported in discontinued operations since the fourth quarter of 2004. Consequently, beginning in the second quarter of 2006, results for this business, which are not material to the Company’s Consolidated Income Statements, have been reclassified into continuing operations and are included in this presentation in All Other for all periods presented. (See Note 16 for more detailed information related to discontinued operations.)
	As discussed in Note 3, on June 7, 2006, the Company acquired all the issued and outstanding shares of capital stock of NMP, one of the world’s leading art dealers. NMP’s results are included in the Company’s Consolidated Income Statements beginning on June 1, 2006 and are not material to the periods covered by this report. Consequently, such results are included in All Other in this presentation. Beginning in the third quarter of 2006, NMP’s results will be reported in a new segment, if material.
	The table below presents the Company’s revenues from continuing operations by operating segment for the three and six months ended June 30, 2006 and 2005:

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
	(Thousands of dollars)
Auction	$	243,511		$	175,558		$	335,235		$	247,733
Finance		4,109			1,840			7,763			3,118
All Other		1,238			1,026			2,097			1,758
		248,858			178,424			345,095			252,609
Reconciling item:
Intercompany revenue earned by Finance from Auction*		(559	)		(72	)		(781	)		(142	)
Total revenues from continuing operations	$	248,299		$	178,352		$	344,314		$	252,467

* The Finance segment charges interest to the Auction segment for certain client loans. Such intercompany revenues were immaterial to the Finance segment prior to the second quarter of 2006 and, therefore, were not included in Finance segment revenues. Beginning in the second quarter of 2006, such revenues are being included in Finance segment revenues for all periods presented.

9

          The table below presents information concerning revenues from continuing operations for geographical areas for the three and six months ended June 30, 2006 and 2005:

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
	(Thousands of dollars)
United States:
Auction	$	116,332		$	75,880		$	159,878		$	103,302
Finance		1,843			975			3,540			1,667
All Other		914			645			1,505			1,037
Sub-total		119,089			77,500			164,923			106,006
United Kingdom:
Auction		81,846			60,291			122,702			97,573
Finance		2,187			817			4,096			1,359
All Other		149			156			294			293
Sub-total		84,182			61,264			127,092			99,225
China:
Auction		17,034			15,175			18,665			15,453
Finance		71			24			106			38
Sub-total		17,105			15,199			18,771			15,491
Other Countries:
Auction		28,299			24,212			33,990			31,405
Finance		8			24			21			54
All Other		175			225			298			428
Sub-total		28,482			24,461			34,309			31,887
Reconciling item:
Intercompany revenue earned by Finance from Auction		(559	)		(72	)		(781	)		(142	)
Total	$	248,299		$	178,352		$	344,314		$	252,467

10

          The table below presents income before taxes for the Company’s operating segments, as well as a reconciliation of segment income before taxes to Income from Continuing Operations Before Taxes for the three and six months ended June 30, 2006 and 2005:

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
	(Thousands of dollars)
Auction	$	109,503		$	64,865		$	104,470		$	52,133
Finance		164			(473	)		526			(1,025	)
All Other		215			232			610			289
Segment income before taxes		109,882			64,624			105,606			51,397
Unallocated amounts and reconciling items:
Antitrust related benefit (expense)*		1,634			(212	)		778			(461	)
Amortization of interest related to Antitrust matters (see Note 11)		(647	)		(988	)		(1,400	)		(2,048	)
Equity in earnings of investees**		(660	)		(201	)		(836	)		(738	)
Income from continuing operations before taxes	$	110,209		$	63,223		$	104,148		$	48,150

*	For the three and six months ended June 30, 2006, antitrust related expenses include a $2.2 million benefit for the recovery of settlement administrative expenses related to the International Antitrust Litigation to be received by the end of 2006 (see Note 11).
**	Represents the Company’s pre-tax share of earnings related to its equity investees. Such amounts are included in the table above in Income Before Taxes for the Auction segment, but are presented net of taxes below Income from Continuing Operations Before Taxes in the Consolidated Income Statements.
The table below presents assets for the Company’s operating segments, as well as a reconciliation of segment assets to consolidated assets as of June 30, 2006, December 31, 2005 and June 30, 2005:

	June 30, 2006		December 31, 2005		June 30, 2005
	(Thousands of dollars)
Auction	$	1,053,555	$	850,978	$	947,795
Finance		148,245		148,576		97,291
All Other***		102,509		110		708
Total segment assets		1,304,309		999,664		1,045,794
Unallocated amounts:
Deferred tax assets and income tax receivable		55,767		61,088		68,422
Consolidated Assets	$	1,360,076	$	1,060,752	$	1,114,216

*** As discussed in Note 3, on June 7, 2006, the Company acquired all the issued and outstanding shares of capital stock of NMP, one of the world’s leading art dealers. NMP’s assets are not material to the Company’s Consolidated Balance Sheet as of June 30, 2006 for segment reporting purposes. Consequently, NMP’s assets are included in All Other in this presentation. Beginning in the third quarter of 2006, NMP’s assets will be reported in a new segment, if material.

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5.	Notes Receivable and Consignor Advances
	The Company’s Finance segment provides certain collectors and dealers with financing generally secured by works of art that the Company either has in its possession or permits the borrower to possess. The Company’s general policy is to make secured loans at loan to value ratios (principal loan amount divided by the low auction estimate of the collateral) of 50% or lower. However, the Company will also lend at loan to value ratios higher than 50%. As of June 30, 2006, such loans totaled $19.1 million and represented 14% of net Notes Receivable and Consignor Advances. The property related to such loans had a low auction estimate of approximately $29.1 million. Furthermore, the Company’s loans are predominantly variable interest rate loans.            The Company generally makes two types of secured loans: (1) advances secured by consigned property to borrowers who are contractually committed, in the near term, to sell the property at auction (a “consignor advance”); and (2) general purpose term loans to collectors or dealers secured by property not presently intended for sale (a “term loan”). The consignor advance allows a consignor to receive funds shortly after consignment for an auction that will occur several weeks or months in the future, while preserving for the benefit of the consignor the potential of the auction process. Term loans allow the Company to establish or enhance mutually beneficial relationships with dealers and collectors and sometimes result in auction consignments. Secured loans are generally made with full recourse against the borrower. In certain instances, however, secured loans are made with recourse limited to the works of art pledged as security for the loan. To the extent that the Company is looking wholly or partially to the collateral for repayment of its loans, repayment can be adversely impacted by a decline in the art market in general or in the value of the particular collateral. In addition, in situations where the borrower becomes subject to bankruptcy or insolvency laws, the Company’s ability to realize on its collateral may be limited or delayed by the application of such laws. Under certain circumstances, the Company also makes unsecured loans to collectors and dealers. Included in gross Notes Receivable and Consignor Advances are unsecured loans totaling $0.2 million, $0.6 million and $4.1 million at June 30, 2006, December 31, 2005 and June 30, 2005, respectively.
	In certain situations, the Company also finances the purchase of works of art by certain art dealers through unsecured loans. The property purchased pursuant to such unsecured loans is sold privately or at auction with any profit or loss shared by the Company and the dealer. Interest income related to such unsecured loans is reflected in the results of the Finance segment within Finance Revenues, while the Company’s share of any profit or loss is reflected in the results of the Auction segment within Auction and Related Revenues. The Company did not have any such unsecured loans outstanding as of June 30, 2006. The total of all such unsecured loans was $0.3 million and $3.6 million at December 31, 2005 and June 30, 2005, respectively. These amounts are included in the total unsecured loan balances provided in the previous paragraph.
	At June 30, 2006, two term loans issued to the same borrower, totaling $51.5 million, comprised in the aggregate approximately 37% of the net Notes Receivable and Consignor Advances balance.

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          As of June 30, 2006, December 31, 2005 and June 30, 2005, Notes Receivable and Consignor Advances consists of the following:

	June 30, 2006			December 31, 2005			June 30, 2005
	(Thousands of dollars)
Current:
Consignor advances	$	9,492		$	21,596		$	14,632
Term loans		87,060			64,468			32,852
Sub-total		96,552			86,064			47,484
Non-current:
Consignor advances		176			1,925			4,616
Term loans		44,720			54,753			42,897
Sub-total		44,896			56,678			47,513
Notes receivable and consignor advances		141,448			142,742			94,997
Allowance for credit losses		(977	)		(792	)		(1,757	)
Notes receivables and consignor advances (net)	$	140,471		$	141,950		$	93,240

          The weighted average interest rates charged on Notes Receivable and Consignor Advances were 6.7% and 6.5% for the three months ended June 30, 2006 and 2005, respectively. The weighted average interest rates charged on Notes Receivable and Consignor Advances were 7.4% and 6.2% for the six months ended June 30, 2006 and 2005, respectively.

          Changes in the Allowance for Credit Losses relating to Notes Receivable and Consignor Advances for the six months ended June 30, 2006 and 2005 were as follows:

	Six Months Ended June 30,
	2006			2005
	(Thousands of dollars)
Allowance for credit losses at January 1	$	792		$	1,759
Change in loan loss provision		237			27
Write-offs		(69	)		—
Foreign currency exchange rate changes		17			(29	)
Allowance for credit losses at June 30	$	977		$	1,757

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6.

Goodwill

Goodwill is currently attributable to the Auction segment, as well as the Company's acquisition of NMP on June 7, 2006. The amount attributable to NMP is based on the Company's preliminary purchase price allocation. Upon completion of the Company's valuation procedures, a portion of this amount will be allocated to NMP's inventory, fixed assets and identifiable intangible assets, if any. (See Note 3 for more information related to this transaction.) For the six months ended June 30, 2006 and 2005, changes in the carrying value of Goodwill were as follows (in thousands of dollars):

	Six Months Ended June 30, 2006						Six Months Ended June 30, 2005
	Auction		NMP		Total		Auction			NMP		Total
Balance as of January 1	$	13,447	$	—	$	13,447	$	13,753		$	—	$	13,753
Goodwill acquired (see Note 3)		—		39,542		39,542		—			—		—
Foreign currency exchange rate changes		140		—		140		(253	)		—		(253	)
Balance as of June 30	$	13,587	$	39,542	$	53,129	$	13,500		$	—	$	13,500

7.	Credit Arrangements
	Bank Credit Facilities—On September 7, 2005, in connection with the Transaction discussed in Note 17 below, the Company terminated its previous senior secured credit agreement and entered into a new senior secured credit agreement with an international syndicate of lenders arranged by Banc of America Securities LLC (“BofA”) and LaSalle Bank N.A. (the “BofA Credit Agreement”). The BofA Credit Agreement originally provided for borrowings of up to $250 million through a revolving credit facility. On May 18, 2006, the Company amended the credit agreement to provide for $50 million in additional commitments from its existing lenders, thereby increasing the total borrowing capacity to $300 million. The amendment also permits the amount of available borrowings to be increased by an additional $50 million to $350 million on a one-time basis.
	The amount of borrowings available at any time under the BofA Credit Agreement is limited to a borrowing base, which is generally equal to 100% of eligible loans made by the Company in the United States (“U.S.”) and the United Kingdom (“U.K.”) (i.e., notes receivable and consignor advances) plus 15% of the Company’s net tangible assets (calculated as total assets less current liabilities, goodwill, unamortized debt discount and eligible loans). As of June 30, 2006, the amount of unused borrowing capacity available under the BofA Credit Agreement was $278.5 million, consisting of a borrowing base of $288.5 million less $10 million in borrowings outstanding on that date. Such outstanding borrowings are classified as long-term liabilities in the Consolidated Balance Sheet as of June 30, 2006. As of July 24, 2006, there were no outstanding borrowings under the BofA Credit Agreement and the amount of unused borrowing capacity available and borrowing base under the BofA Credit Agreement was $210 million.
	The BofA Credit Agreement is available through September 7, 2010; provided that in the event that any of the $100 million in long-term debt securities (the “Notes”) issued by the Company in February 1999 (as discussed in more detail below) are still outstanding on July 1, 2008, then either: (a) the Company shall deposit cash in an amount equal to the aggregate outstanding principal amount of the Notes on such date into an account in the sole control and dominion of BofA for the benefit of the lenders and the holders of the Notes or (b) the Company shall have otherwise demonstrated its ability to redeem and pay in full the Notes; otherwise, the BofA Credit Agreement shall terminate and all amounts outstanding thereunder shall be due and payable in full on July 1, 2008.
	Borrowings under the BofA Credit Agreement were used to finance in part the Transaction and related expenses and are also available to provide ongoing working capital and for other general corporate purposes of the Company. The Company’s obligations under the BofA Credit Agreement are secured by substantially all of the non-real estate assets of the Company, as well as the non-real estate assets of its subsidiaries in the U.S. and the U.K.

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          The BofA Credit Agreement contains financial covenants requiring the Company not to exceed a maximum level of capital expenditures and dividend payments (as discussed in more detail below) and to have a quarterly interest coverage ratio of not less than 2.0 and a quarterly leverage ratio of not more than: (i) 4.0 for quarters ending September 30, 2005 to September 30, 2006, (ii) 3.5 for quarters ending December 31, 2006 to September 30, 2007 and (iii) 3.0 for quarters ending December 31, 2007 and thereafter. The maximum level of annual capital expenditures permitted under the BofA Credit Agreement is $15 million through 2007 and $20 million thereafter with any unused amounts carried forward to the following year. Dividend payments, if any, must be paid solely out of 40% of the Company’s net income arising after June 30, 2005 and computed on a cumulative basis. The BofA Credit Agreement also has certain non-financial covenants and restrictions. The Company is in compliance with its covenants.

          On August 2, 2006, the Company’s Board of Directors declared a quarterly dividend on its common stock of $0.10 per share (approximately $6.4 million), payable on September 15, 2006 to shareholders of record on September 1, 2006.

          At the option of the Company, any borrowings under the BofA Credit Agreement generally bear interest at a rate equal to: (i) LIBOR plus 1.75%, or (ii) 0.5% plus the higher of the Prime Rate or the Federal Funds Rate plus 0.5%. For the three and six months ended June 30, 2006, the weighted average interest rate incurred by the Company on outstanding borrowings under the BofA Credit Agreement was approximately 7.6% and 6.9%, respectively. For the three and six months ended June 30, 2005, the Company had no outstanding borrowings under the previous GE Capital Credit Agreement.

          The Company paid underwriting, structuring and amendment fees of $2.8 million related to the BofA Credit Agreement, which are being amortized on a straight-line basis to Interest Expense over the term of the facility.

          Senior Unsecured Debt—In February 1999, the Company issued a tranche of long-term debt securities (defined above as the “Notes”), pursuant to the Company’s $200 million shelf registration with the SEC, for an aggregate offering price of $100 million. The ten-year Notes have an effective interest rate of 6.98% payable semi-annually in February and August.

          The Notes have covenants that impose limitations on the Company from placing liens on certain property and entering into certain sale-leaseback transactions. The Company is in compliance with these covenants.

          As of June 30, 2006, aggregate future principal and interest payments due under the Notes are as follows (in thousands):

1 year	$	6,875
2 years		6,875
3 years		106,302
Total future principal and interest payments	$	120,052

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          Interest Expense—For the three and six months ended June 30, 2006 and 2005, interest expense related to the Company’s continuing operations consisted of the following:

	Three Months Ended June 30,				Six Months Ended June 30,
	2006		2005		2006		2005
	(Thousands of dollars)
Credit Facility Borrowings:
Interest expense on outstanding borrowings	$	712	$	—	$	1,558	$	—
Amortization of amendment and arrangement fees		142		250		280		500
Commitment fees		153		253		327		503
Sub-total		1,007		503		2,165		1,003
Interest expense on York Property capital lease obligation		4,464		4,475		8,932		8,951
Interest expense on long-term debt		1,741		1,740		3,482		3,479
Amortization of discount - DOJ antitrust fine (see Note 11)		—		294		101		658
Amortization of discount - Discount Certificates (see Note 11)		647		694		1,299		1,390
Other interest expense		511		294		921		661
Total	$	8,370	$	8,000	$	16,900	$	16,142

	Other interest expense principally relates to interest accrued on the obligations under the Sotheby’s, Inc. Benefit Equalization Plan and its successor, the Sotheby’s, Inc. 2005 Benefit Equalization Plan, which are unfunded deferred compensation plans available to certain U.S. officers of the Company whose contributions to the Sotheby’s, Inc. Retirement Savings Plan are limited by Internal Revenue Service regulations.
8.	Defined Benefit Pension Plan
	The Company contributes to a defined benefit pension plan covering substantially all U.K. employees (the “U.K. Pension Plan”). In 2006, the Company expects to contribute approximately $3 million to the U.K. Pension Plan. For the three and six months ended June 30, 2006 and 2005, the components of net periodic pension cost related to the U.K. Pension Plan were:

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
	(Thousands of dollars)
Service cost	$	1,650		$	1,600		$	3,236		$	3,229
Interest cost		3,186			3,194			6,247			6,446
Expected return on plan assets		(4,107	)		(4,226	)		(8,053	)		(8,384	)
Amortization of prior service cost		67			68			131			137
Amortization of actuarial loss		846			532			1,659			1,073
Net periodic pension cost	$	1,642		$	1,168		$	3,220		$	2,501

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9.	Commitments and Contingencies
	Employment Arrangements— The Company has employment arrangements with a number of key employees, which expire at various points between August 2008 and June 2011. Such arrangements provide, among other benefits, for minimum salary levels, incentive bonuses which are payable only if specified Company and individual goals are attained and participation in the Company’s Executive Bonus Plan. Additionally, certain of these arrangements provide for annual equity grants, severance payments and continuation of benefits upon termination of employment under certain circumstances. The aggregate remaining commitment for salaries related to these employment arrangements, excluding incentive bonuses, any participation in the Company’s Executive Bonus Plan and equity grants, was approximately $17.4 million as of August 1, 2006.
	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 $25.6 million at June 30, 2006.
	Legal Actions—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 these pending claims or proceedings will have a material adverse effect on the Company’s business, results of operations, financial condition and/or liquidity.
	Gain Contingencies—The Company owns land and a building at Billingshurst, West Sussex (the “Sussex Property”), which previously housed an auction salesroom. The Company is in advanced negotiations for the sale of vacated parts of the Sussex Property. The completion of the sale is conditional upon the receipt of planning permission for redevelopment of the land for sale. If completed, the sale of the Sussex Property would result in a pre-tax gain in the range of approximately $4 million to $5 million. The Company is not certain when the sale of the Sussex Property will be completed and when the contingency will be resolved.
	Acquavella Modern Art—On May 23, 1990, the Company purchased the common stock of the Pierre Matisse Gallery Corporation (“Matisse”) for approximately $153 million. The assets of Matisse consisted of a collection of fine art (the “Matisse Inventory”). Upon consummation of the purchase, the Company entered into an agreement with Acquavella Contemporary Art, Inc. (“ACA”) to form Acquavella Modern Art (“AMA”), a partnership through which the Matisse Inventory would be sold. The Company contributed the Matisse Inventory to AMA in exchange for a 50% interest in the partnership.
	Pursuant to the AMA partnership agreement, upon the death of the majority shareholder of ACA, the successors-in-interest to ACA have the right, but not the obligation, to require the Company to purchase their interest in AMA at a price equal to the fair market value of such interest. The fair market value shall be determined by independent accountants pursuant to a process and a formula set forth in the partnership agreement that includes an appraisal of the works of art held by AMA at such time. The net assets of AMA consist principally of the Matisse Inventory. At June 30, 2006, the carrying value of this inventory was $67.8 million. To the extent that AMA requires working capital, the Company has agreed to lend the same to AMA. As of June 30, 2006, December 31, 2005 and June 30, 2005, no such amounts were outstanding.
	(See Notes 3, 7, 10 and 11 for other commitments. See Notes 3, 10 and 11 for other contingencies.)
10.	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 in the event the property sells for less than the minimum price, in which event 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 auction commission sharing arrangements with unaffiliated partners.

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	Partners may also assist the Company in valuing and marketing the property to be sold at auction.
	As of June 30, 2006, the Company had outstanding auction guarantees totaling $36.9 million, the property relating to which had a mid-estimate sales price (1) of $49.1 million. Substantially all of the property related to such guarantees is being offered at auctions during the second half of 2006. As of June 30, 2006, December 31, 2005 and June 30, 2005, the carrying amount of the liability related to the Company’s auction guarantees was approximately $0.9 million, $0.3 million and $0.1 million, respectively, and was reflected in the Consolidated Balance Sheets within Accounts Payable and Accrued Liabilities.
	As of July 28, 2006, the Company had outstanding auction guarantees totaling $41.6 million, the property relating to which had a mid-estimate sales price (1) of $54.2 million. Substantially all of the property related to such auction guarantees is being offered at auctions during the second half of 2006. As of July 28, 2006, $5 million of the guaranteed amount had been advanced by the Company and will be recorded within Notes Receivable and Consignor Advances.
	(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.
11.	Antitrust Related Matters
	In April 1997, the DOJ began an investigation of certain art dealers and major auction houses, including the Company and its principal competitor, Christie’s International, PLC (“Christie’s”). The Company has pled guilty to a violation of U.S. antitrust laws in connection with a conspiracy to fix auction commission rates charged to sellers in the U.S. and elsewhere. In February 2001, the U.S. District Court for the Southern District of New York imposed on the Company a fine of $45 million payable to the DOJ without interest over a period of five years. As a result, in the third quarter of 2000, the Company recorded Settlement Liabilities of $34.1 million representing the present value of the fine payable. The $10.9 million discount on the fine payable was amortized to interest expense over the five-year period during which the fine was paid. The final payment of $15 million owed under the fine was paid by the Company on February 6, 2006 and the liability to the DOJ was extinguished.
	In conjunction with the settlement of certain civil litigation related to the investigation by the DOJ, in May 2003, the Company issued to the class of plaintiffs vendor’s commission discount certificates (“Discount Certificates”) with a face value of $62.5 million. The Discount Certificates are fully redeemable in connection with any auction conducted by the Company or Christie’s in the U.S. or in the U.K. and may be used to satisfy consignment charges involving vendor’s commission, risk of loss and/or catalogue illustration. The court determined that the $62.5 million face value of the Discount Certificates had a fair market value of not less than $50 million, which represents the amount recorded by the Company as Settlement Liabilities in the third quarter of 2000. 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. The $12.5 million discount on the face value of the Discount Certificates is being amortized to interest expense over the four-year period prior to May 15, 2007, the first date at which the Discount Certificates are redeemable for cash. As of June 30, 2006, the outstanding face value of unused Discount Certificates that the Company could be required to redeem was $48.3 million and the carrying value of such Discount Certificates reflected in the Consolidated Balance Sheets was approximately $46 million.

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          As of June 30, 2006, December 31, 2005 and June 30, 2005, Settlement Liabilities related to the two matters discussed above consisted of the following:

	June 30, 2006		December 31, 2005		June 30, 2005
	(Thousands of dollars)
Current:
Discount Certificates (net)	$	46,015	$	6,200	$	3,900
DOJ antitrust fine (net)		—		14,899		14,311
Sub-total		46,015		21,099		18,211
Long-term:
Discount Certificates (net)		—		40,794		45,299
Total	$	46,015	$	61,893	$	63,510

          As of June 30, 2006, the classification of the liability for Discount Certificates as current reflects the fact that unused Discount Certificates may be redeemed for cash starting in May 2007. The current portion of the liability for the Discount Certificates as of December 31, 2005 and June 30, 2005 represents management’s estimate of redemptions expected during the twelve-month period after the balance sheet date and is based on an analysis of historical redemption activity.

          During the period January 1, 2006 to June 30, 2006, amounts charged to and cash payments made against Settlement Liabilities with respect to the Discount Certificates and the DOJ antitrust fine were as follows:

	Discount Certificates (net)			DOJ Antitrust Fine (net)			Total
	(Thousands of dollars)
Settlement Liabilities as of January 1, 2006	$	46,994		$	14,899		$	61,893
Cash payment to DOJ		—			(15,000	)		(15,000	)
Redemption of Discount Certificates		(2,424	)		—			(2,424	)
Amortization of discount		1,299			101			1,400
Loss on redemption of Discount Certificates		146			—			146
Settlement Liabilities as of June 30, 2006	$	46,015		$	—		$	46,015

          On March 10, 2003, the Company and Christie’s agreed to each pay $20 million to settle litigation, which alleged violations of the Federal antitrust laws and international law on behalf of purchasers and sellers in auctions conducted outside the U.S. (the “International Antitrust Litigation”), and thereafter, the Company deposited $20 million into an escrow account for the benefit of the members of the class of plaintiffs. The settlement agreement for the International Antitrust Litigation provides that if, as of June 7, 2006, there are any remaining settlement funds following the payment of all submitted claims, the Company and Christie’s will be reimbursed for third party administration costs incurred in distributing the settlement funds. As a result, in the second quarter of 2006, the Company recorded a $2.2 million benefit to General and Administrative Expenses, reflecting the recovery of such third party administration costs incurred through June 30, 2006, to be received by the end of 2006. (See Note 1 for information related to the original income statement classification of such expenses.)

          The Canadian Competition Bureau is continuing to conduct an investigation regarding anticompetitive practices relating to commissions charged by the Company and Christie’s for auction services during the period 1993 to 2000. In the first half of 2006, the Company recorded a $0.7 million accrual related to the settlement of this matter.

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12.	Comprehensive Income
	The Company’s comprehensive income includes the net income for the period, as well as other comprehensive income (loss), which consists of the change in the foreign currency translation adjustment account during the period. For the three and six months ended June 30, 2006 and 2005, comprehensive income is as follows:

	Three Months Ended June 30,					Six Months Ended June 30,
	2006		2005			2006		2005
		(Thousands of dollars)
Net income	$	71,448	$	41,977		$	67,470	$	32,256
Other comprehensive income (loss)		3,535		(4,738	)		4,743		(9,075	)
Comprehensive income	$	74,983	$	37,239		$	72,213	$	23,181

13.	Stock-Based Compensation
	In December 2004, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment.” SFAS No. 123R is a revision of SFAS No. 123, as amended, “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees.” SFAS No. 123R eliminates the alternative to use the intrinsic value method of accounting that was provided in SFAS No. 123, which generally resulted in no compensation expense recorded in the financial statements related to the issuance of stock option awards to employees. SFAS No. 123R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. SFAS No. 123R establishes fair value as the measurement objective in accounting for share-based payment arrangements and generally requires all companies to apply a fair-value-based measurement method in accounting for all share-based payment transactions with employees.
	On January 1, 2006, the Company adopted SFAS No. 123R using the modified prospective method. Accordingly, prior period amounts have not been restated. Under this method, the Company is required to record compensation expense for all share-based awards granted after the date of adoption and for the unvested portion of previously granted awards that remained outstanding at the date of adoption. Prior to the adoption of SFAS No. 123R, the Company applied APB No. 25 to account for its stock-based awards. Under the provisions of APB No. 25, the Company was not required to recognize compensation expense for the cost of stock options issued to employees under its stock option plans, as all such options were granted with an exercise price equal to the stock's fair value on the date of grant. As such, the Company generally only recorded stock-based compensation expense for restricted stock, which amounted to $2 million and $4.4 million for the three and six months ended June 30, 2005, respectively. With the adoption of SFAS No. 123R, the Company recorded stock compensation expense for the cost of stock options and restricted stock of $3.7 million ($2.4 million after tax or $0.04 per diluted share) and $6.5 million ($4.3 million after tax or $0.07 per diluted share) for the three and six months ended June 30, 2006, respectively.
	The following table details the effect on net income and earnings per share had compensation expense for all employee share-based awards been recorded for the three and six months ended June 30, 2005 based on the fair value method under SFAS No. 123. The reported and pro forma net income and earnings per share for the three and six months ended June 30, 2006 are the same since stock-based compensation expense is calculated under the provisions of SFAS No. 123R. The amounts for the three and six months ended June 30, 2006 are included in the table below only to provide the detail for a comparative presentation to the comparable periods in 2005.

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	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
	(Thousands of dollars, except per share data)
Net income, as reported	$	71,448		$	41,977		$	67,470		$	32,256
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		2,427			1,317			4,289			2,965
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(2,427	)		(1,690	)		(4,289	)		(3,709	)
Pro forma net income	$	71,448		$	41,604		$	67,470		$	31,512
Earnings per share:
Basic earnings per share, as reported	$	1.20		$	0.67		$	1.15		$	0.51
Basic earnings per share, pro forma	$	1.20		$	0.66		$	1.15		$	0.50
Diluted earnings per share, as reported	$	1.16		$	0.66		$	1.12		$	0.50
Diluted earnings per share, pro forma	$	1.16		$	0.65		$	1.12		$	0.49

          In recent years, the Company’s equity compensation strategy has evolved towards a preference for restricted stock as opposed to stock options.

          For the three and six months ending June 30, 2006, the adoption of SFAS No. 123R resulted in incremental stock-based compensation expense of $0.5 million ($0.4 million after tax or slightly less than $0.01 per diluted share) and $1.1 million ($0.7 million after tax or $0.01 per diluted share), respectively, for the cost of stock options related to the Sotheby’s 1997 Stock Option Plan (the “1997 Stock Option Plan”) that otherwise would not have been recognized. For the three and six months ended June 30, 2006, stock-based compensation expense for the cost of restricted stock of $3.1 million ($2.1 million after tax or $0.03 per basic and diluted share) and $5.3 million ($3.5 million after tax or $0.06 per diluted share), respectively, would have been recognized in 2006 regardless of the adoption of SFAS No. 123R. In addition, in connection with the adoption of SFAS No. 123R, net cash provided by operating activities decreased and net cash provided by financing activities increased in the first half of 2006 by approximately $8.6 million related to the classification of excess tax benefits from stock-based payment arrangements.

          Stock Options—Stock options issued pursuant to the 1997 Stock Option Plan are exercisable into authorized but unissued shares of the Company’s Common Stock. Stock options are granted with an exercise price equal to or greater than fair market value at the date of grant and generally expire ten years after the date of grant. Stock options granted pursuant to the 1997 Stock Option Plan, generally vest and become exercisable ratably after each of the first, second, third, fourth and fifth years following the date of grant (except in the U.K. where certain options vest three-fifths after the third year and one-fifth after each of the fourth and fifth years following the date of grant). Stock options granted on or after April 29, 1997 vest immediately upon a change in control of the Company (as defined in the plan document for the 1997 Stock Option Plan, as amended). In March 2006, the Compensation Committee approved an amendment to the 1997 Stock Option Plan whereby the maximum amount of shares reserved for issuance under this plan was reduced by approximately 7 million shares to 7.9 million shares. This amendment is consistent with the evolution of the Company’s equity compensation strategy towards a preference for restricted stock as opposed to stock options and was made in conjunction with shareholder approval of a 4.5 million increase in the number of shares of Common Stock authorized for issuance under the Sotheby’s Amended and Restated Restricted Stock Plan (the “Restricted Stock Plan”). On May 8, 2006, the Amended and Restated Restricted Stock Plan was approved. As of June 30, 2006, the number of shares of Common Stock authorized for issuance under the 1997 Stock Option Plan was 7.9 million shares.

          (See “Restricted Stock” for a more detailed discussion of the Restricted Stock Plan.)

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          In January 2002, the Company granted 1.6 million stock options pursuant to the 1997 Stock Option Plan which were due to vest on the earlier of one year from the date of grant or on the day after the market price of the Common Stock closed at or above $30 per share for ten consecutive trading days. These stock options vested in January 2003 as the market price of the Common Stock did not close at or above $30 per share for ten consecutive trading days during the one-year period after the date of grant. Such options will expire on the earlier of five years after the date of grant or six months after the market price of the Common Stock closes at or above $30 per share for ten consecutive trading days.

          In 2003, the Company granted 940,000 stock options pursuant to the 1997 Stock Option Plan. Such stock options, which were granted at an exercise price equal to the fair market value of the Common Stock at the date of grant, generally vest and become exercisable ratably after each of the first, second, third and fourth years following the date of grant and expire ten years after the date of grant.

          In June 2004 and August 2004, the Company granted 140,000 and 100,000 stock options, respectively, pursuant to the 1997 Stock Option Plan. These stock options were granted at an exercise price equal to the fair market value of the Common Stock at the date of the grant and expire ten years after the date of grant. The stock options granted in June vested and become exercisable ratably after each of the first and second years following the date of grant pursuant to the terms of an employment agreement. The stock options granted in August vested and become exercisable ratably after each of the first, second, third and fourth years following the date of grant.

          In 2005, the Company granted 136,500 stock options pursuant to the 1997 Stock Option Plan. These stock options, which were granted at an exercise price equal to the fair market value of the Common Stock at the date of the grant, vested on June 30, 2006 pursuant to the terms of an employment agreement and expire ten years after the date of grant.

          Included in the Company’s stock compensation expense in the three and six months ended June 30, 2006 is the cost related to the unvested portion of stock options granted in 2001 and from 2003 to 2005. The stock options granted before 2001 and those granted in 2002 were fully vested as of the beginning of 2006. No stock options were granted in the first half of 2006.

          Changes in the number of stock options outstanding during the six months ended June 30, 2006 were as follows (shares in thousands):

	Options			Weighted Average
	Outstanding			Exercise Price
Balance at January 1, 2006		6,172		$	16.51
Options canceled		(1	)	$	37.94
Options expired		(2	)	$	14.75
Options exercised		(2,669	)	$	17.12
Balance at June 30, 2006		3,500		$	16.04
Options Exercisable at June 30, 2006		2,963		$	17.14

          The total intrinsic value for stock options exercised during the six months ended June 30, 2006 and 2005 was approximately $20.1 million and $1.2 million, respectively. The weighted-average grant date fair value for the stock options granted in 2005 was $6.03.

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          The fair value of stock options granted in 2005 was estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table. The risk-free rate is based on the comparable U.S. Treasury yield curve in effect at the time of grant. The expected life (estimated period of time outstanding) of the 2005 grants was estimated using historical exercise behavior taking into consideration the shorter-than-normal vesting period. Expected volatility was based on historical volatility for a period approximately equal to the stock option’s expected life. No dividend yield was factored into the Black-Scholes valuation for the 2005 grant due to the fact that the Company had not declared a dividend since 1999.

	2005
Dividend yield		—
Expected volatility		44.0%
Risk-free rate of return		3.9%
Expected life		4.5 years

          The following table summarizes additional information about stock options outstanding as of June 30, 2006 (shares and aggregate intrinsic value in thousands):

	Number of Options		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Options Outstanding		3,500		4.4 years	$	34,999
Options Exercisable		2,963		4.0 years	$	26,404

          In the six months ended June 30, 2006, the amount of cash received from the exercise of stock options was approximately $45.7 million and the related tax benefit was $6.3 million.

          Restricted Stock—The Restricted Stock Plan provides for the issuance of restricted shares of Common Stock to eligible employees, as determined by the Compensation Committee. Restricted Stock shares granted pursuant to the Restricted Stock Plan generally vest ratably after each of the first, second, third and fourth years following the date of grant; however, shares issued in connection with the Sotheby’s Holdings, Inc. Executive Bonus Plan vest ratably over a three-year period; restricted shares issued pursuant to certain employment agreements vest over a three and five-year period and are subject to performance and market conditions, as well as time vesting. Prior to vesting, the participants have voting rights and receive dividends, if any, but the shares may not be sold, assigned, transferred, pledged or otherwise encumbered. On May 8, 2006, the Company’s shareholders approved an amendment to the Restricted Stock Plan whereby the maximum amount of restricted stock that may be issued under the Amended and Restated Restricted Stock Plan was increased by 4.5 million shares to 6.5 million shares. As of June 30, 2006, the maximum amount of restricted stock which may be issued from the Company’s authorized but unissued or reacquired shares of Common Stock was 6.5 million shares, of which 4.3 million shares remained available for future grants.

          For financial statement purposes, the fair value of restricted stock is calculated based upon the closing stock price on the business day before the grant date. Included in the Company’s stock compensation expense for the six months ended June 30, 2006 are costs related to restricted stock granted from 2003 through the first half of 2006, including costs associated with 201,621 restricted shares granted in February 2006 in conjunction with the Company’s Executive Bonus Plan and 215,646 restricted shares granted in June 2006, as well as grants to the Company’s Chief Executive Officer discussed below.

          On April 1, 2006, in an effort to encourage and reward the growth of the Company and the creation of shareholder value, the Company agreed to grant William F. Ruprecht, the Company’s President and Chief Executive Officer, a one time award of 300,000 shares of restricted stock that will only vest and create value for Mr. Ruprecht at the end of the third and fifth years of his employment arrangement, and only if certain objective performance and market-based criteria are satisfied. These criteria are based on either a specified compound increase in shareholder value as measured by stock price and dividends, if any, or a specified compound cumulative increase in the Company’s net income. As he has in the past three years under his previous employment agreement, Mr. Ruprecht received a 2006 equity award of restricted

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shares of stock. This award of 78,785 restricted stock shares, which was received on March 31, 2006, had a fair market value equal to $2,050,000 on the date of grant and will vest in equal annual installments over four years. Mr. Ruprecht is no longer eligible to participate in the Company’s Executive Bonus Plan, but instead, beginning in 2007, will be entitled to a restricted stock grant in each year, subject to agreed annual minimum ($1.4 million) and maximum ($2.2 million) levels, the value of which will be determined based on the extent to which the performance criteria for the Executive Bonus Plan have been satisfied.

          Pursuant to certain employment arrangements agreed to in the third quarter of 2006, the Company granted 427,531 shares of restricted stock that will only vest and create value for the grantees at the end of the third and fifth years of the employment arrangements, and only if certain objective performance and market-based criteria are satisfied. These criteria are based on either a specified compound increase in shareholder value as measured by stock price and dividends, if any, or a specified compound cumulative increase in the Company’s net income.

          Also, the Company granted 19,172 shares of restricted stock in July 2006 that will vest ratably after each of the first, second, third and fourth years following the date of grant.

          Changes in the number of outstanding restricted stock shares during the six months ended June 30, 2006 were as follows (shares in thousands):

				Weighted Average
	Restricted			Grant Date
	Shares			Fair Value
Balance at January 1, 2006		1,356		$	13.73
Restricted shares granted		796		$	27.25
Restricted shares vested		(478	)	$	13.14
Restricted shares canceled		(1	)	$	12.85
Balance at June 30, 2006		1,673		$	20.34

	The total fair value of restricted stock shares that vested during the six months ended June 30, 2006 and 2005 was $12.8 million and $4.8 million, respectively, based on the closing stock price on the date the shares vested.
	Under the provisions of SFAS No. 123R, the recognition of deferred compensation, a contra-equity account representing the amount of unrecognized restricted stock expense that is reduced as stock compensation expense is recognized at the date restricted stock is granted, is no longer required. Therefore, in the first quarter of 2006, the amount that had been in Deferred Compensation was eliminated against Additional Paid-in Capital in the Company’s Consolidated Balance Sheets.
	As of June 30, 2006, unrecognized compensation expense related to the unvested portion of the Company’s stock-based compensation was approximately $25.1 million and is expected to be recognized over a weighted-average period of approximately 3.4 years.
	As of July 24, 2006, unrecognized compensation expense related to the unvested portion of the Company’s stock-based compensation was approximately $37.1 million and is expected to be recognized over a weighted-average period of approximately 3.4 years.
14.	Variable Interest Entity
	In December 2003, the FASB issued a revision to FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which was originally issued in January 2003. FIN 46, as revised, requires that if an entity is the primary beneficiary of a variable interest entity (“VIE”), the assets, liabilities, and results of operations of the VIE should be included in the consolidated financial statements of the entity.

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	The Company has concluded that an entity with whom its Finance segment has outstanding loans of approximately $3.5 million and to whom the Company provides management consulting services meets the definition of a VIE under FIN 46, as revised. As primary beneficiary of the VIE, the Company was required to consolidate the entity as part of the Auction segment beginning on March 31, 2004.
	The entity is an art gallery which is engaged in business as a broker/dealer in works of art. The Company provides management consulting services to the entity in exchange for a management fee, which is equal to 50% of the entity’s net income (excluding the management fee and certain other specified revenues and expenses). Included in the Company’s consolidated assets as of June 30, 2006 is inventory with a carrying value of approximately $3.6 million. Such inventory consists entirely of artwork and is the collateral for the $3.5 million in outstanding loans discussed above, which are eliminated in consolidation. The Company has no equity investment in the entity.
	The Company accounts for its interest in the entity on a quarter lag applied on a consistent basis. As of March 31, 2006, the entity had total assets of $8.3 million, total liabilities of $7.7 million and capital of $0.6 million.
15.	Derivative Instruments
	The Company utilizes forward exchange contracts to manage exposures related to foreign currency risks and client transactions, 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 mostly 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 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.”
	As of June 30, 2006, December 31, 2005 and June 30, 2005, the Consolidated Balance Sheets included assets of $1.1 million, $0.1 million and $0.5 million, respectively, recorded within Prepaid Expenses and Other Current Assets reflecting the fair value of the Company’s outstanding forward exchange contracts on those dates.
16.	Discontinued Operations
	In the fourth quarter of 2003, the Company committed to a plan to sell its domestic real estate brokerage business, Sotheby’s International Realty, Inc. (“SIR”), as well as most of its real estate brokerage offices outside of the U.S.
	On February 17, 2004, the Company consummated the sale of SIR to a subsidiary of Cendant Corporation (“Cendant”). In conjunction with the sale, the Company entered into an agreement with Cendant to license the Sotheby’s International Realty trademark and certain related trademarks for an initial 50-year term with a 50-year renewal option (the “Cendant License Agreement”). Initially, the Cendant License Agreement was applicable to the U.S., Canada, Israel, Mexico and certain Caribbean countries.
	Also in conjunction with the sale, Cendant received options to acquire most of the other non-U.S. offices of the Company’s real estate brokerage business and to expand the Cendant License Agreement to cover the related trademarks in other countries outside the U.S., excluding Australia and New Zealand (the “International Options”). The International Options were exercised by Cendant and the Cendant License Agreement was amended to cover New Zealand during 2004. As a result, such operations qualified for treatment as discontinued operations in the Consolidated Income Statements in 2004.

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          In the fourth quarter of 2004, the Company committed to a plan to discontinue its real estate brokerage business in Australia and license the Sotheby’s International Realty trademark and certain related trademarks in Australia. Previously, the Company expected to consummate a license agreement related to such trademarks some time in 2006, but such an agreement could not be reached on terms acceptable to the Company. As a result, management has decided to continue operating the Company’s real estate brokerage business in Australia. Accordingly, the operating results of this business, which had previously been reported as discontinued operations in the Consolidated Income Statements since the fourth quarter of 2004, have been reclassified into the Company’s results from continuing operations for all periods presented. The Australia real estate brokerage business, which is the only remaining component of the Company’s former Real Estate segment, is not material to the Company’s results of operations, financial condition or liquidity.

          The following is a summary of the results of the Company’s discontinued operations for the three and six months ended June 30, 2006 and 2005:

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
	(Thousands of dollars)
Revenues	$	—		$	186		$	—		$	498
Expenses		1,404			922			1,471			1,198
Operating loss		(1,404	)		(736	)		(1,471	)		(700	)
Other (expense) income		(15	)		—			(15	)		2
Loss from discontinued operations before taxes		(1,419	)		(736	)		(1,486	)		(698	)
Income tax benefit		(488	)		(219	)		(513	)		(198	)
Loss from discontinued operations	$	(931	)	$	(517	)	$	(973	)	$	(500	)

	According to the terms of the Stock Purchase Agreement related to the sale of SIR, the Company is due to receive amounts collected by Cendant for the closing of real estate transactions subsequent to February 17, 2004 that were under contract prior to that date. For the three and six months ended June 30, 2005, revenues from discontinued operations included $0.2 million and $0.5 million, respectively, of such amounts. Additionally, included in the Company’s results from discontinued operations for the three and six months ended June 30, 2006 is a litigation accrual related to events that occurred prior to sale of SIR on February 17, 2004.
17.	Recapitalization
	On September 7, 2005, the Company entered into a Transaction Agreement (the “Agreement”) with various affiliates of A. Alfred Taubman and his family (the “Shareholders”). Prior to completion of the transactions contemplated by the Agreement, the Shareholders were the Company’s largest shareholders, holding in the aggregate 14,034,158 shares of the Company’s Class B Common Stock (the “Class B Stock”), which represented approximately 62.4% of the aggregate voting power of the Company’s capital stock. Pursuant to the Agreement, the Company in effect exchanged all 14,034,158 shares of Class B Stock owned by the Shareholders for $168,409,896 in cash and 7.1 million shares of the Company’s Class A Stock, (such exchange, the “Transaction”).
	Because the outstanding shares of Class B Stock constituted less than fifty percent of the aggregate voting power of the Company’s outstanding common stock following completion of the Transaction, pursuant to the Company’s Third Amended and Restated Articles of Incorporation (the “Articles”), following completion of the Transaction each remaining outstanding share of Class B Stock held by a shareholder not a party to the Transaction was automatically converted into one share of Class A Stock without any action on the part of the holder thereof.

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	As a result of the Transaction, the dual class super-voting share structure that had been in place since the Company’s initial public offering in 1988 was eliminated, allowing for a corporate governance structure that is more consistent with the best practices of public companies.
18.	Reincorporation
	On June 30, 2006, Sotheby’s Holdings, Inc., a Michigan corporation (“Sotheby’s Michigan”), completed its reincorporation into the State of Delaware (the “Reincorporation”). The Reincorporation and related proposals were approved by the shareholders of Sotheby’s Michigan at the annual meeting of shareholders held on May 8, 2006. The Reincorporation was completed by means of a merger of Sotheby’s Michigan with and into Sotheby’s Delaware, Inc., a Delaware corporation (“Sotheby’s Delaware”) and a wholly-owned subsidiary of Sotheby’s Michigan incorporated for the purpose of effecting the Reincorporation, with Sotheby’s Delaware being the surviving corporation. Sotheby’s Delaware was renamed “Sotheby’s” upon completion of the merger.
	In the merger, each outstanding share of Sotheby’s Michigan Class A Limited Voting Common Stock (“Sotheby’s Michigan Stock”) was converted into one share of Common Stock of Sotheby’s Delaware (“Sotheby’s Delaware Stock”). As a result, holders of Sotheby’s Michigan Stock are now holders of Sotheby’s Delaware Stock, and their rights as holders thereof are governed by the General Corporation Law of the State of Delaware and the Certificate of Incorporation and By-Laws of Sotheby’s Delaware.
	The Reincorporation was accounted for as a reverse merger whereby, for accounting purposes, Sotheby’s Michigan is considered the acquiror and the surviving corporation is treated as the successor to the historical operations of Sotheby’s Michigan. Accordingly, the historical financial statements of Sotheby’s Michigan, which Sotheby’s Michigan previously reported to the SEC on Forms 10-K and 10-Q, among other forms, are treated as the financial statements of the surviving corporation.
	The Reincorporation did not result in any change in the business or principal facilities of Sotheby’s Michigan. Upon completion of the merger, the address of Sotheby’s principal executive offices is 1334 York Avenue, New York, NY 10021. Sotheby’s Michigan’s management and board of directors continue as the management and board of directors of Sotheby’s Delaware. Sotheby’s Delaware Stock will continue to trade on the New York Stock Exchange under the symbol “BID.” Shareholders are not required to exchange their existing stock certificates, which now represent an equivalent number of shares of Sotheby’s Delaware Stock.
19.	Recently Issued Accounting Standards
	In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (FIN 48), which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on the derecognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. The provisions of FIN 48 are effective for the Company as of January 1, 2007, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. Management is currently evaluating the impact of adopting FIN 48, if any, on the Company's financial statements.

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ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Seasonality

          The worldwide art auction market has two principal selling seasons, spring and autumn. Accordingly, the Company’s auction business is seasonal, with peak revenues and operating income generally occurring in the second and fourth quarters of each year. Consequently, first and third quarter results of the Auction segment typically reflect lower Net Auction Sales (as defined below under “Key Performance Indicators”) when compared to the second and fourth quarters and, accordingly, a loss from continuing operations due to the fixed nature of many of the Company’s operating expenses. (See Note 2 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”)

Use of Non-GAAP Financial Measures

          GAAP refers to generally accepted accounting principles in the United States of America. Included in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) are financial measures presented in accordance with GAAP and also on a non-GAAP basis.

          Specifically, in MD&A, the Company makes reference to Adjusted EBITDA, which is defined as income from continuing operations excluding income tax expense, net interest expense and depreciation and amortization expense. Management believes that Adjusted EBITDA provides a useful supplemental performance measure of the Company’s operations and financial performance. Management also believes that Adjusted EBITDA-based measures are used by many investors, equity analysts and rating agencies as a measure of the Company’s financial performance. It is important to note that Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies and should not be considered as an alternative to income from continuing operations determined in accordance with GAAP.

          Additionally, when material, the Company excludes the impact of changes in foreign currency exchange rates when comparing current year results to the prior year. Consequently, such period-to-period comparisons are provided on a constant dollar basis by eliminating the impact of changes in foreign currency exchange rates from the prior year.

          Management also utilizes these non-GAAP financial measures in analyzing its operating results. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is presented below in the “Overview” section and in the discussion of general and administrative expenses.

RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005

          Note 4 (“Segment Reporting”) of Notes to Consolidated Financial Statements should be read in conjunction with this discussion.

Overview

          The Company’s income from continuing operations for the three and six months ended June 30, 2006 increased $29.9 million, or 70%, and $35.7 million, or 109%, when compared to the same periods in the prior year, reflecting the continuing strength of the international art market, as Net Auction Sales and Private Sales (both defined below under “Key Performance Indicators”) increased significantly from the prior year. These higher levels of sale activity resulted in increases in auction and related revenues of $68 million, or 39%, and $87.5 million, or 35%, for the three and six months ended June 30, 2006. The higher level of revenues was partially offset by increases in operating expenses of $21.5 million, or 20%, and $33.1 million, or 17%, for these periods. A detailed discussion of each of the significant factors impacting the Company’s results from continuing operations for the three and six months ended June 30, 2006 is provided below. Management is encouraged by the current level of consignments for its fourth quarter auctions. (See Note 2 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”) (See statement on Forward Looking Statements and Item 1A, “Risk Factors.”)

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          The Company’s results from continuing operations for the three and six months ended June 30, 2006 and 2005 are summarized below (in thousands of dollars):

							Favorable/(Unfavorable)
Three Months Ended June 30		2006			2005			$ Change		% Change
Revenues:
Auction and related revenues	$	243,511		$	175,558		$	67,953			38.7	%
Finance revenues		3,550			1,768			1,782				*
License fee revenues		722			448			274			61.2	%
Other revenues		516			578			(62	)		(10.7	%)
Total revenues		248,299			178,352			69,947			39.2	%
Expenses		130,013			108,543			(21,470	)		(19.8	%)
Operating income		118,286			69,809			48,477			69.4	%
Net interest expense		(7,261	)		(6,368	)		(893	)		(14.0	%)
Other expense		(816	)		(218	)		(598	)			*
Income from continuing operations before taxes		110,209			63,223			46,986			74.3	%
Equity in earnings of investees, net of taxes		402			130			272				*
Income tax expense		38,232			20,859			(17,373	)		(83.3	%)
Income from continuing operations	$	72,379		$	42,494		$	29,885			70.3	%
Key performance indicators:
Aggregate Auction Sales (a)	$	1,480,777		$	977,060		$	503,717			51.6	%
Net Auction Sales (b)	$	1,281,559		$	838,747		$	442,812			52.8	%
Private Sales (c)	$	118,956		$	79,537		$	39,419			49.6	%
Auction commission margin (d)		16.6	%		18.7	%		N/A			(11.2	%)
Average loan portfolio (e)	$	150,107		$	92,549		$	57,558			62.2	%
Adjusted EBITDA (f)	$	123,422		$	75,362		$	48,060			63.8	%

							Favorable/(Unfavorable)
Six Months Ended June 30	2006			2005			$ Change			% Change
Revenues:
Auction and related revenues	$	335,235		$	247,733		$	87,502			35.3	%
Finance revenues		6,982			2,976			4,006				*
License fee revenues		1,192			624			568			91.0	%
Other revenues		905			1,134			(229	)		(20.2	%)
Total revenues		344,314			252,467			91,847			36.4	%
Expenses		224,324			191,203			(33,121	)		(17.3	%)
Operating income		119,990			61,264			58,726			95.9	%
Net interest expense		(15,272	)		(12,901	)		(2,371	)		(18.4	%)
Other expense		(570	)		(213	)		(357	)			*
Income from continuing operations before taxes		104,148			48,150			55,998				*
Equity in earnings of investees, net of taxes		509			480			29			6.0	%
Income tax expense		36,214			15,874			(20,340	)			*
Income from continuing operations	$	68,443		$	32,756		$	35,687				*
Key performance indicators:
Aggregate Auction Sales (a)	$	1,992,448		$	1,333,040		$	659,408			49.5	%
Net Auction Sales (b)	$	1,724,583		$	1,143,799		$	580,784			50.8	%
Private Sales (c)	$	233,532		$	138,110		$	95,422			69.1	%
Auction commission margin (d)		16.6	%		19.0	%		N/A			(12.6	%)
Average loan portfolio (e)	$	146,277		$	84,435		$	61,842			73.2	%
Adjusted EBITDA (f)	$	130,919		$	73,006		$	57,913			79.3	%

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Legend:
*	Represents a change in excess of 100%.
(a)	Represents the hammer (sale) price of property sold at auction plus buyer’s premium.
(b)	Represents the hammer (sale) price of property sold at auction.
(c)	Represents the total purchase price of property sold in private sales brokered by the Company.
(d)	Represents total auction commission revenues as a percentage of Net Auction Sales.
(e)	Represents the average loan portfolio of the Company’s Finance segment.
(f)	See “Use of Non-GAAP Financial Measures” above.

          The following is a reconciliation of Adjusted EBITDA (see “Use of Non-GAAP Financial Measures” above) to income from continuing operations for the three and six months ended June 30, 2006 and 2005 (in thousands of dollars):

	Three Months Ended June 30,				Six Months Ended June 30,
	2006		2005		2006		2005
Adjusted EBITDA	$	123,422	$	75,362	$	130,919	$	73,006
Income tax expense related to continuing operations		38,232		20,859		36,214		15,874
Income tax expense related to earnings from equity investees		258		71		327		258
Net interest expense		7,261		6,368		15,272		12,901
Depreciation and amortization expense		5,292		5,570		10,663		11,217
Income from continuing operations	$	72,379	$	42,494	$	68,443	$	32,756

Impact of Foreign Currency Translations

          For the three months and six months ended June 30, 2006, foreign currency translations had a favorable impact of approximately $1.1 million and $0.8 million, respectively, on the Company’s income from continuing operations before taxes. The components of this favorable impact were as follows (in thousands of dollars):

	Favorable /
Three months ended June 30, 2006	(Unfavorable)
Total revenues	$	467
Total expenses		646
Operating income		1,113
Net interest expense and other		22
Income from continuing operations before taxes	$	1,135

	Favorable /
Six months ended June 30, 2006	(Unfavorable)
Total revenues	$	(3,526	)
Total expenses		4,225
Operating income		699
Net interest expense and other		63
Income from continuing operations before taxes	$	762

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Revenues

          For the three and six months ended June 30, 2006 and 2005, revenues from continuing operations consist of the following (in thousands of dollars):

					Favorable/(Unfavorable)
Three Months Ended June 30	2006		2005		$ Change			%Change
Auction and related revenues:
Auction commission revenues	$	212,773	$	156,857	$	55,916			35.6	%
Auction expense recoveries		6,523		7,197		(674	)		(9.4	%)
Private sale commissions		9,904		5,589		4,315			77.2	%
Principal activities		9,752		1,348		8,404				*
Catalogue subscription revenues		2,280		2,548		(268	)		(10.5	%)
Other		2,279		2,019		260			12.9	%
Total auction and related revenues		243,511		175,558		67,953			38.7	%
Other revenues:
Finance revenues		3,550		1,768		1,782				*
License fee revenues		722		448		274			61.2	%
Other		516		578		(62	)		(10.7	%)
Total other revenues		4,788		2,794		1,994			71.4	%
Total revenues	$	248,299	$	178,352	$	69,947			39.2	%

					Favorable/(Unfavorable)
Six Months Ended June 30	2006		2005		$ Change			%Change
Auction and related revenues:
Auction commission revenues	$	286,826	$	216,965	$	69,861			32.2	%
Auction expense recoveries		8,405		10,064		(1,659	)		(16.5	%)
Private sale commissions		17,540		10,722		6,818			63.6	%
Principal activities		12,020		1,754		10,266				*
Catalogue subscription revenues		4,268		4,886		(618	)		(12.6	%)
Other		6,176		3,342		2,834			84.8	%
Total auction and related revenues		335,235		247,733		87,502			35.3	%
Other revenues:
Finance revenues		6,982		2,976		4,006				*
License fee revenues		1,192		624		568			91.0	%
Other		905		1,134		(229	)		(20.2	%)
Total other revenues		9,079		4,734		4,345			91.8	%
Total revenues	$	344,314	$	252,467	$	91,847			36.4	%

Legend:

* Represents a change in excess of 100%.

Auction and Related Revenues

          For the three and six months ended June 30, 2006, auction and related revenues increased $68 million, or 39%, to $243.5 million, and $87.5 million, or 35%, to $335.2 million, when compared to the same periods in the prior year. This improvement is principally due to increased auction commission revenues, and, to a lesser extent, a higher level of principal activities and private sale commissions. Each of the significant factors impacting the increase in auction and related revenues is explained in more detail below.

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          Auction Commission Revenues—For the three and six months ended June 30, 2006, the higher level of auction commission revenues is principally due to increases of 53% and 51%, respectively, in Net Auction Sales, partially offset by reductions in auction commission margin of 11% (from 18.7% to 16.6%) and 13% (from 19% to 16.6%), respectively. See “Net Auction Sales” and “Auction Commission Margin” below for a detailed discussion of these key performance indicators.

          Net Auction Sales—For the three and six months ended June 30, 2006, Net Auction Sales increased $442.8 million, or 53%, to $1.3 billion, and $580.8 million, or 51%, to $1.7 billion, when compared to the same periods in the prior year.

          The increase in second quarter Net Auction Sales is primarily attributable to the following factors:

• A $306.6 million, or 93%, improvement in results from this year’s spring Impressionist and Contemporary Art sales conducted in New York and London. The New York sales were highlighted by the sale of Picasso’sDora Maar with Cat for $85 million, for which there was no comparably priced painting sold in the prior year. The significant improvement in these results is indicative of the continued strength of these markets, which greatly contributed to an increase in both the number of lots sold and the average selling price of such lots.

• A $41 million, or 122%, increase in sales of Russian art in New York and London, reflecting the continued growth of this market.

• A $22.7 million increase in sales of Old Master Paintings, as current year results include the single-owner sale of William Blake watercolors ($8.7 million), for which there was no comparable sale in the prior period. Also contributing to the increase is a $7.2 million improvement in Old Master Paintings sales results in our Milan salesroom.

• A $16.5 million increase in sales of American Paintings.

• A $9.8 million increase in Net Auction Sales conducted by Sotheby’s Asia (which includes auction salesrooms in Hong Kong, Singapore and Australia), primarily due to a 202% improvement in sales of Contemporary Chinese Art in Hong Kong.

• Smaller increases across several other collecting categories, including Jewelry in Switzerland and New York ($10.1 million), Books and Collectibles ($10 million) and Latin American art ($9 million).

          The higher level of Net Auction Sales for the six months ended June 30, 2006 was largely the result of the sales increases discussed above, as well as the Company’s strong first quarter Net Sales results which included:

• A $66 million improvement in results from the winter Impressionist and Contemporary Art sales in London.

• A $36.8 million increase in results from the January various-owner Old Master Paintings sales in New York, principally due to the sale of more high-value lots.

• A $34.1 million increase in Asian art sales in New York as the Company conducted four such sales in the first quarter of 2006 compared to one sale in the same period of the prior year, reflecting market growth in the areas of Chinese Contemporary Art, Chinese Works of Art and Indian Art.

          Auction Commission Margin—Auction commission margin represents total auction commission revenues as a percentage of Net Auction Sales. Typically, auction commission margins are higher for lower value works of art or collections, while higher valued property earns lower margins. Auction commission margins are adversely impacted by arrangements whereby, in certain limited situations, auction commissions are shared with the consignor or with the Company’s partners in auction guarantees. In certain of these instances, the Company may share auction commissions with the consignor as part of an auction guarantee in exchange for a portion of the hammer price in excess of the guaranteed amount. Auction commissions shared with auction guarantee partners are the result of management’s decision to reduce auction risk through sharing arrangements with such partners, whereby the Company reduces its financial exposure under an auction guarantee in exchange for sharing the auction commission.

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          As discussed above, for the three and six months ended June 30, 2006, auction commission margin decreased 11% (from 18.7% to 16.6%) and 13% (from 19% to 16.6%) when compared to the same periods in 2005. This reduction in auction commission margins is due to an unfavorable change in sales mix as a more significant portion of Net Auction Sales in the first half of 2006 were at the high-end of the Company’s business where auction commission margins are traditionally lower. Also contributing to the deterioration in auction commission margin in the second quarter of 2006 were certain significant consignments which were sold subject to commission sharing arrangements, whereby the Company shared the auction commissions in exchange for a portion of the hammer price (see discussion of Principal Activities below). As a result, shared auction commissions increased $11.3 million during the second quarter of 2006, when compared to the same period in the prior year.

          Principal Activities—Principal Activities consists mainly of income or loss related to auction guarantees, gains or losses on sales of inventory and gains or losses related to the sales of loan collateral, as well as any decreases in the carrying value of the Company’s inventory. The level of principal activities in a period is largely attributable to the success of the Company in selling property consigned in connection with auction guarantees, as well as the supply of quality property available for investment and resale and the demand by buyers for such property.

          For the three and six months ended June 30, 2006, principal activities increased $8.4 million and $10.3 million when compared to the same periods in the prior year, primarily due to significantly favorable guarantee experience in the second quarter of 2006 (see discussion of Auction Commission Margin above). As discussed above, in certain limited situations the Company may share auction commissions with the consignor as part of an auction guarantee in exchange for a portion of the hammer price in excess of the guaranteed amount. As a result, in periods impacted by such arrangements, such as in this period, auction commission revenues are best reviewed in the aggregate with principal activities to fully understand auction and related revenues for the period.

          Private Sale Commissions—The level of private sale commissions earned by the Company in any period is typically highly variable. For the three and six months ended June 30, 2006, private sale commissions increased $4.3 million, or 77%, and $6.8 million, or 64%, when compared to the same periods in the prior year. Most notably, private sale results for the second quarter of 2006 include the sale of the Collection of Dr. Martin Luther King, for which there was no comparable private sale in the prior period. The overall increase in private sale commissions reflects management’s continued commitment to pursue private sales opportunities in the strong international art market.

Finance Revenues

          For the three and six months ended June 30, 2006, Finance revenues increased $1.8 million and $4 million, respectively, when compared to the same periods in the prior year. These substantial increases principally resulted from a 73% increase in the year-to-date average loan portfolio balance (from $84.4 million to $146.3 million) and higher interest rates. A significant portion of the increase in the average loan portfolio balance is the result of two term loans issued to the same borrower in the second and fourth quarters of 2005 totaling $51.5 million. For the three and six months ended June 30, 2006 these two loans contributed approximately $1 million and $2.3 million, respectively, to the increase in Finance revenues for the period and, in the aggregate, comprise approximately 35% of the client loan portfolio at June 30, 2006. The growth in the Finance segment’s client loan portfolio reflects the availability of capital to fund new loans and management’s marketing efforts in this area.

33

Expenses

          For the three and six months ended June 30, 2006 and 2005, expenses from continuing operations consist of the following (in thousands of dollars):

					Favorable / (Unfavorable)
Three Months Ended June 30	2006		2005		$ Change			% Change
Direct costs of services	$	23,228	$	19,029		($4,199	)		(22.1	%)
Salaries and related costs		70,338		53,326		(17,012	)		(31.9	%)
General and administrative expenses		31,155		30,618		(537	)		(1.8	%)
Depreciation and amortization expense		5,292		5,570		278			5.0	%
Total expenses	$	130,013	$	108,543		($21,470	)		(19.8	%)

					Favorable / (Unfavorable)
Six Months Ended June 30	2006		2005		$ Change			% Change
Direct costs of services	$	36,111	$	29,270		($6,841	)		(23.4	%)
Salaries and related costs		114,342		92,879		(21,463	)		(23.1	%)
General and administrative expenses		63,208		57,837		(5,371	)		(9.3	%)
Depreciation and amortization expense		10,663		11,217		554			4.9	%
Total expenses	$	224,324	$	191,203		($33,121	)		(17.3	%)

Direct Costs of Services

          Direct costs of services consists largely of catalogue production and distribution costs, as well as sale marketing costs and corporate marketing expenses. The level of direct costs incurred in any period is generally dependent upon the volume and composition of the Company’s auction offerings. For example, direct costs attributable to single-owner or other high-value collections are typically higher than those associated with standard various-owner sales, mainly due to higher promotional costs for catalogues, special events and traveling exhibitions and higher shipping expenses.

          For the three and six months ended June 30, 2006, direct costs of services increased $4.2 million, or 22%, and $6.8 million, or 23%, when compared to the same periods in the prior year. The increase in direct costs is consistent with the volume and type of property offered and sold at auction during the periods. In particular, the increase reflects higher shipping and sale promotion costs related to the successful spring Impressionist and Contemporary sales in New York and London, as discussed above. Also contributing to the increase in direct costs for the three and six months ended June 30, 2006 are $0.4 million and $1.2 million, respectively, in corporate marketing expenses attributable to increased spending for client service programs.

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Salaries and Related Costs

          For the three and six months ended June 30, 2006 and 2005, salaries and related costs consisted of the following (in thousands of dollars):

					Favorable / (Unfavorable)
Three months ended June 30	2006		2005		$ Change			% Change
Full-time salaries	$	26,939	$	24,945		($1,994	)		(8.0	%)
Employee benefits		7,718		5,507		(2,211	)		(40.1	%)
Payroll taxes		4,416		3,357		(1,059	)		(31.5	%)
Incentive bonus costs		23,945		14,049		(9,896	)		(70.4	%)
Stock compensation expense		3,140		970		(2,170	)			*
Option Exchange		530		995		465			46.7	%
Other **		3,650		3,503		(147	)		(4.2	%)
Total salaries and related costs	$	70,338	$	53,326		($17,012	)		(31.9	%)

					Favorable / (Unfavorable)
Six months ended June 30	2006		2005		$ Change			% Change
Full-time salaries	$	53,465	$	50,576		($2,889	)		(5.7	%)
Employee benefits		13,547		10,577		(2,970	)		(28.1	%)
Payroll taxes		8,431		6,515		(1,916	)		(29.4	%)
Incentive bonus costs		25,881		14,785		(11,096	)		(75.0	%)
Stock compensation expense		4,977		1,724		(3,253	)			*
Option Exchange		1,476		2,658		1,182			44.5	%
Other **		6,565		6,044		(521	)		(8.6	%)
Total salaries and related costs	$	114,342	$	92,879		($21,463	)		(23.1	%)

          Legend:

          *      Represents a change in excess of 100%.

          **    Principally includes the cost of temporary labor and overtime.

          For the three and six months ended June 30, 2006, salaries and related costs increased $17 million, or 32%, and $21.5 million, or 23%, when compared to the same periods in the prior year. These increases are primarily due to higher levels of incentive bonus costs, and, to a much lesser extent, higher stock compensation costs, employee benefit costs, full-time salaries and payroll taxes. The overall increase in salaries and related costs for the periods is minimally offset by lower costs related to the Option Exchange program. See discussion below for a more detailed explanation of each of these factors.

          Incentive Bonus Costs—For the three and six months ended June 30, 2006, incentive bonus costs increased approximately $9.9 million, or 70%, and $11.1 million, or 75%, when compared to the same periods in the prior year, due to the Company’s strong financial performance through the first six months of 2006.

          Stock Compensation Expense—For the three and six months ended June 30, 2006, stock compensation expense (excluding costs related to the Exchange Offer described below) increased $2.2 million and $3.3 million, respectively, when compared to the same periods in the prior year. These increases are principally attributable to $1.1 million in stock compensation costs resulting from a compensation arrangement with the Company’s Chief Executive Officer consummated in April 2006, as well as incremental costs from restricted stock grants made during and subsequent to the second quarter of 2005. For the three and six months ended June 30, 2006, the Company also recognized $0.5 million and $1.1 million, respectively, in stock compensation expense resulting from the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment,” on January 1, 2006. (See Note 13 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements,” for more detailed information related to the adoption of SFAS No. 123R.)

35

          For the year ended December 31, 2006, stock compensation expense (excluding costs related to the Exchange Offer discussed below) is expected to increase approximately $9.6 million when compared to 2005 principally due to the compensation arrangement with the Company’s Chief Executive Officer consummated in April 2006 and stock compensation costs associated with other restricted stock grants in 2006, as well as $1.4 million related to the adoption of SFAS No. 123R. (See statement on Forward Looking Statements.)

          Full-Time Salaries—For the three and six months ended June 30, 2006, full-time salaries increased $2 million, or 8%, and $2.9 million, or 6%, respectively, when compared to the same periods in the prior year. These increases are principally due to strategic headcount additions in certain departments within the Auction segment, including Contemporary Paintings, Russian Art and Asian Art, as well as limited salary increases. These increases are partially offset by the $1.1 million impact of favorable foreign currency exchange rates in the first quarter of 2006, when compared to the same period in the prior year.

          Payroll Taxes— For the three and six months ended June 30, 2006, payroll taxes increased $1.1 million, or 32%, and $1.9 million, or 29%, respectively, when compared to the same periods in the prior year, principally due to incremental payroll taxes resulting from a significantly higher level of employee stock option exercises and restricted stock share vests during the period. To a lesser extent, the increase in payroll taxes is also attributable to the increases in full-time salaries and incentive bonus costs discussed above.

          Employee Benefit Costs— Employee benefit expenses include costs of the Company’s retirement plans, the costs of its health and welfare programs and, to a much lesser extent, severance costs. The Company’s material retirement plans include a defined benefit pension plan covering substantially all employees in the United Kingdom (“U.K.”) and defined contribution and deferred compensation plans for employees in the United States (“U.S.”). The U.S. plans provide for a Company matching contribution of up to 6% of each participant’s eligible compensation as well as a discretionary annual Company contribution that varies depending on the Company’s profitability. Generally, the level of employee benefit costs is dependent upon movements in headcount and compensation levels, as well as the Company’s financial performance. Additionally, expenses related to the Company’s U.K. defined benefit pension plan are significantly influenced by interest rates and investment performance in the debt and equity markets (see Part II, Item 1A, “Risk Factors”).

          For the three and six months ended June 30, 2006, employee benefit costs increased $2.2 million, or 40%, and $3 million, or 28%, respectively, when compared to the same periods in the prior year. The higher level of employee benefit costs is due to the headcount, salary and incentive bonus cost increases discussed above, as well as a $0.6 million increase in profit sharing costs related to the Company’s U.S. pension plans in the second quarter of 2006 as a result of the Company’s strong financial performance. For the three and six months ended June 30, 2006, the Company’s results also reflect increases of $0.5 million and $0.7 million, respectively, in costs related to the Company’s U.K. defined benefit pension plan (see Note 7 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”), as well as increases of $0.2 million and $0.7 million, respectively, in severance costs.

          As disclosed in the Company’s Form 10-K for the year ended December 31, 2005, during the three-year period from 2000 to 2002, actual asset returns for the U.K. defined benefit pension plan were less than management’s assumed rate of return on plan assets, contributing to unrecognized net losses of approximately $54 million at December 31, 2005. These unrecognized losses are being systematically recognized as an increase in future net periodic pension cost in accordance with SFAS No. 87, “Employers’ Accounting for Pensions.” For the year ended December 31, 2006, management expects an increase of approximately $1.7 million in costs related to its U.K. defined benefit pension plan principally due to higher amortization of such unrecognized losses. (See statement on Forward Looking Statements.)

          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.

          For the three and six months ended June 30, 2006, compensation expense related to the Exchange Offer decreased $0.5 million, or 47%, and $1.2 million, or 45%, respectively, when compared to the same periods in the prior year as a result of lower stock compensation expense related to the issuance of 1.1 million restricted shares in the Exchange Offer, which is being amortized over a graded four-year vesting period. The amortization of stock compensation expense related to the Exchange Offer is expected to be approximately $2.5 million and $1.2 million for the years ended December 31, 2006 and 2007, respectively. (See statement on Forward Looking Statements.)

36

General and Administrative Expenses

          For the three months ended June 30, 2006, general and administrative expenses increased $0.5 million, or 2%, when compared to the prior period, with increases experienced in professional fees ($1.8 million), travel and entertainment costs ($1.1 million), facilities-related costs ($0.6 million) and various smaller increases in other general and administrative expenses ($0.2 million). These increases were partially offset by the one-time benefit associated with the recovery of $2.2 million in administrative expenses related to the settlement of the International Antitrust Litigation to be received by the end of 2006 (see Note 11 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”) and a $1 million decrease in client goodwill gestures and authenticity claims.

          For the six months ended June 30, 2006, general and administrative expenses increased $5.4 million, or 9%, to $63.2 million. During this period, the favorable impact of foreign currency translations on general and administrative expenses was approximately $1.4 million. Excluding the favorable impact of foreign currency translations, general and administrative expenses increased $6.8 million, or 12%, to $64.6 million, when compared to the same period in the prior year. This increase is largely attributable to the following factors:

• An increase of $2.5 million in travel and entertainment costs principally due to the higher level of travel for pursuing business opportunities during the period. Also contributing to the increase in travel and entertainment costs during the period are price increases for airfares and other travel costs.

• An increase of $2.4 million in professional fees, as a result of outsourcing the Company’s catalogue production operations in the U.K. and other corporate initiatives. Beginning in the third quarter of 2006, the Company is realizing savings as a result of outsourcing catalogue production operations in the U.K.

• A $1.7 million increase in premises rental and maintenance costs.

• A $0.7 million accrual recorded in the first half of 2006 related to the settlement of the Canadian Competition Bureau investigation. (See Note 11 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”)

• Various smaller increases in other general and administrative expenses totaling approximately $2.4 million.

          For the six months ended June 30, 2006, the overall increase in general and administrative expenses was partially offset by the one-time benefit associated with the recovery of $2.2 million in administrative expenses related to the settlement of the International Antitrust Litigation (see Notes 1 and 11 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements” for information related to the original income statement classification of such expenses) and a $0.7 million reduction in insurance costs, reflecting management’s cost reduction efforts and lower overall premiums available in the insurance market.

Net Interest Expense

          Due to funding requirements for new client loans, as well as decreased cash balances resulting from funding the Transaction described under “Recapitalization” below, the Company had significantly lower average cash balances and short-term investments and a higher level of average outstanding revolving credit facility borrowings during the three and six months ended June 30, 2006, when compared to the same periods in the prior year. As a result, for the three and six months ended June 30, 2006, net interest expense increased $0.9 million, or 14%, and $2.4 million, or 18%, respectively, when compared to the same periods in 2005. (See “Liquidity and Capital Resources” below and Note 7 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”)

Income Tax Expense

          The Company’s effective tax rate for the three and six months ended June 30, 2006 was approximately 35%, compared to 33% in the comparable periods of the prior year. The change in the effective tax rate was primarily attributable to permanent disallowances of employee compensation and an increased proportion of the Company’s taxable income generated in the United States, which is a higher tax jurisdiction than some of the international countries or territories where the Company earns income.

Discontinued Operations

          For information related to Discontinued Operations, see Note 16 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”

37

FINANCIAL CONDITION AS OF JUNE 30, 2006

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, 2006, total cash and cash equivalents related to the Company’s continuing and discontinued operations decreased $32.2 million primarily due to the factors discussed below.

Net cash used by operations was $42.6 million for the six months ended June 30, 2006 and is principally due to the following factors:

• A $122.4 million net increase in net amounts owed by clients principally due to the timing and settlement of auction sales conducted in the fourth quarter of 2005 and the first half of 2006.

• The funding of $15 million of the fine payable to the DOJ in February 2006 and the redemption of $2.4 million in vendor’s commission discount certificates (see Note 11 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”).

• A $10.9 million net increase in inventory (excluding inventory acquired in conjunction with the acquisition of Noortman Master Paintings, B.V., as discussed in Note 3 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”).

The impact of these net cash outflows from operations was partially offset by net income of $67.5 million during the period.

Net cash used by investing activities was $8.4 million for the six months ended June 30, 2006 and was largely due to the funding of $162.1 million in client loans, and, to a lesser extent, an increase of $8.2 million in restricted cash and capital expenditures of $4.5 million. These investing cash outflows are largely offset by the collection of $165.8 million in client loans.

Net cash provided by financing activities was $17.9 million for the six months ended June 30, 2006 and is principally due to $353.8 million in proceeds received from credit facility borrowings, $45.7 million in proceeds received from the exercise of stock options and $8.6 million in excess tax benefits resulting from the stock option exercises. These financing inflows are partially offset by repayments of credit facility borrowings of $380 million and, to a much lesser extent, the $9.5 million repayment of acquiree bank debt (see Note 3 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”).

RECAPITALIZATION

          On September 7, 2005, the Company entered into a Transaction Agreement (the “Agreement”) with various affiliates of A. Alfred Taubman and his family (the “Shareholders”). Prior to completion of the transactions contemplated by the Agreement, the Shareholders were the Company’s largest shareholders, holding in the aggregate 14,034,158 shares of the Company’s Class B Common Stock (the “Class B Stock”), which represented approximately 62.4% of the aggregate voting power of the Company’s capital stock. Pursuant to the Agreement, the Company in effect exchanged all 14,034,158 shares of Class B Stock owned by the Shareholders for $168,409,896 in cash and 7.1 million shares of the Company’s Class A Stock, (such exchange, the “Transaction”).

          Because the outstanding shares of Class B Stock constituted less than fifty percent of the aggregate voting power of the Company’s outstanding common stock following completion of the Transaction, pursuant to the Company’s Third Amended and Restated Articles of Incorporation (the “Articles”), following completion of the Transaction each remaining outstanding share of Class B Stock held by a shareholder not a party to the Transaction was automatically converted into one share of Class A Stock without any action on the part of the holder thereof.

          As a result of the Transaction, the dual class super-voting share structure that had been in place since the Company’s initial public offering in 1988 was eliminated, allowing for a corporate governance structure that is more consistent with the best practices of public companies. Management believes that the simplified share structure has enhanced share liquidity and increased the Company’s strategic and financing flexibility. (See statement on Forward Looking Statements.)

REINCORPORATION

          On June 30, 2006, Sotheby’s Holdings, Inc., a Michigan corporation (“Sotheby’s Michigan”), completed its reincorporation into the State of Delaware (the “Reincorporation”). The Reincorporation and related proposals were approved by the shareholders of Sotheby’s Michigan at the annual meeting of shareholders held on May 8, 2006. The Reincorporation was completed by means of a merger of Sotheby’s Michigan with and into Sotheby’s Delaware, Inc., a Delaware corporation (“Sotheby’s Delaware”) and a wholly-owned subsidiary of Sotheby’s Michigan incorporated for the purpose of effecting the Reincorporation, with Sotheby’s Delaware being the surviving corporation. Sotheby’s Delaware was renamed “Sotheby’s” upon completion of the merger.

          In the merger, each outstanding share of Sotheby’s Michigan Class A Limited Voting Common Stock (“Sotheby’s Michigan Stock”) was converted into one share of Common Stock of Sotheby’s Delaware (“Sotheby’s Delaware Stock”). As a result, holders of Sotheby’s Michigan Stock are now holders of Sotheby’s Delaware Stock, and their rights as holders thereof are governed by the General Corporation Law of the State of Delaware and the Certificate of Incorporation and By-Laws of Sotheby’s Delaware.

          The Reincorporation was accounted for as a reverse merger whereby, for accounting purposes, Sotheby’s Michigan is considered the acquiror and the surviving corporation is treated as the successor to the historical operations of Sotheby’s Michigan. Accordingly, the historical financial statements of Sotheby’s Michigan, which Sotheby’s Michigan previously reported to the SEC on Forms 10-K and 10-Q, among other forms, are treated as the financial statements of the surviving corporation.

          The Reincorporation did not result in any change in the business or principal facilities of Sotheby’s Michigan. Upon completion of the merger, the address of Sotheby’s principal executive offices is 1334 York Avenue, New York, NY 10021. Sotheby’s Michigan’s management and board of directors continue as the management and board of directors of Sotheby’s Delaware. Sotheby’s Delaware Stock will continue to trade on the New York Stock Exchange under the symbol “BID.” Shareholders are not required to exchange their existing stock certificates, which now represent an equivalent number of shares of Sotheby’s Delaware Stock.

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ACQUISITION

          On June 7, 2006, the Company and Arcimboldo S.A., a private limited liability company incorporated under the laws of Luxembourg, (“Arcimboldo”) entered into a sale and purchase agreement (the “Purchase Agreement”), pursuant to which the Company acquired all the issued and outstanding shares of capital stock of Noortman Master Paintings B.V., a company incorporated under the laws of the Netherlands (“NMP”), one of the world’s leading art dealers. NMP is based in Maastricht, the Netherlands. Robert C. Noortman is the sole shareholder of Arcimboldo and has guaranteed the obligations of Arcimboldo under the Purchase Agreement. The acquisition of NMP offers the Company growth opportunities by adding a pre-eminent art dealer in an important market. NMP’s results are included in the Company’s Consolidated Income Statements beginning on June 1, 2006 and are not material to the periods covered by this report. Consequently, such results are included in All Other for segment reporting purposes for the three and six months ended June 30, 2006 (see Note 4). Beginning in the third quarter of 2006, NMP’s results will be reported in a new segment, if material.

          Pursuant to the Purchase Agreement, the Company paid initial consideration (the “Initial Consideration”) in the form of 1,946,849 shares of Sotheby’s Class A Limited Voting Common Stock (“Sotheby’s Shares”), which had a fair value of approximately $41.4 million. The fair value of the Sotheby’s Shares issued as Initial Consideration is based on the actual number of shares issued using the closing price of Sotheby’s Shares on the New York Stock Exchange of $25.30 per share on June 6, 2006 reduced by $7.9 million to reflect the fair value of certain restrictions on the future transfer of the Sotheby’s Shares issued as Initial Consideration, as discussed in more detail below. The fair value of these restrictions was determined by an independent valuation expert. In addition to the Initial Consideration, the Company acquired NMP subject to approximately $25.6 million of indebtedness, consisting of a $16.1 million long-term non-interest bearing note payable to Arcimboldo over a period of three years and $9.5 million of bank debt that was repaid upon the closing of the transaction, as well as the settlement of a $11.7 million payable to Sotheby's (see Note 3 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”). The present value of the note payable to Arcimboldo is $14.6 million. The $1.5 million discount on the note payable is being amortized to interest expense over the three-year term. The first payment of $2.6 million under the note payable was made on July 26, 2006.

          An additional 486,712 Sotheby’s Shares (the “Additional Consideration”) have been released and placed into escrow if NMP achieves certain targeted performance criteria specified in the Purchase Agreement during the five years following the closing of the transaction and if Mr. Noortman continues to be employed by the Company. Based on the closing price of Sotheby’s Shares on the New York Stock Exchange of $27.63 per share on July 31, 2006 the Additional Consideration has a value of approximately $13.4 million, the Additional Consideration is being held in escrow pursuant to an escrow agreement dated June 7, 2006, among the parties to the Purchase Agreement and LaSalle Bank N.A.

          If NMP fails to achieve a minimum level of financial performance during the five years following the closing of the transaction, up to 20% of the Initial Consideration will be transferred back to the Company.

          The Purchase Agreement also provides for certain restrictions on the transfer of Sotheby’s Shares received by Arcimboldo, as discussed above. Subject to certain limited exclusions, Arcimboldo may not transfer any of the Sotheby’s Shares that it received as Initial Consideration for a period of two years after the closing, and may not transfer 20% of the Sotheby’s Shares that it received as Initial Consideration for a period of five years after the closing.

          The Company, Arcimboldo and Mr. Noortman also made customary warranties and covenants in the Purchase Agreement, including certain post-closing business covenants of the Company and certain non-competition and non-solicitation covenants of Arcimboldo and Mr. Noortman for a period of five years following closing. Mr. Noortman also entered into a seven-year employment agreement with NMP.

          (See Note 3 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements,” for information related to this acquisition.)

SHARES OUTSTANDING

          Diluted weighted average shares outstanding for the three and six months ended June 30, 2006 decreased by approximately 2.2 million and 3.7 million shares, respectively, when compared to the same periods in the prior year. The impact of the Transaction on diluted shares outstanding was partially offset by the impact of employee stock option exercises subsequent to the first quarter of 2005, which has resulted in the issuance of approximately 3.2 million additional shares of the Company’s Common Stock, as well as the issuance of 1.9 million shares in conjunction with the acquisition of NMP. As a result of these events, management expects weighted average diluted shares outstanding for the year ended December 31, 2006 to be in the range of approximately 62 million. (See statement on Forward Looking Statements.)

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CONTRACTUAL OBLIGATIONS AND COMMITMENTS

          The following table summarizes the Company’s material contractual obligations and commitments as of June 30, 2006:

			Payments Due by Period
	Total		Less Than One Year			1 to 3 Years		3 to 5 Years		After 5 Years
			(Thousands of dollars)
Principal payments on borrowings:
Credit facility borrowings (1)	$	10,000		$	—	$	—	$	10,000	$	—
Long-term debt (2)		100,000			—		100,000		—		—
Sub-total		110,000			—		100,000		10,000		—
Interest payments on borrowings:
Long-term debt (2)		20,052			6,875		13,177		—		—
Sub-total		20,052			6,875		13,177		—		—
Other commitments:
York Property capital lease		379,314			19,287		39,224		41,274		279,529
Operating lease obligations		78,553			14,775		23,812		11,620		28,346
Discount Certificates (3)		48,316			48,316		—		—		—
Note payable to Arcimboldo (4)		16,082			5,361		10,721		—		—
Employment arrangements (5)		11,335			2,965		4,514		2,620		1,236
Sub-total		533,600			90,704		78,271		55,514		309,111
Total	$	663,652		$	97,579	$	191,448	$	65,514	$	309,111

(1)	Represents the outstanding principal related to the Company’s credit facility borrowings. (See “Liquidity and Capital Resources” below and Note 7 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements,” for information related to the Company’s credit arrangements.)
(2)	Represents the aggregate outstanding principal and semi-annual interest payments due on the Company’s long-term debt. (See “Liquidity and Capital Resources” below and Note 7 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements,” for information related to the Company’s credit arrangements.)
(3)	Represents the face value of the Discount Certificates that were distributed in conjunction with the settlement of certain civil litigation related to the antitrust investigation by the U.S. Department of Justice (the “DOJ”), which are fully redeemable in connection with any auction that is conducted by the Company or Christie’s International, PLC 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. (See Note 11 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”)
(4)	See Note 3 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”
(5)	Represents the remaining commitment for future salaries as of June 30, 2006 related to employment arrangements with a number of key employees, excluding incentive bonuses. (See Note 9 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”)

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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 in the event the property sells for less than the minimum price, in which event 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 auction commission sharing arrangements with unaffiliated partners. Partners may also assist the Company in valuing and marketing the property to be sold at auction.

          As of June 30, 2006, the Company had outstanding auction guarantees totaling $36.9 million, the property relating to which had a mid-estimate sales price (1) of $49.1 million. Substantially all of the property related to such guarantees is being offered at auctions during the second half of 2006. As of June 30, 2006, December 31, 2005 and June 30, 2005, the carrying amount of the liability related to the Company’s auction guarantees was approximately $0.9 million, $0.3 million and $0.1 million, respectively, and was reflected in the Consolidated Balance Sheets within Accounts Payable and Accrued Liabilities.

          As of July 28, 2006, the Company had outstanding auction guarantees totaling $41.6 million, the property relating to which had a mid-estimate sales price (1) of $54.2 million. Substantially all of the property related to such auction guarantees is being offered at auctions during the second half of 2006. As of July 28, 2006, $5 million of the guaranteed amount had been advanced by the Company and will be recorded within Notes Receivable and Consignor Advances.

(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 $25.6 million at June 30, 2006.

DERIVATIVE FINANCIAL 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 and client transactions. 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 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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          At June 30, 2006, the Company had $197.8 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. As of June 30, 2006, December 31, 2005 and June 30, 2005, the Consolidated Balance Sheets included assets of $1.1 million, $0.1 million and $0.5 million, respectively, recorded within Prepaid Expenses and Other Current Assets reflecting the fair value of the Company’s outstanding forward exchange contracts on those dates.

CONTINGENCIES

          For information related to Contingencies, see Note 9 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”

LIQUIDITY AND CAPITAL RESOURCES

          On September 7, 2005, in connection with the Transaction discussed in Note 17 below, the Company terminated its previous senior secured credit agreement and entered into a new senior secured credit agreement with an international syndicate of lenders arranged by Banc of America Securities LLC (“BofA”) and LaSalle Bank N.A. (the “BofA Credit Agreement”). The BofA Credit Agreement originally provided for borrowings of up to $250 million through a revolving credit facility. On May 18, 2006, the Company amended the credit agreement to provide for $50 million in additional commitments from its existing lenders, thereby increasing the total borrowing capacity to $300 million. The amendment also permits the amount of available borrowings to be increased by an additional $50 million to $350 million on a one-time basis.

          The amount of borrowings available at any time under the BofA Credit Agreement is limited to a borrowing base, which is generally equal to 100% of eligible loans made by the Company in the U.S. and the U.K. (i.e., notes receivable and consignor advances) plus 15% of the Company’s net tangible assets (calculated as total assets less current liabilities, goodwill, unamortized debt discount and eligible loans). As of June 30, 2006, the amount of unused borrowing capacity available under the BofA Credit Agreement was $278.5 million, consisting of a borrowing base of $288.5 million less $10 million in borrowings outstanding on that date. Such outstanding borrowings are classified as long-term liabilities in the Consolidated Balance Sheet as of June 30, 2006. As of July 24, 2006, there were no outstanding borrowings under the BofA Credit Agreement and the amount of unused borrowing capacity available and borrowing base under the BofA Credit Agreement was $210 million.

          The BofA Credit Agreement is available through September 7, 2010; provided that in the event that any of the $100 million in long-term debt securities (the “Notes”) issued by the Company in February 1999 (as discussed in more detail below) are still outstanding on July 1, 2008, then either: (a) the Company shall deposit cash in an amount equal to the aggregate outstanding principal amount of the Notes on such date into an account in the sole control and dominion of BofA for the benefit of the lenders and the holders of the Notes or (b) the Company shall have otherwise demonstrated its ability to redeem and pay in full the Notes; otherwise, the BofA Credit Agreement shall terminate and all amounts outstanding thereunder shall be due and payable in full on July 1, 2008.

          Borrowings under the BofA Credit Agreement were used to finance in part the Transaction and related expenses and are also available to provide ongoing working capital and for other general corporate purposes of the Company. The Company’s obligations under the BofA Credit Agreement are secured by substantially all of the non-real estate assets of the Company, as well as the non-real estate assets of its subsidiaries in the U.S. and the U.K.

          The BofA Credit Agreement contains financial covenants requiring the Company not to exceed a maximum level of capital expenditures and dividend payments (as discussed in more detail below) and to have a quarterly interest coverage ratio of not less than 2.0 and a quarterly leverage ratio of not more than: (i) 4.0 for quarters ending September 30, 2005 to September 30, 2006, (ii) 3.5 for quarters ending December 31, 2006 to September 30, 2007 and (iii) 3.0 for quarters ending December 31, 2007 and thereafter. The maximum level of annual capital expenditures permitted under the BofA Credit Agreement is $15 million through 2007 and $20 million thereafter with any unused amounts carried forward to the following year. Dividend payments, if any, must be paid solely out of 40% of the Company’s net income arising after June 30, 2005 and computed on a cumulative basis. The BofA Credit Agreement also has certain non-financial covenants and restrictions. The Company is in compliance with its covenants.

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          On August 2, 2006, the Company’s Board of Directors declared a quarterly dividend on its common stock of $0.10 per share (approximately $6.4 million), payable on September 15, 2006 to shareholders of record on September 1, 2006. It is the intention of the Company to continue to pay quarterly dividends at this rate (an annual rate of $0.40 per share), subject to Board approval depending on economic, financial, market and other conditions at the time. (See statement on Forward Looking Statements.)

          At the option of the Company, any borrowings under the BofA Credit Agreement generally bear interest at a rate equal to: (i) LIBOR plus 1.75%, or (ii) 0.5% plus the higher of the Prime Rate or the Federal Funds Rate plus 0.5%. For the three and six months ended June 30, 2006, the weighted average interest rate incurred by the Company on outstanding borrowings under the BofA Credit Agreement was approximately 7.6% and 6.9%, respectively. For the three and six months ended June 30, 2005, the Company had no outstanding borrowings under the previous GE Capital Credit Agreement.

          The Company paid underwriting, structuring and amendment fees of $2.8 million related to the BofA Credit Agreement, which are being amortized on a straight-line basis to Interest Expense over the term of the facility.

          The Company generally relies on operating cash flows supplemented by borrowings to meet its liquidity requirements. The Company currently believes that operating cash flows, current cash balances and borrowings available under the BofA Credit Agreement will be adequate to meet its presently contemplated or anticipated short-term and long-term commitments, operating needs and capital requirements through September 7, 2010.

          The Company’s short-term operating needs and capital requirements include peak seasonal working capital requirements, other short-term commitments to consignors, the funding of the Finance segment’s client loan portfolio, the funding of capital expenditures and the payment of the quarterly dividend discussed above, as well as the short-term commitments to be funded prior to June 30, 2007 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 funding of the Finance segment’s notes receivable and consignor advances and the funding of capital expenditures, as well as the funding of the Company’s presently anticipated long-term contractual obligations and commitments included in the table of contractual obligations above through September 7, 2010.

FUTURE IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

          In July 2006, the Financial Accounting Standards Board (the “FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (FIN 48), which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on the derecognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. The provisions of FIN 48 are effective for the Company as of January 1, 2007, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. Management is currently evaluating the impact of adopting FIN 48, if any, on the Company's 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 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 below under Item 1A, “Risk Factors,” which are not ranked in any particular order.

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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, notes receivable, consignor advances, revolving credit facility borrowings, long-term debt, the note payable to Arcimboldo (see Note 3 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”) and the settlement liability related to the Discount Certificates issued in connection with certain civil antitrust litigation (see Note 11 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”).

At June 30, 2006, 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 $18.3 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, 2006 from that set forth in the Company’s Form 10-K for the year ended December 31, 2005.

At June 30, 2006, the Company had $197.8 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, 2006, 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, 2006.

Changes in Internal Control over Financial Reporting

          As a result of the Company’s acquisition of NMP in June 2006, (see Note 3 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements”), we incorporated internal controls over financial reporting to include the consolidation of NMP's balance sheet and income statement, as well as acquisition related accounting and disclosures. There were no other changes in our internal control over financial reporting made during the Company’s most recent fiscal quarter that 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. In the first half of 2006, the Company recorded a $0.7 million accrual related to the settlement of this matter.

          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 statement on Forward Looking Statements.)

          (See Notes 9 and 11 of Notes to Consolidated Financial Statements under Part I, Item 1, “Financial Statements.”)

ITEM 1A: RISK FACTORS

          Operating results from the Company’s Auction and Finance segments, as well as the Company’s liquidity, are significantly influenced by a number of risk 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

          The art market in which the Company operates is influenced over time by the overall strength of the international economy and financial markets, although this correlation may not be immediately evident in the short-term. The Company’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 (principally China and Japan).

Interest rates

          Fluctuations in interest rates influence the Company’s cost of funds for borrowings under its credit facility that may be required to finance working capital needs and, in particular, the Finance segment’s client loan portfolio.

Government laws and regulations

          Many of the Company’s activities are subject to laws and regulations that can have an adverse impact on the Company’s business. In particular, export and import laws and cultural patrimony laws could affect the availability of certain kinds of property for sale at the Company’s principal auction locations or could increase the cost of moving property to such locations.

Political conditions

          Global political conditions may affect the Company’s business through their effect on the economies of various countries, as well as on the decision of buyers and sellers to purchase and sell art in the wake of economic uncertainty. These conditions may also influence the enactment of legislation that could adversely affect the Company’s business.

Foreign currency exchange rate movements

          The Company has operations throughout the world, with approximately 58.6% of its revenues from continuing operations coming from outside of the U.S. for the year ended December 31, 2005. Accordingly, fluctuations in exchange rates can have a significant impact on the Company’s results of operations.

Seasonality of the Company’s auction business

          The worldwide art auction market has two principal selling seasons, spring and autumn. Accordingly, the Company’s revenues and operating income may be affected as described under “Seasonality” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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Competition

          Competition in the art market is intense, including competition both with other auctioneers and with art dealers.

The amount and quality of property being consigned to art auction houses

          The amount and quality of property being consigned to art auction houses are influenced by a number of factors not within the Company’s control. Many major consignments, and specifically single-owner sale consignments, 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 the Company to sell such property, can cause auction and related revenues to be highly variable from period to period.

The demand for fine arts, decorative arts, and collectibles

          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 kinds of property and the works of which artists are most sought after and by the collecting preferences of individual collectors, all of which can be unpredictable.

Qualified personnel

          The Company’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 the Company’s success. Moreover, the Company’s business is both complicated and unique, making it important to retain key specialists and members of management. Accordingly, the Company’s business is highly dependent upon its success in attracting and retaining qualified personnel.

Demand for art-related financing

          The Company’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.

Value of artworks

          The art market is not a highly liquid trading market, as a result of which the valuation of artworks is inherently subjective and the realizable value of artworks often varies over time. Accordingly, the Company 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.

U.K. Pension Plan

          Future costs related to the Company’s U.K. defined benefit pension plan are heavily influenced by changes in interest rates and investment performance in the debt and equity markets, both of which are unpredictable. (See “Salaries and Related Costs—Employee Benefits” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”)

Income taxes

          The Company operates in many tax jurisdictions throughout the world. Variations in taxable income in the various jurisdictions in which the Company does business can have a significant impact on its effective tax rate.

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ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On May 8, 2006, the Company held its annual meeting of shareholders. The matters on which the shareholders voted were:

(i)	The election of nine directors by the holders of the Company’s Class A Common Stock;
(ii)	The ratification of the Company’s reincorporation in the state of Delaware;
(iii)	The ratification of the provision in the surviving corporation’s certificate of incorporation regarding who may call special shareholder meetings;
(iv)	The ratification of the Company’s Amended and Restated Restricted Stock Plan;
(v)	The ratification of the appointment of Deloitte & Touche LLP as the Company’s independent auditors for the year ending December 31, 2006;
(vi)	The ratification of the provision in the surviving corporation’s certificate of incorporation to provide that shareholder actions may only be taken at a duly called meeting of shareholders.

The results of the voting are shown below:

(i) ELECTION OF CLASS A COMMON STOCK DIRECTORS

NOMINEES	FOR		AGAINST		WITHHELD
Michael Blakenham		47,692,785		0		3,681,468
Steven B. Dodge		49,040,701		0		2,333,552
Duke of Devonshire		36,890,794		0		14,483,459
Allen Questrom		49,079,025		0		2,295,228
William F. Ruprecht		46,399,197		0		4,975,056
Michael I. Sovern		49,011,113		0		2,363,140
Donald M. Stewart		48,888,892		0		2,485,361
Robert S. Taubman		48,136,655		0		3,237,598
Robin G. Woodhead		47,519,972		0		3,854,281

(ii) RATIFICATION OF REINCORPORATION IN THE STATE OF DELAWARE

	43,858,964	Votes were cast;
	39,531,164	Votes were cast for the resolution;
	4,286,829	Votes were cast against the resolution; and
	40,971	Votes abstained
(iii)	RATIFICATION OF THE PROVISION IN THE SURVIVING CORPORATION’S CERTIFICATE OF INCORPORATION REGARDING WHO MAY CALL SPECIAL SHAREHOLDER MEETINGS

	43,858,965	Votes were cast;
	32,025,117	Votes were cast for the resolution;
	11,814,571	Votes were cast against the resolution; and
	19,277	Votes abstained
(iv)	RATIFICATION OF THE AMENDED AND RESTATED RESTRICTED STOCK PLAN
	43,858,965	Votes were cast;
	34,275,941	Votes were cast for the resolution;
	9,559,635	Votes were cast against the resolution; and
	23,389	Votes abstained
(v)	RATIFICATION OF INDEPENDENT AUDITORS
	51,374,251	Votes were cast;
	49,195,383	Votes were cast for the resolution;
	2,164,375	Votes were cast against the resolution; and
	14,493	Votes abstained
(vi)	RATIFICATION OF THE PROVISION IN THE SURVIVING CORPORATION’S CERTIFICATE OF INCORPORATION TO PROVIDE THAT SHAREHOLDER ACTION MAY ONLY BE TAKEN AT DULY CALLED MEETINGS
	43,858,964	Votes were cast;
	29,852,421	Votes were cast for the resolution;
	13,990,790	Votes were cast against the resolution; and
	15,753	Votes abstained

ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

(a)	Exhibits –
	2.1	Agreement for the Sale and Purchase of All the Issued and Outstanding Shares in Noortman Master Paintings B.V.
	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 April 6, 2006, the Company filed a current report on Form 8-K under Item 1.01, “Entry into a Material Definitive Agreement.”
	(ii)	On April 18, 2006, the Company filed a current report on Form 8-K under Item 2.03, “Creation of a Direct Financial Obligation or an Obligation under and Off-Balance Sheet Arrangement of a Registrant.”
	(iii)	On May 12, 2006, the Company filed a current report on Form 8-K under Item 1.01, “Entry into a Material Definitive Agreement,” Item 2.02, “Results of Operations and Financial Condition,” Item 5.02, “Departure of Directors or Principal Officers; Election of Directors; Appointment of Principal Officers,” Item 8.01, “Other Events” and Item 9.01, “Financial Statements and Exhibits.”
	(iv)	On May 23, 2006, the Company filed a current report on Form 8-K under Item 1.01, “Entry into a Material Definitive Agreement,” Item 5.02, “Departure of Directors or Principal Officers; Election of Directors; Appointment of Principal Officers” and Item 9.01, “Financial Statements and Exhibits.”
	(v)	On June 8, 2006, the Company filed a current report on Form 8-K under Item 1.01, “Entry into 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” and Item 3.02, “Unregistered Sale of Equity Securities.”

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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/ Michael L. Gillis
	Michael L. Gillis
	Senior Vice President,
	Controller and Chief
	Accounting Officer
Date:August 3, 2006

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Exhibit Index

Exhibit No.	Description
2.1	Agreement for the Sale and Purchase of All the Issued and Outstanding Shares in Noortman Master Paintings B.V.
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

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