Sotheby's Holdings, Inc. Q2 2010 Earnings Call Transcript

| About: Sotheby's (BID)

Sotheby's Holdings, Inc. (NYSE:BID)

Q2 2010 Earnings Call

August 5, 2010 4:45 pm ET

Executives

Bill Ruprecht - President and CEO

Bill Sheridan - CFO

Analysts

David Schick - Stifel Nicolaus

George Sutton - Craig-Hallum

Rommel Dionisio - Wedbush Morgan

Kristine Koerber - JMP Securities

Operator

Good afternoon, ladies and gentlemen, and welcome to the Sotheby's second quarter first half 2010 earnings call. (Operator Instructions)

During the course of this call, the company may make projections or other forward-looking statements regarding future events or future financial performance of the company. We wish to caution you that such projections and 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.

We refer you to the documents the company files periodically with the Securities and Exchange Commission, specifically the company's most recently filed Form 10-Q and 10-K. These documents identify important factors that could cause the actual results to differ materially from those contained in the projections or forward-looking statements.

At this time, I would like to introduce Mr. Bill Ruprecht, President and Chief Executive Officer; and Bill Sheridan, Chief Financial Officer. Mr. Ruprecht, please go ahead.

Bill Ruprecht

Thank you, Jonathan. Good afternoon. Welcome, and thank you all for your interest in Sotheby's. Today we're announcing second quarter and first half results, which we consider outstanding.

Total revenues are up dramatically to $281.4 million in the second quarter and to $383.3 million for the half, thanks to strong worldwide sales, which are up 116%, that's to $2.2 million for the first half, and particularly Impressionist Art and the Contemporary Art net auctions increased to 188% in the half.

We're pleased to report that despite the significant increase in revenues, 68% for the quarter, 73% for the half, operating expenses were well-controlled. As a result, second quarter net income grew $74 million to $86.2 million. First half net income was up $106.4 million, which is the second best for the period in our history.

Expense control remains a regular and indeed constant focus for us, although our payroll is smaller. There's some expense growth, which is attributable to the significant increase in sales revenue and profitability. The significant driver is an increase in accrued incentive bonus cost due to the improvement in profitability in 2010 as compared to last year.

It's important to note in this regard that the entirety of our salaries and related cost line as a percentage of our operating revenues is down below 32%, a year ago this ratio was 44%, and this first half percentage is lower than we've seen it any full year for at least the last dozen years.

We assume in the middle of property gathering, it's early August for the Autumn sales, but we already have a number of exciting auctions and considerable property for those sales. I'll talk some more about that later in the call.

I'll turn it over now to Bill Sheridan, the CFO, who will give you some detail on the P&L and balance sheet.

Bill Sheridan

Thanks, Bill, and good afternoon, everyone. I'll be referring to page 6 of our earnings release, which has the three months and six month income statement.

Our overall results, as Bill said, net income for the second quarter was $86.2 million or $1.26 per diluted share, and $84.1 million or $1.22 per diluted share for the first six months. This compares to prior year second quarter net income of $12.2 million or $0.18 per diluted share, and prior year first half net loss of $22.3 million or a loss of $0.34 per diluted share.

Looking at operating revenues, for the three and six months ended June 30, total revenues increased $114.1 million or 68%, and a $161.5 million or 73% respectively when compared to the prior years. This growth principally stems from $716 million or 113% increase in net auction sales in the second quarter, and the $1 billion or 120% sales increase in the first half.

Also, revenues from private sales commissions increased $4.6 million or 31% in the first half when compared to the prior year as a result of higher commission margins on private sales. Partially offsetting this increase was a decline in auction commission margin from 21.3% to 18.7% in the second quarter, and from 20.8% to 18.3% in the first half, which is attributable to the change in sales mix towards higher-valued items in both periods. As you are aware, over $1 million the buyer premium rate declines from 20% to 12%.

Lots sold over $1 million grew from $115 million in 2009 to $273 million in the first half of 2010 for an increase of 137%. That was the principal reason for the decline in auction commission margins.

Turning to the direct cost line, for the three of six months ended June 30, direct cost of services increased $6.7 million or 46% from $4.4 million or 18% respectively. These increases are in line with the level and mix of our auction offerings and sales growth year-to-date, and are due in part to the following factors.

A $1.9 million increase in costs incurred in the second quarter to promote a higher level of single-owner sales; increases of $1.4 million and $1.2 million respectively, and traveling exhibition cost primarily due to traveling exhibitions for property offered in our second quarter Impressionist and Contemporary Art sales. In addition, we had an unfavorable experience in property loss and damage claims with a year-to-date increase versus the prior year of $1.5 million.

Turning to the salary and related cost line, salary and related cost increased $25 million or 51% to $74.3 million in the second quarter of 2010, and $23.6 million or 24% to $120.9 in the first half of 2010 as compared to the same period in 2009.

As Bill Ruprecht noted, salaries as a percentage of revenues was below 32%, the lowest level in over a dozen years. The increase is almost entirely due to the higher level of accrued incentive compensation cost due to the significant improvement in Sotheby's profitability during the first half of 2010 compared to 2009.

Incentive compensation expense increased $26.7 million to $28.9 million in the second quarter, and $27.3 million to $31 million in the first half compared to the prior years. The amount of incentive compensation expense recorded in a period is largely dependent on the level of Sotheby's EBITDA and profitability.

Offsetting the incentive compensation increase was a decline in full-time salaries of $2 million, or 7% in the second quarter and $4.8 million or 8% in the first half of 2010 due to lower headcount from the implementation of our restructuring plans in 2009.

With respect to general and administrative costs for the three and six months ended June 30, G&A expenses increased $2 million or 7%, or 5% compared to the prior year. These increases were principally due to the following factors.

An increase of $2.3 and $3.6 million respectively in travel and entertainment expenses in response to the higher level of consignment opportunities and business getting in the first half of 2010; increases of $1.9 million and $4.1 million respectively in bad debt expense, principally due to bad debt recoveries which occurred in the first half of 2009 that were not repeated in the current year of 2010, as well as $1 million recorded in the first quarter related to overdue auction receivable balance.

Offsetting these items are declines of $1.3 million and $2.9 million respectively in facility-related cost attributable to lower rent and building maintenance expenses in the United Kingdom where we vacated a former London middle-market action salesroom in June of 2009. Also offsetting the increases in G&A expenses in the second quarter and year-to-date was a decline of $2 million in authenticity and litigation related matters, and $1 million decrease in professional fees due to lower costs associated with our previously-outsourced tax compliance function.

Turning to net interest expense for the three and six months ended June 30, net interest expense increased $1.5 million or 15%, and $3.2 million or 16% respectively due to lower interest income and higher cost related to arrangement and commitment fees related to our revolving credit facilities.

On the income tax line, our effective income tax expense for the three and six months was approximately 32% for those periods, which is a more normalized effective tax rate resulting from our higher levels of earnings.

Lastly, a brief comment on the balance sheet. We had strong liquidity through the first half of the year. Our total cash position at the end of June is $494 million, and we were undrawn under our $200 million revolving credit facility.

At this time, I'd like to turn things back over to Bill Ruprecht for some closing remarks. Bill.

Bill Ruprecht

Couple of comments from the second and then third quarter sales. In London in late June, the summer sales brought $274 million, a little over 107% higher than last year's total. Impressionist and Modern Art sales brought $194 million, several works for over $15 million individually.

The Contemporary Art sales totaled $80 million, highlighted by a Yves Klein "Blue Sponge" picture which sold for over $9 million. In July, our old master sales and British sales strongly led the marketplace for a little over $94.5 million near the high-end of our pre-sale estimates and 31% above the prior year. We sold Turner titled "Modern Rome" there which sold for almost $45 million, a record for the artist at auction. And it was sold for the J. Paul Getty Museum in Los Angeles, California.

Looking beyond today, Asia is of course a strategic focus for our organization. And our Hong Kong autumn sales will be among our best ever. Held from October 2 to October 8, we'll offer over 3,000 lots of Chinese works of arts, traditional paintings, ceramic works of art as well as jewelry, watches and wine in excess of $200 million at the low estimate. In particular, the Chinese ceramics and works of art sales will be the largest in our history; pre-sale value they're over $100 million.

On September 25, in New York just before those sales, we're holding a single-owner sale of works from the Neuberger Berman and Lehman Brothers Corporate art collection, that's worth in excess of $10 million. Wonderful object we're selling in New York, we're selling a flag known as the Culbertson Cavalry flag from the Battle of the Little Bighorn, also known as Custer's Last Stand. Very few physical artifacts of that battle were left on the field, but a swallow-tailed flag was discovered after the battle by Sergeant Ferdinand Culbertson. The flag has a pre-sale estimate of $2 million to $5 million and will be sold in October of this year.

Also in early October, October 5 to October 7 we selling property from Chatsworth house Derbyshire, England of the Magnificent home of the Duke and Duchess of Devonshire. Towards the end of November, we're selling 20 works from Jewels of Duchess of Windsor sales, which we held many years ago in Geneva which brought record sales from 23 years ago. The upcoming sale includes extraordinary example of collaboration between the Windsor's and Cartier. That's a group which we hope to bring we excess of $4 million.

I know some of you will like this one, RM Auctions in association with Sotheby's will be offering the world's most famous automobile, the 1964 Aston Martin DB5 car that James Bond drove, and this in their automobiles of London auction of October 27. The car, which has a pre-sale estimate of in excess of $5 million, comes to the market for the first time in its history and is the sole remaining of the original 007 DB5 driven by Sean Connery and in the Goldfinger and then Thunderball movies.

Last quarter on this call, we said that we believed that we were well positioned for strong operation results and I believe that these second quarter and first half results confirm that view. We continue to have our eye very much on the ball in terms of the cost side of the business. In the second half of 2010, we do expect individual works of art to sell for very strong prices. Of course, we would be surprised to replicate the extraordinary sales growth achieved in the first half or 2010 when the recovery of the global art market accelerated.

We are encouraged by the current strength of the current strength of the global art market and by the level and quality of our consignments for the remainder of the year, which have largely been secured without the use of auction guarantees. We limit these auction guarantees and when appropriate, will enter into risk and reward sharing arrangements to reduce our financial exposure under any such guarantees; as is the case now, where our guarantee portfolio is fully hedged.

We're still very much in the middle of our busy property gathering period for the autumn sales, but as I said, we are encouraged by the material secured to-date. The cupboard is far from empty as we speak today, and there is considerable discussions and opportunities in the near future we believe.

That concludes our prepared comments. We'll look forward to any question you have on the quarter of the half.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of David Schick from Stifel Nicolaus.

David Schick - Stifel Nicolaus

If feels and looks like the revenue in years made $2 to $3, but as you mentioned a couple of different ways the salaries run-rate is lower, is it fair to be thinking about those kind of numbers?

Bill Ruprecht

David, we don't comment of future projections, we can't comment on that.

David Schick - Stifel Nicolaus

Let me ask you a different question, how are the different geographic buyer bases acting? You mentioned if auctions are having, but the buyers in the broader market; Asia, Europe, North America?

Bill Ruprecht

I would say, the biggest move in the pie chart on the buy side has been the growth of Asian buyers, particularly Chinese buyers in terms of the total pie, that wedge has gotten larger. I'd say that Europe has increased in selling on the sell side significantly as well. United Sates flops around a little bit as still as a major force on both the buy and the sell side. But the biggest news on the buy side is the strength of the Asian market. And on the sell side, the biggest is the move of Europeans towards a greater level of global sales volume.

Operator

Our next question comes from the line George Sutton from Craig-Hallum.

George Sutton - Craig-Hallum

I wanted to just ask a question first on your competitive outlook section, you talked about the extraordinary sales growth percentage achieved in the first half of 2010 is unlikely to be replicated. Is that what you were effectively saying? In other words, you don't expect Q4 to be 79% year-over-year?

Bill Sheridan

As you recall, George, our Q4 last year was the second best in our history I believe. So that's a pretty strong quarter. So we're just trying to be realistic here.

George Sutton - Craig-Hallum

I understand, obviously that would be an unbelievable percentage growth?

Bill Sheridan

We're going to grow 100% in margin sales over the fourth quarter last year. I guess we're cautioning you about that.

Bill Ruprecht

It would be a happy surprise, George.

George Sutton - Craig-Hallum

Now, just to be clear in Q2, obviously we went through these challenging European sales relative to the expectations other than the Old Master which actually came out very strong. I'm just curious, what you took away from that, because obviously this performance could have been even better had those sales gone better? What do you take away from that in terms of the demand equation and ultimate supply for Q4 that might come as a result?

Bill Ruprecht

You know, you're always fighting a certain amount of headwind, I'm not interested in media for anything, but those sales if you recall I believe were up over 100% in June in London. So there is disappointment by some characterization I guess, but I'll live with a 100% sales growth most weeks and feel just fine about it.

I do think George, its fair to say that the sell-through rate in the sales was lower than it has been running in some of the sales, and I think that's got very little to do with the appetite of the world to buy great works of art; it's got something to do with the increased seller expectations. I think it's a remainder for everybody, sellers, buyers, auctioneers to be prudent and thoughtful in how they price works going forward.

I think we had a pretty healthy marketplace. And frankly, the task of an auctioneer in a marketplace when things are not accelerating or declining in value dramatically is less challenging in a marketplace which we're very confident and comfortable working in.

George Sutton- Craig-Hallum

That's very well put. One other thing if I could. Bill Sheridan, you were referring to the reasons for the auction margin being down year-over-year, largely being mix. We were actually surprised nicely at how high it had come out given the dynamics of what you saw in the quarter. Can you discuss anything that might have influenced that? Really it looks like a lack of competitive pressure. Was there a private treaty, additions to that? I'm just wondering what drove that?

Bill Sheridan

I think it was basic blocking and tackling, George. I think our expert community has a better appreciation of the importance of margin coming through second half of '08 and first half of '09. And we've invested in training and negotiating better. And as Bill said, we're focused on that and we're focused on cost. So we're hopeful we can keep it up.

Operator

Our next question comes from the line of Rommel Dionisio from Wedbush Morgan.

Rommel Dionisio - Wedbush Morgan

I think in the prepared comments, Bill you talked about commission margins on private sales being a little higher. Can you just sort of walk us through what drove that? And just as an addendum to that, I know you'd put through some initiatives in the last few months to get your employees focused on private sale business. And I wonder if you could just talk us through just an update on how that's going.

Bill Ruprecht

On a global basis, depending upon which wag you listen to, the non-auction marketplace is as big or twice as big as the auction marketplace on a global basis. So we continue to have some remarkable skills and assets to bring to bear in the non-auction as well as auction market marketplace.

Nine out of ten people come to the auction marketplace, leave with the money in their pocket without having been able to acquire a work of art. Bidders don't spend anything unless to the highest bidder. We're very often in a position to marry that unsatisfied demand with other works of art in the marketplace.

We, to be fair, have a history of being more casual about some of the margins we received on those private transactions, and we've put some of the same disciplines in place that we put into place in the auction business about what margins we're going to get on different kinds of transactions.

So I don't think it's really a ratcheting up of fees; it's really a harmonization and an expression and guidance for an organization with 90 offices as to what we expect within the organization. As far as I can recall this afternoon, anything that's particularly driving that margin shift, I think it's a pretty consistent move rather than one or two traits driving it or moving it in a big way.

Operator

(Operator Instructions) Our next question comes from the line of Kristine Koerber from JMP Securities.

Kristine Koerber - JMP Securities

A couple of questions. First, how should we think about bonus accruals going forward? I know you've accrued $31 million to date, and if I look back at 2007, I know the bonus accrual was $66 million. Is it safe to assume we won't see that level of payout unless we get back to 2007 earnings, or how should we be thinking about that?

Bill Sheridan

Ultimately it's the compensation committee of our Board that makes those decisions who are all independent directors. They do look at those historic relationships. So my assumption would be, we'd have to return to pretty high levels of profitability to get back there, and I think the employees are working hard to do that. So we'll see how the second half sales go.

Bill Ruprecht

Kristine, but if you go back to the last proxy document, you'll find an exhaustive discussion on the nature of how they do this, which is frankly a function of revenues and profitability. So you're not going to see management taking hostage an inordinate portion of shareholder returns.

We've articulated and pointed out a material decline in the percentage associated in being allocated to employees, which seems to us an extremely responsible position of rewarding both shareholders while acknowledging the dramatic improvement, in part delivered by a loyal and talented employee population.

Kristine Koerber - JMP Securities

Another question, it's sort of somewhat related to the earnings power. There's no reason to believe that, if we look back in 2007 and kind of your peak year, there's no reason to believe that given operating leverage, the cost cutting that you've done, you shouldn't be able to get back to at least the $320 million or $325 million in earnings. Is that fair?

Bill Sheridan

What we said is we're focused on cost. What we said, the three components of costs that would increase with sales and profitability growth are travel and entertainment to get the stuff, direct cost to do more catalogues from the sales, and the bonus pool. And I think that's really where we are. So that relationship should stay in place, and let's hope we get back to 2007.

Kristine Koerber - JMP Securities

Bill Ruprecht, you stated that you're confident in the second half as far as art selling for very strong prices. What gives you the level of confidence at this point?

Bill Ruprecht

I didn't say that art will sell for enormous prices; I said individual works of art will sell for very strong prices because I think the equation which we see in spite of economic uncertainty is that great rarities, when they come to the market once in a generation continue to find an extraordinary level of interest.

Works of art fresh to the marketplace, properly priced, we are very confident we'll find considerable enthusiasm from bidders. We keep saying it all the time, both in the public and in the private marketplace.

Kristine Koerber - JMP Securities

And as a follow-up to that, obviously supplies looking good so far for the autumn sales, is the supply, or winning consignments getting any easier at this point?

Bill Ruprecht

I wish it was easier, Kristine. I guess it's fair to say that the marketplace is perceived as open. If you have something of great quality in the marketplace, people understand that there's demand out there, and they are willing to entrust things to us without typically an awful lot of marketplace fear. So in that sense I think, versus a year ago there is a dramatic and marked shift in terms of seller trepidation.

And so I think, those discussions about working with us are more frequent. And as in those parts of the United States where the residential real estate market has recovered materially, once that happens, a lot more people engage brokers in discussions about what they want to do.

Kristine Koerber - JMP Securities

And are you seeing anything irrational as far as your competition, what they are doing?

Bill Ruprecht

I am probably the wrong person to answer that question. I think the simple answer is, not really. I think you should ask somebody else that question.

Bill Sheridan

If you look at our 10-Q, you will see there was no outstanding guarantees at June 30 for the company; a fairly sizable one that was covered through the irrevocable bid for the most part in July.

Operator

There are no further questions in the queue at this time. I would like to turn the program back to Mr. Ruprecht and Mr. Sheridan for any further remarks.

Bill Ruprecht

Have a great summer everybody. I look forward to seeing you. We'll be here all of August working away in all of your interest, and feel free to come visit us at your leisure. This is a very busy time of year, and let's hope for a terrific autumn.

All the best. This concludes the call. Have a great summer.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.

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