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Sotheby’s (NYSE:BID)

Q3 2010 Earnings Call Transcript

November 4, 2010 4:45 pm ET

Executives

Bill Ruprecht – President and CEO

Bill Sheridan – CFO

Analysts

George Sutton – Craig-Hallum Capital Group

David Schick – Stifel Nicolaus

Marc Riddick – Riddick Consumer Strategies

Operator

Good afternoon, ladies and gentlemen, and welcome to the Sotheby's third quarter and first nine months 2010 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session (Operator instructions). As a reminder, ladies and gentlemen, this conference is being recorded.

GAAP refers to generally accepted accounting principles in the United States of America. In this earnings call, financial measures are presented in accordance with GAAP and also on a non-GAAP basis. A reconciliation of the non-GAAP financial measures used in this earnings call to the comparable GAAP amounts is provided as an appendix to the outline of the call, which can be found on the Investor Relations sections of the company’s Website.

Also 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 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 Bill Ruprecht, President and Chief Executive Officer; and Bill Sheridan, Chief Financial Officer. Mr. Ruprecht, please go ahead.

Bill Ruprecht

Thank you, Mary. Good afternoon everybody. Thank you for your ongoing interest in Sotheby's. Today, we are announcing very strong third quarter and nine-month results. Revenues were up 63% to $73.1 million in the third quarter, up 71% to $456 million through September 30th, thanks of course to strong sales worldwide, which have brought consolidated sales up to $2.8 billion in the first nine months. Impressionist and Contemporary art auction sales increased $666 million or 183% in the first nine months.

In the third quarter, we are reporting a net loss of $19.4 million, that’s $0.29 a share, a 67% improvement from the prior period. This results due to the increased revenues and a return to more normal tax rates for the company. Total expenses did grow in the quarter by 23% to just over $102 million, but continued to reflect focused cost management. 75% of that expense increase was due to non-auction higher dealer cost of sales, which is offset by growth in dealer revenues, again non-auction. Excluding the dealer inventory costs and sales, total expenses for the business increased in the quarter only 6%. Remember, on a 63% revenue increase, that’s 6% cost increase. We continue to be confident in our ability to manage both our expenses and margins to positive effect.

We are reporting net income in the nine months of $65 million, $0.94 diluted share, $145 million increase from the prior net loss of $80 million. We have come a long way in the last year. The bottom line for nine months is possible due to a mix of factors; of course the increase in revenues related to strong worldwide demand for works of art, we will talk a little bit about that later in the call; fierce attention to managing margins; and ongoing focus on cost control in an environment of significantly higher top line sale results.

Our profitability has led to a much more normal effective income tax rate. With respect to costs, there are some growth, which is attributable to the significant sales increase, revenues and profitability. The driver is an increase in accrued incentive comp costs, which is attributable to the significant improvement in profitability in 2010 as compared to last year.

The fourth quarter has begun remarkably. Our Hong Kong sales series brought a record $397 million – almost $400 total, that’s 137% above last year’s total, and well above our highest pre-sale estimate. And our Impressionist sales this week brought a strong $264 million, 24% above last year’s total, highlighted by a Modigliani picture, which brought $69 million on Tuesday of this week.

Bill Sheridan, take it over, please.

Bill Sheridan

Thank you Bill. I will be referring Page 8 of the earnings release, which is Appendix A. Overall results, our overall net loss for the third quarter was $19.4 million or $0.29 per diluted share, which compared to a net loss of $57.8 million or $0.89 per diluted share of the prior period, $38.4 million or 67% improvement.

For the first nine months, net income was $64.7 million, or $0.94 per diluted share. This compares to prior-year net loss of $80.1 million or $1.23 per share, improvement of $145 million. Turning to operating revenues, for the three and nine months ended September 30th, total revenues increased $28.1 million or 63%, $189.7 million or 71% respectively when compared to the same periods in the prior year. This principally stems from the $85.7 million or 66% increase in net auction sales in the third quarter, and the $1.1 billion or 113% sales increase for the first nine months, very impressive.

Partially offsetting this increase is a decline in auction commission margins, almost entirely attributable to the change in sales mix towards higher-valued items in the period. As you aware, at over $1 million, the buyer premium rate declines from 20% to 12%. And year-to-date, the value of lots sold in excess of $1 million has increased by over 200%.

Turning to the expense side, direct cost of services, for the three and nine months ended September 30th, direct cost of services increased $1.7 million and $6.1 million or 23% respectively when compared to the same periods in the prior year. These increases are in line with a much higher level of auction sales and the mix of our auction offerings year-to-date, due in part to the increase of $2.3 million for the nine months and costs incurred to promote substantially higher level of single owner sales in 2010.

In addition, we had a year-to-date increase of $1.2 million in travelling exhibition costs principally for property offered in our Impressionist and Contemporary art sales. In addition, we had unfavorable experiences in property loss and damage claims, which increased $1.5 million versus the prior nine months.

Turning to the salary line, in the third quarter, salaries and related costs increased $3.6 million or 8% due to the higher levels of full-time salaries, incentive comp, other comp related costs, as well as share-based payments. For the nine months ended September 30th, salaries and related costs increased $27.2 million or 19% when compared to the same period in the prior year, almost entirely due to the higher level of accrued incentive compensation costs, due to the significant improvement in profitability in 2010 versus the same period in 2009.

General and administrative costs on the G&A line for the three and nine months ended September 30th, G&A expenses increased $1.1 million and $4 million or 4% when compared to the same periods in the prior year. The increase was principally in the area of growth in traveling expenses, T&E. T&E increased $1.4 million and $4.8 million or 43% for the nine months, in response to the higher level of consignment opportunities through the first nine months of 2010.

Turning to the net interest expense line, for three and nine months ended September 30th, net interest expense increased $700,000 or 7% for the quarter, and $3.9 million or 13% for the nine months, primarily due to lower interest income and the higher costs related to the arrangement amendment fees related to our revolving credit facility. On the income tax line, for the first nine months of 2010, our income tax expense was $21.4 million or an effective rate of 25%.

During the quarter, liquidity remained strong. At the end of September, we had $345 million in cash, and at today’s Board meeting, Sotheby's Board granted management the authority to repurchase a portion of the outstanding seven-and-three-quarters senior notes subject to appropriate pricing in the marketplace. With that, I will turn it back over to Bill Ruprecht.

Bill Ruprecht

Couple of comments about the fourth quarter. As I indicated, we have already had some remarkable sales and have a slate of events to finish out the year. Our Impressionist in Modern art sale as I said brought $263 million of, smack dab in the estimates. I spoke about this $69 million Modigliani, also sold a Monet Water Lilies work for almost $25 million, and a Matisse Dancer which went for $21 million. That Hong Kong sales series was a remarkable one, we totaled of just under $400 million and 55% above the past record we achieved for our spring sales of April of 2010. The real highlight of that sales series were four private collections of Imperial treasures and Chinese works of art that carried a pre-sale estimate of $43 million at the low end, and $60 million at the high end, and that group fetched $148 million.

In London, last month, we held our typical autumn Contemporary and Italian art sales, including contemporary Arab and Iranian art, which brought a combined total of $70 million, more than double last year's total of $33 million, and at the top end of our pre-sale estimate range. Top lots of the week were both by Italian artist, Lucio Fontana, we sold for just under $4 million each.

Many of you will enjoy this, on October 29th, we sold over 2,000 bottles of Chateau Lafite in Hong Kong, dating from 1869 to 2008, which have never left the Chateau. It is unprecedented for Lafite to release these library vintages from their private cellar, and collectors responded to that sales. It was 100% sold, three times the high estimate, and it was our tenth consecutive wine sale in Hong Kong where we sold absolutely every lot in the last 18 months. Highlight of the sale was three bottles of Chateau Lafite 1869, each of which sold for $232,000 plus, to set a new record for a single bottle of wine at auction, should be a good dinner party.

We are looking forward to our Contemporary sales here in New York next week, which should have a combined pre-sale estimate of just under $200 million. Couple of highlights, there is a 1955 Mark Rothko that's yellow, orange, pink and white canvas, it’s a $20 million to $30 million estimate, and the really important 1961, 1962, Andy Warhol of a coke bottle that's extremely important with $20 million to $25 million estimate.

In Geneva, as it’s nearing year-end, on November 16th, we are holding a jewelry sale with a presale estimate of approximately $70 million. The star of that sale is one of the most beautiful gem stones ever offered at auction, it is an almost 25-carat pink diamond last seen on the market 60 years ago. The presale estimates for that individual diamond ring is $27 million to $38 million. In January of next year, we have got an Old Masters painting sale with a monumental work by (inaudible), that work has a presale estimate of $15 million to $20 million and it has not been seen in public for over 30 years.

The third quarter results and the strong sales we have enjoyed thus far in the fourth quarter are encouraging for our business. We continue to feel optimistic about our future and at the moment, we see no signs of the worldwide appetite for art abating. Christie’s sale yesterday in the Impressionist and Modern marketplace continued the strength we demonstrated on Tuesday. And we would or I would be surprised to replicate however the extraordinary sales growth which we have achieved to date in 2010 in this fourth quarter, as the comparable fourth quarter 2009 was strong, very strong reflecting the global market recovery that began in that period.

All that said, about 30 minutes ago, we sold a Alta Totimer [ph] painting here in our New York sales room for our $35 million against the $3 million presale estimate, creating a record for a 19th century European painting at little over 10 times its presale estimate, with bidders from virtually every corner of the world. Our results today in 2010 as well as our future expectations stem from a focus on two imperatives; the long-term efforts of our global team in cementing loyal client relationships and the development in retention of talented and passionate employees.

We have the best team in the business, which is profoundly about people and we expect to continue to differentiate ourselves in this important way. That concludes our prepared remarks for today. Mary, take over, I suspect somebody will want to ask us a question or two.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of George Sutton from Craig-Hallum.

George Sutton – Craig-Hallum Capital Group

Good afternoon, congratulations on the great results. The question I wanted to ask Bill Ruprecht is one I know you don't like to answer, but it does relate to what you have in the text of your release. And that is, and I will quote, "There is confidence in the art market as we approach the conclusion of this remarkable year." So, I think the big question that I have, and I think everybody has, is that as we look out to 2011, how much more remarkable will 2011 be than 2010? Is there a relevant way to answer that?

Bill Ruprecht

I am pausing George because I am trying to find a relevant way to answer it. I think my comments this afternoon looked to address it. I think it’s fair to say, George, we have been surprised by the speed of the recovery in this marketplace. I think it’s fair to say that the global relevance of works of art that we are selling are less regional than ever, in other words, people from far corners of the world are bidding on works of art all over the world, and the globalization of our business is something or other, which seems to be accelerating daily. What does that imply about wealth creation in the rest of the world, where is wealth creation going, what kind of global economy are we going to see in the next couple of years. I think all I can say really, George, is that history would suggest to us that when we have periods of unprecedented prices for great works of art, we continue to see supply. And if that circle is virtuous and repeated as it has been in the past, we will continue to see great opportunity and great demand.

I can’t predict, never have been any good at predicting what we are going to look like three quarters into the future. It’s simply not possible, not because I am reluctant, but because I don’t have the tools.

George Sutton – Craig-Hallum Capital Group

Understand. I appreciate it. The dealer sales in the quarter were fairly high. Can you just explain what was driving that, and whether that will be replicated, which I assumed it won't?

Bill Sheridan

It’s principally timing of closing some significant transactions. It’s hard to predict when a painting gets old, George.

Bill Ruprecht

It’s chunky, George.

George Sutton – Craig-Hallum Capital Group

Okay. As I expected. Again, congratulations. Thanks.

Operator

Thank you. Our next question comes from the line of David Schick from Stifel Nicolaus.

David Schick – Stifel Nicolaus

Hi. Good afternoon and congratulations as well. If you look at the comments you've made, both on the call today and in your release, about upcoming sales, and some estimates will be up more than 100%, Geneva jewelry, when you look at the range, and then some are less than that. Is there anything consistent in what is driving the larger growth? Is it simply the ones that had been smaller, or is there something about the buyer base, or is it just the size of the sales? Is there anything to that, to what is the biggest growth categories right now?

Bill Ruprecht

Well, at the beginning of our remarks, I think I said something like Impressionist and Contemporary through the nine months, it has been up $660 million or 188%. I think you continue to see those numbers up, I can’t conjugate them through last night for us on a year-over-year basis. An awful lot of the demand in our world from Traditional as well as Contemporary centers of wealth have focused on a few categories, Asian works of art, Impressionist, Contemporary works of art, jewelry, clearly this week, 19th European painting has found a new gear, Russian works of art are doing well, but I think that there is, and I say this with fondness rather than pejoratively, there is a belly of our business which is many of the traditional collecting categories that have not enjoyed as much growth as few of the categories that I have mentioned.

And I can’t explain that except to speculate sociologically that if I am from Kiev, I might be interested in Warhol, and I might be less interested in 19th century French furniture. And so, what resonates with different people from different parts of the world is a cultural and emotional set of things rather than a particularly pragmatic or rationale narrative.

David Schick – Stifel Nicolaus

Just the obligatory competitive landscape question for procurement, etcetera. What have you seen out there? You mentioned your competitor joining your strength this week, but just any other comments on that front? Thank you.

Bill Ruprecht

Well, Christie's has got a new Chief Executive as probably many of you know. You will have to ask the owners of that company why they have that shift or what their intended ambitions are. Our early reports from the meetings that he has had with this own staff or that he is mentioning profitability with great frequency. I have no idea when and to what effect he will influence his own organization and can speculate on what that impact could be. All I can say is we have got a little bit less than 50-50 share position with Christie’s, we like it there. We are relevant, we are focused on profitability.

Bill Sheridan

And David, it’s early days for next year’s consignment. So, it’s really hard to get a good read on the pool of properties coming to market.

David Schick – Stifel Nicolaus

Okay. Thanks a lot.

Operator

Thank you. Our next question comes from the line of Marc Riddick from Riddick Consumer Strategies.

Marc Riddick – Riddick Consumer Strategies

Good afternoon and congrats on another strong quarter there. I wanted to get some additional color on the strength of the market, if you could take a moment to address what you are seeing from long-term established collectors and those who are perhaps new bidders to the market? And then I have a quick follow up on that.

Bill Ruprecht

This is pretty anecdotal rather than analytical, because we are sort of drinking from the fire hose right now on a day-to-day basis, because we get such concentrations of revenue and events this in next week. Anecdotally rather than with through analytics behind it, I would say you have got a real mix between a strong traditional collectors active and confident both as buyers and sellers, and you have got enormous wealth hitting our marketplace from Asia as well as other BRIC economies.

I would say other than that, whenever you are seeing very strong prices as we are currently seeing it, conversations with potential sellers are less strained and challenging, because they see the market is open and they see the value of testing great works of art through the auction process. So, where is demand coming from? All over the place. And the supply, the supply is coming from where it always comes from in general, which is places that were wealthy and really wealthy over the last 50 years. So, the United States and Western Europe are principal hunting ground for our organization on for properties that we then put through New York, London or Hong Kong sales platform primarily.

Marc Riddick – Riddick Consumer Strategies

Okay. And that actually touches on what my follow-up was going to be, as far as the drivers behind recent procurement, so I do appreciate that. Thank you.

Operator

Thank you. I am showing no further questions in the queue. So, I would like to turn the conference back to Bill Sheridan and Bill Ruprecht for closing remarks.

Bill Ruprecht

Mary, thank you for your help. Investors, analysts, thank you for your interest in Sotheby's. Wish us luck over the next couple of weeks as we conclude 2010, one of those years we just like to keep performing that way and certainly enjoy this year in a way that we did not enjoy the second half of 2008 and the first half of 2009. Concludes our remarks, have a good day everybody.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect at this time.

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