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Executives

Bill Ruprecht -- President and CEO

Bill Sheridan -- CFO

Analysts

Oliver Chen -- Citigroup

Jason Kreyer -- Craig-Hallum

David Schick -- Stifel Nicolaus

Rommel Dionisio -- Wedbush Securities

Eric Hollowaty -- Stephens Incorporated

Sotheby's (BID) Q3 2012 Earnings Conference Call November 8, 2012 4:45 PM ET

Operator

Good afternoon, ladies and gentlemen, and welcome to the Sotheby's Third Quarter 2012 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.

During the course of this call, the Company may make projections or other forward-looking statements regarding future events or the 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 to Bill Ruprecht, President and Chief Executive Officer; and Bill Sheridan, Chief Financial Officer. Mr. Ruprecht, please go ahead.

Bill Ruprecht

Thank you, Rodrigo. Hi. Welcome, everybody. In the third quarter of this year 2012, revenues increased 18% to $68.5 million, primarily due to the private sale commission revenue increase of 50% and, to a smaller extent, a 56% increase in finance revenues. Clearly, our focus and commitment to these areas is proving – driven providing some solid rewards.

Net loss for the third quarter was $32.6 million which is – again, this is the tax affected number, slightly unfavorable to 2011, due to the comparable for last year we had an $11.6 million benefit last year on the tax line in the third quarter that did not recur. On a pre-tax basis, our quarterly results improved 20% to $46.4 million loss for the third quarter in this year.

For the nine-month period to-date income is down, not based upon the third quarter but based of course on the first two quarters auction sales in the second quarter, in particular, were substantially impacted by smaller levels of single owner sales. In 2012, we had an unprecedented level of such sales in 2011.

There are some bright spots, as I indicated in the period to-date, private sales revenues of $56 million for the nine months are up 17% and lending revenues have increase pretty dramatically by 41% for the nine months, operating expenses are well controlled.

For the fourth quarter, our Asian business again the period when it slowed alongside the economy there, but it remains very profitable and a source of long-term opportunity for newly wealthy collectors. And we're opening a new platform in mainland China.

Our sales in London last month brought record results and we have a number of rate works on offer, beginning tonight, which we're excited about. The art market remains robust, especially in the high end.

Bill Sheridan will take you through the P&L for the quarter.

Bill Sheridan

Thank you, Bill, and thank you all for your interest in Sotheby's. I'll be referring to Appendix A which is page 5 of the press release. Overall results; net loss for the third quarter, as Bill said, was $32.6 million, or $0.48 per diluted share and net income is $42.2 million, or $0.61 per diluted share for the first nine months. This compares to 2011 third quarter net loss of $29.7 million, or $0.44 per share, and nine months ago net income of $99.9 million, or $1.43 per diluted share.

Turning to operating revenues, for the third quarter, total revenues increased 18% to $68.5 million, primarily due to a 50% increase in private sales commission revenues, as well as an increase in Financial Service revenues, and, to a lesser extent, slightly higher auction commission revenues, with auction commission margins increasing to 21.8% from 19.7% a year ago.

For the nine months, total revenues declined 13% to $477 million when compared to the prior year, largely resulting from a decline in single owner sales from the record levels in 2011, as Bill mentioned.

Direct costs and services declined 17% or $900,000 in the third quarter, largely due to lower private sale exhibition expenses. Year-to-date, direct costs of services declined $1.4 million, or 3%.

Turning to marketing expenses, for the three and nine months ended September 30, marketing expenses increased $700,000 and $1.9 million, respectively, largely a result of our brand promotion in Asia and in particular, China, where Sotheby's incurred costs in the third quarter to promote the launch of our joint venture with GeHua Art Company.

Turning to salaries and related costs, for year-to-date Q3 full time salaries increased to 3% for the nine months. There's some noise in there that you'll see in MD&A relating to our Deferred Comp Plan where expenses are recorded and other expenses within the salary line, but we get a benefit below the line. Incentive comp for the year is lower by $11.7 million, or 25%, due to the lower level of earnings.

Turning to G&A for the three and nine months, G&A increased 2% and 5%, principally due to professional service fees. Net interest expense for the year increased $2 million and as you know, in September we successfully issued $300 million in ten-year debt at 5.25%. This will be used to pay down our high yield notes and our current intent is to repay our convertible securities next June. This will result in a savings of close to $5 million a year. Income taxes for the year should be around 32%.

At this time, I'll turn things back over to Bill Ruprecht.

Bill Ruprecht

Thank you, Bill. As I said, we launched the fourth quarter of our sales series in Hong Kong. We had a little over 3,000 lots in the five-day sales series for $262 million, that's down from the prior period which is just over $410 million.

In conjunction with the Frieze week in London last month, our Contemporary and Italian Art sales brought very strong results. We did little over $112 million in those sales, which was at the high end of our pre-sale estimates and a record for London October sales series.

In Contemporary sales particularly there, we made a high watermark for a picture by a living artist with the sale of Gerhard Richter painting for $35 million in that sales series.

Now we begin now to turn to New York again for a period with some important sales here beginning tonight and we have two significant Picasso portraits of Marie-Thérèse painted one in 1932, the other in 1936. They carry substantial estimates of $35 million to $50 million and $50 million to $20 million, respectively. We have a pre-sale estimate on tonight's sale with just over $170 million. We rescheduled that sale for Monday night to get out of the way of Sandy. At this point that feels like it was a good decision and better to serve our clients.

Next week here in New York, we've got our Contemporary sales with really a strong offering with some significant works of art. There is Mark Rothko's 1954, a large colorful picture that so beautiful and one of the pictures from the first show of his works at the art institute Chicago.

There's also an important Jackson Pollock good picture from 1951 and a great Francis Bacon from one of the Pope pictures. Those respectively over $25 million to $35 million estimate and $18 million to $25 million estimate. That sale series carries a pre-sale value of $363 million to little over $500 million.

We have a couple of extraordinary further offerings in the autumn both from the Chatsworth Trust in the North of England and indeed some remarkable jewels which will be offered here in New York both from Mrs. Wrightsman and from Mrs. Lauder.

As we mentioned in previous calls, we've had some tough comparables in regard to 2011 largely due to the record level of significant single owner sales that took place in 2011. We do continue to see a competitive climate for high-value consignments, and these consignments do sometimes offer fractional margins. We're focused on stabilizing those margins and generating maximizing revenues. And we continue to see opportunity to secure impressive consignments.

We remain confident in the opportunities in the global art market. Demand and prices continue to be quite strong, especially at the high end, and we're anticipating that great works of art will continue to fetch great prices and we'll see the sales over the next 10 days as last night largely to be confirming events of that market vigor.

That concludes our remarks for the quarter. Happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Oliver Chen with Citigroup. Your line is open.

Oliver Chen -- Citigroup

Hi, guys. Thanks a lot. The private sales number was pretty impressive today. How should we think about that evolving next quarter and into next year? Do you feel like you'll continue to see this kind of 50% growth level or do the – is this quarter an anomaly given that it's a small volume quarter?

Bill Ruprecht

I wish I could give you visibility into one-off events, Oliver. Clearly, the offerings we have are relevant to our clients and they increasingly view the auction channel and the private sale channel as both offering compelling value propositions. As we are given great objects to sell for either channel, we continue to do pretty well by them. So I can't give you guidance against something or other that's even more episodic than the auction line and if I gave you any guidance there, you shouldn't listen to me. It's simply not a business which offers much visibility as to who's going to die, who's going to need liquidity or who's going to on, a discretionary basis, chose to sell.

Bill Sheridan

Oliver, Bill Sheridan, it's a strategic imperative of the Company to grow that business, so we continue to focus on it and continue to invest in that. But as Bill said, it's hard to predict the supply of the product.

Oliver Chen -- Citigroup

Thank you, guys. And regarding the global luxury industry, we have seen a relative slowdown or deceleration out of Asia as different considerations in gift giving have kind of evolved. What is you thought with respect to your market and if those trends play out, and how the demand trends look with respect to that trend?

Bill Ruprecht

We had a superb sale yesterday in London of Chinese Works of Art that sold for well above our highest pre-sale estimates. I think it's fair to say that we continue to see very real and robust interest out of the mainland in participation in our sale and Hong Kong and over time, we hope and expect in Beijing. I would not say that I think that in the near term that China is likely to deteriorate. I understand the slowdown that you're referencing in 2012 year-to-date. I'd be surprised if you didn't see that flatten out or look better over the next 12 months.

Oliver Chen -- Citigroup

Okay. Thank you. And my last question is you gave really helpful information related to single owner, so how should we think about the comparisons for next year? Does that imply the single owner comparisons will ease on top of the year we just had? Are the prospects pretty optimistic for next year with respect to how that evolved from an actuarial point of view?

Bill Ruprecht

If you're smart enough to know how that's going to play out quarter-to-quarter, Oliver, we all want to admire your pre-sense. I simply can't tell you which family is going to make which decision based upon which lawyers' advice in which quarter of next year. As I indicated, and I know this is hard to hang you out on, we continue to see opportunities to secure very substantial consignments from individual family. Is that predicted? No. It means that we do see some deal flow that's interesting.

Oliver Chen -- Citigroup

Okay. Thanks. In the first and second quarter of this year, did you feel like you had a higher average level of single owner lots of the year that just elapsed?

Bill Ruprecht

Well, as we speak, really simply now beginning to be in the throws of writing the business for January and February, I couldn't speak with any clarity to the quarter. I know I'll frustrate you with the lack of visibility that I can offer, but anything I say today would be a gross injustice to what happens in the quarter.

Oliver Chen -- Citigroup

Okay. Thanks, guys. I'll see you tonight. I appreciate it.

Bill Ruprecht

Take care.

Operator

Next question comes from the line of George Sutton with Craig-Hallum. You're line is open.

Jason Kreyer -- Craig-Hallum

So Bill, a couple of times you mentioned that the market is robust at the high end. Can you provide any commentary on what you're seeing at kind of the mid end?

Bill Ruprecht

That doesn't sound like George?

Jason Kreyer -- Craig-Hallum

No, it's Jason on for George.

Bill Ruprecht

It's interesting. I think it's fair to say that in our business, people are very interested in things that are once in a generation sort of opportunities. And if there's something or other on offer which there are likely to be five more similar works available in the next six months, people are more cautionary.

So, you can drive a hole through my narrative, Jason, because there's so many different markets with so many different price band probabilities. But in the most abstract and broader sense, I think it's fair to say that we think the market's very open, seems pretty stable and there's price sensitivity around things that are not great rarities.

Bill Sheridan

Jason, in our 10-Q you'll see disclosure on a number of objects above the $1 million mark where the commission margin drops at 12%. But for the quarter, as I said, our auction commission margin was up from 19%-something to over 21%, which means the middle market is doing, I'd say, pretty well this quarter.

Jason Kreyer -- Craig-Hallum

Okay. That's helpful. Thank you. And then I just had one more question actually. On private sales, can you just talk a little bit about the competition that you see there and how it compares to normal auctioning competition?

Bill Ruprecht

We don't see deals typically being commoditized in any sense in the private sale business. In other words, there are some fiduciaries and some advisory groups that think that they're benefitting their clients by seeing how they can pit Sotheby's against any of the other alternatives in a commission dual. That is almost inevitably unproductive in our estimation because in showing works of art to lots of different groups of potential advisors, you tend to make the market a little bit wearier of those objects and they become less exciting to whoever might be presented with the opportunity to buy them.

So it's in that backdrop that I would say to you that we probably create most of the opportunities in the private marketplace that we handle ourselves. In other words, we approach a collector or a potential buyer and create most of those opportunities in a way that's more proactive than certainly some of the auction business where we get asked to consider pieces of business in that way. So I'd say it's less a business where there's daily bidding against opportunities.

Jason Kreyer -- Craig-Hallum

Okay, great. That's all I got. Thank you, gentlemen.

Bill Ruprecht

Thanks, Jason.

Operator

Next question comes from the line of David Schick with Stifel Nicolaus. Your line is open.

David Schick -- Stifel Nicolaus

Good afternoon.

Bill Ruprecht

Hey, David.

David Schick -- Stifel Nicolaus

First question, just on private sales, I know it's been asked a couple of ways, but I'll give it my shot. I appreciate there's no visibility and what I'm wondering is, is this a change in the way you're customers, your clients are preferring to do business, is the market changing and there is – obviously, you've had a lot of efforts there, but separately or even as a result, is this just a new piece of business that continues to grow in customer preference?

Bill Ruprecht

I think that the only shift is what role we're playing in the broader art market. I think that people have always done business privately through brokerage negotiated transactions and they've always done business through auctions. So what we do quite uniquely is consider both channels at the same time and discuss the alternatives to create the most value for the clients.

And that appreciation and really -- we're pretty agnostic as to channel selection. We want to do what the client wants and often we'll recommend the pros and the cons of both channels. So I think we're seeing growth. I don't think that -- about a real pivot or shift in client perceptions. I think it speaks more to the nimbleness and coherence of our offering, trying to do what's in the best interest of the client rather than be monosyllabic advocate for one channel.

Bill Sheridan

And David, we're in 40 different countries which a lot of our competition is not, so we have a global footprint of global experts to help drive that process.

Bill Ruprecht

So the unique advantage that we have in some circumstances is most of the money goes home every night, David. You have several bidding on almost every object and when somebody bids on an object and they're unsuccessful, they've just demonstrated demand and an interest that is out of price and something or other and that's information which is often productive and then trying to satisfy their interest with another object or something.

David Schick -- Stifel Nicolaus

Right, that's very interesting. On the – just one follow-up then on the mainland China JV, just any framework we're thinking about this in the longer term, that market?

Bill Ruprecht

Not yet. I think the wealth in China remains remarkable, growth there makes GDP growth in most of the rest of the world look very pedestrian and getting closer to that wealth is something or other that seems to us over the next significant period of years to be a smart thing to do. So, having more offerings closer to and in Beijing is smart now. How fast that moves, is that a hockey stick or is that a glacial curve of opportunity, I don't think we know the answers yet. We're just grappling with the long-term opportunities wanting to invest and build our presence in the marketplace. This is a learn as you go rather than project transformation overnight kind of situation.

David Schick -- Stifel Nicolaus

All right, thank you very much.

Operator

Next question comes from the line of Rommel Dionisio with Wedbush Securities. Your line is open.

Rommel Dionisio -- Wedbush Securities

Thank you very much. A question on – in your prepared comments, I think you referenced some increasing marketing expenditure in China with regards to the JV. Was that sort of, little bit more of a one-time grand opening type marketing expenditure or is that something that we could maybe expect to occur as you seek to build that business out in the future?

Bill Ruprecht

Rommel, it was a launch event so there was additional marketing. But we can't predict what we're going to be next year with our new partners. The agreement's only a couple of months old, so my sense is you don't always spend that unless you have a good reason to drive revenues. So, I'd guess you'd see revenue and marketing spend ramp at the same time rather than out of whack with one another, Rommel.

Rommel Dionisio -- Wedbush Securities

Okay, very good. That's all I had. Thank you.

Operator

And we have a question from the line of Eric Hollowaty with Stephens Incorporated. Your line is open.

Eric Hollowaty -- Stephens Incorporated

I wanted to go back to the auction commission margin in the quarter for a second and we understand why on an absolute basis, it might have -- that number might have ticked up in the quarter given the mix of lots that were sold. But from a relative standpoint versus the buyer's premium, we were very surprised to see it so much higher given the recent trend and I'm wondering if you could just add a little color on why that might have been the case?

Bill Sheridan

Thanks, Eric. It's Bill Sheridan. As we tell everyone, don't read too much into the first quarter and the third quarter which are traditionally lost quarters. A lot has to do with the price points below 1 million and just the math of the higher commission margin. So I wouldn't read into that too much. We'll see how the fourth quarter does. And it's probably a better discussion once we publish our 10-K for the full year to see how margins come out, as most of the price competition is in the high end, which are sold in May and November so it's Q2 and Q4.

Eric Hollowaty -- Stephens Incorporated

Okay, great. That's very helpful, Bill. Thank you. That's all I have.

Operator

And I'm showing no further questions. I'd like to turn the call back over to Mr. Ruprecht or Mr. Sheridan for closing remarks.

Bill Ruprecht

Thank you, Rodrigo. Thank you for your interest in Sotheby's. Wish us luck over the next 10 days in New York with the Contemporary and remaining Impressionist sales and onward towards the end of the year. Have a good week everybody. Hope it stays dry and safe for those of you on the Eastern seaboard. Have a good evening. Good night.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference. You may now disconnect.

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