BID
#Thank you, Vince.
Good morning and thank you for joining us today.
With me here are Tad <UNK>, Sotheby's President and Chief Executive Officer; and Patrick <UNK>, Chief Financial Officer.
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 an adjusted non-GAAP basis.
An explanation of the non-GAAP financial measures used in this earnings call as well as reconciliations to the comparable GAAP amounts are provided as an appendix to the earnings release, which can be found on the Investor Relations section 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 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.
Please see our investor webpage for a slide presentation which outlines Sotheby's first-quarter financial results.
With that, I will turn the call over to Tad.
Thank you, Jennifer.
Good morning.
Thank you also for joining us this morning and for your interest in Sotheby\
Thank you, Ted.
More often than not, the first quarter is a loss quarter for Sotheby's.
Thanks to the buyers' premium increase instituted earlier this year and some excellent deal execution, along with continued attention to cost, this quarter delivered a nice profit.
Turning to the detailed financial information on slide three of the presentation deck and beginning with our overall results: with a healthy global art market, increased sales worldwide, and improved commission margins, we achieved 127% increase in adjusted operating income in the first quarter of 2015.
First-quarter 2015 adjusted net income is $7.4 million and adjusted diluted EPS is $0.11 per share compared to adjusted net loss of $3 million and adjusted loss per share of $0.04 a year ago.
The adjusted operating and net income figures exclude restructuring and special charges as well as CEO separation and transition costs.
Now let's look at each of our main operating segments.
Starting with the agency segment on slide 4, we continue to see growing revenues on strong auction sales.
In the first quarter, agency gross profit increased $3.3 million or 3% to $112.8 million.
An $8.3 million or 8% increase in auction commission revenues resulted from an improvement in auction commission margins and an increase in net auction sales during the quarter.
Excluding the impact of foreign currency exchange rate changes, auction commission revenues increased $15.2 million or 15% over the prior quarter.
Auction commission margin increased from 14.3% to 15% in the quarter, primarily due to the increase in the buyers' premium rate structure, effective as of February 1, and a lower level of buyers' premium shared with consignors.
This is partially offset by sales mix, as a higher proportion of net auction sales in the first quarter occurred in the higher-priced bands of Sotheby's buyers' premium rate structure than in the prior period.
Offsetting the gains in auction commission revenues, private sale commissions decreased $1.6 million or 12% in the first quarter of 2015 as compared to the prior year, due to a lower volume of high-value transactions completed when compared to the first quarter of 2014.
The unfavorable variance in Sotheby's auction guarantee and inventory activities when compared to the prior period is primarily due to the higher level of inventory write-downs and a lower level of gains associated with guaranteed property offered at auction.
Agency direct costs increased $1.4 million or 13% in the quarter, primarily due to higher level of costs incurred to promote and conduct Sotheby's contemporary art sales in London, including the single-owner Bear Witness sale.
Turning to slide 5, you'll see a decrease in principal revenues and cost of principal revenues in the first quarter.
In the first quarter of 2014 we had sales of property acquired from a potential consignor in lieu of the agency segment providing an auction guarantee.
There was no comparable event in the current period.
Moving to slide 6, we are pleased with the growth of Sotheby's financial services and our ongoing process of debt funding this business.
The finance segment average loan portfolio balance for the first quarter of 2015 was $678 million, a 41% increase from the prior period.
Finance segment revenues increased $7 million or 78% in the quarter, reflecting the growth of the portfolio.
Finance segment gross profit, which is net of borrowing costs, increased $4.3 million or 53% in the quarter.
Finance segment results in the current period were also favorably impacted by a $1.3 million collateral withdrawal fee earned in the period.
Withdrawal fees are not common.
As previously announced, we have established a separate capital structure for the finance segment that provides for the debt funding of loans through a dedicated revolving credit facility.
Debt funding the loan portfolio reduces the finance segment's cost of capital and enhances returns.
Beginning this quarter, we are disclosing the finance segment's return on equity, which is 10.9% for the 12 months ending March 31, 2015.
As we define it, the finance segment's LTM return on equity is its net income over the last 12 months, excluding allocated corporate overhead costs in relation to the average equity in our loan portfolio during that period.
Assuming our current average leverage of 72%, to LTM return on equity would have been 13.6%.
Next, on slide 7, salaries and related costs decreased $2.8 million or 4% in the first quarter as compared to the first quarter a year ago.
Changes in foreign currency exchange rates reduced salaries and related costs by $3.3 million when compared to the prior period.
Excluding this impact, salaries and related costs increased $500,000 or 1% during the current period.
For the first quarter of 2015, full-time salaries decreased $1.1 million or 3%, principally due to changes in foreign currency exchange rates ---+ $1.9 million ---+ and savings resulting from the restructuring plan enacted in July of 2014, partially offset by base salary increases and headcount reinvestments.
Excluding the impact of foreign currency exchange rate changes, full-time salaries increased $800,000 or 2% during the current period.
Incentive compensation expense decreased $1.2 million or 40% due to lower private sale incentive costs, resulting from a decline in private selling activity.
Employee benefit costs increased $2.2 million or 33% in the first quarter, primarily due to a $900,000 increase in nonrestructuring-related severance costs as well as higher pension costs in the UK and US.
For the year ending December 31, 2015, the net cost associated with the UK defined benefit plan is expected to increase $2.3 million, primarily due to a decrease in the assumption for the weighted average expected long-term rate of return on client assets from 6.1% to 5.4% and an increase in the required amortization of prior-year actuarial losses.
Turning to slide 8, general and administrative expenses improved $2.6 million or 7% in the first quarter of 2015.
Changes in foreign currency exchange rates reduced G&A costs by $1.5 million when compared to the prior period.
Excluding this impact, general and administrative expenses decreased $1.1 million or 3% during the current period.
Professional fees improved $2 million or 15% in the quarter, largely attributable to lower legal and compliance expense, which is $800,000 of the decrease, and lower operations expenses ---+ $600,000 of the decrease ---+ primarily due to negotiated rate reductions related to certain outsourced functions such as catalog production and the client contact management center, as well as reduced usage of service providers in other areas.
For the first quarter Sotheby's effective income tax rate was approximately 50%.
The income tax rate for the current quarter is higher than the 2015 estimated annual effective income tax rate of 36%, due to a discrete tax expense of $1 million related to the expected results of income tax audits.
In the prior period, income tax expense of $300,000 was recorded on a pretax loss of $5.7 million, primarily as a result of a $3.1 million income tax charge recorded in the prior-year quarter related to the enactment of new legislation in New York State.
As Tad mentioned earlier in this call, we have initiated a broad strategic review of Sotheby's business.
As a result, management is reevaluating its expense projections for 2015 and is withdrawing expense guidance at this time.
On a final note, we just want to remind you that our Summer London Contemporary sales are being held on July 1 and 2 instead of at the end of June, as they have been historically.
Therefore, those will be third-quarter events this year instead of second-quarter events.
This concludes our comments on today's announcements.
And we would be happy to address your questions.
Too soon to say, <UNK>.
We are going through the peak portion of the spring right now, and I'm studying it carefully.
So it is a very good question, and one I am going to be very focused on.
I will say, though, that the animating focus I have is return on invested capital, for what it's worth.
Yes.
I think it's critically important when you look at an organization that essentially really has three activities going on inside of it.
One is a deep understanding of either art or jewelry ---+ whatever the substantive area, such as wine, might be ---+ and call them specialists or experts.
Secondly, you have effectively a sales force or business development team.
And third, you have the support functions around that.
And by the way, there are lots of hybrids between the first two groups, for what it's worth, because clearly the experts and specialists interact directly with clients; and, in fact, they often have clients.
But in every event like that, every single individual that organization, in our organization, needs to know precisely what it is that they are trying to accomplish, exactly what the goals are ---+ both measurable and also, frequently, qualitative.
They need to be concrete.
They need to understand exactly what their accountabilities are, and to whom, and what the levels of responsibilities are in order to effect that.
And in a complex and creative organization like this one, if there's any lack of clarity around any of those things, you can end up with a suboptimal result.
Moreover, the incentives themselves need to be highly aligned with the shareholders' needs.
Thinking that through creatively with a keen and also a very clear perspective on what the shareholders are looking for is a top priority for us.
I am optimistic.
Number comes from TFAB.
Jerry Kazdan found it for me.
And of course a significant portion of that is in the primary market, and you could debate whether we should be or could be in the primary market, even though with S|2 right now, with the Henry Hudson, we already have an example of where we are.
So the addressable portion of that, again, is subject to debate and will be further fleshed out in the strategy.
With respect to the second portion, in terms of alliances there, it's really too soon to say.
There are clearly interesting opportunities for us to think about partnering with various groups, because significant areas of part of the market are consolidating and turning ---+ you know, with large branded dealers around the world.
And it's an interesting question ---+ too soon to say, though.
<UNK>, it's Patrick.
I will take that one.
No, there's no change in how we think about underwriting the risk.
We can borrow ---+ a qualifying loan can be up to 60% loan-to-value in terms of our ability to fund that asset.
So typically, you will see our loans right around 50%, but they can go as high as 60%.
And there's really no change in terms of our process or our thoughts around underwriting the risk.
In terms of growth, we'll see.
We have obviously been growing the business rapidly over the last couple of years.
That has given us the flexibility to add some resources to the business in terms of client-facing people and transaction processors.
So we've got high expectations for the business.
As we've discussed on these calls, believe that the loan economics themselves are compelling.
And obviously it provides an engine of property for the auction side of the business.
So our goal is to continue the growth.
We are not really clear on what the ceiling could be for this business.
We never talk about percentages in terms of what drives the change in auction commission margin.
We always talked about the factors.
And things that matter are mix, and certainly mix was meaningful in this quarter.
We talked about how sharing of commissions has an impact on it.
And in this instance, yes, the increase in the buyers' premium certainly had an impact on it.
We don't really give specifics on that, but certainly all those factors mattered this quarter.
With respect to the management item, I would just say one of the things that I've observed here and also in similar organizations ---+ and I'll give you some examples in a minute ---+ is that when you have an extraordinarily talented and autonomous group of people interacting with clients, the more layers that they have to deal with in order to get client service effectuated between them and someone who can approve a particular transaction, often the more frustrating and the more complicated it can be.
So what I would like is an organization that is very flexible, very lean, and can make decisions quickly and also sensibly for the shareholders, and also, frankly, for the clients.
And that's one where I don't think it makes ---+ I think it's generally better that the top management here is very close to the clients, and there's not a significant number of process steps or layers in between, for what it's worth.
I want to clarify, <UNK>, before Tad answers ---+ when you say acquire inventory, you're really just talking about winning consignments, correct.
Again, too soon to say.
Certainly the 4Ds are where I see the opportunity now.
But I hinted, I think, in my remarks that we could think about taking a longer-term view on specific ---+ not necessarily consignments, but positions, and potentially with partners.
Sure, sure.
I don't think there's any trend that you could look to in terms of the inventory write-downs.
We go through a process where we look at all of our inventory, whether it's on the agency side or the principal side; think about what fair market value is.
We do put a lot of effort into making sure that we identify opportunities to sell property that's currently in inventory, either privately or identify upcoming auctions.
So we try to be very disciplined about that.
But there's nothing that I would point to as trendsetting from this first quarter.
It's a very good question.
I'll point out, <UNK>, we already do a substantial amount of middle-market business now under our current brand.
And it seems to have no deleterious effect.
However, to think about how to grow it dramatically, we need to think about precisely what is the service level we provide in those categories.
Where are we on the cost curve.
And what is their differentiator.
All of those are TBD.
Overwhelmingly, by the way, our clients say tremendous things about us.
They say that they clearly love our understanding of and appreciate our depth of understanding of both art and jewelry.
They think we have a great deal of expertise.
They think we also are very trustworthy.
They think we are confident.
They enjoy spending time with us.
There are tremendous positives.
In areas where they think we have improvement opportunities, it's things that are very encouraging in the sense that they are very fixable.
They are in things like turnaround time; they are in some client service hygiene things; they are in a bit of financial flexibility stuff.
It's process improvements and that stuff.
It's management opportunities that I'm very encouraged by, because what I hear is the clients and the collectors are saying very strong things about the stuff that's hard to fix; and they are saying please fix a few of the things that require effort, but they are very fixable.
Again, this one also, too soon to say; but I can give you a little bit of a framework to think about it.
If one thinks about where wealth is being created ---+ in various parts of Asia, in various parts of the Middle East, and essentially in various parts of the Americas south of our border ---+ and where we are arrayed, both in terms of collectors, and staff, and whether art or jewelry sales, my suggestion is that there is a bit of an imbalance.
We have significant areas of client development in areas where there is relatively slower growing, a la Europe and North America, and wealth creation over the next decade.
And my fond hope and, moreover, my commitment is to balance that out and find new markets to put more resources into.
I would be surprised if a year or two down the road, looking backward, we wouldn't have a more significant commitment to South Asia; to the Middle East; and to, potentially, the Americas, south of the border of the United States.
Yes, it's a great question.
When you look at our client system, what you see is that we have a robust technology platform and a lot of data in it on clients.
And it's reasonably facile to use, which is encouraging.
But I don't know, for example ---+ because I haven't seen an audit ---+ how accurate the stuff is in it.
And that would certainly be a first place.
And the second thing, where I think that we are a little bit softer, is in what I would call information on products or information on things that go through our auction houses rather than the clients who serve them.
And moreover, the third area would be how we connect the two of those would be an area of opportunity in my mind.
So that's where I think we would see some effort applied to make the system better.
Also, there's some fundamental usability things ---+ which, again, are in the category of technology hygiene ---+ making sure that when you use a system, it suggests things that you might have not thought of that are close to it.
It's little stuff like that.
But very encouraging on that, generally.
I just want to say, thank you all for joining the call.
Thank you to my colleagues who prepared the quarterly stuff, and Jennifer.
And you all have a great day.
