Bid Pic

Source: Sotheby's

Sotheby's (NYSE:BID) stock was rising by 2.4% on Monday as investors reacted with moderate optimism to the company's earnings report for the third quarter. Active cost reductions and strong sales momentum for the crucial fourth quarter of the year were the main positives in the report, while declining commission margins represent a relevant risk to watch.

The top line
Total sales during the third quarter of 2014 came in at $94.2 million, a 12.7% decline versus $107.8 million in the same quarter last year. The number was above analysts' forecast of $91.3 million for the quarter, according to data compiled by Thomson Reuters.

The agency segment brought in $76.3 million in sales during the quarter, a big 81% of total revenues. Revenues in this segment were relatively stable, with a decline of only 1%. Gross margin in the agency segment improved from 91% in the third quarter of 2013 to 92%.

Improved performance in the agency segment was mostly driven by a 26% increase in net auction sales and a significant reduction in auction direct costs as a percentage of sales, partially offset by a 35% decrease in private sale commission revenues and a decline in auction commission margin from 16.2% to 15.5%.

Although much smaller than the agency segment, finance revenues and licence fees contributed positively to sales growth. Finance revenue increased 73% to $8.9 million, while license fees grew 25% to $2.4 million.

On the other hand, sales in the principal segment fell steeply, from $23.5 million to $6.3 million.

Cost-cutting
Reported operating loss increased to a net loss of $37.5 million versus $34.4 million in the same quarter last year. However, this figure includes the negative impact of $14.3 million from restructuring charges, partially offset by $4.2 million in net gains from insurance recovery provisions. Excluding these nonrecurrent items, operating loss would have been a much narrower $23.7 million during the quarter.

Management is implementing a series of cost reductions across the board, and this is having a positive impact on profit margins. Marketing expenses fell 39% to $3.1 million, salaries and related costs declined 5% to $58.9 million, and general and administrative expenses fell 7% to $37.8 million during the quarter.

Adjusted pre-tax loss during the quarter was $34.1 million, a 19% improvement versus $41.9 million in adjusted pretax loss during the same quarter in the prior year.

Sotheby's reported a net loss of $0.4 per share during the last quarter, a narrower loss than the $0.44 per share loss it delivered during the third quarter in 2013. The number was below expectations, though, as Wall Street analysts were on average forecasting a net loss of $0.38 per share.

Moving forward
Sotheby's is facing declining commission margins due to increased competition over the last several quarters, and management is relying on cost cuttings to buffer the impact on profit margins. Leaving one-time items aside, profitability is moving in the right direction, so cost-cutting efforts are bearing their fruits.

Chairman, President and CEO Bill Ruprecht sounded quite pleased about the sales outlook for the crucial fourth quarter of the year:

Sotheby's Impressionist & Modern Sales brought a combined $470 million, with the Evening Sale establishing Sotheby's highest total for any auction in company history. Registered bidders came from 40 countries, with the highest percentage from the United States, Europe and Asia. The results bookended a very strong year for Impressionist & Modern Art at Sotheby's, which opened this February with an Evening Sale that totaled $266.6 million-Sotheby's highest total for any London auction.

Sotheby's Autumn Hong Kong sales series last month brought $327 million. Sotheby's position as a market leader in Hong Kong was reaffirmed, with participants from a record 60 countries this season, including increased interest from clients from Greater China. Sotheby's auctions and activities in Beijing as well as continued engagement with clients through gallery exhibitions, mid-season auctions and retail offerings in Hong Kong are also contributing significantly to Sotheby's success in Asia.

While declining commission margins are an important risk to watch, management is doing a sound job at cutting costs to buffer the decline in overall margins. All in all, the third quarter was a solid one for Sotheby's, and the company seems to be entering the seasonally important fourth quarter on strong momentum

Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Sotheby's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.