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LaBranche & Co Inc. (NYSE:LAB)

Q4 2008 Earnings Call

January 21, 2009 9:00 a.m. ET

Executives

Steve Gray - General Counsel

Michael LaBranche - Chairman, President and CEO

Jeffrey McCutcheon - SVP and CFO

Analysts

Richard Repetto - Sandler O'Neill

Michael Vinciquerra - BMO Capital Markets

John Turgliana - Clearbook

Operator

Good morning. My name is Julianne and I will be your conference operator today. At this time I would like to welcome everyone to LaBranche Q4 and Year-end Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. (Operator Instructions). Thank you.

I would now like to turn the conference over to Mr. Steve Gray, General Counsel. Please go ahead.

Steve Gray

Good morning and welcome to the LaBranche & Co Inc. 2008 fourth quarter and full year conference call.

Anyone who has not received a copy of this morning's press release please call the offices of KCSA at 212-896-1250. A copy will be faxed or emailed to you. Or you can visit the company's website at www.labranche.com.

Before management begins their formal remarks this morning I would like to remind you that to the extent the company's statements or comments are forward-looking. I refer you to the risk factors and other cautionary factors in today's news release as well as the company's SEC filings. The company's fourth quarter results and full year results and any forward-looking statements are present expectations and actual results and events may differ due to the impact of factors such as industries, volatility, general economic and market conditions, the competitive environment and other risks and uncertainties detailed in the company's SEC filings.

Please note that the company disclaims any obligation to update its forward-looking statements. In addition this call is being recorded on behalf of LaBranche. This is copyrighted material and cannot be recorded or rebroadcast without the company's express written permission. Your participation on this call implies consent to this statement.

With us this morning are Michael LaBranche, Chairman and Chief Executive Officer, and Jeffrey McCutcheon, the CFO. Michael and Jeff will take your questions after they conclude their formal remarks. And with that I'll turn the call over to Michael.

Michael LaBranche

Good morning and before I talk about the past quarter, I am going to have Jeff make a presentation on our results.

Jeffrey McCutcheon

Thank you Michael and good morning everyone. As reported our fourth quarter GAAP net income is $3 million or $0.05 per diluted share, excluding an after-tax unrealized loss of $22.1 million related to our investment in NYSE Euronext stock. The company reported pro-forma net income from operations of $24.7 million or $0.41 per diluted share.

The comparable pro-forma net income from operations for the fourth quarter of 2007 was $2.3 million or $0.04 per share as noted on the Regulation G reconciliation attached to the press release.

For the 12 months ended December 31, 2008 the pro-forma net income from operations is $47.8 million or $0.78 per diluted share compared to the pro-forma net income of $1.6 million or $0.03 per share loss for the same period in 2007.

Our revenues net of interest expense and excluding unrealized loss from the NYX shares increased by $33.8 million to $112.8 million when compared to the third quarter of 2008 pro-forma net revenues of $79 million.

The revenue increase noted during the fourth quarter was mainly attributable to the increased principle trading revenues at the company’s market making segment. By comparison the fourth quarter 2007 pro-forma net revenues were $41 million.

Revenues net of interest expense and the NYX stock for the 12 months of 2008 were $289.1 million compared to $161.3 million for the comparable period in 2007.

Although not reported for our GAAP financial statements our management generally refers to net trading revenue as net gain on principle transactions less the net cost for financing of the inventory which is a result of the trading interest income less the margin interest expense. Thus if you take the sum of our net principle trading revenue of $111.7 million and the trading interest income of $4.8 million, less the margin interest expense of $12.1 million, the trading revenue for the company is $104.4 million for the fourth quarter of 2008.

Comparable amounts for the third quarter of 2008 and the fourth quarter of 2007 would be $75.7 million and $37 million, respectively. On an annual basis the net trading revenue for the company increased by $142.1 million to $275.7 million when compared to the 2007 full-year net trading revenue of $133.6 million.

Commissions and other fee revenues increased to $13.8 million in the fourth quarter of 2008 as compared to $10.9 million in the third quarter of 2008 and $11.2 million in the fourth quarter of 2007.

The fair value of the company’s investment in NYX shares decreased during the quarter in value by $36.8 million before taxes to $85.8 million at December 31, 2008. The closing price of the NYX shares was $27.38 at December 31, 2008.

The final trading restrictions were removed from our NYX shares on October 1, 2008 upon completion of the NYSE Euronext acquisition of the American Stock Exchange. LaBranche exchanged its AMEX membership for 8,138 NYX shares during the fourth quarter.

Margin interest expense, which is mainly used to finance our market making inventory, decreased to $12.1 million from $23.8 million in the third quarter of 2008. Other interest costs mainly on our bonded debt decreased quarter-over-quarter to $5.9 million in the fourth quarter of 2008, versus $6.5 million in the third quarter of 2008, mainly due to debt repurchases of $10.6 million during the fourth quarter.

Year-over-year, our margin interest expense and interest expense on debt decreased by $165.2 million and $18.7 million, respectively. As of the end of the year, our public debt was comprised of $199.3 million of the 11% notes maturing on May 15, 2012 with an annual interest expense of $21.9 million, compared to approximately a $15 million annual interest coupon on debt at December 31, 2007.

For the twelve months of 2008, the company extinguished $266.2 million of debt. Overall expenses of $72.6 million, excluding taxes, increased from the comparable quarter of a year ago by $36.3 million mainly due to an increased incentive compensation cost.

Quarter-over-quarter, the total expenses excluding taxes and debt extinguishment expenses, increased $16.7 million from $55.9 million, mainly due to the increased incentive compensation and exchange clearing and brokerage fees, which are both a result of our increased trading results in the fourth quarter of 2008.

Year-over-year, total expenses excluding taxes and debt extinguishment cost increased to $213.9 million from $167.9 million in 2007. The compensation costs for the fourth quarter of 2008 were $50.1 million, which increased $31.5 million over the fourth quarter of 2007 compensation of $18.6 million. This is mainly due to the incentive pay relationship to increased trading results.

Quarter-over-quarter, the compensation cost increased $15.1 million from $35 million in the third quarter of 2008. The year-over-year increase in compensation was $53 million, or a 66% increase as compared to an increase in net trading revenue year-over-year of $142.2 million or an increase of 106%.

Exchange, clearing and brokerage fee expense increased quarter-over-quarter from $12.4 million in the third quarter of 2008 to $13.9 million in the fourth quarter of 2008. The full year 2008 exchange, clearing and brokerage fee expense increased by $9.2 million to $46.7 million, or an increase of approximately 25% as compared to the net trading revenue increase of 106% year-over-year.

All remaining expenses comprised mainly of depreciation, occupancy, insurance, professional and consulting fees, directed payments and other miscellaneous sundries decreased by $16.2 million to $34.1 million or approximately 32% decrease in reduce costs year-over-year.

The year-to-date effective tax rate for 2008 was approximately 42.4%. For the fourth quarter the effective rate is 21.6% reflecting tax benefits from the dividends received deduction on the NYX shares and closed state tax audits.

Going forward our tax accrual rate is anticipated to be approximately 40%. Deferred tax liabilities net of deferred tax assets, have decreased from $71 million at December 31, 2007 to $6.5 million at December 31, 2008. This change was mainly due to the decrease of the unrealized tax gain on our NYX shares.

Our total assets decreased from $5.3 billion at December 31, 2007 to $3.7 billion at December 31, 2008. The decrease of approximately $1.6 billion was mainly comprised of a decrease in cash and cash equivalents of $200 million, a $252 million decrease in the receivable from broker, dealers and clearing organizations and a decrease in the financial instruments owned have fair value of $1.1 billion.

Our total liabilities decreased due to the financial instruments sold but not yet purchased in an amount of $1.2 billion and long-term debt decreased by $260 million. Our cash and cash equivalents decreased from $505 million in the fourth quarter of 2007 to $304 million in the fourth quarter 2008.

The company’s cash available at its holding company has decreased to approximately $166 million at December 31, 2008 from $269 million at December 31 2007. Primarily due to debt extinguishment and payments offset by additional cash from the reduction of the regulatory capital at the cash equities market making business during the 12 months of 2008.

The company’s book equity value has decreased quarter-over-quarter to $444.6 million mainly due to the repurchase of $14.7 million of the company’s outstanding shares during the fourth quarter. The total shares purchased in the fourth quarter were $3.4 million. At December 31, 2008 the total shares outstanding excluding treasury shares is $58.2 million.

Now, I’ll turn the call back over to Michael.

Michael LaBranche

Thanks Jeff. So our market making segment had a profit of $49 million last quarter and that is reflective all of the changes we've made. We have reduced our costs, our legacy costs are almost gone. And I think we’re in a very good position now to take advantage of new market.

So, I’ll turn the call over to questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question is from the line of Rich Repetto with Sandler O'Neill.

Richard Repetto - Sandler O'Neill

Yes, good morning, Michael.

Michael LaBranche

Hi Rich.

Richard Repetto - Sandler O'Neill

Great quarter. The $49 million, you just said, is that a margin off of the principle the trading -- what do you call it, your net trading revenue?

Michael LaBranche

No. Well that is market making segments profit, pre-tax profit. So, that’s after all expenses after all compensation. And then, in addition to that our other operating segment is our institutional brokerage segment, that broke even in the past quarter. And so if you take the $49 million less administrative cost, which is basically servicing the bonded debt of $200 million approximately and other costs of our holding company, our pre-tax profits for the quarter of $40 million on an operating basis.

Richard Repetto - Sandler O'Neill

Okay. The question everybody’s going to ask you is, out of that $49 million you are trying to break out sort of the ETF sort of profitability versus --

Michael LaBranche

Okay. Let me try to answer that question, I think, if I don’t answer, just come back and ask me again. But that $49 million encompasses all of our market making segments. So, that includes our traditional cash equities business, which used to be known as a specialist business, it includes our ETF business, and includes our London trading operation and includes our Hong Kong trading operation, it includes option trading. So it’s all of our businesses together.

Now, with regards to our traditional cash, equities business, that particular business had the second best quarter since the introduction of the hybrid in the beginning of 2007. So in the eight quarters since the hybrid was put in place, it had the second best quarter, there are changes going on in that business. It still remains a small portion relative of our overall business today going forward.

There is some speculation that the changes will be beneficial to us. That business is still in transition. We are adapting to the new trading market model. And as much as I think this management has done a very good job in keeping this business growing and keeping it profitable with some of the changes that have taken place, tt’s still is going to be a small relatively piece of our business going forward in our estimation.

Richard Repetto - Sandler O'Neill

Okay. And the definition is small I think, you’ve said before, is much less than 50%.

Michael LaBranche

Correct.

Richard Repetto - Sandler O'Neill

Okay. And then I guess the last question and I’ll get back in the queue. But the ETF, trying to ETF volume surged, it looks like is a pretty good indicator of your net trading revenue. How would we look at trading ETF versus options versus the international component? Where was the biggest incremental contribution -- go ahead.

Jeffrey McCutcheon

Our ETF component, we have a domestic and a non-U.S. component of ETF trading and those markets are both growing as you just pointed out. One of the trends we are seeing is that ETFs are being used by more mainstream players more and more especially in Europe in that business. We are seeing a lot of interest there. So that business year-over-year was much better. And for example, the ETF business in the Europe seems to be much more a part of trading strategy. It’s almost like people can use it for indexing and certainly we’re seeing the effects of that.

Michael LaBranche

But we kind of view everything as an aggregate, because sometimes you can use your ETFs trade against options and so you can’t really just completely separate those businesses.

Richard Repetto - Sandler O'Neill

Okay. And this would be the very last question. The optionally just sequentially when you go from $0.22 to $0.41 the option volumes actually went down as an industry. Was your option profitability, quarter-to-quarter, did it go down as well or did it not mirror the industry?

Michael LaBranche

What we think that there is going to be much more interest in options as people need to lay off risk and certainly what’s happened in Wall Street in the last year is that there has been a dynamic change for obvious reasons. But people still need market makers. And one of the things that, we never thought that the move to an all electronic market would lessen the need for dedicated market makers though an all electronic market does not eliminate some of the challenges posed by excessive demand or supply. And those challenges are still there.

And so I just think that there is going to be a need for people to trade options to lay off the risk so I think that’s one of the things that drove our business in the past year.

Richard Repetto - Sandler O'Neill

Okay, I’ll get back in the queue Michael.

Michael LaBranche

Thank you.

Operator

(Operator Instructions). Your next question is from the line of Mike Vinciquerra with BMO Capital Markets.

Michael Vinciquerra - BMO Capital Markets

Thank you good morning Jeff, good morning Michael.

Michael LaBranche

Hi, Mike.

Michael Vinciquerra - BMO Capital Markets

I want to follow-up on just on the ETF side, historically market making benefits from some volatility for sure, but extraordinary volatility you’ve pointed out in the cash business can actually be detrimental to your revenue capture. How does that affect the ETF market making business?

Michael LaBranche

Its hard for me to say, but I would say that volatility makes people turn to ETFs more I think, and which creates more volume. And the other trend that I was talking about before is that ETFs has moved from being a primarily a retail product when it was first created a long time ago, its moving to become an institutional product. And we are really wholesale brokers and that trend is good for us.

In terms of excess of volatility, I mean some times too much volatile is bad, sometimes no volatility is bad. But I don’t think that one particular market is effected more than the other, although what we are seeing in Wall Street right now in terms of individual stock trading. The, just some of the moves we’re seeing are really severe especially in some of the banking stocks. And those are much more severe swings than we are seeing in ETFs.

Michael Vinciquerra - BMO Capital Markets

Okay and the last would --

Michael LaBranche

A 5% move in a ETF would be a lot that we are seeing 50% moves in banking stocks, and things like that.

Michael Vinciquerra - BMO Capital Markets

Alright, okay. And the vast majority of the ETF trading is on still on tape B but some on tape A, but did you do anything on tape C or should we just mostly we’ll be looking at NYSE and AMEX in terms of the how your ETF business might be trending intra quarter?

Michael LaBranche

Well the ETF business to us is really just it’s trading on Arca and those kind of venues. It’s not trading on floors anymore.

Michael Vinciquerra - BMO Capital Markets

Sure.

Michael LaBranche

We are not making markets on floors and ETFs.

Michael Vinciquerra - BMO Capital Markets

I guess I was more saying just looking at the overall tapes obviously they traded in the multiple venues but I guess if we are looking at volume trends,,the trends on tapes A and B are most important for that business, is that safe?

Jeffrey McCutcheon

Correct but we remember, the whole market structure has changed for us and what we are trading as we have customers coming directly to us or coming to us through other parties and we are trading electronically but also that the markets have shifted upstairs. Trying to answer your question I would just say that it’s really a more a wholesale over the counter market traded also on venues such as Arco.

Michael Vinciquerra - BMO Capital Markets

Okay. And then on the cash business, the new, I guess, revenue sharing put in place by the NYSE, how is that impacting your business if it is at all yet?

Michael LaBranche

Well, it's different. We are trading more and the new market structure that was introduced has only really been in place for us since the beginning of the year for all intents and purposes.

On an average day, we're trading something like 60 million shares now electronically that would be, if the volumes are running at 1.3 billion or 1.4 billion on the New York. So we are trading more, we do get paid for posting at the best bidder offer, so we’re seeing those revenues go up.

I think that overtime you will see it develop into as much a quoting business as it is a trading business. During normal trading activity, our job is to quote as much as possible which is reflected in that 60 million share number I just mentioned.

And then on the other hand, we are taking in balances as they occur if there's dislocations in the market. But trying to answer your question, it's becoming more and more of a quoting business.

Michael Vinciquerra - BMO Capital Markets

So the 60 million shares, so that executed, and but you being encouraged obviously to quote at the inside to draw volume down or back to the NYSE.

Michael LaBranche

Yeah, that's true.

Michael Vinciquerra - BMO Capital Markets

Okay, and then finally just for Jeff. The salary and benefits line, can you breakout the incentive comp from the salary and benefits itself?

Jeffrey McCutcheon

We don’t normally breakout such details.

Michael Vinciquerra - BMO Capital Markets

Is it fair to say now that the $15 million delta between Q3 and Q4 was almost all incentive based?

Jeffrey McCutcheon

Yes.

Michael Vinciquerra - BMO Capital Markets

Okay, alright. Thank you, guys.

Jeffrey McCutcheon

You're welcome.

Operator

You have a follow-up question from the line of Rich Repetto with Sandler O'Neill.

Richard Repetto - Sandler O'Neill

Hi Michael, I guess probably the most important question for me is, how much do you think this is sustainable? If you look at the ETF’s, I agree with you on adoption and penetration. But if it's related to the volatility, I am just trying to see is, is $0.41,the earnings run-rate going forward?

Jeffrey McCutcheon

It's probably frustrating for you to try to guess what our earning is going to be. And if I could have give you guidance to what our earnings would be, I would do that, but the truth is I don't know how well we’re going to do coming into a given year.

When we had a conference call here at this time last year, I mentioned that a lot of the things the company has done over the past several years has put us in a position to be able to benefit if opportunities come our way. And I went down a list of things and talking especially about reducing the legacy costs that were associated with the manual market, which were really very cumbersome at the time as we were making that transition, and it wasn't always easy to make that transaction, but I think we did.

So, several things that are playing in our favor right now, that is the reduced debt is lowering our overhead by $30 million a year. That presumably that should go to the bottom-line. The other factors are, our fixed costs are lower in terms of salaries, where you know our headcount is down from high of, what was it 600 people, a lot of that slack has been taken up by technology, investment in technology.

The floors have effectively been eliminated except for the New York floor, and that New York floor has employees of about 48 people. I am trying to tell you, I can't tell you what the run-rate is going to be going forward except that this company has got a lot more flexibility than it had before

Secondly, is that we are still here as a dedicated market maker. We still have our capital intact. So, I think, that’s a benefit. People need market makers, I think people realize that now more than ever.

In terms of trading, there is no magic sauce here in trading. The only way you can make money is to take on risks. That’s something we’ve always done. So, I think that we’re used to doing that, last year was a very challenging year and we showed that we had some experience in doing that.

So, I don't know what to tell you what the run-rate is, but certainly the onerous things that were hanging over our business from say 2004, 2005, a lot of that’s been lessened.

Richard Repetto - Sandler O'Neill

Okay, last question. If you had one category, asset class of volumes that to grow in 2009, the concern is that volumes are going to drop off, lower volatility, if you could pick options, EPS or US cash equities, which volumes would you want to see some stabilization of growth in '09 the most?

Jeffrey McCutcheon

I had to pick one?

Richard Repetto - Sandler O'Neill

Yes.

Jeffrey McCutcheon

I would pick cash equities, because I think it's been market that we have a big position in, but I want to see them all grow. I know what a lot of the concerns are. And certainly when we look at the price of NYX to having going down from wherever it was at the beginning of 2008 until where it is today.

I think that there is lot of fear there that, we’re going to go after a terrible bear market, we are just going to have a kind of lull in the market, where people are despondent, not a part of the market.

So we don’t know how bad that’s going to be, but we can’t operate thinking that it’s going to be horrendous, or it’s going to be great. We’re just going to have to rationalize our business. You know, I personally think that the NYX sell off, it was very surprising and that it’s so severe, as it is factoring in some really unfortunate events going forward. I still think people need the markets and there is going to be interest in trading so as long as that’s there, we will be there and I think we can do okay.

Richard Repetto - Sandler O'Neill

Okay. Thanks Michael.

Michael LaBranche

You’re welcome.

Operator

Your next question is from the line of John Turgliana with Clearbook.

John Turgliana - Clearbook

Good morning, Michael. Very good job. Thank you. I noticed there was an announcement about Research Edge, I think it was a joint venture or something in specialized research?

Michael LaBranche

Yes. That has to do with our institutional brokerage operating company and that is a partnership we formed because we think that they have a very good product in terms of market analysis and lot of our customers are paying attention to that so that’s associated with our institutional brokerage division.

John Turgliana - Clearbook

Thank you.

Michael LaBranche

You’re welcome.

Operator

Your final question is from the line of Mike Vinciquerra with BMO Capital Markets.

Michael Vinciquerra - BMO Capital Markets

Thank you. Michael, kind of looking forward here where are you guys putting more capital to work in terms of growing your business, where you are trying to spend, where is your CapEx going, that type of thing?

Michael LaBranche

Our CapEx is going into building our businesses out in Hong Kong and London. It’s going into building our ETF trading business. What we are seeing is we’re seeing a trend towards trading all sorts of different types of asset classes and that they are becoming more and more intertwined and we have been talking about that for years and that continues to be the case. So, obviously our floor presence is greatly diminished and that’s reflected in amount of employees going from 600 to 200.

So I would say that we are, we are going to continue to focus on new trading. There are opportunities for us out there, we are going to evaluate them certainly with the changes are going on Wall Street. That is also as much as its bringing challenges as much as its bringing opportunities, there is a lot of smart people out there and we are looking at getting in to areas that we can continue to grow our non-traditional businesses.

Michael Vinciquerra - BMO Capital Markets

And Hong Kong and London are predominantly today ETFs or you do a lot of cash business there as well.

Michael LaBranche

ETFs, right now its ETFs that could change but right now its ETFs.

Michael Vinciquerra - BMO Capital Markets

Okay. And then I also noticed, I had missed this before, that you guys mentioned yourselves as future’s market makers, what products are you focused on there, is it only domestic or you doing some stuff in Europe as well.

Michael LaBranche

It’s primarily domestic.

Michael Vinciquerra - BMO Capital Markets

And it’s like a equity indexes that kind of you can pull of.

Jeffrey McCutcheon

We use them to trade other products because they give you flexibility in terms of hedging.

Michael Vinciquerra - BMO Capital Markets

Okay, but you are not into commodities and interest rates things like that, it’s mostly just on the equity side?

Jeffrey McCutcheon

This company really trades listed security. So we are not into esoteric non-listed securities. We are not into customized products or anything like that.

Michael Vinciquerra - BMO Capital Markets

But if you trade on the..

Michael LaBranche

On our balance sheet, they are almost exclusively securities are listed on one exchange and another one that’s options and exchange, a future’s exchange and stock exchange.

Michael Vinciquerra - BMO Capital Markets

Okay, alright. Thank you guys.

Michael LaBranche

Thank you.

Operator

There no further questions at this time. I’ll turn the floor back over to Mr. Michael LaBranche for any closing remark.

Michael LaBranche

Okay I would like to thank everybody for listening. And we look forward to seeing talking to you again in April. So thank you very much, bye.

Operator

Thank you for participating in today’s conference call. You may now disconnect.

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