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LaBranche & Co. Inc. (NYSE:LAB)

Q3 2009 Earnings Call Transcript

October 20, 2009 9:00 am ET

Executives

Steve Gray - Corporate Secretary and General Counsel

Michael LaBranche - Chairman, President and CEO

Jeff McCutcheon - SVP and CFO

Analysts

Chris Donat - Sandler O'Neill

Max Rushberg [ph] - Bearalon [ph]

Robert Strougo - RIS Investments

Phyllis Camara - PAX World Fund

Mary Austin - PAX World Fund

Operator

Good morning. My name is Latangie, and I will be your conference operator today. At this time, I would like to welcome everyone to the LaBranche third quarter 2009 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. Please go ahead, sir.

Steve Gray

Thank you. Welcome to the LaBranche and Co., Inc. 2009 third quarter 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 please visit the company's Web site 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 third quarter 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 our SEC filings.

Please note that the company disclaims any obligation to update its forward-looking statements. This call is being recorded on behalf of LaBranche as 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, Jeff McCutcheon, Chief Financial Officer. 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

Thanks, Steve. Before I turn the call over to Jeff, in terms of our operating earnings this past quarter, which were -- which showed a loss of $22 -- $20.2 million pre-tax, included in those loss is $2 million non-cash expenses. As has occurred in the previous two quarters before this one, substantially, all of our operating loss is attributable to our results in our option market making business. So we are taking steps to reverse that trend and to end that string of events.

Namely, one of the more important things we've done with respect to our option market making business is that we have shortened up the duration of the contracts considerably. This is a much different situation than we had in the beginning of the year, to the point now where 85% of those option contracts that we have outstanding will be expiring between now and January 2010. As a result, this will give us a lot more flexibility in determining how we choose to allocated our capital going forward.

The results that we've had in our option market making business this year have not been so much attributable to the actual trading losses that we've had, but they rather have been attributed to the cost associated with the trade so far this year. These costs could be such as exchange in clearing and brokerage fees as well as the cost of carrying our positions. We understand that the markets have been changing in some regards. However, we are going to make sure that any trades that we are undertaking in the future are going to reflect the new market -- the market as it really exists today. And we are going to take into consideration any capital commitments we make with respect to any future costs associated with our trades.

We also believe that our strong and liquid balance sheet, together with our personnel represents our really greatest strength. We had, over the years, been really focused on creating more capital for our company. We're using our balance sheet wisely. And with this in mind, we've always had a focus of creating more tangible book value for our shareholders. And for example, despite the challenges facing our industry, we've increased our tangible equity from effectively zero in 2001 after we finished making several acquisitions, to more than $300 million today.

Despite the substantial increase in our tangible book value -- tangible equity, our stock continues to trade at a substantial discount to this number. This is something of considerable concern to us, and we will be cognizant of this as we make important decisions about our company going forward. At this point, I'd like to turn the call over to Jeff. Thank you.

Jeff McCutcheon

Thank you, Michael. Good morning, everyone. As reported, our third quarter GAAP net loss of $8.9 million or $0.17 per share, a comparable GAAP net loss for the third quarter, 2008, was $5.6 million or $0.09 per share. Excluding an after tax, unrealized gain of $3.1 million related to our investment in the NYSE Euronext stock, the company reported a pro forma net loss from operations of $12 million or $0.22 per share.

The comparable pro forma net income for operations for the third quarter of 2008 was $13.6 million or $0.22 per share, as noted in the Regulation G reconciliation attached to this morning's press release.

Our revenues, net of interest expense and excluding the unrealized gain from NYX shares, decreased by $11 million to $13.5 million when compared to the second quarter of 2009 pro forma net revenues of $24.5 million. By comparison, the third quarter 2008 pro forma net revenues were $79 million. The revenue decrease noted during the third quarter of 2009 was mainly attributable to the decreased principal trading transactions revenue at the company's market making segment.

Revenues net of interest expense in the market making segment decreased by $11.3 million to $12 million, when compared to the second quarter of 2009 pro forma net revenues of $23.3 million for the segment. Consolidated revenue from net gain on principal trading decreased by $8.1 million to $5 million when compared to the second quarter of 2009. The market making segment's performance in the third quarter of 2009 continues to be challenged with trading strategies and opportunities in the options trading business.

Commissions and other fee revenues increased to $17.3 million in the third quarter of 2009, as compared to $10.9 million in the third quarter of 2008. The main driver of this increase year-over-year was the liquidity payment rebate from the NYSE to the designated market makers under the new market model. The fair value of the company's investment in the NYX shares increased during the quarter in value by $5.1 million before taxes to $90.6 million at September 30th, 2009. The closing price of the NYX shares was $28.89 at September 30th, 2009, as compared to $27.25 at June 30th, 2009.

Margin interest expense, which is mainly used to finance our market making inventory, remain relatively flat from the second quarter of 2009 to the third quarter of 2009. Other interest costs, mainly on our bonded debt, were unchanged quarter-over-quarter at $5.4 million. Year-over-year, our margin interest expense and interest expense on bonded debt, decreased by $18.5 million and $1.1 million, respectively. As of the end of the quarter, our public debt was comprised of $189.3 million of the 11% notes maturing on May 15th, 2012, with an annual coupon expense of approximately $20.8 million.

Overall expenses of $33.6 million, excluding taxes, decreased from the comparable quarter of a year ago by $22.3 million, mainly due to reduced incentive compensation cost; and exchange, clearing, and brokerage fees. For the first nine months of 2009, overall expenses of $90.2 million decreased $57.1 million when compared to the same period in 2008. The overall expenses remain relatively flat from the second quarter of 2009 to the third quarter of 2009.

Compensation costs for the third quarter of 2009 were $14.3 million, as compared to $35 million for the third quarter of 2008 and $13.7 million for the second quarter of 2009. Compensation costs for the first nine months of 2009 were $36 million compared to $83.1 million for the same period in 2008. Compensation costs are mainly lower year-over-year due to the lower trading revenues realized in 2009 when compared to 2008.

Exchange, clearing, and brokerage fee expense decreased quarter-over-quarter from $12.1 million in the second quarter of 2009, to $10.5 million in the third quarter of 2009. Year-over-year, the exchange, clearing, and brokerage fee expense decreased when compared to $12.4 million of expense reported in the second quarter of 2008. The exchange, clearing, and brokerage costs were mainly lower this quarter due to decreased trading in the market making segment.

All remaining expenses comprised of mainly depreciation, occupancy, insurance, professional and consulting fees, directed payments, and other miscellaneous costs were relatively the same quarter-over-quarter and year-over-year.

For the second quarter, the effective tax rate is 40.8%. And going forward, our tax accrual rate is anticipated to be approximately 40%. Deferred taxes have increased to a net asset of $7.2 million from a net liability of $5.3 million at December 31st, 2008. At the end of the third quarter, the consolidated net income tax receivable is $7.3 million, compared to an income tax liability of $5.8 million at December 31st, 2008.

Our total assets increased from $3.7 billion at December 31st, 2008 to $4 billion at September 30th, 2009. The increase in assets of approximately $300 million was mainly comprised of an increase in financial instruments owned at fair value. Similarly, our total liabilities increased mainly due to an increase in payable to brokers, dealers, and clearing organizations.

Our cash and cash equivalents have decreased from $304 million in the fourth quarter of 2008, to $156 million in the third quarter of 2009. At September 30th, 2009, the company's operating subsidiaries had $286 million of trading equity, and the holding company had available cash and short-term receivables of approximately $95 million for total liquid assets of $381 million, excluding the value of the NYX position.

Our total trading assets, which combine our total liquid assets with our NYX position of approximately $91 million, was relatively unchanged at $472 million, as compared to $477 million noted at June 30th, 2009. This amount excludes the value of fixed assets, pre-paids, deposits, deferred taxes, and other long-term asset holdings at September 30th, 2009. As noted, our total trading assets of $472 million less the public debt of $189.3 million and short-term payables and debt interest accruals of $27.3 million, result in approximately $255 million of cash equity at the company, which significantly exceeds the company's market capitalization on September 30th, 2009 of $182.4 million.

The company's book equity at September 30th, 2009, was $398.4 million or $7.43 per share. At December 31st, 2008, the book equity was $442.9 million or $7.61 per share. By comparison, the tangible equity, which the company defines as book equity less intangible assets of $109.2 million net of approximately $25.8 million of related tax benefits on those intangibles, was $315 million or $5.87 per share.

Now I will turn the call back to Michael.

Michael LaBranche

Thank you, Jeff. As I've talked about in the opening remarks, I did talk about some of the changes that we're making in our options market making business. We are also making changes in the senior management of the option trading business to help us better execute our business plan going forward.

What I did not mention earlier is that our other market making business were profitable and contributed cash to our company. Our traditional cash equity market making business continued to contribute cash to the company's bottom line. As did our equity market making business.

With regards to our institutional brokerage business, it lost $1.7 million this past quarter. We are currently still making considerable investments in that business with regards to both personnel and our new trading business in the leveraged loan business. We are committed to making sure that that business adds value to the company during a period of the past three months of somewhat declining volumes in some of the areas where we operate. However, we are still making investments and we are committed to that business.

At this point, I'd like to turn the call over to questions if there are any.

Question-and-Answer Session

Operator

(Operator instructions) We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Chris Donat with Sandler O'Neill.

Chris Donat - Sandler O'Neill

Good morning, Michael and Jeff. It's Chris Donat here.

Michael LaBranche

Hi, Chris.

Chris Donat - Sandler O'Neill

Hi. First question is can you give us a little more detail on what those senior management changes are to your options market maker?

Michael LaBranche

Well, we've basically -- we have kept all of our traders, by and large. And we are committed to the strategies, and we are -- we've had -- the senior manager we've replaced.

Chris Donat - Sandler O'Neill

Okay. And as you look at your market making businesses, do you view them as three separate businesses or do you have an inclination to start looking at maybe a whole book across--

Michael LaBranche

In the past, we have been somewhat precluded by a Chinese wall to integrated some of the businesses going forward. We are looking into integrating many of those businesses, and one of the reasons why we think that this will be an opportune time to do that is that in the past, with regards to our market making business in options, in ETS, and indexes, we've been in some capacities a specialist.

As of now, we are no longer a specialist at all in any of those businesses. So we think that there's a very good opportunity for us to integrate them. We would like to integrate our institutional brokerage business as much as we can with some of those businesses so that we can get better synergies in many different ways. Right now, we have different silos as a result of the Chinese wall and the old Chinese wall requirements that came with having a former specialist business, which we do not have anymore. So that is something that we are actively pursuing. And we think that we'll be able to aggregate some of those businesses, cut up [ph] cost down, use the capital more efficiently.

Chris Donat - Sandler O'Neill

Okay. That's helpful.

Michael LaBranche

It might take a matter of months to have that take place.

Chris Donat - Sandler O'Neill

Okay. All right. And then, just a little more color on what happened in the past quarter with the options market maker. Do all the -- is all of that business appearing in the principal trading line or you mentioned that it's sort of the cost of doing business. Does some of that appear as--

Michael LaBranche

Yes. Because if you were to look at our performance in the past quarter, and if you look at the next segment breakdown that we put out in the Q, you'll find that the option -- the market making segment lost, on balance, about -- put it this way, without the option making market -- option market making division, the company would have broken approximately even across the boards. So I think that's really the question now.

We also have expenses that are related to the holding company, which include interest on bonded debt as well as other expenses -- administrative expenses that account for $8 million. So that what you would have had without the option making business is a profit of $8 million approximately or a little bit more. Actually, close to $10 million in our market making businesses. So if you want a kind of back into the number of how the options, then you could probably get there from that.

Chris Donat - Sandler O'Neill

Okay. And then just, I guess what I'm trying to make sure is that I'm understanding your comment that -- I thought you said something about like the loss and the options--

Michael LaBranche

Yes. I actually did. Maybe I should clarify that a little bit. Whereas the option market making business showed a loss in terms of profitability, it did not necessarily show a loss in terms of our trading as much as the loss was. The most of the losses in terms of our bottom line came in carrying costs and exchange fees, brokerage fees. And we are re-evaluating our strategy so that doesn't happen again.

Chris Donat - Sandler O'Neill

Okay. And those carrying costs, do those appear in the inventory financing?

Michael LaBranche

That would be part of it. Yes. And also exchange and brokerage fees.

Chris Donat - Sandler O'Neill

Okay. Okay. That's helpful. Thanks, Michael.

Michael LaBranche

Okay. You're welcome.

Operator

Your next question comes from the line of Max Rushberg [ph] with Bearalon [ph].

Max Rushberg - Bearalon

Thanks for taking the question. Could you just give us an update on the CalPERS litigation please?

Michael LaBranche

You know we're not going to make any comments on that beyond any regulatory filings. We never have. We're not going to now.

Max Rushberg - Bearalon

Okay. Can you clarify what you just said on the options trading? Can we understand that you actually made money for exchange fees in the options business, the trading was profitable?

Jeff McCutcheon

I think what we were saying is that there was net principal trading transaction income on the top line. And then there were margin interest expense fees, which we call carrying costs, also in revenue and the expense line. And then, the net from that as well as the exchange clearing of brokerage fees was where the loss came in at.

Michael LaBranche

Right. So we're not -- all I'm really trying to get across is that was -- it might show that we had a profit on paper in terms of our trading. And we always think that our trading is all in costs. So we think of our trading revenues. And we've always said that consistently over our earnings calls in the past that we take into consideration exchange fees, brokerage fees, interest costs. And they all add up to a loss in that business.

Max Rushberg - Bearalon

Thanks.

Operator

(Operator instructions) We'll pause for just a moment to compile the Q&A roster. (Operator instructions) Our next question comes from the line of Robert Strougo of RIS Investments.

Robert Strougo - RIS Investments

Gentlemen, you're a -- our stock has gone below over approximately $3 a share, while the market has gone up 50%. And you have a large amount of inventory of stocks. The market seems to be saying that our performance has been horrible over this period of time. We're hitting a new low. And the market's hitting a 50% increase. So what do you have to say about that particular situation? I mean, it seems to me you're short, rather than long, in this market.

Michael LaBranche

That's actually not the case. What we are is we've had our losses in terms of our option making business, which is -- it is not directional towards the market going up or down. Now, I don't disagree with you in that the stock prices has been a poor performer. As I said earlier in the call, that's of considerable concern to us. One of the concerns is that we're this company who has always done well in creating tangible equity. The stock prices have not responded accordingly, and that's part of our thinking going forward. And so, we are definitely focused on that.

We're not happy with the stock, where it is. We're not happy with the fact that it traded at substantial discount to tangible book value. But if the question is that our inventory is short and we're losing money because of that, that is not the case. And I would like to emphasize that to you.

Robert Strougo - RIS Investments

Well, I mean you do have a stock buyback situation. And I don't know if you're still buying stocks back because, obviously, you're stock is going lower. And you have a lot in NYMEX stock, and you have a lot of debt there too. So the question I have is, are we continuing this stock buyback in view of the fact that the stock is so cheap and you have happening in the stock?

Michael LaBranche

We have the ability to buy stock back currently, about $15 million. But getting back to what I was saying earlier is that we are considering all our options when it comes to making sure that we can improve the company's profitability. And there are many things that go into that. You did mention the fact that we have -- yes, we still have a substantial cash to compensate for that debt. And we are looking at our options there as well. So those are the things we are talking about, doing, again, flexibility. I talked about our balance sheet as one of our greatest strengths. And we're going to use that to try to correct the situation that you're describing right now.

Robert Strougo - RIS Investments

Of the NYMEX stock that you have, is that free to sell now?

Michael LaBranche

Yes, it is. And I think you're referring to our NYSE Euronext stock, right, which is NYX track.

Robert Strougo - RIS Investments

I mean, you can sell that stock and get rid of some of your debt. Is that possibly…?

Michael LaBranche

We have flexibility to do that. We don't necessarily have to do that to eliminate our debt panel. That's not one of the requirements to pay off debt.

Robert Strougo - RIS Investments

How do you feel about the NYMEX investment position? I mean, you have investment positions in other companies too. And this…

Michael LaBranche

Well that's always been a big investment for us. And as I said before, that is an investment that's a legacy from us being one of the largest C holders on the New York Stock Exchange. We have, over time, done well in that investment. It's had, obviously, periods where it hasn't done well, this year -- last year in particular that investment went down a lot. And a lot of it had to do with the market going down. It has paid off. It has paid us over $20 million in dividends since we've had it. It currently pays a fairly good dividend. So we are keeping our options open to that.

But in terms of using that as a source of cash, it is available to source the cash to us. But we certainly don't need to tap that resource right now. And as I said before, we will keep our options. Right now, our trade's at about $28 or $29 a share, and we're watching that share price very closely.

Robert Strougo - RIS Investments

That stock has also not participated in this run up in the market that much. I mean, it has gone up, but not much. Compared to $100 price when national television said that was a great buy. That's $70 and $80, and filled up with it. And now it's down to these low numbers. You think that there's a possibility it might return to those numbers again hopefully?

Michael LaBranche

I don't really know. And keep in mind that with regards to us, a lot of our stock was locked up during that period when that stock was trading at those prices. So we are now evaluating our options with the stock at a much lower price. I happen to think that the company -- it makes sense for us to have owned the stock in the past. We're not necessarily committed to it going forward. It is a source of funds for us if we choose to make it so.

But we're not -- we don't need it right now. So that I think that that's really where we are. And we're just watching it and just see how things develop, and how their strategy develops. We just want to make sure that we get as -- a higher price for it as we possibly can.

Operator

Thank you. Your next question comes from the line of Phyllis Camara with PAX World Fund.

Phyllis Camara - PAX World Fund

Thank you. And I apologize because I missed the very beginning part of your comments on the options transactions and the options group. And you mentioned, these -- that you were changing the senior management team. Is this the same team that you just recently rehired back in the second quarter?

Michael LaBranche

No, it isn't. No.

Phyllis Camara - PAX World Fund

Okay.

Michael LaBranche

This is the management team that was from here before. And so, we are now -- we're still working with the group that you talked about before. And they're still an important part of our team.

Phyllis Camara - PAX World Fund

And I just -- I guess--

Michael LaBranche

The management that we're referring to that I talked about earlier in the call is more an administrative, not a trading capacity.

Phyllis Camara - PAX World Fund

Okay, okay. Do you think -- how will that help your revenues increase in that group?

Michael LaBranche

Well, a great part of this call, so far, has been talking about what we're going to do there. And as I said before, we have really shortened up our positions. So we have an enormous amount of flexibility with what we're going to do with that capital going forward there. And so, what we're just going to do is target markets that makes sense for us.

As I said, also, before in the call, we had positive returns in our cash equity market making business as well as our EPF market making business, so. As things move forward, we will definitely target areas that make sense for us to commit capital to. We're not going to continue commit capital markets where the carrying costs exceed any of the returns that we're going to get. And that's one of the things that we have actually addressed in the last few months, even though the results so far ended on $9.30 do not reflect that.

Phyllis Camara - PAX World Fund

Have you held -- did you hold any much inventory other than the NYSE stock in general, just thinking that the market was going up at the beginning of the year and you--?

Michael LaBranche

No. That is not the way we've ran our business in the past, and we've not ran our business that way this year. We're not directional players in the market per se. And that's really not what we -- that's not the problems that we've had so far this year. As I like to reiterate, the problem had come almost entirely in the option market making part of the business, which is not directional.

Phyllis Camara - PAX World Fund

Okay. And then, I know you mentioned too that part of what you're doing in the institutional business. Is that going to be or has that in past been more on the option trading side institutionally or is that across the board--?

Michael LaBranche

Actually, that's more -- in the past, it's been equity focused, not at options. There is some options instant brokerage business there. But it's been primarily in equities. Again, things are changing in that regard as the markets have evolved. And we are focusing on other parts of the market, which would be trading bank loans. And we've started a new division for that. So we are changing our focus there, although we -- the bulk of that business is still gone in what you might consider plain vanilla equities.

Phyllis Camara - PAX World Fund

You can make capital to that at all too?

Michael LaBranche

To some degree, it's not a big focus of our capital commitment though.

Phyllis Camara - PAX World Fund

Okay.

Michael LaBranche

We have the ability to do so if a customer needs it, although it's not a big part of our capital commitment. Most of our capital commitment takes place at the market making segment, which includes a cash equities market making, which is our designated market makers down on the New York Stock Exchange, options market making, our equity market making, our equity market making in London. And that's where most of the capital's committed.

Phyllis Camara - PAX World Fund

And then, you mentioned that there's also a possibility you would do -- you're taking a look at where your bonds are trading, and there's maybe a possibility of buying back bonds. Do you have the -- I know you've done this in the past. Do you have anymore room on any covenants that you could buy back more bonds? Is that something you're looking at?

Michael LaBranche

We have no covenant restrictions at all in buying bonds back. So that's not a factor in any way. As Jeff delineated in the conference call earlier, we have substantial liquidity in the company. One of our -- the option's that's available to us would be to retire bonds. We've done that in the past. That would depend on the price then from our standpoint.

If you look at our actions with regard to that in the last couple of years, we've taken our total debt down from more than $520 million three years ago or two years ago, to $190 million approximately today. So you can see that we've done a lot of debt reduction there. We still have the ability to reduce it by even more so. So we're not locked into that strategy of having debt.

Phyllis Camara - PAX World Fund

Do you have any covenants anywhere on under anything that you're hitting up against or have any worries about?

Michael LaBranche

Covenants with regard to what, to the bonds?

Phyllis Camara - PAX World Fund

Yes, to the bonds.

Michael LaBranche

No. We don't have any problems at all there. And as I said before, there's no restrictions on how many bonds we can buy back.

Phyllis Camara - PAX World Fund

Okay.

Operator

Your final question comes from the line of Mary Austin with PAX World Fund.

Mary Austin - PAX World Fund

Hi. Thank you. Most of my questions have been answered. But I'm just curious since this was a surprising quarter, a disappointing quarter, why you hadn't considered to clean house at all? I'm just reading on the blogging, and people are talking about this on Friday.

Michael LaBranche

Because of the stock price (inaudible). And with the stock trading at half the tangible book value, I don't really think that it would make sense to do it there in that situation. We've also said repeatedly in the past that we are not required or we -- and do not expect earnings warnings. We did not have an earnings warning when we had a very large upside in the fourth quarter, for example.

But in view where the stock is trading, that was really the primary reason for that in this particular case, although we'll take it on a case-by-case basis going forward. If this options trading had a huge premium to its market or its capital, or its equity, in anticipation of high earnings, then we might consider doing it. But this wasn't the case this time.

Mary Austin - PAX World Fund

Right. I just think sometimes it adds more credibility to the investors or just--

Michael LaBranche

And I think that to have done that right now without explaining the reasons for the loss, it would have actually created more confusion than answering the question.

So I think that's far as the reason for that.

Operator

Thank you. We've reached the allotted time for questions. I would now like to turn the conference over to Mr. LaBranche for closing remarks.

Michael LaBranche

Okay. So thank you for listening this morning, and I hope to have better results for you in January. So thank you very much. Bye.

Operator

Thank you. This concludes today's conference call. You may now disconnect.

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