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LaBranche & Co., Inc. (NYSE:LAB)

Q4 2009 Earnings Call

January 20, 2010 9:00 a.m. ET

Executives

Steve Gray - General Counsel

Michael LaBranche - Chairman and CEO

Jeffrey McCutcheon - CFO

Analysts

Rich Repetto - Sandler O'Neill

Robert Torray - Torray Company

Jonathan Vyorst - Paradigm Capital

Presentation

Operator

Good morning. Welcome to the LaBranche & Company fourth quarter and year-end 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. (Operator instructions). As a reminder today January 20, this call is being recorded. I would now like to turn the call over to Steve Gray, General Counsel. Please go ahead, Sir?

Steve Gray

Good morning and welcome to the LaBranche & Co Inc. 2009 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 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. This call is being recorded on behalf of LaBranche. It is copyrighted material and cannot be recorded or rebroadcast without the company's express written permission. Your participation on this call implies consent to the statement.

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

Michael LaBranche

Thanks Steve. This past quarter we showed a profit of $6 million on a continuing operating basis. These results include $2 million in non-cash charges and expenses also included in those results are $5 million in interest expenses for debt that we are redeeming on February 15. As a result we will no longer be paying interest on that debt. However, on a cap accounting basis the results are much different and this is primarily due to the intangible write down associated with the sale of our DMM subsidiary. Jeff will explain that write down as it's included in our results now so I will turn it over to Jeff.

Jeffrey McCutcheon

Thank you Michael. Good morning everyone. As reported our fourth quarter GAAP net loss is $72.5 million or $1.38 loss per share. The comparable GAAP net income for the fourth quarter 2008 was $1.2 million or $0.02 per diluted share. Excluding an after tax loss of $6.6 million, related to our investment in the NYSE Euronext stock and a $69.7 million after tax loss from discontinued operations related to the sale of the DMM business reported on January 13 of this year.

The company reported a pro forma net income from continuing operations of $3.8 million or $0.07 per share. The comparable pro forma net income from continuing operations for the fourth quarter 2008 was $14.2 million or $0.24 per share as noted on the Regulation G reconciliation attached to this morning's press release. These pro forma results include the interest expense on the company's public debt of $5.4 million in the fourth quarter of 2009 and $5.9 million in the fourth quarter of 2008. The company's public debt will be redeemed in full on February 15 2010.

For the 12 months ended December 31, 2009 the full year GAAP loss was $97.8 million or $1.78 loss per share which compares to a GAAP loss of $66 million or $1.07 loss per share for the full-year ended December 31, 2008.

For the 12 months ended December 31, 2009 the pro forma net loss from operations is $35.5 million or $0.65 loss per share compared to the pro forma net income of $22.6 or $0.37 per share for the same period in 2008. The pro forma full year amounts reported excluded the loss of the NYSE Euronext shares, income or expense from the early extinguishment of debt and results from discontinued operations for both 2008 and 2009. These pro forma results include the interest expense on the company's public debt of $21.8 million in the year ended December 31 2009 and $31.5 million in the year ended December 31, 2008.

The company previously announced that it has signed a definitive agreement to sell its DMM business to Barclays Capital for $25 million in addition to purchasing all other companies in that DMM securities as of the closing day. As such the company has reported a loss from discontinued operations for the fourth quarter of $69.7 million which is comprised of the income from the DMM business unit of the market making segment offset by a non-cash impairment charge of $70.2 million after tax. The company has also reported the assets available for sale on the consolidated statements of financial condition which mainly reflects the net DMM positions fixed and intangible assets, which Barclays has agreed to purchase.

As noted in the pres release issue last week, the company will retain all of the other assets and the broker deal of LaBranche & Co. LLC which approximates $100 million of liquid working capital comprised mainly of cash, broker dealer receivables and NYX stocks. Immediately after the transaction close, the company will not be subjected to the NYSE net liquid capital requirement to the designated market makers, which required in excess of $76 million of working capital to maintain the DMM business.

Going forward, our broker dealers will be subjected to a minimal regulatory capital requirement of approximately $4 million for all the broker dealers combined. Any capital that are operating companies over the regulatory minimum will be at the discretion of the company based on the strategies and opportunities pursued.

The following overview comments regarding the revenues and expenses reported on the consolidated statement of operation excludes the amounts related to the DMM business that is included in the discontinued operations, but do include the public note interest expense amounts which will be fully redeemed by February 15, 2010.

Our revenues net of interest expense and excluding the loss from the NYX shares increased by $31.7 million to $34.2 million when compared to the third quarter of 2009 pro forma net revenues of $2.5 million. By comparison the fourth quarter 2008 pro forma net revenues were $89.1 million. Revenues net of interest expense and the NYX for the twelve months of 2009 were $40.7 million compared to $208.7 million for the comparable period in 2008.

As noted in prior earnings calls the first three quarters of 2009 were impacted by losses in the operations market making activities which have returned the profitability in the fourth quarter of 2009. Pro forma revenues, net of interest expense and excluding the loss from NYX in the market making segment, increased by $30.2 million to $31.2 million when compared to the third quarter of 2009 pro forma net revenues of $1 million for that segment. Consolidated revenue from the net gain on principal trading increased by $32.4 million to $38.1 million when compared to the third quarter of 2009. The revenue increase noted quarter-over-quarter was mainly attributable to increased profits on principal trading transaction revenue at the company's market making segment in the options trading activities.

Commissions and other fee revenues decreased to $7 million in the fourth quarter of 2009 as compared to $7.2 million in the third quarter of 2008 and $8.2 million in the fourth quarter of 2008. I am sorry that was 2009 at $7.2 million and $8.2 million was the fourth quarter of 2008. On a year-over-year comparison, commission income increased to $30 million when compared to $26 million for the comparable period in 2008. The company sold approximately 950,000 shares of its NYX investment during the quarter. The remaining value of this investment is $55.2 million at December 31, 2009. The closing price of the NYX shares was $25.30 at December 31, 2009 as compared to $28.89 at September 30, 2009.

Inventory financing interest expense which is mainly used to finance our market making inventory increased from $5.3 million in the third quarter of 2009 to $6.9 million in the fourth quarter of 2009. Other interest costs mainly on our bonded debt were unchanged quarter-over-quarter at $5.4 million. Our inventory financing and interest expense on bonded debt decreased by $64.2 million and $99.7 million respectively for the 12 months ended December 31, 2009 compared to the same period in 2008. As of the end of the year, our public debt was comprised of $189.3 million of 11% notes.

As mentioned our board of directors have approved the redemption of all the remaining public debt at the current redemption price of 102.75% plus accrued and unpaid interest thereon pursuing to the optional redemption provisions of the indenture governing the notes. The redemption will be completed on February 15, 2010 resulting in a reduction of the company's interest expense by approximately $21 million per year or $5.4 million per quarter.

Overall expenses of $28.2 million excluding taxes decreased from the comparable quarter of a year ago by $37. 7 million mainly due to the reduced incentive compensation cost and exchange, clearing and brokerage fees. For the 12 months of 2009, overall expenses of $101.9 million decreased $78.9 million when compared to the same period in 2008.

The overall expenses remain relatively flat from the third quarter of 2009 to the fourth quarter of 2009. Compensation cost for the fourth quarter of 2009 were $11.8 million as compared to $46.9 million for the fourth quarter of 2008, and $11.2 million for the third quarter of 2009. Compensation cost for the 12 months of 2009 were $39.8 million compared to $108.2 million for the same period in 2008. Compensation cost were mainly lower year-over-year due to lower trading revenues realized in 2009 when compared to 2008.

Exchange, clearing and brokerage fee expense decreased quarter-over-quarter from $9.5 million in the third quarter 2009 to $8.5 million in the fourth quarter of 2009. Year-over-year, the exchange, clearing and brokerage expense decreased when compared to $12.8 million of expense reported in the fourth quarter of 2008. The main driver of exchange, clearing and brokerage fees were from the options market making activities which focused on lowering this cost after increasing in the second and third quarters of 2009.

The full year 2009, exchange, clearing and brokerage fee expense decreased by $7.2 million to $33.9 million. All remaining expenses comprised mainly of depreciation, occupancy, insurance, professional and consulting fees, directed payments and other miscellaneous in cost, increased by $1.2 million to $8 million to quarter-over-quarter and $3 million to $29 million year-over-year. The $1.2 million increase is primarily comprised of several one-time charges for communications, bad tax, asset write downs that will not repeat in future periods. We will be actively managing these costs to be lower subsequent to our close of the DMM sale transaction and consolidation of our domestic broker dealers.

For the fourth quarter of the effective tax rate on continuing operations is 44.8%. The full year tax rate on continuing operations is 42.4% and going forward our tax accrual rate is anticipated to be 40%. Deferred taxes have increased to a net asset of $25.4 million at December 31, 2009 from a net liability of $5.3 million at December 31, 2008. At the end of the fourth quarter the consolidated net income tax receivables is $10.2 million compared to an income tax liability of $5.8 million at December 31, 2008. The company expects to monetize the tax receivables by the second quarter of 2010 by following a refund claim for taxes paid in 2008. The net deferred tax assets includes approximately $17 million of tax benefit related to the impairment of the intangibles. These amounts have yet to be deducted in tax filings and can be used to offset future taxable income.

The company's continuing operations pro forma income of $5.9 million generated positive cash flows of approximately $8 million when considering that the company will not pay taxes due to excess NOLs as well as $2 million of non-cash charges reported during the quarter for mainly depreciation and stock compensation expense. Total assets of approximately $3.8 billion at December 31, 2009 were relatively flat as compared to December 31, 2008. During the year, the most notable change is the reduction of our intangibles due to the sale of the DMM business. Our cash and cash equivalents have decreased from $304 million in the fourth quarter of 2008 to $186 million in the fourth quarter of 2009. At December 31 2009, the company's operating subsidiaries had $276 million of trading equity and the holding company had available cash and short-term receivables of $120 million for total liquid assets of $396 million excluding the value of the NYX position.

Our total trading assets which combined our total liquid assets with our NYX position of $55 million decreased to $451 million as compared to $468 million noted at September 30, 2009. This amount excludes the value of the fixed assets, prepaid deposits, deferred taxes and other long-term asset holdings. As noted our available cash and trading assets of $450 million plus the available for sale assets of $32.7 million and the pending tax receivable of $10 million result in over $493 million of liquid assets. The company has committed to a debt redemption of approximately $200 million, including fees and accrued interest for the remaining public debt which results in approximately $293 million in cash and trading assets after the bond repurchase. The company's board management believes that this is more than sufficient liquidity to operate the two remaining business segments and carry out any other opportunities.

The company's board of directors intends to increase the share repurchase authorization from approximately $23.4 million remaining as per the current authorization to 100 million upon completion of the sale of the DMM business. The company's book equity value at December 31, 2009 was $321.3 million or $6.24 per share. At December 31, 2008, the book equity was $442.9 million or $7.61 per share. As of the completion of the sale of the DMM business there will be no intangible assets remaining in the company's balance sheet. Thus, all of the firm's equity is tangible equity at this point.

Now I'll turn the call back over to Michael.

Michael LaBranche

Thanks Jeff. Now the business going forward is going to be much different as we all know we're going to consolidate our broker dealers. This should help us save a lot of money in terms of that. We're eliminating our interest payments, our DMM business did not cover, our interest payments recently and that's really one of the drivers for doing what we did. It's obviously a big change for this company. However, we think looking at the future, it's for the better. We've also changed our approach to our options trading strategy. That has been successful on the last quarter.

That did well, as we've said; we generated $8 million in pre-tax income not including, which also includes the $5 million in interest we paid. We'll fairly consolidate our domestic businesses. And we think that our businesses in London and Hong Kong will be very profitable going forward. And we think that there's great opportunities there, in Hong Kong and in London, is our plan to focus on ETF institutional market making. One of the things that's happened in our business recently, especially when it comes to the former specialist business, that scale is extremely important.

When we started, when I started here a long ago, our market share was about 2% and we operated with less than $2 million in capital running that business. Under those circumstances, it was a on-going business that did quite well. However, everything has changed in the past few years to the point where we had 25% market share most recently. However, scale is critical. So we recognize that fact, we recognize that the business environment has changed enormously and we think that having recognized that, that the changes that we have made most recently and in terms of redeeming our debt are very important.

By redeeming our debt there's very positive implications in that, that allows us to invest in new businesses that allows us to focus on businesses that we think would be have better margins than ones that we've been in the past. It will allow us to buy our stock back without the covenant restrictions. It will allow us to pay dividends as well, positive things for our shareholders. So leaving the DMM business was not a decision that we made lightly. We thought long about it, long and hard about it but we also think that one of the great benefits our company has is a strong balance sheet with no public debt and no intangible assets. So, all in all, I think that one of the most important things for our shareholders to realize is that we are focused on making sure that the assets and the cash that we have are more transparent and that the market will understand that. So these are all reasons that we made the decision that we made.

So at this point I will turn the call over to questions if there are any.

Question-and-Answer Session

Operator

Thank you. (Operator instructions). And your first question comes from Rich Repetto with Sandler O'Neill

Rich Repetto - Sandler O'Neill

Yeah I guess you know just listening to the last comments. Going forward and I'll be honest with you looking back but going forward, do you have any intention of reporting some metrics in regards to the continuing option to breakout of the businesses to give more transparency?

Michael LaBranche

If I can I will. Let me put it that way. But it's a much more complicated situation than it was when we were looking at capture rates back, what was it, nine or 10 years ago. So our business has changed dramatically as a result of that. And right now, going forward, we're going to be a company that really is just, what we think is a very good cash position and we're going to be more selective in how we reallocate our capital. So we're still trading wholesale trades when it comes to trading options. It is not what I would consider the same sort of degree of turnover in those trades that we had historically. So I think its going to be difficult for me to give you a metric. However, if we can devise a metric, we would be very happy to do it.

What we're seeing right now is we're seeing a business environment especially in trading that has changed really rapidly and we understand it and when we talked about last quarter, we talked about changing our option market making strategy and that was in reflection of that as well whereas making lots of trades and high turnover was important to us when we were doing that in the past. Today, we're more focused on selective commitment of capital. Last quarter we talked about showing the capital, and by controlling our capital and showing the life of our options book as well as reducing options, expenses, reducing expenses related to our options trading and we did all those things and as a result we have a lot of flexibility with our positions right now in terms of our liquidity position. So I don't know if I'm going to be able to give you an exact metric of how we're doing things because it's a wholesale trading business is very complicated. It goes against other baskets of stocks in ETFs and things like that. So, it's very difficult to quantify it.

Rich Repetto - Sandler O'Neill

So it's probably even if you look back, it's not a proper reflection on mirror view of the business to try to breakout options versus ETFs versus clearing and other BD operations.

Michael LaBranche

No because there is all sorts of events that takes place and corporate events take place that make a big difference in trading options and actually in ETFs as well, but again you're making trades against other securities, you are making trades against other baskets of stocks, and it's really hard to quantify what your tax rate would be into those circumstances.

Rich Repetto - Sandler O'Neill

So I guess the last thing, you talked about a new strategy in options and I'm assuming that's one 4Q results into that $0.07 that's the driver. Is that correct, and then could you elaborate a more, what was this change to the strategy, and is this sustainable going forward?

Michael LaBranche

Well, we have from our continuing operations, we've got an ETF domestic market-making business, wholesale options, market-making business. We have a institutional brokeraged business and a fixed income business which is new to us. Apart from those operations which those are domestic operation which we're as Jeff described in his talk, we're consolidating into one broker dealer. In addition to those businesses, we have a business in London and Hong Kong which is focused on market making in ETF. Those things all together were our results for this past quarter.

As far as our institutional brokerage business, we are experiencing a slowdown in volumes that is an industry wide slowdown, it's not particular to our company, it has been going on for a few months now. Again that kind of business would be dependent on volumes improving. So in the meantime we are going to have to focus on cutting our costs in that business and that's part of our planning in combining our domestic op business segments in Q1 broker and dealer. So if you want to think about what we have going forward we've got that business, domestic institutional brokerage business, our fixed income, trading business which is new and which we are optimistic about. We've got the options market making business the ETF market making business and in addition to that we have our ETF market making business in London and in Hong Kong. The one in Hong Kong we are still in the process of building out, London is up and running, its been going for several years and producing profits to the company.

With all of those things I think that the other thing that we have to look at our business going forward is simply the flexibility to get into businesses and use our capital wisely and have no restrictions on how we are going to use that capital relative to what we were before. I think that is a big reason that the management undertook this new approach to running the business. We don't know exactly what the market structure is going to look like. We don't know what the implications of the financial crisis that we went through in 2008. What the far reaching consequences of that are going to be relative to large financial companies and what does it mean for the small one.

However, I am sure there will be opportunities and we are just going to focus on businesses and in a highly specialized approach we are not going to try to do all things. And we're not going to try to compete on a capital basis with the large financial companies because they've got a different way of going about how they're going to function in their business environment.

Rich Repetto - Sandler O'Neill

Okay. And if I could just sneak one last question, if you look back, you can back out the specialists pretty much in giving what you're release today. The specialist was sort of breakeven in 4Q. Could you say going back farther, do you think the business now historically is less volatile without the specialists or more volatile or unchanged because it doesn't look like the results, like its smoothes the results out and materially by removing the specialists if I'm doing this correctly.

Michael LaBranche

I don't think that it's going to necessarily make the result less volatile. I think that what it does is it eliminates a very large expense for the company which in the event that business slowed down that it would smooth out our earnings that way because the worst case scenarios for us would be to have those high expenses and all of our businesses slow down. So that I think is a very good development for the company. So in that respect it does probably lessen the volatility to some extent.

With respect to the specialist business or the DMM business, that's been undergoing changes for a long time. We have, I think, done a very good job in the past in adapting to the changes it took place. But as I said before on my comments the world has changed and scale is very important and we recognize the importance of that in our position. So we think that it makes sense to focus on other aspects of our business.

Rich Repetto - Sandler O'Neill

Okay.

Michael LaBranche

If we can also reduce the volatility in the earnings, at least what we can do is make the strength of our balance sheet more apparent to the public and that's what we've done here.

Rich Repetto - Sandler O'Neill

Understood, I get it. Thanks Michael, and congratulations.

Michael LaBranche

Thank you.

Operator

[Operator instructions]. And you have a question from Robert Torray of Torray Company.

Michael LaBranche

Bob

Robert Torray - Torray Company

Hey good morning Mike. Mike?

Michael LaBranche

Yes. Hi Bob.

Robert Torray - Torray Company

I just wanted to tell you how well thrilled we are with what you and your team have accomplished. That's really in such a tough environment which you know better than we do, but we were very, very pleased with the outcome. I just want to let you know.

Michael LaBranche

I appreciate that Bob, and we think these are all positive developments for the company going forward.

Robert Torray - Torray Company

Yeah me too.

Michael LaBranche

And I really appreciate it.

Robert Torray - Torray Company

Okay.

Michael LaBranche

Thank you.

Operator

Your next question comes from Jonathan Vyorst of Paradigm Capital.

Jonathan Vyorst - Paradigm Capital

Hi. I was just wondering if you could give a little color on here, on the increase in the repurchase authorization.

Michael LaBranche

We believe that our stock has been trading at a discounted tangible book for considerable period of time and one of the covenants in our debt covenants, in our debt was that we had what was called restrictive payments which at this point would have allowed us only to buy $9 million worth of our stock back but having redeemed our debt, those restrictions disappear and we can actually buy whatever we think is appropriate for the company. So those restrictions are gone and with that restriction having been eliminated from the ceiling of $9 million, we think that that was the appropriate thing to do considering the price of the stock. That's really that simple.

Jonathan Vyorst - Paradigm Capital

Okay are you thinking about a tender you know offer or something.

Michael LaBranche

Well, in both of our release when we talked about selling the DMM business we talked about the fact that we increased it to $100 from $23.4 million and there's also language in there that describes what the company may or may not do and at that point I am not going to go any far than that for the company to determine what the best approach would be to the buy back but the language in there in that language there are several options which is open market purchases, the tender offer Dutch tender, privately negotiated transactions.

Jonathan Vyorst - Paradigm Capital

Okay. Thank you.

Michael LaBranche

Welcome.

Operator

Thank you. At this time there are no further questions. Mr. LaBranche are there any closing remarks?

Michael LaBranche

I just want to thank everybody for listening and will talk to you soon, thank you bye.

Operator

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

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Source: LaBranche & Co., Inc. Q4 2009 Earnings Conference Call
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