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

Q2 2008 Earnings Call

July 18, 2008 9:00 am ET

Executives

Michael LaBranche – Chief Executive Officer, President and Chairman

Jeffrey McCutcheon – Chief Financial Officer and Senior Vice President

Stephen H. Gray – General Counsel and Corporate Secretary

Analysts

Marc Sulam - Healy Circle

Phyllis Curcuru - Pax World Funds

Richard Repetto - Sandler O’Neill

Mike Vinciquerra - BMO Capital Markets

Daniel Harris - Goldman Sachs

Operator

Good morning. My name is Natasha and I will be your conference operator today. At this time, I would like to welcome everyone to the LaBranche second quarter 2008 earnings 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 period. (Operator Instructions) It is now my pleasure to turn the floor over to Steve Gray, General Counsel.

Stephen H. Gray

Thank you. Good morning and welcome to the LaBranche & Co Inc., 2008 second 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 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 second 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.

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 CEO and Jeff McCutcheon, Chief Financial Officer. Michael and Jeff will take your questions after they conclude their formal remarks.

With that, I will turn the call over to Mike.

Michael LaBranche

Good morning. Today we reported loss of $21 million on our U.S. NYSE Euronext charge. On a pro forma basis, LaBranche earned $3.5 million on a pre-tax basis. These results also include $2.2 million in non-cash expenses. At this point, I’ll turn the call over to Jeff.

Jeffrey McCutcheon

Thank you, Michael. Good morning, everyone. Our second-quarter GAAP net loss is $21.3 million or $0.34 per diluted share, which includes an unrealized after-tax loss of $19.9 million related to our investment in the NYSE Euronext stock position and a $3.1 million after-tax expense on early extinguishment of the debt of $169.1 million.

Excluding the after-tax effects of the unrealized NYSE Euronext loss and the debt extinguishment expenses, the company had a pro forma net income from operations of $1.7 million or $0.03 per diluted share.

The comparable pro forma net income from operations for the second quarter of 2007 was $6.6 million or $0.11 per share as noted on the Regulation G reconciliation attached to the press release this morning. Similarly, the comparable pro forma income for the first quarter of 2008 was $7.8 million or $0.13 per share.

Our revenues, net of interest expense and excluding the unrealized loss from the NYX shares, decreased by $15.6 million to $41 million when compared to the first quarter 2008 operating net revenues of $56.6 million.

The revenue decrease noted during the second quarter was mainly attributable to reduced trading opportunities in our specialist and market-making business, as compared to the first quarter of 2008. By comparison to the second quarter of 2007, operating net revenues were $53.4 million.

Revenues net of interest expense for the first six months of 2008 were $97.6 million compared to $95.5 million for the same comparable period in 2007. Our net principal trading revenues were $43.6 million in the second quarter of 2008.

Year-over-year, the trading revenues for the second quarter of 2008 were $20.4 million lower than the $64 million reported in the second quarter of 2007. However, the inventory financing costs related to the principal trading revenues were also lower year-over-year by $14.5 million.

The commission and other fee revenues were flat at $10 million for the second quarter and the first quarter of 2008 and declined when compared to the $11.9 million reported in the second quarter of 2007.

The two-tiered liquidity provision payment amounted to approximately $3.8 million for the second quarter of 2008 versus $5.3 million in the first quarter of 2008.

The company’s investment in $3.1 million NYX shares decreased during the quarter in value by $33.2 million before taxes to $154.4 million at June 30, 2008. This included a valuation allowance of 7.5% on the final one-third tranche of restricted shares.

The closing price of the shares was $50.66 at June 30, 2008. As a reminder, the final tranche of restrictions is scheduled to be removed from the shares on March 7, 2009.

Interest income was $17.4 million in the second quarter of 2008, compared to $67.3 million in the same period last year. For the second quarter of 2008, $15.7 million of this amount represents a component of our trading revenue in our market-making transactions. The trading interest income decreased $12.5 million quarter-over-quarter from $29.9 million in the first quarter of 2008.

Other interest income, mainly generated by our short-term investment of our excess cash balances, decreased $1.7 million to $1.8 million for the second quarter, compared to $3.5 million in the first quarter of this year.

The decline in the other interest income is mainly due to the continued decline in the federal funds rate since January 2008 and reduced cash balances due to the repurchase of our public debt noted earlier.

Margin interest expense, which is mainly used to finance our market-making inventory, decreased $20.8 million from $30.8 million in the first quarter of 2008. Other interest cost related to our bonded and subordinated debt decreased quarter-over-quarter to $8.5 million in the second quarter of 2008 versus $10.9 million in the first quarter of 2008, mainly due to our repurchase of $169.1 million of our public debt during the quarter.

The $10 million decrease in inventory financing costs for the quarter netted against the $10.7 million decrease of trading interest income, noted earlier, results in a combined increase in the trading finance cost of $700,000 to $5.1 million versus the first quarter of 2008. As noted earlier, however, the financing trading costs year-over-year are down $14 million.

The management of the company views stock borrowed interest income and margin interest expense as an integral component of the net principal transaction revenue for the market-making division.

Although not reported for GAAP financial statements, our management generally refers to net trading revenue as net gain on principal transactions less the net cost from financing of the inventory, which is the result of the stock borrow rebate interest income less the margin interest expense.

Thus, if you take the net principal trading revenue of $43.6 million less the net cost from financing inventory of $5.1 million, which is derived from the $15.7 million of stock borrowed interest income, less the $20.8 million of margin interest expense, the trading income for the company is $38.5 million for the second quarter of 2008.

The same amount for the second quarter of 2007 would be $63.8 million less the inventory financing cost of $19.6 million, which is derived from the $59.3 million of stock borrowed interest income in that quarter, less the $78.9 million of interest expense. The net trading income for the same period in 2007 was $44.2 million.

Overall expenses of $37.6 million, excluding taxes and debt extinguishment expenses, decreased from the comparable quarter of a year ago by $12.3 million, excluding the impairment charges of $499.4 million in 2007.

Quarter-over-quarter the total expenses, excluding the taxes and debt-extinguishment expenses, decreased $10.3 million from $47.9 million. The decrease in total expenses was mainly attributable to decreased compensation, depreciation, and other expenses.

The compensation costs for the quarter were $19.6 million, which decreased $4.6 million over the second quarter of 2007 compensation of $24.2 million. Quarter-over-quarter, the compensation costs decreased $8.9 million from $28.5 million in the first quarter. Domestic employee head count as of June 30, 2008, was 215 compared to 312 employees at June 30, 2007.

Exchange, clearing and brokerage fee expense decreased quarter-over-quarter from $10.7 million in the first quarter of 2008 to $9.7 million in the second quarter of 2008. Year-over year, the exchange, clearing and brokerage expenses decreased compared to the $10.6 million of expenses in the second quarter of 2007.

Depreciation and amortization expenses were basically flat in the first and second quarters of 2008 at $900,000.

Other expenses decreased quarter-over-quarter to $6.9 million in the second quarter versus $7.3 million in the first quarter of 2008. Compared to the same period in 2007, other expenses have decreased $3.1 million from $10.1 million in the second quarter of 2007.

For the first six months of 2008, the other expenses of $14.3 million decreased by $5.3 million from $19.6 million in the comparable period last year. The company has realized significant year-over-year reductions of communication, occupancy, insurance and legal expenses as part of management’s commitment to reduce legacy costs.

The effective tax rate for the second quarter of 2008 was approximately 38.9%. Going forward in 2008, our tax accrual rate is at 40%. Deferred tax liabilities, net of deferred tax assets have decreased from $71 million at December 31, 2007, to $26.1 million at June 30, 2008. This change was mainly due to the decrease of the unrealized tax gain on our NYX shares.

The company has been successful in offsetting its deferred tax assets against current earnings. As such, actual tax payments for the first six months of 2008 were $1.1 million. The company received an $11 million tax refund in April, thus creating a net tax cash inflow of approximately $10 million for quarter.

During the last quarter, the company exercised a call opportunity to extinguish $169.1 million of the 9.5% public notes. In addition, the company had other debt retirement opportunities of $4.7 million for subordinated debt.

The cost of the call opportunity was $4 million, in addition to an accelerated write-down of related debt issuance cost of $1.1 million for a total expense of $5.1 million on a pre-tax basis.

On an after-tax basis, the cost for the call opportunity was $2.4 million, which was further reduced by a $400,000 tax cash flow from the write-down of the debt issuance costs resulting in a net cash outlay of $2 million for the entire $160 million debt extinguishment.

For the first six months of 2008, the company has extinguished $255.6 million of debt, including subordinated debt. At June 30, 2008, the remaining debt consists of $209.9 million of the 11% public notes maturing on May 15, 2012.

There are call opportunities remaining on the debt, which places the company in a very flexible position to manage liquidity. The current interest expense on the remaining notes is approximately $6 million per quarter, including the related amortization of debt issuance costs.

Our total assets decreased from $5.3 billion in the fourth quarter of 2007 to $4.5 billion in the second quarter of 2008. The decrease of approximately $800 million was mainly a decrease in cash and cash equivalents of $228 million related to repurchase of public debt and a decrease in financial instruments owned at their value of $586 million, related to a decrease in current trading assets employed in the specialist and market-making segment.

Financial instruments sold, but not yet purchased, decreased by $534 million. There also was a $250 million reduction of public debt during the six months ended June 30, 2008. At June 30, 2008, the firm’s balance sheet continued to be highly liquid with significant cash and cash equivalent balances.

Our cash and liquid asset position including the federal segregated cash and repurchase agreements has decreased from $505 million in the fourth quarter of 2007 to $277 million in the second quarter. The decrease in the cash is mainly related to the repurchase of our public debt.

The company’s cash available at its holding company has decreased to approximately $189 million at June 30, 2008, from $269 million at December 31, 2007. Again, mainly due to the debt extinguishment payments offset by additional cash flows from the reduction of the 75% of the regulatory capital at the cash equities specialist business during the first six months of 2008.

The company’s book equity value has decreased quarter-over-quarter to $468.9 million mainly due to a GAAP loss of $21.3 million for the second quarter. Our June 30, 2008, balance sheet still includes intangible assets of $109.2 million for goodwill and trade name.

A portion of the remaining intangible assets are tax deductible and will yield an estimated tax benefit of approximately $25.8 million. Thus the company estimates the tangible equity at June 30, 2008, to be approximately $385.5 million.

At June 30, 2008, our trading subsidiaries had approximately $254 million of liquid working capital, mainly composed of $224 million for the specialist and market-making segment and $30 million at the institutional brokerage segment. These amounts exclude any value for NYX shares pledged as trading capital.

In summary, there is cash of $189 million at the holding company and $254 million of working capital at our trading subsidiaries, as noted. These amounts added to the fair market value of the NYX position constitute the majority of our assets over $600 million and represent the flexibility of our company to operate and grow the existing businesses, while considering other opportunities as they arise.

Now I’ll turn the call back to Michael.

Michael LaBranche

Thank you, Jeff. We’ve made a lot of changes in our specialist business and our market-making segment and I think it’s paying off. We showed a profit of $15.3 million at our specialist and market-making segment this past quarter; that’s excluding the loss of the NYX shares and we are really working to adapt to the new marketplace using technology. We’ve made a lot of progress there.

We are also very big in trading newer business lines in terms of both ETFs, options, indexes and things like that. We’re also building our institutional brokerage business. That particular subsidiary showed a loss of $2.1 million this last quarter, but I think that loss is really mainly attributable to start-up costs and that we are really making a concerted effort there. We see a great opportunity there.

We bring a lot of expertise. We’ve made a lot of key hires. Many of the people that we’ve hired have just gotten here and several are just about to get here. So I think that we can show some real added-value there. So between those two operating subsidiaries, I think that there’s some leverage there to benefit from the change in the market structure.

Our biggest expense has been basically what we call the negative carry on our bonded debt. That is a number that we get to by calculating the cost of the debt, the coupon, less what monies we would receive as a result of having that cash on-hand.

So if we had had our whole $460 million in bonded debt, that negative carry would have been $10.2 million; this past quarter it was $7.1 million and this quarter, we anticipate that the negative carry will be reduced to approximately $4.7 million. I’d like to also add that we have flexibility on that number going forward, as we manage our balance sheet.

Our balance sheet is very strong and very liquid. This year so far, we’ve returned about $250 million in capital back to the investment community. But even having done that, we are in an extremely liquid balance sheet, strong position there; we have ample capital to run our business and grow it.

We’re concentrating on building our business in London and Hong Kong. That is yielding results. There’s a lot more trading going on in London in ETFs and things like that, and we see an opportunity there.

I think that the most important thing for us to do here is realize that we need to continue to get our expenses down and at the same time work on growing our revenues. I think we’ve made some very good progress this last year.

It’s been a lot of hard work getting to where we are today, but I think we’re really in a better position we’ve been in in a long time. So, at this point I’d like to turn the call over to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Daniel Harris - Goldman Sachs.

Daniel Harris - Goldman Sachs

There’s been obviously, and I think you mentioned a little bit, Michael, there’s been press over the last almost a year now that sales traders continue to leave the bigger firms and move to the independent firms like what you’re building up there.

Can you comment a little bit on the competition for these guys, and once they’re in the seat, how long you think it takes for them to generate the kind of returns that you think they’re capable of generating?

Michael LaBranche

That’s a good question. I think it’s a matter of months; maybe somewhat less and it’s going to depend on who’s there and what the situation is. The important thing is they have the technology and the capability of scaling the business.

As you know, Wall Street has undergone some very significant changes in the way people interact; a lot more electronic trading. However, we still believe that there’s a need for what I consider the relationships, with knowing the customer, what their needs are, and I think that’s a very important thing to focus on.

I think that you’ll get rewarded for providing good prices, for giving good service. I just think that there’s an opportunity there. The fact is, is that a lot of firms are moving to more electronic platforms and not as much what we call high-touch business, which is high service.

But we think that there’s a very good opportunity for us. We have a lot of capital. We’re very experienced in trading, we understand what it is to do facilitation for customers and so that’s what we’re focused on.

Daniel Harris - Goldman Sachs

Would you expect a loss that you inferred about the $2.1 million to be ongoing for the next quarter or two or do you think that that could turn to a positive number by, say, the early part of next year?

Michael LaBranche

It’s hard for me to predict that, because I don’t know what activities will be, but right now the markets are pretty busy. I am anticipating that that number should go positive sooner rather than later.

Daniel Harris - Goldman Sachs

Okay. And just to follow-up on something you said about capital, Michael. You obviously have a very solid balance sheet and in some cases it might actually be too solid for what you do with the ROE that you’re generating, in the single digits here.

What do you think about in terms of longer-term ROE that you can develop with the businesses that you’re in today? Do you think you can get this into a 15% range or should we expect that unless you’ve really changed the capital structure of the company that we should expect around the same level.

Michael LaBranche

I think that right now it’s better in today’s environment to have too strong a balance sheet, even though it might not be optimal for ROE, but I think that there’s going to be some very significant opportunities coming up in the next year. So having that I think is a good problem to have if your balance sheet is too liquid or too strong.

We have the flexibility of eliminating that bonded debt of $210 million. So we can certainly look at that. If the negative carry of $4.7 million per quarter is what we think is unnecessary.

However, I think that what we’ve done in the last few years and the last year in particular, it has put us in a much better position. We’ve been very careful with our capital.

We’re sticking to the businesses that we understand. We’re going to continue to do that. I don’t know exactly where the opportunities are going to come, but you can see that there’s so many changes going on that it’s good to have that extra money.

Daniel Harris - Goldman Sachs

Okay. Thanks for that. And then just lastly for me, if I look at the volume and the activity in the quarter across the industry, Tape A and Tape B were up pretty significantly on a year-over-year basis and ETFs were up something like 40% and yet the trading revenues, when you calculated them were down 13% year-over-year.

Is that just losing market share, or is that the change in the interest rate throughout the quarter that was negatively impacting that? How should I think about that relative to the industry?

Michael LaBranche

The second quarter of last year, I believe, was our best quarter for the year. It’s hard to look at that in quarter segments, because I’d really like to think of how we’re doing over a longer period of time. I can’t explain why it was down 13% over our best quarter of last year, but I do think it’s good to come up with that number, having had a much better trading revenues in the first quarter.

The markets are very volatile right now. Some of the declines that we’ve seen in some things have been totally unprecedented, but we did manage to do okay, considering all these things that are going on.

If we can put together a good third and fourth quarter, so we can show you a picture of twelve months, I think it’d be much more meaningful to you. We are still continuing to work very hard on our electronic trading at the specialist business, the cash equity business. We think we’re making some very good progress there.

It’s basically all electronic now, and so those are all things that we’re doing so for us to come in with this number, the second quarter, we’re always looking for a higher number and we’d like that. Can’t guarantee it, but it’s still a positive number and against the backdrop of a good first quarter, I think it’s a pretty decent six months and something to build on.

Daniel Harris - Goldman Sachs

Thank you, Michael.

Operator

Your next question comes from Mike Vinciquerra - BMO Capital Markets.

Michael Vinciquerra - BMO Capital Markets

I want to ask on the changes that are occurring at the NYSE, where it’s now going to allow you to trade on par with everyone, but you lose potentially some information advantage. Can you talk, Michael, about the net impact to your business and the way you have been managing for the future?

Michael LaBranche

We’re watching the proposals very closely for obvious reasons. Can’t make any guarantees, but we think that it will be net positive on balance, as again I can’t guarantee anything. But we think it is, there’s some trade-offs there.

But keep in mind, in electronic trading is a totally different way of trading. You are not seeing block trades the same way as once occurred and the information that you might think is there is a completely different kind of information; it’s electronic messages and the average size of a trade is down to just a very small fraction of what it used to be a few years ago.

So in terms of trading on parity, I don’t know what’s going to be approved. What I can tell you is that whatever market structure is decided upon, we’re going to work with it. That’s what we’ve been doing up to now and getting by, as things change. I think on balance, the new proposal should help us; should give us more flexibility.

Again, another important thing I think to think about is with the New York Stock Exchange market share being down as low as it is today, a lot of what I would consider the old structure is an anachronism in terms of being able to integrate trading units and I think that a lot of the Chinese Wall things really actually work the same way they were and obviously, we need to safeguard everything and make sure everything is done properly.

But there should be some more integration as the market changes, especially with cash equities being just one piece of the puzzle now.

Michael Vinciquerra - BMO Capital Markets

On that topic, your expertise in options having been a market-maker for many years now, the opportunity for your − whatever they’re going to be called − designated market-makers to utilize options trading directly from the floor, is that going to be an advantage to you?

Michael LaBranche

That’s just getting back to what I was talking about before. I think that there should be more integration of how things trade and certainly when 70% of the market’s trading away from you, you need access to that market in order to make markets. I would think that over the next couple of years, we would look very much forward to integrate some of these cash equities businesses with the options.

Michael Vinciquerra - BMO Capital Markets

Okay. Very good. Thank you. And you’ve mentioned the London operation a couple of times. Can you give us any sense for what contribution your international businesses as a whole are making to your top line revenue at this point? In London, you mentioned specifically ETFs, is that your lead product right now, is specialist market-making in ETFs?

Michael LaBranche

It is our lead product right now and we’re expanding our product base there as we speak. It’s still a small minority of our business, but it is getting for the six months it was much better than it has been and it has been growing pretty rapidly. So I see a lot of opportunity there.

I think people really need it and they need market-makers there too and getting back to what we’ve always said in the past that I think that the markets themselves really do need market-makers, dedicated market-makers. I think it’s more evident now than it’s been in a long time that market-makers are important in providing liquidity. I think that’s what we’re doing there.

Michael Vinciquerra - BMO Capital Markets

Okay. And then just one question on the numbers side. When we look at the employee comp and benefits, you have been managing that quite aggressively and effectively. Can you give a sense for the fixed costs on your 210 or so employees, just as we look forward and then obviously we can vary that based on what we think in terms of revenues and production?

Michael LaBranche

It’s a variable cost. So if we make a lot of money and we’re able to make money for our shareholders, we’ll be able to pay our employees more, but on a fixed basis, in terms of like fixed overhead which I think you probably think of as salary, correct?

Michael Vinciquerra - BMO Capital Markets

Right. That’s right. And benefits as well.

Michael LaBranche

Benefits too, which I consider part of salary, because it’s a fixed cost. Jeff’s the expert on that.

Jeffrey McCutcheon

The run rate’s about $1.2 million a pay period, times 24 pay periods. I want to say it’s about $25 to $27 million a year. Then there’s the incentive pay.

Michael LaBranche

And then that points out the fact that how much our business has changed, having gone from 600 employees to 200 employees in two to three years.

Jeffrey McCutcheon

Absolutely.

Michael Vinciquerra - BMO Capital Markets

Okay. Thank you.

Operator

Your next question comes from Rich Repetto - Sandler O’Neill.

Richard Repetto - Sandler O’Neill

Just getting into the smaller line items. Excluding the NYX investment, you still had a net loss on investments of $3.1 million or so. You had a couple of million loss last quarter too, but I couldn’t find in the filings what that’s due to. Could you explain the $3 million loss after the NYX?

Michael LaBranche

We hold certain other assets and like proprietary trading assets, hedge funds…

Jeffrey McCutcheon

Very small amounts of money, by the way. Our non-marketable securities are a total of $12 million; it’s not a big number, but that $3.1 million would include some proprietary trading, as well as some small markdowns and some small investments.

Michael LaBranche

One other thing to realize is to think about that number more unrealized than realized, because again there are lot of situations where we are marking the market or taking our equity share due to the GAAP rules and not necessarily, we’re not disclosing any of those investments.

Richard Repetto - Sandler O’Neill

Hopefully the model transforms, but if $1 million is around a $0.01, that’s $0.03 or almost what you’ve reported on operating profit.

Jeffrey McCutcheon

That’s true but when you have some assets, there’s always going to be mark-ups and mark-downs and they can go positive too sometimes. I understand what your point is but the way we’re running the business is that hopefully, we’re going to get to the point where the $3 million isn’t our whole profit.

Richard Repetto - Sandler O’Neill

Sure. On the other flipside in this other revenue line, you had $2.5 million and I’m not sure what that is either. $2.46 million.

Michael LaBranche

In other revenue, again, we have various income producing assets; you have to think of it that some of them are net trading amounts, but we also have like income from rebates; income from assets that we hold; sometimes even deposits that we have on things. So we have other income items that are coming in, continuously throughout the year.

Richard Repetto - Sandler O’Neill

What rebates are we talking about?

Michael LaBranche

Like ISE rebates or other types of trading activities…

Jeffrey McCutcheon

From exchanges, things like that.

Richard Repetto - Sandler O’Neill

Okay.

Michael LaBranche

…participation-type activities, and that’s the other category. They’re not large enough to break them out on their own as a separate identified piece on the balance sheet, so they’re just other.

Richard Repetto - Sandler O’Neill

But it did go up by more than $2 million quarter-to-quarter though?

Michael LaBranche

For example like we had ISE rebates that came in this quarter; we had more participation than we did in the past. As the business grows, there is other detailed amounts in there, and bear in mind too, we’re having situations where we’re getting rebates back from things that we have dealt with getting rid of our occupancy leases and things like that and there’s just charges for other income.

There are really other income items in the sense that they are not like planned revenues, like your other things are. They’re more one-offs that come in every so often.

Richard Repetto - Sandler O’Neill

Got you. Okay. And then the implied tax rate; we’re sitting here with a higher estimate than $0.03. But the implied tax rate on your operating profit was 51.5%. What should be a good operating tax rate going forward?

Michael LaBranche

As I said in the comments for the quarter, it was 38.9%. I’m not sure how you are getting to that…

Jeffrey McCutcheon

There was a reserve.

Michael LaBranche

Yes, there were reserve items that went through, but with the overall numbers it’s run rate of more than 40% as the haircut for taxes. So that I believe is the true number to think about − this 40%.

Jeffrey McCutcheon

Yes, I think what the point you are getting to, if I’m not mistaken is, that our tax rate on the operating income was actually more than 40%.

Richard Repetto - Sandler O’Neill

I’m looking at the pro forma adjustments. You had $3.4 million of pre-tax and $1.759 million of taxes; so it’s 51.5%?

Michael LaBranche

It has to do with some of the reserves on taxes from the quarter; Jeff’s the expert on that, but it was like $400,000 or $500,000 right?

Jeffrey McCutcheon

Basically what happened under FIN 48, we have interest related to that reserve as well as other small changes in the reserve during the quarter and for the prior three quarters we’ve always had reserve decreases, mainly due to expiring tax years that were going on.

Basically this is the first quarter in the last four quarters where we’ve had an increase of reserve mainly around interest and small related items that have to be reserved for under FIN 48.

Richard Repetto - Sandler O’Neill

Okay. And my last question: the compensation went down. On the operating expenses, you cut out $10 million plus of expenses quarter-to-quarter. I heard you say you’re investing in the institutional brokerage and hiring. So I expect it to go up but, other than the institutional brokerage, is any of that comp line variable with net gain on principal transactions, now that it’s so electronic?

In other words, I wouldn’t expect that if you had a good quarter, or a quarter like the first quarter, for that comp line to go up with it, because you are way more electronic, other than the hiring for institutional brokerage. Is that correct or not?

Michael LaBranche

Remember the trading itself is electronic, but you still have people here in the company that are designing the systems and still people making capital commitments and it’s not just a server farm. There are 211 people here and some of them are very, very capable and we’re going to increase our bonus accruals if the company does well to reward those people that are making the company do well.

I don’t think it’s going to stay static, no matter what. We’re obviously managing our compensation cost and I think we’re doing very well with it but it’s not going to be a static number necessarily, Rich.

Richard Repetto - Sandler O’Neill

Got you. Okay. That’s all I have. Thanks.

Operator

Your next question comes from Phyllis Curcuru - Pax World Funds.

Phyllis Curcuru - Pax World Funds

Hi, thank you. I was just wondering if you could talk a little bit about what you expect volumes to be as we get maybe more deep into this recession? What usually happens during that kind of timeframe? I know you have been around long enough to have gone through a couple of these things. What do you usually expect to happen?

Michael LaBranche

That’s always the big question, is what’s going to happen and I think, if you think about what’s happened to the exchange stocks and why they’ve been going down so much is, I think that there’s a lot of sentiment out there that after the bear market progresses and you get into a recession, if that’s what people think is going to happen, that volumes tend to go down. I think that’s what has happened historically.

What’s happening now is interesting because there’s been a big deregulation in trading and overall volumes have really grown quite a lot. I think that the consolidated volume on the New York Stock Exchange the other day was something like 7 billion shares. So you can see that’s like what happened to the telecom industry 20 years ago when they got deregulated.

So you’ve got two different dynamics working here. It seems to me though with the amount of shares outstanding today, you can’t compare today’s market to what went on back in the 80s or last recession.

My feeling is that as transaction costs go down, electronic trading continues to go up, that volumes should increase over time. I don’t think we’re going into a period where people just stop trading. I really don’t think that’s going to happen. But that’s my opinion.

Phyllis Curcuru - Pax World Funds

Yes, and certainly with volumes being up over during the last quarter.

Michael LaBranche

Yes. The New York Stock Exchange market share yesterday was – I don’t know what it was – but there was 2 billion shares traded on the floor. We’re seeing some big changes in behavior with electronic trading, but volumes should I think over time continue to grow.

Phyllis Curcuru - Pax World Funds

Do you think ETFs have an impact on that as well?

Michael LaBranche

ETFs, sure. Because when people do ETFs they do baskets against them.

Phyllis Curcuru - Pax World Funds

Right.

Michael LaBranche

And that increases volumes.

Phyllis Curcuru - Pax World Funds

Okay.

Michael LaBranche

So all of that ties in together, and that goes back to what I was saying now the markets are all interrelated and where cash equities was once everything, it’s just a piece of the puzzle now.

Phyllis Curcuru - Pax World Funds

Okay. I know you trade with other brokerage firms and banks and that type of thing. Have you increased any kind of reserves for the possibility that somebody can’t repay their debts?

Michael LaBranche

You mean counter-parties?

Phyllis Curcuru - Pax World Funds

Yes, counter-party issues.

Michael LaBranche

No, we trade exchange listed.

Phyllis Curcuru - Pax World Funds

But you had some repo and some other things in there, at one-time?

Michael LaBranche

In terms of our operating business, we trade exchange-listed securities. So we clear in a net settlement system, a DTC.

Phyllis Curcuru - Pax World Funds

Okay.

Michael LaBranche

We don’t have direct counter-parties that way. Our repos or whatever we are using for overnights are done through a bank and we are very careful about the counter-parties there. That’s just with our excess cash.

Phyllis Curcuru - Pax World Funds

Okay. Great. Thanks.

Operator

Your final question comes from Marc Sulam - Healy Circle.

Marc Sulam - Healy Circle

Thanks. Michael, two separate issues. Earlier you mentioned the breaking down of some of the Chinese Walls, under the new regulatory scheme, is it possible or do your competitors on the floor have the advantage of integrating their broker dealers? So Lehman integrating the broker-dealer with VanderMeulen?

Michael LaBranche

I don’t know exactly what’s going on with them. I don’t know what their deal is on that. I think that there is a proposal being prepared or actually it might even be out there already, to certainly modify much of what we call Rule 98, which is the Chinese Wall rule.

I think we’re going to get to a more level playing field that way, which will I think benefit investors. As you can integrate your operations, you should be able to provide more liquidity which will help people. I think that process is underway and I think it’s going to happen.

Marc Sulam - Healy Circle

And wouldn’t modifying or changing Rule 98 make you more attractive to have some relationship with a broker-dealer or somebody who wants to be a broker-dealer?

Michael LaBranche

We are broker-dealer.

Marc Sulam - Healy Circle

I’m sorry. A larger broker-dealer?

Michael LaBranche

I can’t really speculate on that, Marc. I think that what we’ve been doing for the last couple of years just makes us a better company and we’re more flexible, and I think that as we’re a better company, we’re probably perceived differently in the marketplace.

Marc Sulam - Healy Circle

Great. Thanks.

Michael LaBranche

Since there’s no more questions that we will say goodbye to you and we’ll look forward to speaking to you in three months. Thanks very much.

Operator

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

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Source: LaBranche & Co., Inc. Q2 2008 Earnings Call Transcript
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