Updated from 8:15 a.m.

Shares of specialist firm LaBranche ( LAB) surged Friday, despite another disappointing earnings report, as investors believe the company can turn profitable by slashing expenses.

On an operating basis, LaBranche lost $1.8 million, or 3 cents a share. But the stock rallied after CEO Michael LaBranche told investors during a conference call that the firm plans to slash expenses and is finding ways to prosper from the New York Stock Exchange's move to electronic trading.

LaBranche's profits have tumbled the past few years as it floor-based execution specialists have lost market share and the firm finds fewer opportunities to trade its own capital in an increasingly electronic market place.

But for the moment, investors are willing to give LaBranche the benefit of the doubt. Shares, at midday, were up 76 cents, or 8%, to $9.76.

It's not clear, however, if that optimism is warranted based on the firm's fourth-quarter earnings report, which reveals that LaBranche is turning into a giant holding company for shares of the parent of the Big Board.

The once-powerful trading firm says a pretax gain in the value of its restricted shares of NYSE Group ( NYX) accounted for about 60% of the $118.6 in revenue LaBranche generated in the fourth quarter. The paper appreciation in the value of those shares helped LaBranche more than double its net income in the fourth quarter.

But without the revenue boost from the increased value of those shares, it was another woeful quarter for LaBranche on an operating basis.

The net income numbers are impressive. The firm earned $39.1 million, or 63 cents a share, compared with $17.4 million, or 28 a share, a year earlier. Total revenue rose 48%

Yet the operating numbers at LaBranche, which has been hit hard by the NYSE's rapid move to electronic trading, tell the real story. Stripping out the $72.3 million gain in the value of the firm's restricted shares, LaBranche lost $1.8 million, or 3 cents a share.

Net revenue -- less the restricted stock gain -- totaled $46 million, down from $80.5 million. The year-ago fourth quarter did not include a similar restricted stock revenue gain because the New York Stock Exchange did not go public until last spring.

The fourth-quarter results also include restructuring charges of $3.7 million and a net benefit of $1.9 million due to a decrease in the firm's tax and legal contingencies.

Analysts as surveyed by Thomson Financial were looking for earnings of 6 cents a share on revenue of $108.4 million. It's not clear whether analysts had stripped out all of the restricted stock gain from their estimates.

The firm says that excluding the value of its Big Board restricted shares, it earned just $1.1 million, or 2 cents a share, for all of 2006, compared with $37.5 million, or 61 cents per diluted share for 2005.

Either way, the fourth-quarter numbers are further evidence of the withering of LaBranche's core specialist, or market-making, business. Net gain on principal transactions fell 24% from a year ago to $45 million.

LaBranche is one of a handful of trading firms that used to power trading on the Big Board. But the advent of electronic trading has cut into the market share of specialists who rely on people on the floor of the Big Board to process trades through the increasingly outmoded open-outcry form of stock trading. LaBranche recently said it may lay off many of its employees who work on the exchange's storied floor.

In the conference call, LaBranche says the firm will reduce expense further going forward. That sounds like even more layoffs could be in the works.

The NYSE's new hybrid trading system, which combines electronic trading with floor trading, is making it more difficult for specialists to find their own trading opportunities and generate revenue.

Significantly, LaBranche says it reduced the regulatory capital at its specialist and market-making segment by $57.0 million in the fourth quarter. In the third quarter, it reduced regulatory capital by $49 million. The firm expects similar capital reductions in 2007, which it says will free up "additional funds to be used for other corporate and business purposes."

Specialists are required to maintain a level of regulatory capital to guarantee their solvency and ability to back customer trades. LaBranche offered no explanation for the capital reductions. But it may be an indication that as its market share declines, it needs to hold less capital in reserve.

Interest paid by borrowers of stock soared to $58 million, up from $17 million a year ago. Rising interest rates have made stock loans more profitable.

But at the same time, LaBranche's own interest expense has risen. In the quarter it paid out $80 million in interest expense, up from $30 million a year ago.

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