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Edited Transcript of MN earnings conference call or presentation 5-Feb-20 10:00pm GMT

Q4 2019 Manning & Napier Inc Earnings Call

New York Feb 11, 2020 (Thomson StreetEvents) -- Edited Transcript of Manning & Napier Inc earnings conference call or presentation Wednesday, February 5, 2020 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Marc Orlans Mayer

Manning & Napier, Inc. - CEO & Director

* Nicole Marie-Kingsley Brunner

Manning & Napier, Inc. - CMO

* Paul J. Battaglia

Manning & Napier, Inc. - CFO

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Conference Call Participants

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* William V. Cuddy

JP Morgan Chase & Co, Research Division - Analyst

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Presentation

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Operator [1]

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Good evening. My name is Catherine, and I will be your conference operator today. At this time, I would like to welcome everyone to the Manning & Napier Fourth Quarter and Fiscal Year 2019 Earnings Conference Call. Our host for today's call are Nicole Kingsley Brunner, Chief Marketing Officer; Marc Mayer, Chief Executive Officer; and Paul Battaglia, Chief Financial Officer. Today's call is being recorded and will be available for replay beginning at 7:00 p.m. Eastern Standard time today. The dial number -- the dial-in number is (404) 537-3406, and enter pin 8669959. (Operator Instructions)

It is now my pleasure to turn the floor over to Ms. Nicole Kingsley Brunner.

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Nicole Marie-Kingsley Brunner, Manning & Napier, Inc. - CMO [2]

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Thank you, Catherine, and thank you, everyone, for joining us today to discuss Manning & Napier's fourth quarter and full year 2019 results.

Before we begin, I would like to remind everyone that certain statements made during this call not based on historical facts, including any statements relating to financial guidance, may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements involve known and unknown risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements. Manning & Napier assumes no obligation or responsibility to update any forward-looking statements. During this call, some comments may include reference to non-GAAP financial measures. Full GAAP reconciliations can be found in our earnings release and related SEC filings.

With that, allow me to introduce our Chief Executive Officer, Mr. Marc Mayer. Marc?

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Marc Orlans Mayer, Manning & Napier, Inc. - CEO & Director [3]

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Thank you, Nicole. I'm going to begin, as we always do, with a review of our performance for clients, collectively summarizing the quarter and the full year, followed by a review of the strategic initiatives we've put in place during 2019.

We are pleased to report good 2019 results across almost the entirety of our suite of investment strategies. Last year was a very strong year for both equities and debt around the world, particularly for U.S. equities, and we delivered outstanding absolute results for clients.

Starting with our multi-asset class portfolios, which represent the majority of our assets. Our balanced solutions posted strong absolute returns during the quarter as well as for the full year. On a relative basis, we experienced modest underperformance during the quarter but participated well in the strong market for both equity and debt for the full year. Strong risk management disciplines are ingrained in our DNA. These disciplines typically lead us to provide substantial downside protection and sustained bear markets, while allowing us to capture most of the upside in bull markets.

Our clients have come to expect this type of performance pattern and our broad outperformance during a difficult year for equities in 2018, which preceded robust participation in a very strong 2019 for both stocks and bonds, illustrates the effectiveness of our research process. Particularly for wealth management clients who generally are invest in our multi-asset class solution, our goal remains to deliver investment results that meet or exceed expectations over full market cycles.

By way of example, our flagship long-term growth strategy has a track record stretching back to January 1973. Over 47 years, this globally diversified portfolio of stocks, bonds and real estate has compounded at 9.46% per annum after fees. $100,000 invested in January 1973 is worth $6.5 million today. That is a hugely differentiated proof statement of our capabilities to deliver results in wealth management.

In our fundamental all-equity portfolios, we generated strong outperformance in 2019, driven by excellent security selection. Each of our fundamental bottom-up equity portfolios outperformed its respective domestic, international and global equity benchmarks for the year, and in some cases, the outperformance was dramatic. Most notable were the excellent results in our international accounts. Our Overseas Series outperformed its benchmark by an outstanding 599 basis points in 2019, significantly improving the intermediate term track record of the strategy.

Now on prior calls, we have mentioned that several of our most successful long-term strategies experienced a difficult performance stretch several years ago. Those challenging quarters are continuing to roll off our intermediate term track record. And at the same time, we are very pleased to have added on excellent relative performance this year. Collectively, these factors have led to very impressive improvements in relative results, and we believe we have made huge strides in repairing our 3- and 5-year performance numbers. For example, our global equity separately managed account strategy improved its rolling 3- and 5-year annualized relative returns by 252 and 71 basis points, respectively, versus its benchmark in the fourth quarter alone. The restoration of the intermediate term track record for our global equity strategy is a fair representation of our simultaneous improvement across almost all of our fundamental equity strategies, both domestically and abroad.

Although our quantitatively based disciplined value strategies underperformed benchmarks in 2019, they generated strong absolute returns. The strategy is biased towards out of favor and more defensive-oriented securities weighed on relative results. This performance pattern is in line with our expectations and over the intermediate to long term, Disciplined Value continues to exhibit a very strong track record versus its Morningstar peer group, the Disciplined Value series ranks in the top fifth percentile on both a 3- and 5-year basis.

Our Rainier team delivered strong absolute and relative results in 2019, with the Rainier International Discovery series outperforming its benchmark by over 250 basis points. Performance remains impressive over longer time periods as well. Over the trailing 3 and 5 years, the Rainier International Discovery series is ahead of its benchmark by an annualized 366 and 248 basis points, respectively.

Also worthy of comment, even though the assets are not large, is our real estate series. This REIT fund outperformed by almost 500 basis points in a strong real estate market in 2019 and has outperformed by about 200 basis points per annum for 3, 5 and 10 years.

Looking ahead to our investment outlook for this year, our investment disciplines have led us to take a more defensive stance on risk in client portfolios. We believe we are facing a more challenging financial market backdrop today than in several years. So for our multi-asset class clients, this means we are modestly underweight equities versus our neutral allocations while remaining flexible enough to capitalize on bottom-up, stock-by-stock opportunities as we find them. This nuanced investment outlook is a reflection of our active approach. But our emphasis on active solutions extends beyond portfolio management. The recent passage of the SECURE Act is the most significant overhaul to retirement regulation since the Pension Protection Act in 2006. For many high net-worth clients, the bill has real financial planning consequences that should be proactively addressed on a case-by-case basis. We believe our ability to pay our dynamic, custom-tailored advisory advice alongside our investment strategies is a key driver of our wealth management value proposition.

I'll now address the progress made on our strategic initiatives during the quarter. These initiatives include our digital transformation and new partnership with InvestCloud, the promotion of one of our top employees to the role of Director of Human Resources, and the rebuilding and expansion of our client-facing efforts under new sales leadership.

Let me now discuss those in more detail, starting with InvestCloud. Recently, we announced a new partnership between Manning & Napier and Los Angeles-based fintech leader InvestCloud. This partnership is a crucial step in our technological transformation, and we are excited by the possibilities that will enable. InvestCloud will provide front and middle office solutions encompassing digital engagement with clients, portfolio accounting and reporting. As we complete our implementation of the Charles River order management system and trade processing in 2020, we will make huge strides towards fully modernizing our front, back and middle offices with respect to investment management and client engagement. As Paul will discuss in some more detail, in 2020, we will also begin to implement Workday to replace legacy finance technology. Workday is widely recognized as the best-of-breed solution for this important function.

There are 2 main ways we expect InvestCloud's expertise to elevate our competitiveness. First and most importantly, InvestCloud's world-class capabilities will allow us to deliver a client experience that is vastly improved. This includes a state-of-the-art client portal, allowing for seamless digital engagement and document processing. We will upgrade our well-respected financial planning capabilities with advanced tools, allowing us to more effectively provide clients with holistic planning, advice and investment solutions, while also improving our ability to attract prospective clients. We believe this partnership with InvestCloud has the potential to drive meaningful revenue synergies by attracting new business and retaining existing business.

Additionally, by leveraging InvestCloud's expertise, we expect to generate significant productivity and operational efficiencies. We will be reengineering business processes, improving cost controls and introducing productivity-enhancing collaboration tools that will better position our enterprise for continued profitable long-term success.

However, as critical as technology is, ours is a professional services business. And our people are, without a doubt, our most valuable asset. We are excited that Stacey Green, a seasoned Manning & Napier manager has been named our new Director of Human Resources. Stacey will help ensure that we set the highest standards for ourselves in terms of the quality and diversity of our team, the training and development they receive and in our efforts to operate with true managerial and leadership excellence.

During the fourth quarter, we made further strides in evolving our wealth and asset management businesses. In Wealth Management, we continue to focus on investing in our people. We added to and rounded out a number of our financial consultant teams, and we have rededicated ourselves to developing and delivering excellent sales training in order to ensure we are the best equipped we can be to handle client needs and to substantially grow our new business. Aiding in those efforts have been 2 notable initiatives undertaken during the quarter. We launched a client survey intended to both generate feedback from our clients as well as to ensure a culture that actively solicits and acts on that feedback. We are completing the survey as we speak and will report on results in the future, but early reads are quite encouraging.

We also put on our annual fall client seminar series, focusing on our high net-worth individuals within Wealth Management. Our seminars were attended by about 500 clients, a meaningful proportion of our client base. Client engagement remains excellent, and we are always excited to have the opportunity to share our insights with so many of our long-standing clients.

Now before turning the call over to Paul to cover our financials, I want to be clear that while we are making progress in positioning the business for sustainable future success, our financial turnaround will not be immediate. In 2020, we continue to expect net outflows across our businesses, albeit at gradually improving rate as well as for year-over-year reductions in revenues and potentially in earnings. Although improved investment performance numbers are critical, our efforts to revitalize the business development functions of our organization are an increasing focus. We are in the process of fundamentally rebuilding our business development disciplines, processes and technologies. This rebuilding includes a significant expansion of the capacity and quality of our teams in order to improve our service for existing clients as well as to accelerate our new business development efforts. While a financial turnaround is not yet imminent, our execution has begun in earnest and early signs of improvement are expected to emerge soon in terms of a pickup in new account acquisition. Despite our expectations for substantial future cost savings from initiatives taken in 2019 as well as from those which will occur this year, we are ramping up our spending on IT and adding to our sales teams to position us for future growth. Consequently, we expect margins to remain under pressure.

Looking back on the last year, we put in place a new management team, established plans and put in motion a wide range of initiatives against the backdrop of a third consecutive year of good results for clients. We enhanced our distribution strategies under the direction of our new sales leadership teams, we formed our governance and operating committees, substantially increased the opportunities for employees to own stock through the expansion of our long-term incentive plan, launched a new technology strategy led by a new Chief Technology Officer, consolidated subscale offerings, eliminated tangential distractions, including the sale of prospective partners in dial and materially reduced costs and head count. I believe we have made progress in reestablishing our firm on solid ground, and I look forward to the strides we will make this year.

With that, I'll turn the call over to Paul for more detail on our financials. Paul?

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Paul J. Battaglia, Manning & Napier, Inc. - CFO [4]

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Thanks, Marc. Good afternoon, everyone, and thanks for joining us today. I'll add some color to Marc's comments, especially with regard to our outlook for 2020, but I'll first begin with addressing our fourth quarter and full year 2019 results.

As a reminder, my remarks will make reference to the non-GAAP financial measure economic income as defined in our press release. Economic income excludes from pretax income, restructuring and transaction costs related to our strategic changes. These expenses may include severance-related costs, certain consulting and other professional service fees related to our key initiatives, costs related to the termination of existing contracts and any gain or loss associated with the sale of a business. Full GAAP reconciliations are included in our press release.

Turning to our fourth quarter results and starting with assets under management. AUM decreased from $20.5 billion as of September 30 to $19.5 billion on December 31, 2019. The primary driver of the reduction in AUM was the $1 billion sub-advisory relationship outflow that took place in October and was addressed during our last call. This outflow represented approximately 1/3 of the total outflows during the quarter.

Gross inflows of approximately $850 million represented a modest improvement compared to the prior quarters of 2019, but remained below historical levels. The $2 billion of net client outflows was partially offset by $1 billion of market appreciation, thanks to the strong work of our investment team. As of December 31, our Wealth Management business of approximately $8.7 billion is being serviced by our 10 teams of financial consultants and represents approximately 45% of our total assets. The remaining $10.8 billion of AUM includes our institutional and intermediary business, including Taft-Hartley.

Looking back at 2019. It was a year of significant change for our sales teams as we repositioned ourselves to better capitalize on our strength. The pace of inflows slowed in part due to the transition that took place. For the year, inflows were about evenly split between our Wealth Management team and our institutional and intermediary line of business. Over half of our gross inflows for the year came in through our balanced portfolios, another indicator that our investment disciplines, and in particular, our active asset allocation strategies remain attractive to clients.

Our gross client outflow numbers for the quarter and the year are somewhat skewed by the large sub-advisory outflow. As reported, our separate account retention rate, which we calculate based on dollars and not relationships, was 60% for the quarter and 83% for the year. However, when excluding the $1 billion outlier, those rates would have been 87% for the quarter and 90% for the year, which is more representative of our longer-term trends, particularly for our Wealth Management relationships. We think that the steps that we have taken during 2019 and will continue to take during 2020, along with our strong investment results, will provide us the opportunity to see further stabilization of our client retention rates. While we believe that the overall at-risk profile for our client population has improved, in particular, on the Wealth Management side, those relationships that involve third-party intermediaries and, in particular, investment consultants will continue to be an area of focus.

Turning to our fourth quarter P&L. We reported revenue of $32.7 million for the quarter, down from revenue of $34.2 million reported last quarter, with overall revenue margins of 66 basis points, up slightly from 65 basis points last quarter. The modest increase in average fees was expected given that the sub-advisory outflow mentioned earlier was a low fee relationship. After seeing some average fee volatility in prior years as a result of business mix changes and our fund fee restructuring efforts, it is our expectation that fees will remain in the mid 60 basis point range during 2020.

Operating expenses were $37.2 million in the quarter, an increase of $6.5 million compared to the prior quarter and a $5.1 million increase compared to the fourth quarter of 2018. The increase is being driven by approximately $6.8 million of strategic restructuring and transaction costs related to our technology initiatives that are being reflected in our other operating expenses including $6.3 million of impairment charges, as disclosed in the December 8-K filing. As we reported at that time, we will be writing off certain existing contracts as we pivot to our partnership with InvestCloud as part of our digital transformation. The $6.3 million impairment includes approximately $3.2 million of anticipated exit costs for existing vendor contracts that we will not be utilizing as we move forward. We have not formally terminated these contracts as of December 31 and expect future cash reductions when exiting these contracts in the future.

Compensation-related costs increased by $350,000 or 2% in the quarter. During the quarter, we recorded approximately $1.6 million of severance costs, which contributed to an elevated compensation ratio as a percentage of revenue, approximately 61%. We expect compensation will continue -- will decline on a run rate basis as we reduce the size of our workforce.

Distribution, servicing and custody expenses decreased by 4% during the quarter, generally in line with the 6% decrease in average fund and collective trust assets. These distribution expenses continue to represent approximately 19 basis points of average mutual fund and collective trust assets. As stated previously, the significant expense increase in the quarter came through other operating costs, which were $14.5 million in the quarter due to the aforementioned charges related to our technology platform upgrade. We reported nonoperating income of $1.3 million during the quarter, a $2 million decrease from last quarter when we recognized the onetime gain on the sale of prospective partners.

On a GAAP basis, we are reporting a pretax net loss of approximately $3.1 million. However, when excluding $8.4 million of strategic restructuring costs, including $1.6 million of severance and $6.8 million of digital transformation costs during the quarter, we report economic income of $5.3 million. Economic net income for the quarter was $3.8 million or $0.05 per adjusted share.

With that, I'll summarize our full year results. We reported revenue for the year of $136 million, down 16% from $161 million in 2018, with overall revenue margins of 66 basis points. Operating expenses were $133 million, a decrease of $4.7 million or 3% from last year as decreases in distribution expenses and compensation were offset slightly by increases in other operating costs. Compensation and related costs of $81 million for the year, including approximately $3 million of employee separation costs, decreased by approximately $6.4 million since last year, but represented 60% of revenue. A majority of the decrease was due to the reduced size of our workforce, down from 366 employees at this time last year to 307 as of December 31.

Distribution, servicing and custody expenses decreased by 31% in 2019 as a result of both reductions in fund and collective assets as well as the restructuring of our mutual fund fees during 2018 and 2019. Other operating expenses increased by a little more than $7 million in 2019, mostly due to the expenses related to our digital transformation. As a result, our pretax income for 2019 was $10.3 million with economic income of $18.5 million and economic net income of $13.2 million or $0.17 per adjusted share. The adjusted share count decreased slightly from 79 million shares outstanding at December 30 -- at September 30 to 78.8 million shares on December 31.

Additionally, during the quarter, we declared a $0.02 per share dividend to our Class A shareholders. And with regard to the adjusted share count, we will see an increase in the adjusted shares outstanding during the first quarter of 2020 in conjunction with award delivery under our long-term incentive plan. Specifically, we delivered approximately 2.5 million restricted stock units to key employees and future leaders throughout the firm that will vest over the next 5 years.

Looking at the balance sheet. We continue to maintain a debt-free capital structure with cash and investments of approximately $158 million. The increase compared to the last quarter primarily stems from the seasonality of our incentive -- year-end incentive payments, which will be paid during the first quarter of this year based on our 2019 results. Once those are accounted for, we estimate that our cash and investments will continue to be in the $140 million to $150 million range prior to considering future spending on strategic initiatives.

Before opening up the call for any questions, I want to provide a bit more color on some of Marc's earlier comments. Regarding our 2020 financial outlook, we are expecting that both revenues and potentially earnings will be down on a year-over-year basis compared to 2019. We believe that we will see improvements in both the rate of client inflows and outflows, but it is our expectation that we will remain in a net client outflow position for the year of 2020. Thus, prior to considering the impact of markets, we expect that AUM will continue to decrease, albeit at a slower rate than we have seen in prior years. These factors, along with the AUM decline that took place during 2019, inform our belief that revenues will decrease during 2020.

Similarly, we expect to see further decreases in both compensation and ongoing expenses as we continue to simplify and improve our existing business processes in an effort to manage operating expenses. However, these savings will be at least partially offset by the impact of our spending on new initiatives.

We will be strategic in expanding our team of financial consultants. During January, we added another financial consultant to our Columbus, Ohio territory, and we look to continue to build out our existing territories throughout the year. Our current plan assumes spending of approximately $10 million during 2020 to support our digital transformation, mainly in the form of implementation costs and software licensing for both InvestCloud and Workday. Much of this spending will be capitalized over future years, but will represent incremental expense compared to 2019. Also worth noting, the $10 million spending assumption noted here is not reflective of any final exit costs associated with the contracts impaired during the fourth quarter.

Lastly, we continue to review our existing suite of product and service offerings in terms of both subscale offerings that we should eliminate as well as gaps that we want to address to improve our overall solution for clients. As we have done in the past, we will utilize the flexibility of our strong balance sheet to address these items and improve what we deliver to clients.

In summary, we will continue to manage ongoing costs as appropriately given the projected decreases in revenue, but not at the expense of progress for our key strategic initiatives and digital transformation. As such, it is our expectation that from a financial perspective, 2020 will again be a transitional year as we take the necessary steps to accelerate the changes implemented in 2019 and position us for growth in 2021 and beyond. Thank you for participating in today's call. That concludes my formal remarks.

I'll now turn the call back over to the operator, and we will take any questions. Catherine?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Ken Worthington with JPMorgan.

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William V. Cuddy, JP Morgan Chase & Co, Research Division - Analyst [2]

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This is Will Cuddy filling in for Ken. First, have there been any disclosed redemptions in the coming quarters?

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Paul J. Battaglia, Manning & Napier, Inc. - CFO [3]

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No. No material redemptions that we've disclosed or other updates besides what we've given you on the prepared remarks here.

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William V. Cuddy, JP Morgan Chase & Co, Research Division - Analyst [4]

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Okay. Great. On InvestCloud, how long do you think it will take to fully implement it? And what do you think InvestCloud means for the Manning & Napier expense profile over the medium term?

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Marc Orlans Mayer, Manning & Napier, Inc. - CEO & Director [5]

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So Will, it's Marc. It will take more than 1 year to fully implement. So this is -- this -- we will not be complete in 2020. However, we will make very, very material strides in a number of areas. So I think important capabilities will be in place around the middle of this year with further work extending to the end of the year and into 2021. It's -- honestly, it's difficult to precisely quantify the magnitude of savings. As indicated, it's not just the implementation of new technology, it's reengineering of business processes that were anchored in old technology. And as the new technology comes in, and we can begin to transition, I think we'll get a much clearer sense of what the efficiencies can be. So we're just -- we are not in a position to be precise and give guidance, but it's certainly in the many millions of dollars. I mean, we expect this to be important in terms of driving efficiency over the medium and longer term, but we can't be more precise.

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Paul J. Battaglia, Manning & Napier, Inc. - CFO [6]

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And I think -- this is Paul. It's also worth adding here that we think that this will really improve the deliverable that we provide to clients, the way we deliver financial planning and potentially open up the ability to increase wallet share with existing clients and be a differentiator for new prospects as well. So the reason why it's hard to quantify is that it's our hope that over time we see improvement on both the top line as well as on the expense line.

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William V. Cuddy, JP Morgan Chase & Co, Research Division - Analyst [7]

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Got it. That makes sense. Turning to your Wealth Management business. We're seeing the industry consolidate to benefit from economies of scale. To further scale your business, how do you think about M&A with other wealth management providers? And what criteria do you use to evaluate opportunities in the space?

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Marc Orlans Mayer, Manning & Napier, Inc. - CEO & Director [8]

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So Will, it's Marc. We are open-minded, but have -- I think the way you phrase the question is wise. I think having clear criteria and high standards and strong hurdles is very important. So there are critical elements of our strategy. We are a distinctive investment managers, our own and proprietary investment management solutions are the heart and soul of what we offer to our clients. And so we -- that plays very, very strongly in this. So it's not to say that we could not, in some way, combine with a firm that has open architecture or some hybrid of open architecture and proprietary solutions, but we have to think very, very carefully about it because it is a meaningful step away from what we have done historically. So I think the -- as in any of these circumstances, the things that firms considering any form of combination, have to think about, first and foremost, is the client experience. Anything that is disruptive of clients and doesn't clearly drive a superior future for clients, we really have to question why we would do it. That's not to say that returns for shareholders aren't top of mind and critical. Obviously, they are. But in our business, in a fiduciary business, the first thing we always have to think about is any initiative, any strategic step we take, any combination we consider, what's in it for our clients and will we benefit them. So I think that is -- of all the -- there were plenty of other criteria in terms of return on capital and spreads over cost of capital, and all the things that you would assume in thinking about this, but the #1 criterion that dominates our thinking is will this deliver something better for our clients.

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Operator [9]

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And there are no further questions at this time.

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Marc Orlans Mayer, Manning & Napier, Inc. - CEO & Director [10]

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Thank you. Thank you, everyone.

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Paul J. Battaglia, Manning & Napier, Inc. - CFO [11]

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Thank you, everyone.

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Operator [12]

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Thank you. This does conclude today's conference call. Please disconnect your lines at this time, and have a wonderful day.