Pearson 2019 Preliminary Results (Unaudited)

Throughout this announcement: a) Growth rates are stated on an underlying basis unless otherwise stated. Underlying growth rates exclude currency movements, portfolio changes and changes related to the adoption of IFRS 16. b) The 'business performance' measures are non-GAAP measures and reconciliations to the equivalent statutory heading under IFRS are included in notes to the attached condensed consolidated financial statements 2, 3, 4, 5, 7, and 17. 

*Net debt pre-IFRS 16

Board Changes

Following our announcement on the 16th January 2020, we confirm that Coram Williams will step down as Chief Financial Officer at the Annual General Meeting on the 24th April 2020 and Sally Johnson, currently Deputy Chief Financial Officer, will be appointed to the Board as his successor.

Pearson announces that Josh Lewis, a Non-Executive Director of Pearson since 2011, is retiring from the Board at the Annual General Meeting in April, and will not be seeking re-election.

Pearson's chairman Sidney Taurel said:

"The Board joins me in thanking Josh for his commitment and invaluable contribution to Pearson. He has brought considerable experience and practical know-how to our Board, particularly in relation to finance, by way of his background in private equity investment focused on technology enabled education businesses; and in education more broadly, where he has for many years been involved with several pioneering enterprises and is also active in the non-profit education sector. We wish Josh all the best in his future endeavours."

Contacts

Forward looking statements: Except for the historical information contained herein, the matters discussed in this statement include forward-looking statements. In particular, all statements that express forecasts, expectations and projections with respect to future matters, including trends in results of operations, margins, growth rates, overall market trends, the impact of interest or exchange rates, the availability of financing, anticipated cost savings and synergies and the execution of Pearson's strategy, are forward-looking statements. By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that will occur in future. They are based on numerous assumptions regarding Pearson's present and future business strategies and the environment in which it will operate in the future. There are a number of factors which could cause actual results and developments to differ materially from those expressed or implied by these forward-looking statements, including a number of factors outside Pearson's control. These include international, national and local conditions, as well as competition. They also include other risks detailed from time to time in Pearson's publicly-filed documents and you are advised to read, in particular, the risk factors set out in Pearson's latest annual report and accounts, which can be found on this website (www.pearson.com/corporate/investors.html). Any forward-looking statements speak only as of the date they are made, and Pearson gives no undertaking to update forward-looking statements to reflect any changes in its expectations with regard thereto or any changes to events, conditions or circumstances on which any such statement is based. Readers are cautioned not to place undue reliance on such forward-looking statements.

Operational review - Geography

See note 2 in the condensed consolidated financial statements for the reconciliation to the equivalent statutory measures.

Financial Review

Operating result

Sales decreased on a headline basis by £260m or 6% from £4,129m in 2018 to £3,869m in 2019 and adjusted operating profit increased by £35m or 6% from £546m in 2018 to £581m in 2019 (for a reconciliation of this measure see note 2 to the condensed consolidated financial statements).

The headline basis simply compares the reported results for 2019 with those for 2018. We also present sales and profits on an underlying basis which exclude the effects of exchange, the effect of portfolio changes arising from acquisitions and disposals and the impact of adopting new accounting standards that are not retrospectively applied. Our portfolio change is calculated by taking account of the contribution from acquisitions and by excluding sales and profits made by businesses disposed in either 2018 or 2019. Portfolio changes mainly relate to the sale of our US K12 school courseware business in 2019 and the sale of our Wall Street English language teaching business in the first half of 2018. Acquisition contribution was not significant in either 2018 or 2019.

In 2019, our underlying basis excludes the impact on adjusted operating profit of IFRS 16 'Leases'. This new standard was adopted on 1 January 2019 but the comparative figures for 2018 have not been restated. The impact in 2019 was to increase adjusted operating profit by £25m (see also note 1b to the condensed consolidated financial statements).

On an underlying basis, sales were flat in 2019 compared to 2018 and adjusted operating profit increased by 6%. Currency movements increased sales by £97m and adjusted operating profit by £15m. Portfolio changes decreased sales by £347m and together with the impact of IFRS 16 (as noted above) decreased adjusted operating profit by £12m.

Adjusted operating profit includes the results from discontinued operations when relevant but excludes intangible charges for amortisation and impairment, acquisition related costs, gains and losses arising from acquisitions and disposals and the cost of major restructuring. In 2018, we also excluded the impact of adjustments arising from clarification of guaranteed minimum pension (GMP) equalisation legislation in the UK which impacted the post-retirement benefit charge in 2018 but does not recur in 2019. A summary of these adjustments is included below and in more detail in note 2 to the condensed consolidated financial statements.

In May 2017, we announced a restructuring programme, to run between 2017 and 2019, to drive significant cost savings. This programme began in the second half of 2017 and costs incurred relate to delivery of cost efficiencies in our enabling functions and US higher education courseware business together with further rationalisation of the property and supplier portfolio. The restructuring costs in 2019 relate predominantly to staff redundancies whilst the restructuring costs in 2018 relate predominantly to staff redundancies and the net cost of property rationalisation including the net impact of the consolidation of our property footprint in London.

Intangible amortisation charges in 2019 were £163m compared to a charge of £113m in 2018, as although acquisition activity has reduced in recent years, there was an additional £65m impairment charge in 2019 relating to acquired intangibles in the Brazil business following a reassessment of the relative risk in that market. Other net gains included in operating profit of £16m in 2019 mainly relate to the profit on sale of the K12 business. Other net gains of £230m in 2018 relate to the sale of the Wall Street English language teaching business (WSE), a gain of £207m, the disposal of our equity interest in UTEL, the online University partnership in Mexico, a gain of £19m, and various other smaller disposal items.

The statutory operating profit of £275m in 2019 compares to a profit of £553m in 2018. The decrease in 2019 is largely due to the decrease in gains on disposal, together with increased intangible and restructuring charges which offset the increase in adjusted operating profit.

Net finance costs

Net interest payable in 2019 was £41m, compared to £24m in 2018. The increase is due to the adoption of IFRS 16 which resulted in an additional £34m of net interest payable in 2019. After excluding the impact of IFRS 16 there was a reduction in net interest payable due to lower levels of average net debt together with favourable movements in interest on tax and the absence of one-off costs relating to the redemption of bonds.

Finance income relating to retirement benefits has been excluded from our adjusted earnings as we believe the income statement presentation does not reflect the economic substance of the underlying assets and liabilities. Also included in the statutory definition of net finance costs (but not in our adjusted measure) are interest costs relating to acquisition consideration, foreign exchange and other gains and losses on derivatives. Interest relating to acquisition consideration is excluded from adjusted earnings as it is considered to be part of the acquisition cost rather than being reflective of the underlying financing costs of the Group. Foreign exchange and other gains and losses are excluded from adjusted earnings as they represent short-term fluctuations in market value and are subject to significant volatility. Other gains and losses may not be realised in due course as it is normally the intention to hold the related instruments to maturity (for more information see note 3 to the condensed consolidated financial statements).

In 2019, the total of these items excluded from adjusted earnings was a charge of £2m compared to a charge of £31m in 2018. Finance income relating to retirement benefits increased from £11m in 2018 to £13m in 2019 reflecting the comparative funding position of the plans at the beginning of each year. The remainder of the decrease was largely driven by a reduction in foreign exchange losses on unhedged cash and cash equivalents in 2019 compared to 2018. For a reconciliation of the adjusted measure see note 3 to the condensed consolidated financial statements.

Taxation

The effective tax rate on adjusted earnings in 2019 was a charge of 16.5% compared to an effective rate credit of 5.2% in 2018. The increase is mainly due to the absence of several one-off benefits present in 2018 including the release of provisions due to the expiry of relevant statutes of limitation, the reassessment of historical positions as well as a one-off benefit from a reassessment of the tax treatment of certain items of income and expenses.  

The reported tax charge on a statutory basis in 2019 was a credit of £34m (14.7%) compared to a credit of £92m (18.5%) in 2018. The statutory tax credit in 2019 was primarily due to US tax losses generated on the disposal of the US K12 business.  

Operating tax paid in 2019 was £9m. This was impacted by a refund received in the US relating to historical periods together with no US tax being paid in relation to 2019 as a result of the tax loss on the sale of our US K12 business. Non-operating tax paid of £21m in 2019 relates to tax paid to the Chinese tax authorities following the disposal of WSE during 2018 and New York state and city taxes paid in the US as a result of a settlement with the tax authorities relating to past disposals. Deferred tax liabilities reduced from £136m in 2018 to £48m in 2019 mainly due to the generation of tax losses in the US as noted above. Deferred tax assets and current tax liabilities remained relatively consistent year on year. There are contingent liabilities in relation to tax as outlined in note 18 to the condensed consolidated financial statements.

The Group adopted IFRIC 23 'Uncertainty over Income Tax Treatments' on 1 January 2019 resulting in a reduction of £5m in provisions for uncertain tax positions. The cumulative effect of applying this adjustment has been applied to retained earnings at 1 January 2019 (see also note 1c to the condensed consolidated financial statements). The impact of adopting IFRIC 23 on the income statement for 2019 was not material.

Other comprehensive income

Included in other comprehensive income are the net exchange differences on translation of foreign operations. The loss on translation of £115m in 2019 compares to a gain in 2018 of £90m. The loss in 2019 mainly arises from the weakness of the US dollar compared to sterling. A significant proportion of the Group's operations are based in the US and the US dollar weakened in 2019 from an opening rate of £1:$1.27 to a closing rate at the end of 2019 of £1:$1.32. At the end of 2018 the US dollar had strengthened from an opening rate of £1:$1.35 to a closing rate of £1:$1.27 and this movement was the main reason for the gain in 2018.

Also included in other comprehensive income in 2019 is an actuarial loss of £149m in relation to retirement benefit obligations of the Group and our share of the retirement benefit obligations of PRH. The loss arises from the unfavourable impact of changes in the assumptions used to value the liabilities in the plans and in particular movements in the discount rate. The value of assets was also impacted following the UK plan's purchase of insurance buy-in policies in the first half of 2019. The loss in 2019 compares to an actuarial gain in 2018 of £25m.

Cash flows

Our operating cash flow measure is used to align cash flows with our adjusted profit measures (see note 17 to the condensed consolidated financial statements). Operating cash outflow decreased on a headline basis by £95m from £513m in 2018 to £418m in 2019. The decrease results from increased investment in pre-publication and other increases in net working capital including the impact of reduced staff incentives and the absence of a contribution from the K12 business following its disposal in the first half of the year. These factors more than offset a positive impact from the adoption of IFRS 16.

The equivalent statutory measure, net cash used in operations, was £480m in 2019 compared to £547m in 2018. Compared to operating cash flow, this measure includes restructuring costs but does not include regular dividends from associates or capital expenditure on property, plant, equipment and software. Restructuring cash flow inflow of £25m in 2018 included proceeds from the sale of property primarily associated with the rationalisation of the property footprint in London and in 2019 restructuring cash outflow was £111m. The restructuring payments made in 2019 together with the impact of the adoption of IFRS 16 (see section below) largely explain the reduction in provisions and other liabilities on the balance sheet when comparing 2019 and 2018. The adoption of IFRS 16 has resulted in a change in the classification of lease related cash flows in the cash flow statement although there is no impact on the total movement in cash and cash equivalents.

The Group's net debt increased from £143m at the end of 2018 to £1,016m at the end of 2019. The adoption of IFRS 16 added £666m of debt on transition with the remainder of the increase principally due to treasury share purchases, additional capital invested in PRH and outflows from the K12 disposal transaction which outweighed the normal cash inflow from operations after taking account of interest, tax and dividend payments.

Post-retirement benefits

Pearson operates a variety of pension and post-retirement plans. Our UK Group pension plan has by far the largest defined benefit section. We have some smaller defined benefit sections in the US and Canada but, outside the UK, most of our companies operate defined contribution plans.

The charge to profit in respect of worldwide pensions and retirement benefits amounted to £56m in 2019 (2018: £56m) of which a charge of £69m (2018: £67m) was reported in adjusted operating profit and income of £13m (2018: £11m) was reported against other net finance costs. The small increase in the operating charge in 2019 is largely explained by the absence of material past service items which in 2018 included a credit of £11m relating to changes in the US post-retirement medical plan and a charge of £8m relating to guaranteed minimum pension (GMP) equalisation.

The overall surplus on UK Group pension plans of £571m at the end of 2018 has decreased to a surplus of £429m at the end of 2019. The decrease has arisen principally due to the actuarial loss noted above in the other comprehensive income section. In total, our worldwide net position in respect of pensions and other post-retirement benefits decreased from a net asset of £471m at the end of 2018 to a net asset of £337m at the end of 2019.

Adoption of new accounting standards and interpretations in 2019

The adoption of IFRS 16 'Leases' has impacted both the income statement as described above and has had an impact on certain lines in the balance sheet. The lease liability (classified as financial liabilities - borrowings) brought onto the balance sheet at transition was £881m with the corresponding right-of-use asset (classified within property, plant and equipment) valued at £424m. In addition, certain subleases have been reclassified as finance leases resulting in an additional lease receivable (classified as other receivables) of £215m being brought on balance sheet.  The net impact on the balance sheet is a reduction of net assets of £83m after taking into account existing liabilities relating to onerous lease provisions (reducing provisions for other liabilities and charges by £101m), lease incentives, prepayments, adjustments to tax and the net impact on associates. The full impact of the adoption of this standard is outlined in note 1b to the condensed consolidated financial statements.

The impact of adopting IFRIC 23 'Uncertainty over Income Tax Treatments' had a small impact on the current tax balance but has not materially impacted the income statement (see note 1c to the condensed consolidated financial statements).

Dividends

The dividend accounted for in our 2019 financial statements totalling £147m represents the final dividend in respect of 2018 (13.0p) and the interim dividend for 2019 (6.0p).  We are proposing a final dividend for 2019 of 13.5p bringing the total paid and payable in respect of 2019 to 19.5p. This final 2019 dividend which was approved by the Board in February 2020, is subject to approval at the forthcoming AGM and will be charged against 2020 profits. For 2019, the dividend is covered 3.0 times by adjusted earnings.

Businesses held for sale and businesses disposed

Following the decision to sell the K12 school courseware business in the US, the assets and liabilities of that business were classified as held for sale on the balance sheet at the end of 2018. In March 2019, the Group completed the sale of its K12 business resulting in a pre-tax profit on sale of £13m. Total gross proceeds were £200m including £180m of deferred proceeds which include the fair value of an unconditional vendor note for $225m and an entitlement to 20% of future cash flows to equity holders and 20% of net proceeds in the event of a subsequent sale.

The cash outflow in the year relating to the disposal of subsidiaries was £101m mainly reflecting the deferral of proceeds for K12 and the level of working capital held in this business at the disposal date.

Tax on the disposal of K12 is estimated to be a benefit of £51m. The benefit arises as the transaction gives rise to a loss for tax purposes mainly due to the differing treatment of deferred revenue disposed in the tax computation. In addition to the tax on K12 there were £17m of tax credits relating to adjustments following settlement of tax relating to prior year disposals.

Further details relating to this transaction can be found in notes 10, 14 and 16 to the condensed consolidated financial statements.

In December 2019, the Group announced the sale of its remaining 25% interest in PRH. At the end of December our share of the assets of PRH has been classified as held for sale on the balance sheet.