Pearson PLC (PSO) 2015 Q2 法說會逐字稿

Good morning, everybody. Thanks for taking the time to join us on what I know is a busy day at the end of what's been a busy week for all of us. So we'll keep the presentation as brief as we possibly can so we've time to answer all your questions.

I'm John Fallon. I'm here with Robin Freestone, our CFO. This time we've left the executive team out in the field. As you know, July is one of our biggest trading months in the year. They will be with us for the full-year results in February. But we do have with us, sitting next to our Chairman Glen Moreno, Coram Williams who, as you know, takes over from Robin next week as our CFO.

Before we get into the half-year results, just a quick word on the Financial Times. Whenever I've been asked that question over the last few years I've always said we will ask ourselves on a regular basis for the Financial Times as we would for any other part of the Company, are we still the best owner of the asset?

About a year ago, as we were asking ourselves that question, I think a few things became clear. First Pearson had great reason to be incredibly proud of its 58 years' ownership of the Financial Times. We've supported its global expansion, its digital expansion. We've stuck with it and invested in it through good times and not so good times and we've been rewarded with the world's leading business newspaper that's made a very successful digital transformation of its own.

But it was also clear to us that, and I know this is an over-used and hackneyed phrase but I really do think this is now an inflection point for journalism around the world.

The rapid growth in mobile, the rapid take up of social media, more and more people now accessing news analysis comment through social media and the like, meant that this was both a great opportunity for the FT, because it was a chance for its journalism to reach more people than ever before, but, actually, a very, very significant commercial challenge as well; both to the next stage of the digital growth and to its remaining, still quite significant, analog business.

And it would require the FT to continue even more rapidly to reinvent and rethink how it makes and sells journalism every day.

And, faced with that challenge, we thought the FT's best chance of doing that successfully, making the most of the opportunity, was to be part of a company that is absolutely focused in everything it does on its journalism and that's the central thing it does each and every day.

That's not to say that there aren't some synergies between the FT and Pearson. And, actually, I'd say that those, ironically in some ways, the synergies between the FT and Pearson are greater now than they've probably been at any point in my time with the Company. But those synergies are not compelling enough, given that bigger challenge.

And, actually, those synergies can actually be achieved through partnership, as we've proved with our relationship with Nikkei in Japan over the last few years, which had, in itself, given us the chance and given me the chance to get to know Nikkei as a company and its senior management and leadership quite well.

So I am very confident that we found a really good home for the Financial Times; one that secures the ongoing commercial and journalistic success of the FT and the great global and iconic brand but, at the same time, also achieves what I think would be widely recognized as a pretty fair price for Pearson and its shareholders as well.

And, of course, that also enables us to focus even more intensely on what we see as our great growth opportunity, which is in global education. And so let's now move on to do just that.

As we say every year, our first half usually contributes around about 40% of our sales and very significantly less of our profits. So it's not always a reliable indicator of our full-year performance.

So let me share with you what I think is the one sentence summary you should take from today's results. It's this. A good competitive performance in most parts of the Company means that, although in the round the policy and cyclical factors are somewhat worse than we thought six months ago, we're still able to reiterate our earnings guidance for the year.

In terms of those cyclical and policy-related pressures, a mixed picture. So let's just take a minute or two to go through them.

First, UK curriculum reform is playing out much as we thought. Declines in registrations to sit our qualifications now tailing off. They should start to grow again in 2016.

Spring US college enrolments were softer than we would like, but the fall figures are far more significant as that's when the big public universities enroll their students.

And state and local tax receipts to fund US schools are actually looking pretty healthy. But the policy debate around the new college and career readiness standards in the United States has been more uncertain and even more fractious than even we expected it to be.

As you know, we've been at the forefront of helping states to develop assessments that measure these new standards. And, initially at least, the teacher evaluation that's linked to these new standards is proving unpopular with teachers; primarily because they're worried that they should be given more time to adjust to the higher expectations that are now being placed on them.

Some parents, as you may have seen in some of the press coverage, are worrying that, do they drive a culture of teaching to the test? And, perhaps most significantly, you've seen state governors and local politicians concerned about federal overreach.

In the political fallout from all that, we've lost, as you've known and will have seen, a number of high-profile testing contracts; worth to us around GBP100 million in sales this year that we won't have in 2016.

Obviously we hate losing any business in any circumstances but the context here is important.

First point, the state assessment services, which this relates to, account for around 7% of Pearson's total annual sales. We will still lead the market in state and national assessment services next year, with a share of around 30%. That's slightly lower, but only slightly lower, than it was before we started the shift from No Child Left Behind to Common Core back in 2012.

New bipartisan legislation passed last week by the Senate, reaffirms a commitment to annual assessments as a means of promoting equality in education. So we can expect annual assessments to continue to be an important part of the US policy landscape for the foreseeable future.

The biggest contract we've lost in Texas is still largely paper based. And we've announced plans last week that some of you may have seen to halve our print-based test-processing facilities nationwide. The costs of doing that, the one-off costs of that restructuring, are included in the guidance we've reiterated today for 2015.

And that work frees us up, actually, to take much more of a lead in developing the next generation of better, smarter, digitally-led assessments, which meet the understandable concerns of parents and teachers that I referred to earlier. And I'll say a bit more on that later in the presentation.

But an equally important key headline from this morning is that, overall, our competitive performance is pretty good. We've bounced back strongly in US school with a market-leading 31% share of new adoptions that we've competed in and we're doing particularly well this year in Texas.

We're gaining share, yet again, in US college. And we're performing equally strongly in most of our major markets around the world.

And whilst the post-election spending hangover in South Africa is taking longer than we hoped to clear, we're performing really well in other growth markets, especially in China and Brazil, where we've got our private Sistema's business growing again. We have taken a hit from terminating a loss-making contract in the Gulf region, but we do see other more profitable ways to grow there.

That strong competitive performance, combined with tight control of costs, means that, in spite of those pressures, we are reiterating our earnings guidance for 2015 and we are increasing our interim dividend by 6%.

For all the policy challenges, we still see a very big growth opportunity in education for Pearson in the years ahead. And, with the progress we're making on our priorities for the year, we're increasingly confident in our ability to capitalize on it.

So let Robin talk you through the numbers in more detail, flesh out that four-year guidance. Then I'll be back to talk about our progress on our key priorities this year and our confidence in 2016 and future years. So Robin?

Thank you very much, John, and good morning, everybody. So, as John said, despite tough trading in some markets, overall we've had a pretty decent first half. And we remain on track to land within the EPS guidance range of 75p to 80p, based upon the assumptions that we set out at the full-year results on February 27.

But let's start with a quick rundown of the first half and then we'll come back to guidance in a bit.

So our sales were up 1% underlying and we're seeing good growth in North America, in Brazil and in China, as well as strength in digital and services, Connections Education and Penguin online university services.

This is partly offset by the smaller new adoption market in the US schools, later phasing of school textbook purchasing in the US and the UK and lower college enrolments in South Africa.

Portfolio changes relates mainly to an additional month's contribution from Grupo Multi. And FX was positive to the tune of GBP96 million, or 4%, due to weaker first-half sterling against the dollar compared to the first half last year, although the scale of the currency benefit is running a little bit behind the guidance that we gave at the start of the year.

Following a very significant jump up in first half last year, deferred revenues grew 3% at CER compared to the same point last year, with good growth in our US school business partly offset by lower deferrals in the US and UK testing and in South Africa, due to lower enrolments at CTI.

Our sales in North America were up 3% underlying. In US schools, good growth in Connections Education, assessments and VUE was offset by a smaller new adoption market opportunity and continued market softness in open territories.

Encouragingly, we put in a strong competitive performance in the textbook adoption market with that 31% win rate that John mentioned; up from just 25% last year.

In US higher education, learning services was resilient, despite soft spring enrolment numbers and continued policy-related disruption in the career channel. We benefited from new product launches, including REVEL, and, overall, we gained some market share again.

Our online university service managed business continued to grow strongly, with course registrations up 24% year on year, boosted by ASU's online partnership with Starbucks.

In professional, VUE global test volumes grew 10% year on year, boosted by continued growth in IT, professional certifications and GED, with increased volumes from Microsoft's Certified Professional program.

Our sales in core were down 5% underlying, in part due to phasing.

In the UK, revenues declined 3%, with general qualifications stabilizing, as expected, but vocational qualifications, BTECs, still feeling the tail end of curriculum change. Our UK's school learning services business declined, due to the phasing of purchases this year compared to last year.

In Australia, revenues declined, with strong growth in Pearson online services and the Pearson test of academic English offset by tough market and phasing in higher education learning services.

Italy grew in the first half, boosted by another strong adoption performance and phasing.

And while FT revenues were up slightly overall, this comprised good growth in North America offset by declines in core, primarily due to print declines in the UK and weakness in Continental Europe.

Our sales in growth were flat.

In China, our revenues grew strongly and continued growth in our English language schools. In Brazil, revenues increased, with our private Sistemas and private English language schools growing well.

In South Africa, our revenues declined, with our learning services business continuing to feel the effects of the strong 2013/2014 textbook adoption. Enrolments at CTI/MGI fell, primarily due to a 13% decline in qualified students graduating from high school.

And, to help you with your modeling, we've again included some more detail, including a rather smart pie chart, in the back of your packs to give you some more sales analysis.

In underlying terms, profit was down 5% on 2014. This reflected the net benefit of restructuring that we undertook in 2014, offset by fixed cost inflation; the impact of stranded costs, as Penguin rapidly integrates with Random House; some margin pressures in South Africa from the lower sales I mentioned; a contract termination charge arising from the transition of our three Saudi Arabian colleges of excellence and new providers; and an unfavorable mix in North America.

But in North America, profits were level at CER, despite the unfavorable sales mix.

Our core business has benefited from the restructuring activity taken in 2014 and lower restructuring charges in 2015.

In growth, down by GBP18 million at CER, about one-half of this decline relates to that contract termination charge in Saudi Arabia I mentioned, and most of the rest results from drop-through on lower revenues in South Africa.

Penguin Random House had a good publishing performance in the first half of 2015 and benefited from integration work done in 2014, partly offset by significantly higher first-half integration charges.

Our EPS was slightly below 2014 at 4.4p, primarily due to the absence of Mergermarket, which contributed GBP2 million last year, and a slightly higher interest charge offset by a lower tax rate.

On a statutory basis, 2014 EPS was significantly bolstered by net profit on the sale of Mergermarket of GBP196 million. While 2015 was depressed by a first-half balance sheet write-down related to the disposal of PowerSchool, which will be charged against the gain on disposal for PowerSchool on completion during the third quarter.

This write-down reflects the reduced market opportunity for software, including the Pearson system of courses and Schoolnet, which was to be integrated with PowerSchool, and the recognition that adoption of such software in US schools is now unlikely to occur at the rate originally envisaged.

Overall, the disposal of PowerSchool is expected to deliver a profit on sale of around $50 million pretax.

Our traditional free cash outflow was a little higher in the first half compared to last year, in part reflecting the impact of later sales phasing in US and UK school learning services, which I talked about earlier, but also reflecting adverse deferred revenue movements in US testing, which again is partly phasing, higher physical returns in the US higher education market and US dollar exchange rate movements.

Increased capital expenditure on our technology enabling program and our [1CRM] program was phased more to the first half. And we still expect cash conversion this year to be similar to last year.

Our average working capital of sales ratio ticked up a little in the first half, primarily due to the absence of Mergermarket, which was working capital negative. And this added about 0.5 percentage point.

The benefit of lower average inventory levels was offset by higher capitalized prepublication expenditure.

On our balance sheet, our net debt increased by GBP261 million, mainly due to FX and the working capital movements I discussed earlier. FX compared to the end of June last year added GBP186 million, due to the dollar denomination of much of our debt.

Now we've sustained our BBB+ and Baa1 ratings, but recognize the need to reduce our net debt level a little. And the PowerSchool and FT disposals will help do that.

So I thought it would be worth just reminding you of our policy on uses of cash.

Firstly, to maintain our strong balance sheet.

Secondly, to invest organically to accelerate and sustain future growth.

Thirdly, to fund our progressive dividend policy. And Pearson has returned GBP1.7 billion to shareholders through our dividends over the last five years alone and has increased our dividend above inflation for 23 straight years.

And fourthly, to acquire education companies with a strong strategic fit and return on capital employed potential.

And, in line with best practice, we'll continue to assess all of the above against alternative uses of cash.

Based on the assumptions that we set out at our full-year results on February 27 we remain on track to hit our guidance of 75p to 80p. That guidance assumed ownership of PowerSchool for all of 2015, and exchange rates as at January 21.

As you know, on June 17 we announced the disposal of PowerSchool to Vista Equity Partners for $350 million. The absence of PowerSchool for most of the second half 2015 is likely to knock up to 1p off our guidance range.

Our guidance was also based on sterling exchange rates on January 21. Exchange rates have been up and down quite a bit since then but if sterling stays at current rates through to the end of the year it would knock about 2p off our guidance range, mainly due to the relative strength of sterling against the US dollar and the Brazilian real.

Our estimate of shared service costs that stay with Pearson as Penguin rapidly integrates into Random House is unchanged at GBP30 million.

We remain on track for net restructuring charges of approximately GBP30 million for the full year. The restructuring of our US school testing business, following the downscaling of the Texas contract, does not add materially to that number.

As John said, cyclical and policy pressures are slightly worse overall than we expected at the start of the year.

There are ups and downs within that. US state budgets and UK policy environment are, on balance, a bit better than we might have expected, whereas US college enrolments and the US policy environment looks a little bit worse. But our competitive performance in the first half has been very good, particularly in much of North America.

In emerging markets, we expect China, India and private education in Brazil to do well. Public-facing education in Brazil is tough, given Government constraints. And South Africa will likely remain challenging this year, but we still expect our growth business to grow.

In core, we continue to expect to see greater stability in our major UK education market and, as I always remind you at this time of year, the first half represents a very small proportion of our full-year earnings.

But market trends and our competitive performance mean we remain confident that we will land within our guidance range for the full year.

Back to John.

Thanks, Robin. So back in February I explained how our efficacy strategy, having a bigger impact in education by expanding access and improving outcomes, increases our addressable market and brings higher financial returns for Pearson.

As we see again in these results, the products and services that already best embody that strategy are also our fastest growing ones. For example, virtual school enrolments up 15%. College online service enrolments up 24%.

So let's take a quick look at the progress we're making on our key priorities in implementing that strategy across the whole Company in terms of new digital products and services, a simpler, more focused Company, a higher performing culture and a stronger Pearson brand.

First, we're making really good progress in developing the priority products and services that address our biggest global opportunities.

What each of these products illustrate is our ability to combine the potential of new technology to engage, to personalize, to diagnose, with our own deep knowledge and experience about the most effective ways of teaching. It's that combination that allows us to develop these products and services that drive richer, deeper learning and scale far more widely.

For this morning, let's just give two examples and update on them from the preliminary results.

In the last six months, over 24 million assessments have been taken online on our TestNav platform. That is up 170% on last year.

In terms of operations, technology, psychometrics, this is a major achievement and it is widely recognized as such by our customers.

But it also brings into sharp relief the technology gap that still exists between how teaching, most teaching, is still done in many schools in America: traditional, direct instruction, relatively little technology support and how, as you can see, the assessments are now being carried out, which is primarily online, using tools with which many kids are still unfamiliar.

We're going to help bridge that gap. As we wind down our analog testing operations more quickly through the restructuring that I mentioned earlier, we're freer now to up and go faster on the next generation of assessment.

We will still provide states with the performance data they require to ensure accountability and equality; a need reaffirmed by that Senate bill I mentioned earlier. But it's more deeply embedded now into the daily teaching flow of the school, with richer, more immediate feedback; much more helpful to teacher, parent, student.

It does it in a much more balanced and less stressful way, too, for the student and less stressful for their parents as well, because it provides a more rounded and holistic view, which is less dependent on a single high-stakes moment.

The reason this is important is because we think that this is the future of assessment that wins widespread support and speaks directly to the concerns of parents, teachers and students. And, over the next five years, we are going to be at the forefront of making that a reality.

This more integrated approach can also be seen in REVEL, which is shaping up to be one of our fastest-growing product launches of the last decade.

It's increasing our market share and, this is vital, it's increasing our average revenue per enrolments in college, humanities and social sciences, where traditionally, as you know, our sell-through has been lowest and our exposure to secondhand book sales and open-education resources is highest.

And it's the first of a next generation of digital courseware, because it's an immersive mobile learning tool.

To put that in context. Whereas the MyLabs started life a decade ago as an add-on to the course, albeit an increasingly important one, REVEL integrates digital courseware assessments from the outset and so it's much more central to delivery of the course. This helps students to be better prepared to complete the course and, again, it helps our sell-through rate too.

The early efficacy studies are also very encouraging. For example, the University of Dallas at Irving in Texas, average exam scores increased from 75% to almost 90% after implementing REVEL. And, as one teacher said, REVEL makes it much easier for my students to keep up with their work.

We can tell a similar story of the progress we're making with every single one of these priority products and services listed here and the difference that they are already making to our customers around the world. And what they have in common is this.

One, they all start with the same insight that the bigger our impact in improving access to good-quality education and translating that into better learning outcomes for more people, the more we create a faster growing, a more profitable and more sustainable company.

Second, they begin to capitalize on the promise of adaptive learning to apply advances in scientific data-driven approaches to personalize learning far more effectively. But they also recognize that to be effective you also need the scale and you also need the services, the capabilities, to implement that adaptive learning at the enterprise level to ensure the benefits of these new digital tools can be widely shared.

And three, they're increasingly being built using the same core technology and instructional design.

So, for example, the new identity and access management capability in REVEL, which we're rolling out this year with our new global customer relationship management system, will also be common to the next generation of MyLab and mastering products that we will launch over the next year or so.

And that's just one example of how our second priority, simplifying our platforms, helps us to develop much better digital product and, crucially, address what we know, because they tell us every day, are our customers' biggest pain points.

So it's a better user experience because it's a single sign-on for teachers and students. It enables more personalized learning because, for the first time, it recognizes the same individual across different courses. It improves performance reliability and availability. And it provides not just much better data analytics, which is vital for the strategy I was talking about earlier, but also greatly improved security and privacy too, which is obviously a huge issue, particularly in education.

And it's just one example of the fact that we're continuing to make really good progress on many fronts in simplifying our platforms as we slim down from the 3,000 applications, the 700-plus technology vendors, the 50 or more datacenters we talked about last year.

So we are on track to reduce the number of those applications by more than 10% again this year.

We are consolidating our technology development and delivery previously spread across 94 different locations with global service centers being established in India and Sri Lanka.

And we're working hard to roll out the first phase of our new global human resources and finance systems, which will streamline all our operations across Pearson over the next few years.

Over time, this work is going to very significantly reduce our technology cost. It will free up resources to invest in products and services that drive faster organic growth and can reach global scale. And it will contribute as well to margin improvement.

And it helps to embed the efficacy program, this focus on access, impact and outcomes, into everything we do as a company because our third priority, a higher performing culture, means that for every new product we invest in we track systematically each month at the senior levels of the Company the clarity of the learning outcome we aim to achieve; the evidence we're gathering to measure our success; how we use that evidence to further improve our products and services; and, increasingly now, how we build our sales and marketing around this outcomes-based approach.

Culturally, this is a major change in how we do business and we aim to approach it in an open, transparent and accountable way.

For example, we've appointed auditors to independently assess our progress on efficacy. Every single executive now has a specific goal as part of their annual incentive plan. And, crucially, whilst it's early days, we're confident now that higher performing products translate into higher sales.

One example. We had a large institutional customer recently who swapped out their own proprietary math program, which they had acquired at significant expense, in favor of MyMathLab. This multimillion dollar deal was the direct result of a year-long research program, with evidence of student improvement so compelling the customer felt they had little choice but to switch to the Pearson product.

In terms of our fourth priority for the year, in February we talked about the fact that education's an issue that, quite rightly, generates much public debate and it arouses strong opinions and feelings. We've seen that in the debate around testing in the United States in recent months.

And we know that 15 years after we made our first big moves into education, public awareness of Pearson as the world's leading learning company is still relatively limited. We can't change that overnight but we know that we can and, indeed, we must change it over time.

So we are now engaging much more publicly: working with parents and teachers, listening to employers, helping learners of all ages. The defining characteristics of Pearson, love of learning, deep desire to help people acquire the knowledge and skills to be successful in their careers, we know are widely shared around the world.

For us to win hearts and minds, as we must, we have to ensure we tell that story more effectively. So you'll start to see that work publicly as we build the Pearson brand much more proactively and consistently over the next few years and starting later this year.

So to recap. The policy factors are somewhat worse than we thought six months ago but it affects a relatively small part of Pearson and is manageable.

Overall, competitively as we enter our key selling season, we're shaping up to have another strong year. And this gives us the confidence to sustain our full-year earnings guidance and increase the interim dividend by 6%.

Looking beyond this year, as I've just explained, we're making good progress in developing better digital products and services and building a more focused company with a higher performing culture and a stronger brand. This will make Pearson a higher returning company, both to our shareholders and, as importantly, to the communities and students we serve for many years to come.

And finally, as you all know, this is Robin Freestone's final Pearson results meeting after 11 years with the Company, nine as CFO. Robin's intelligence, his integrity, his decency, means he's widely respected by his colleagues, by our shareholders, by his peers. And, if I may be so bold, even, I think, by the analysts who follow the Company on a daily basis. And he's also played a key role in the growth and transformation of Pearson and the value that's been created over more than a decade.

And so we wish Robin every future success. We welcome Coram to his new role. And, with that, I and, for one last time, Robin are very happy to take your questions. Thank you.

Sami Kassab, Exane. Three questions and, first of all, thank you very much, Robin, for the last few years and enjoy the next.

First of all, school testing. You presumably have better technology than your peers. At least that's what you have said in the past. Pricing seems to be better. At least from California we've seen you underprice your competitors. And yet you've been losing all these contracts.

So what's the rationale in holding to an asset in a market where, despite being the best offer at the lowest price point, you still lose contracts to not-for-profit competitors?

Secondly, can you remind us of your strategic thinking behind your stake in Penguin Random House?

And lastly, can you quantify the Financial Times organic revenue decline in H1 2015 and perhaps last year as well?

So I'll take the first two and then ask Robin to pick up on the third one.

I'll repeat again what I said, just to put it in context, we're talking about less than 7%, or about 7%, of our revenues. We have very successful testing and assessment businesses here in the UK in Pearson VUE, in our clinical assessment. You can work out the percentages in the pie chart we provided at the back. They're not part of the 7%. They are all doing well, but they all share and benefit from common systems and technology and support.

Secondly, to remind you, we're still the market leader with a 30% share and we are, essentially, back to where we started at the transition from Common Core to No Child Left Behind.

And the way I would think about is those GBP100 million of revenues next year that I've talked about, we lost an RfP in Texas, we gained a contract in Indiana. Those are the sort of ups and downs of a high-stakes RfP process that you would expect in any normal year.

But the lion's share of the GBP100 million is really a number of states who signed up for Common Core through the PARCC consortia and then, for the political reasons I mentioned, have then reverted back, in one case to a joint partnership with Pearson called ACT Aspire. In the other cases, they've reverted back to their own local state test that they had previously.

There is still some political uncertainty but we think that has mostly flowed through now and we should see greater stability.

And we think that, whilst the implication of your question might be that the easy expedient thing would be to cut and run, this is still a good, profitable business for Pearson. We believe absolutely in the value of these assessments in improving learning outcomes for young people and putting them better prepared for the future.

And so, consistent with our purpose as a Company, we're going to stick with it and we're going to develop the next generation of products and services which, as I say, we think we'll do very well. So that's the answer to the first question.

One quick follow up on that, please, John. The GBP100 million you gave us, is that a net number including Indiana and other contract gains? Or is that a gross number, just what you've lost?

That's the value of the contracts that we've lost. (multiple speakers) It's about the net impact of the overall effect.

The net. And it will remain profitable after the loss of the GBP100 million?

It will remain significantly profitable, a contributor to Pearson margins. And, as I mentioned, that's helped by the fact that because we've taken the restructuring costs this year, and that is factored into our guidance, that will, obviously, help to mitigate the profit impact next year.

On Penguin Random House, we own 47% of the company. As you can see, it's on a creative and commercial roll. The bestselling performance continues to be exceptionally strong. The integration process is still working through. It's providing a good economic return to Pearson and its shareholders.

Clearly, it's something that we will review and consider on a regular basis. But, as things stand at the moment, it's not really until 2016/2017 that you see the full benefits of the integration savings coming through.

And Robin, do you want to talk about organic growth at the FT?

So what you've seen, Sami, is the same trend in the first half as you've seen now for some time, which is digital subscriptions to ft.com actually rising very nicely, readership of the print newspaper declining, as you would expect as you see cannibalization by ft.com subscription, and then print advertising coming down a little bit as well.

Now the effect of that on a global basis is pretty flat. But when you start to carve it up across our three territories, which we do for external reporting purposes, what you find is that the subscription growth is that bit faster in places like North America.

And when you look at print advertising, which is one of the declining areas, then quite a lot of that actually goes into core because, although it's a global package, it's booked through our London people. So it's a couple of percentage points that that effect has had on core in the first half.

Ruchi Malaiya, Bank of America Merrill Lynch. Just a question on the share gains and the new adoptions at US schools. Is there any more color you can give us in terms of where you were gaining share? Have you fixed some of the problems you had in the middle school math programs from last year? Or is it just a different mix of subjects you were competing for this year?

And then just any further you can give us on -- any further color on open territories where you've noted some weakness. Does the stronger new adoption share give you any confidence going into the second half of the year in open territories?

The performance this year is a combination of two factors. One, the changes to the salesforce that we made back end of 2013 are now settling down and we're starting to see the benefits of the new, more integrated approach. I think that's improving our competitive position.

But you've alluded to the other major reason. The investments that we've made, for example, in a new elementary social studies program has performed exceptionally well and that's helped us to do really well in Texas. We had a very, very strong competitive performance in Texas.

We are fixing the middle school math product mix but, in truth, it's probably next year before we start to see the benefits of that coming to market.

I think in terms of the open territories, a similar story would apply; that the consolidation of the salesforce, improved competitive performance, is starting to feed through. Probably takes a little longer to see the full benefits of that and, obviously, because in open territories schools are buying across the whole range of subjects rather than focusing on one area, you don't get such a bigger swing from one year to the next.

So I think, in essence, I'd say, I think, our competitive performance in open territories is improving but it doesn't improve quite as quickly as it has in the adoption states.

Thank you.

Ian Whittaker, Liberum. Three questions. First of all, just in terms of picking up on the comment that Robin mentioned about high returns in the higher education physical market, could you just explain what's driving that? We know you had a very strong relative performance last year in higher education physical sales. Was it related to that? Are there any other factors?

And then could you just remind us again, from an accounting perspective, how those returns are treated in terms of the P&L?

The second thing is just in terms of your cash flow. There's been a marked increase in the CapEx. How should we think about CapEx for the full year? And, I guess also more generally, just in terms of cash flow generation and the cash flow conversion rate.

And the third question, just coming back on the guidance. We had in 2012/2013 first-half reiteration of guidance, then we had profit warnings and so forth.

Looking forwards into the second half of the year, what's going to be the single most important factor as to whether you meet your guidance or not? Is it going to be round the US higher education market in terms of enrolments? Are there going to be any other factors that are going to be tested in Common Core? If you could just give us an explanation of that that would be great as well. Thank you.

Robin, do you want to pick up on the first two points and I'll talk a bit about the --?

The higher physical returns, and these do trend up occasionally and down occasionally, depending on what bookstores are doing and their philosophy to working capital management. This is a market trend and, actually, our returns have been less than the market in the first half.

But you have seen the market trend increase somewhat because Follett have returned quite a lot of books in the first half and you'd have to ask them what they've been up to, frankly. So that is not just us. We can see the trend across the entire market. And, actually, our returns have been very reasonable within the context of that market.

We have to make provision for returns when we sell stuff, so that is all reflected in our P&L accounts.

In terms of your CapEx question, if you look back to last year we had CapEx, fixed capital spend, of GBP170 million. We've said that while we go through this phase of investing in the enabling program, which is the new Oracle ERP global rollout, and the 1CRM program using salesforce.com, consistent approach to the use of that round the world, our fixed capital would go up a slight amount. You're probably talking GBP10 million or GBP20 million.

So based on GBP170 million last year, what you're seeing this year is that more evenly phased between the first half and second half because those programs are up and running and ongoing.

Just providing a bit of color to the competitive performance in US college that probably might help to answer the question as well, we're able on a monthly basis to track our performance and competitive performance at both a gross and net basis against the industry as a whole.

On a rolling 12-month average basis our market share is higher now than it has been at any point that we've seen in recent times. And, clearly, that has flowed through into the gross sales that are coming through. So we're feeling very confident about that.

And that probably leads into your third question. Robin gave you the basis on which our guidance is. We're seeing a very strong competitive performance right across the Company, especially in most parts of North America.

And that gives us good confidence that, as that flows through, as we see the adoption gains that we're tracking flow through in actual to received orders in Q3, that gives us good confidence to reaffirm the guidance in the way that we have this morning.

Can I just follow up on something Robin said? You said higher physical returns have been a feature across the market. In terms of that again, what exactly is driving that? Is it that essentially there's a change of bookstores that need physical inventory? Is there something else? Do you think it's a temporary factor, a more structural change that's coming through?

Frankly it's very difficult for us to understand the buying patterns of our customers, including Amazon and some of the other big bookstores.

What you have seen in recent years is they try to manage their working capital down very, very tightly, so that they're buying later and later and later, is suddenly they've worked out come September, we've still got demand through our book stores, we haven't got any stock. And they'll ring us and say, can you send books now? And our response will be, well we haven't got any either, so you should have planned this a bit better.

So what you see over time is bookstores and the major distribution channel contract and contract and contract. And then they'll suddenly find they haven't got enough stock, so they'll buy a bit more, a bit more and a bit more. And they're trying to continually manage that desire for stock to meet a peak up in demand.

Imagine all the demand that comes through their door is very largely factored on two seasons. One is the September season and the other one is the December/January season. Managing that working capital on their part is actually pretty hard and sometimes they get it a bit wrong and then they buy a bit more. And then maybe they overdo it and then they cut back again. So this is a trend that it concertinas all the time.

Exactly what's happening, your visibility and asking them is probably as good as my visibility, frankly.

The returns in the first half of this year are not out of kilter with any sort of trend or pattern if you went back to 2011, 2012, 2013, essentially. So you've got to see it through the context.

Paddy, Goldman Sachs. I've got three questions as well, actually.

You don't have to have three questions. You can have two if you want.

I've got a lot more but I'm sticking to three. I was interested, John, in your talk about the Pearson brand. Do you think these testing issues in the US has tainted the brand? And would you consider maybe not selling the testing but white labeling it or doing -- powering other people's business that way with the testing? And have you -- you clearly haven't in the first half seen any impact, but is there a danger from that?

The second question is again on the GBP100 million loss of revenues next year. What sort of margin should we factor in for that?

And the third question. Robin, I think we're running on GBP30 million stranded Penguin costs for this year. Are there -- are you on track for that? And are there any -- is there likelihood of stranded FT costs for next year?

So, Robin, if you want to pick up the margins on the GBP100 million and the stranded costs at the FT. Do you want to do that? And then I'll come back and talk about the Pearson brand.

So I reiterated, I think, Paddy that the GBP30 million for this year is still the right number on Penguin Random House. And I also tried to make sure you understood quite a lot of that integration has gone through Penguin Random House's numbers in the first half. So those numbers in Penguin Random House are really looking very, very good for the year, which is very heartening.

The stranded costs concept on the FT, we're kind of ignoring because there's quite a few upsides and downsides. And we've given you guidance on the EBIT that will come out for a full year. I think we said GBP24 million. I think that's the best number to use and ignore the stranded costs. There'll be a bit of rental income from property that might offset that. So I'd say that those two things are pretty much awash and it's best just ignored, frankly.

On the margin side in testing, I think we've said to you before that in our assessment business the margins in state and national testing, and particularly state testing, are not as strong as the margins in other parts of our testing business in the US. And certainly margins in the UK on certain tests are also pretty strong.

That's not the case in most of our state-based testing in the United States. It tends to be slightly lower than average margin business. I don't think we want to give you any more than that.

And then on your brand point, I think you answered your own question by stating clearly you can see by the very strong competitive performance that we've had in the first half of the year what the impact has been.

And take Texas, as an example, wherein since 2012/2013 the political debate around testing has been at the highest profile. I've spent a lot of time in Texas in the last couple of months, whether you speak with the Higher Education Commissioner, who is really thrilled about the work that we're doing to help make the transition from high school to community college, the work we're doing down at places like Texas Southmost College, the relationship we've just found with the Dana project, which is about transforming foundational math.

The wider relationship in a state like Texas, in spite of the political noise around testing, I think has never been deeper or stronger for Pearson but we need to build that ever more.

And the reality is that the familiarity with Pearson as the world's biggest education company and leading learning company is relative low in the public eyes compared to the impact that we have. And that's not something that we should be happy about, particularly as we're all about building a business that is much more directly about engaging with students and their parents.

So it's a positive reason why we need to build the Pearson brand because it's fundamental to the strategy that we develop over the next few years.

I think that one of the things that we've learned on the testing front is that we need to be more proactive and preemptive. So probably in the past we've largely felt, well, our customer, the state testing agency, it's for them to lead the public debate on testing and we'll serve them. And I don't think that has always served Pearson's public reputation as well as it should. And we're not going to do that any more.

So we are going to be much clearer about our strategy, what work we will do, the work that we won't do. And the work that we will do and the assessment work that we will take on will be work that we are clear is unambiguously a good thing for education and the learner.

And that, to me, is a real test of our efficacy strategy because it means we're going to be driven by the things that really we believe the research and the data and the evidence tell us will have the best impact on outcomes. And I think that's a strategy that wins because it will sustain growth over the longer time. And frankly, I think it puts us on the right side of the argument in terms of teachers, parents and the wider public.

So it is a big thing that we've got to learn from and build on and we're all over it, right on top of it and I'm very confident we'll get there over the next few years.

Matthew Walker, Nomura. Two questions, please. The first one is on the FT and PowerSchool proceeds. You suggested, I think, that you might use those for lowering the debt. How much of the FT proceeds, if any, of the net GBP700 million are going to be put into education acquisitions? That's the first question.

Second question is on clearly Penguin Random House having a strong year. What kind of -- should we take the percentage increase in operating profits at PRH to put that into the full year? That's the second question, because you've also got some popular titles.

Robin, do you just want to remind and recap on our use of capital and cash and also talk on the Penguin Random House profits question.

I think it's a little bit premature to be really explicit about how this cash is going to be used. And what I tried to do this morning was just lay out the priorities that we've always laid out, actually. They're not new. They're exactly the ones that I must have talked about the 19 times I've stood here.

So I think it's really about organic investment. We're not looking to increase that significantly. We've done that over the last couple of years. It's given us a great pipeline of products and we'll continue to invest organically.

You heard me talk about the dividend, which we've been very consistent on. We would like to do a bit more M&A activity than we've done so far this year. Given that's been nil that wouldn't be difficult. But also we recognize that our rating with Moody's is under some pressure and, therefore, we would like to get back to stable rating as opposed to having a negative outlook on that.

So exactly how that all pans out, I think, is for another day, frankly, given the proceeds won't actually be here from the FT sale until later in the year in any case.

On PRH, again the bulk of the season is yet to come at PRH. I think what you've seen in the first half is some really big titles. You've not yet really seen the Harper Lee prequel, sequel, call it what you will, affect those numbers. And, therefore, I think that will be for UK, we don't have that in the US but we do have that in the UK, could be quite exciting and there are some other good titles to come.

So I don't think we want to give specific guidance each segment by segment, but certainly it looks like PRH are going to have a pretty good year.

There are a couple of questions that have come in online, which I think I should take.

There's a rather interesting one from Alex DeGroote at Peel Hunt. Why is growth so called? It is not growing. Will it grow? (laughter)

So, Alex, I'm glad you asked that question. And, even with the slowdown last year, the compound annual growth rate for Pearson over the last five years for the geographies that make up growth have grown by a compound annual rate of about 10%. Certainly in the 8% to 10% range per year on an underlying basis over the last five years.

The issue in those growth markets almost by their very nature is the growth is not even, necessarily, from one year to the next. So let me give you an example of that.

In South Africa our revenues in 2013 were 80% higher than they were in 2011. They have fallen back since then and that's been the biggest single factor on why growth collectively didn't grow last year and why it's been flat in the first half of this year.

However, to put that in context, our sales in South Africa this year still look like they'll be something like 60% higher than they were back in 2011.

And, just to add some extra context to that, if you take CTI, the acquisition we made a few years ago, where enrolments have slipped back a little bit, even with the slip back in enrolments our revenues from CTI this year will be 70% higher than when we made the acquisition in the last full year before we made the acquisition.

So growth are called growth because they have grown in a compound rate of 10% a year for the last five years.

And I am very confident that, as we work this through with all the work that we've got going on, we can sustain certainly high-single digit growth on a compound basis over the next five years. It just will not be a steady sequential growth each and every year.

Related to that, there is a question around how we're doing in Brazil, which I think I will pick up specifically here, and that was from Andrea at Kepler Cheuvreux.

So, I think, as I mentioned earlier, really pleased to see that our private Sistemas are growing again in the first half of this year. You're all aware of how difficult the macroeconomic environment is in Brazil and the impact that's having on public spending.

However, from the Multi acquisition from a profit point of view, we're actually very much on track with the expectations that we had at the time that we made the acquisition. That's because we've got now a really strong management team that came with Multi.

They've taken the leading role in integrating Multi, our Sistemas, bringing it all together. And that means we're confident that we're going to see good growth from that business on a bottom-line basis, even in this difficult economic environment.

And, obviously, in turn that puts us in great shape to capitalize on what we still think are good long-term trends in Brazil over the next five years or more.

Nick Dempsey, Barclays. Just to dig back into that GBP100 million, can I just check is that a year-on-year effect on next year? So GBP100 million you've got this year, the drop down next year, i.e., it's a 2 point drag on organic growth next year, right?

Yes, that is it. And that is obviously a headwind, GBP100 million headwind, that we face as we think into 2016. But it relates to a relatively small part of the Company. And, as I've just described, we're getting good growth in virtually every other part of North America, good growth in other parts of the Company around the world.

And so my job, and that of the senior team, is to make sure that we're pushing hard on all the other things and other opportunities that we've got available to us so we can get as much growth as we can next year. And, obviously, we'll update you on that in February.

And just a follow up. You mentioned the FCAT in Florida. I thought that was lost to AIR in 2014, at the beginning. It says it only kicks in in 2016?

There's a sort of lag effect, (multiple speakers) so we've still been doing the science part of that (multiple speakers) --

In terms of looking forward, that's factored into next year's number compared to this year's number.

Yes, that's in the GBP100 million, but that might be why the GBP100 million is bigger than I thought.

Yes, it's a tail off of the contract.

Great.

I think we're, what, 10 o'clock so we'll finish it there. So three more people. So if you don't all ask three questions it will help.

18 questions. (laughter) No, just two very quick ones as well. Firstly, FT coming out. The impact that will have on the deferred revenue balance and the working capital as a percentage of sales, is that -- are we going to have a another step up in the working capital intensity, if that's the right way of putting it?

And the second one on Penguin Random House. I appreciate you're not necessarily going to walk away from it whilst the integration process is half way through and there's still a lot of good growth. But there was an opportunity to recapitalize that and potentially take some cash out. Is that something we should expect in the second half?

So I'll deal with that and then Robin deal with the FT deferred revenue.

Just to be precise about the way the shareholder agreement works is we have the -- I always get the put and the call wrong, whichever way it is, we have the right to put our shares to Bertelsmann. They don't have to take that put but if they don't take the put that then triggers the recapitalization.

So it's not completely in our control to say, well we'll sell them or we'll force a recapitalization. You can only get the recapitalization to go if you do the former, if that makes sense.

Robin, do you want to pick up on the deferred revenue?

So I'll be brief, Tom. Yes, deferred revenue will come down if we do the disposal in quarter 4 as we expect. You could work with a probably GBP50 million to GBP60 million number, that sort of level, and that's obviously just a disposal event.

Working capital of sales. Again, that may be somewhat negative to us but remember this is an average over 12 months. So that will take time to come through the numbers and may not be there in the yearend numbers, frankly, given the averaging won't be fully effective until it falls out of the equation.

Yes it's a growth question. You've had flat organic growth broadly speaking for the last three years, you're kind of flat this year and, with Nick's question there, you've got a 2% headwind next year. So I guess the question is how do you see that profile of returning to a respectable level of organic growth?

We are expecting the Company to return to growth this year. We have got a 2 percentage point tailwind that we face in 2016. But, as I say, lots of great things happening across the Company; really strong competitive performance. The cyclical and policy-related factors that I mentioned earlier do start to ease next year; for example, here in the UK as qualifications enrolments will start to grow again.

So, clearly, we'll give our guidance when we get to February next year. But me and the whole of the management team, all the investment that we're making in the new products and services are all completely focused on getting this Company growing again underlying terms as soon and as quickly as we can.

And just on deferred income it was up 10% last year. It's up 3% now. Is that anything --?

So you're asking three questions just one by one. Is that the plan here? (laughter)

It was kind of linked, but how significant, if at all, is it?

I think as it's shown on the graph that we showed, Patrick, actually last year was the outlier in many ways. That was such a significant increase up and this year we've gone back to trend. So I think the direction is still the same.

And there's some seasonal impact between from half year to half year, so let's see how it looks at the full year as well.

Chris Collett, Deutsche. And just one question, also on growth but on the profits in the growth division. Back in 2013 you were doing about GBP35 million of profits. Since then you've bought Grupo Multi, which is making, I think you said at the time, also about GBP35 million. It made, obviously, some challenges to profitability in the start of this year.

When should we think of that business delivering around GBP70 million or so of profitability? Or was that so impacted by the South Africa boost that that was really an anomaly in terms of profitability?

So Simon's showing enormous self-restraint sitting next to you. I think he's about to say, if I answer that question I'm giving future profits guidance that is above and beyond.

So the position in 2013, clearly, we had that very, very strong performance in South Africa and that's obviously a high-margin business.

Robin, you mentioned the fact that we'd taken a hit that we took from the termination of the contract in the first half of this year. That clearly unwinds in the second half.

And, just as surely as we expect to get good underlying revenue growth going in growth, as those businesses scale and we start to see significant scale, then we would expect the margins to improve as well.

Okay. On that note thanks very much, everybody, for joining us. Have a good summer and see you all soon.