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Pearson (NYSE:PSO)

2012 Earnings Call

February 25, 2013 4:00 am ET

Executives

John Fallon - Chief Executive Officer, Chief Executive of International Education Businesses and Director

Robin Freestone - Chief Financial Officer and Executive Director

William T. Ethridge - Executive Director and Chief Executive Officer of Pearson Education North America

John Ridding - Chief Executive Officer of FT & FT.com

Analysts

Sami Kassab - Exane BNP Paribas, Research Division

Mark Braley - Deutsche Bank AG, Research Division

Vighnesh Padiachy - Goldman Sachs Group Inc., Research Division

Ian Whittaker - Liberum Capital Limited, Research Division

Matthew Walker - Nomura Securities Co. Ltd., Research Division

Alexander Christian DeGroote - Panmure Gordon & Co. plc, Research Division

Sarah Simon - Berenberg Bank, Research Division

Giasone Salati - Espirito Santo Investment Bank, Research Division

Patrick Wellington - Morgan Stanley, Research Division

John Fallon

Okay. Well, good morning, everybody. Last October, when Marjorie announced that she was stepping down, I said I was going to use the transition to talk to a wide range of people both inside Pearson and outside about the company. And what I've heard is consistent with my own view and my experiences of the company over the past 16 years.

The Pearson strategy is settled and sound, and what we now need to do is to accelerate the implementation of it significantly and urgently. So we are reshaping the organization to take advantage of what we believe is a once-in-a-generation opportunity, and one that will lead Pearson into its next phase of vigorous and sustainable growth.

And this next phase is really all about accelerating the digital transformation, accelerating our move into services and building our presence in emerging markets. And we're going to do that by shifting some resources more quickly from our textbook publishing businesses to fund the faster-growing opportunities, and that, in essence, is what the restructuring we've announced this morning is all about.

So my key point for today is this: We are concentrating on being a global education services company for these intensely local in our focus on the biggest market opportunities. And some of those opportunities are very, very big indeed. And so we're going to have to be very highly disciplined about how we allocate capital to them. And that means freeing up resources currently tied up in other parts of the company.

It also means that we're going to be absolutely focused on what we call the educational efficacy of what we do on measuring everything in terms of improved learning outcomes. And the prize, we think, from doing all this will be clearly to shift in a very important and very exciting global growth industry. It will give us an expanded market opportunity. It will give us faster growth potential. It will give us more attractive financial characteristics. And it also means we can make a greater impact on student achievement.

So let's have Robin talk us through the 2012 results, and then I'll be back to talk about what it actually is we're going to do. Thanks, Robin.

Robin Freestone

Thanks, John. Good morning, everyone. So relative to what we hoped at the start of the year, I reckon that I've characterized 2012 as one of the toughest that I can remember since I've been with Pearson.

I'll give you the key numbers. Sales were up 5% at CER; and profits up 1%, recognizing, of course, that the FTSE disposal reduced profits by GBP 20 million compared to 2011. Operating cash was down on 2011, mainly due to a mismatch between accruals and cash payments due to FX and lower cash collections in the second half of the year.

Our net debt was GBP 419 million higher at GBP 918 million, mainly as a result of acquisition spend of GBP 759 million in the year. And we increased our dividend again by 7% despite the difficulties of the year, reflecting our confidence in the future.

Our largest markets, particularly for traditional textbook and testing services remained under budgetary pressure throughout the year. Against that backdrop, it was heartening that all our businesses made progress on sales at CER in 2012. And overall, we finished the year 5% ahead of 2011, helped by contribution from acquisitions.

Of particular note were the following: one, the contribution to our U.S. School business from new digital products, such as iLit and the new services from Connections Education; two; the continuing growth in MyLab registrations and at eCollege in United States Higher Education despite enrollment contraction of around 2%; three, in international, the 25% growth in our emerging market businesses, which means these now represents 45% of our international segment; four, growth at CER achieved in Professional despite the well-documented problems at Pearson in Practice where sales declined by GBP 50 million to just GBP 32 million. This alone knocked off more than 1 percentage point off group organic growth.

Pearson VUE had another strong year, helped by its Certiport acquisition; fifth, the resilience of the FT Group, which continues to deliver digital subscriber growth, ahead of physical newspaper contraction and passed an important milestone, having more than half its circulation online; and sixth, after a tough first half, the second half bounced back by Penguin to end the year with a higher number of bestsellers than last year.

In the face of profits, excluding FTSE, up 3%, it was heartening to see significant profit rises in both North America and International Education, which together, contributed a profit increase of GBP 70 million at constant exchange rates. A particular feature was the North American margin increment of 1.1%, helped by lower returns of physical product. As expected, margins in International remained level with last year, reflecting ongoing investments to drive emerging-market growth.

On the downside, the drop-through on sales at Pearson in Practice resulted in a GBP 38 million negative profit swing year-on-year in our Professional division. Restructuring at the FT took out GBP 5 million, and the mix impact in the first half at Penguin in the United States meant a GBP 12 million profit shortfall at CER there for the year.

On an EPS basis, the combination of lower headline operating profit, a more normalized tax rate and slightly higher shares in issue resulted in EPS down 3% to 84.2p. The impact of the changes to IAS 19 on our 2012 results, to be reflected in our 2013 comparatives, is scheduled as an appendix in your packs.

On a statutory basis, the one-off loss on disposal and closure of Pearson in Practice is the main difference to our adjusted numbers. You'll recall that in 2011, our statutory numbers were helped by the GBP 412 million profit on sale of FTSE, which is also excluded from our adjusted numbers. In 2013, we expect to book a significant statutory profit on the formation of Penguin Random House due to Penguin being treated as a disposal under IFRS. That profit, net of associated costs of disposal, will also be excluded from our adjusted earnings. In 2012, we incurred initial joint venture set-up costs, and we made provision through the statutory accounts for settlement of legal action related to Penguin's agency distribution arrangements.

Our operating cash flow was down in 2012 after a good performance in 2011. This was affected by: one, marginally higher debtor days at year-end in our education businesses; two, increased investment in international to both the growth and in new digital programs for North America, ahead of launch of Common Core, as ever the analysis of pre-pub is in your packs; three, a lower reserve for returns provision as our analogue business contracts; and four, foreign exchange, which swung from a positive in 2011 to a negative in 2012 due to strengthening sterling during quarter 4.

Cash tax paid in 2012 was artificially reduced by the deferred payment of U.S. corporation tax from December 2012 to February 2013 as a result of a federal government dispensation, following Hurricane Sandy. Clearly, this means cash tax in 2013 will be significantly higher.

On our balance sheet, deferred revenue was up again, bolstered by recent digital and services acquisitions, and I'll come back to this shortly.

Our net debt remains low at GBP 918 million, meaning we currently have around GBP 500 million of available acquisition headroom. That low net debt position means our interest cover and net-debt-to-EBITDA ratios remain very robust.

Our post-tax ROIC, helped by that lower cash tax, was level at 9.1% in 2012, well above our WACC, which declined again and now stands at 7.1%, helped of course, by the higher average net debt level.

The downward working capital trend -- working capital sales trend, which has being well established in recent years continued in 2012, albeit with a less-marked improvement, reflecting increased debtor days in the second half of the year and higher net pre-pub invested.

Particularly pleasing though was the reduction in inventory, which we focused on in 2012 and which fell 7%. This trend and the Penguin Random House JV implications will see a significant reduction in our warehouse capacity requirement in coming years and an acceleration of the trajectory towards having 0 working capital. Indeed, excluding Penguin, our average working capital to sales ratio in 2012 was just 10.7%.

Now I mentioned our deferred revenue trend earlier, and here you can see the continued improvement in this measure, one which possibly best reflects our transition to becoming a digital and services company. Digital and services revenues accounted for 56% of total revenues across Pearson in 2012, excluding Penguin.

Clearly, 2012 was a very tough year. However, we take a long-term view of performance and reflect that confidence in the future in our dividend, which we've increased above inflation for over 20 consecutive years. We're proposing a 7% increase for 2012 to 0.45p.

Our guidance for 2013 is that before restructuring and associated benefits, which I'll come back to in a moment, we expect operating profit and adjusted EPS to be broadly level with 2012 when comparing on a like-for-like basis under revised IAS 19, which we'll adopt in 2013. Overall, we expect market conditions to be tough again, as cyclical and structural pressures continue to hold back our developed world and publishing businesses. However, our digital, our services and our emerging market businesses will continue to grow well.

In North America, an improving economy is likely to mean further enrollment declines in higher education, and the uncertainty generated by Common Core rollout timing will mean K-12 markets remain subdued. However, we expect continued good growth from our digital products and services, such as the MyLabs and Connections Education and a first time contribution from EmbanetCompass to generate modest U.S. growth.

In international, we expect continued strong growth in emerging markets to drive growth overall despite ongoing austerity measures and a changing qualifications environment in the United Kingdom. Professional will benefit from continued growth at testing and the absence of Pearson in Practice. We expect advertising to remain subdued at the FT, but continued growth from subscriptions. And at Penguin, we expect similar market conditions to 2012 with the Penguin Random House merger to complete during the second half of the year.

Turning now to our restructuring. This will be in 3 areas. First, and most significantly, we're accelerating change in our education company. We will redeploy resources, currently focused on print publishing and in developed markets and in subscale geographic markets. We will shift investment faster towards education software and services in our major priority markets.

Second, our shared services infrastructure, which currently supports both our education business and Penguin, will have significantly lower volumes and complexity following the Penguin Random House merger. We're, therefore, reducing our fixed cost infrastructure in areas, such as warehousing and physical distribution and also in shared services functions like technology.

Thirdly and finally, we'll be integrating Penguin with Random House, some of the benefits of which will be invested back into new formats, new channels and new markets. The timing of this is uncertain, partly due to the timing of the regulatory process. This, together with a reluctance to disrupt our major second half selling season, will mean the Penguin Random House restructuring cost will not start to be incurred until s2014.

In total, we expect to expense net restructuring charges in 2013 of GBP 100 million. Those charges relate to our Education businesses around the world, and to a lesser extent, starting to separate Penguin activities from Pearson shared services and operations.

From 2014, we expect this restructuring to generate approximately GBP 100 million of annual cost saving. However, in 2014, we will reinvest these savings in 2 areas: one, organic investment in digital and emerging markets; and two, further restructuring, notably in Penguin Random House. And we'll update you on our plans here later in the year once the regulatory timetable is clearer.

This is a substantial program of restructuring to accelerate delivery of our strategy. It means that our 2013 and 2014 results will contain even more new moving parts than usual. We will report profits and EPS both before and after restructuring activities to give you visibility on the underlying performance of the business.

Clearly, the restructuring will suppress reported earnings in the short term. However, in 2015, we will benefit from both the reduction of restructuring charges and a flow-through of cost savings to the P&L. We also believe we'll benefit from greater focus and higher levels of investment in our largest and fastest-growing opportunities. And John's going to describe those further now.

John Fallon

Okay, thanks, Robin. So let's talk now about that next phase in Pearson's development. It is, of course, something that we've been planning for some time, through for example, the creation of Penguin Random House.

Penguin has been a very special part of Pearson for more than 4 decades. It is a very special company in its own right. It's deeply intertwined with both Pearson's culture, and indeed, its operations. But it had become increasingly clear to us that in a rapidly changing consumer book industry, Penguin's creative and financial success could be best secured in combination with another major international publishing house. And we viewed Bertelsmann and Random House as the ideal partners. And the more we get to know them, as for example, John Makinson and his colleagues engage with their counterparts in planning and plotting the future of the new company, the more convinced of that match that we become. This will be an excellent business and we will be active long-term partners in it.

But this merger, as important as it is, is really only one part of Pearson's next phase. And as we think about that next phase, I draw 3 major conclusions from the 2012 results that Robin has just described. First, we won a lot of market share last year, yet in some of our biggest markets, the reward for gaining all that share was that we declined at a slower rate than our rivals.

Second, we can draw strong confidence from really strong organic growth in some of our fastest growing markets, and those markets are categories just as much as they're geographies. So they're digital products and services; they're learning systems; they're the direct delivery of education as much as they are Brazil and China and India.

And third, all parts of Pearson, all parts of Pearson are reflected by fundamental structural change. These are changes we've anticipated, we've been preparing for. We've talked to you about them often enough, and they present us with both challenges, as well as opportunities. And the precise nature and timing of the changes are up for debate, but the overall direction is not.

And so what I want to do is spend the rest of my time this morning talking about how we're going to tackle those challenges and opportunities. And the very first point I want to make is that we have many of the key building blocks in place as Robin has just described: one, we have made a radical shift from traditional print products to digital and services; two, we are becoming now a significant player in the world's most dynamic education markets; three, we have significant financial capacity and a disciplined approach to deploying it; and four, we do have a position of leadership in Global Education. And whilst we must never be complacent about this, this is a vigorously competitive market, but nor should we be in any doubt about the scale of the opportunity that comes. We've been the clear leader in what is a global growth industry.

So that, I think you'll agree, is a powerful set of advantages with which we can tackle that dramatically changing external environment. For as I say, we do continue to see significant structural change.

So what I want to do now is to highlight a few of the most important of those changes to our thinking and the lessons that we draw from them. So structural change number one, is the shift from print to digital content and from classroom instruction to online learning. It is real, it is gathering pace. Spending on textbooks is flat or declining. Mobile devices are proliferating. One-to-one learning in the MOOCs, massive open online courses, are on the rise. This shift to digital is profoundly changing the business model for content. One-off sales will diminish while subscription sales, most likely bundled services, as you can see here, will grow. This transition, with which many of you will be -- all of us will be very familiar with, has affected many industries from software to gaming, it puts short-term pressure on revenues and profit. But over time, it presents us with a bigger market opportunity, a better cash profile and the rich data and insight with which to drive educational outcomes.

Now that same shift to digital also causes profound change and consolidation in the retail channel as you can see here. There is clearly a dramatic shift to online sales and dramatically different sales patterns for physical and digital formats. So the first lesson from this structural change for Pearson is this: We have to manage disruption in our traditional businesses, whilst building direct relationships with our customers and leading the digital transformation of education.

Structural trend number two, is the rise of the global middle class. This is a trend we've perhaps not talked about so much in the past. We'll be talking much more about it in the future, because it is, I believe, potentially the most important single factor in our future growth.

The Brookings Institute forecasts that the global middle class will almost double to over 3 billion people by the end of this decade alone. This is a mega trend, and it's affecting many industries from consumer goods to luxury brands to financial services. But I think there are very few industries for whom it will be as beneficial as for education, and that leads directly to our third structural trend, which is the rising consumer demand for education. The rising middle class is a huge deal for Pearson, precisely because as those consumers earn higher disposable incomes, they invest more of their own money in education. In fact, the proportion of household income spent on education is at its highest in those very economies that are growing the fastest. And of course, those are the ones that are forecast to contribute the majority of the growth in global GDP over the next 20 years.

So the second lesson for Pearson is this: Our future customers will be consumers or learners directly just as much as they will be the institutions of the educators that serve them. That consumer spending is very rational because the economic returns to education are becoming increasingly clear. For example, 90% of the fastest-growing jobs in the U.S. economy require a college degree. And a college graduate will earn, on average, $1 million more than a high school dropout over the lifetime of their respective careers. Indeed, as you can see here, the latest figures from the U.S. Bureau of Labor Statistics show that a high school graduate is almost 4 times as likely to be unemployed as someone with a professional degree. And that gap, as you can see, has been widening in recent years. However, while the consumer motivation for better education, leading to a better life is pretty much universal, the sources of demand is shifting. Asia already accounts, as you know, for well over half of the world student population, and enrollments are growing several times faster than there -- there than they are in North America and in Western Europe. Sub-Saharan Africa actually shows the fastest enrollment growth, as countries making progress towards universal prime education extend the average years of schooling and indeed as the content itself now enjoys sustained economic growth.

So the third lesson for Pearson is this: We have to tilt the company more quickly towards where the biggest sources of future demand actually are.

Structural change number four. With this shift to digital with the size of the opportunity, the competitive landscape, our competitive landscape is changing fundamentally. We are going through -- this is a period of intense industry change and innovation. And we think about our competitive environment in terms of 4 major buckets really, somewhat crudely: there are the traditional publishers; there are educational services companies, who are generally, but not exclusively locally based; there are technology companies; and there are online learning platforms and ecosystems. You can see those 4 groupings set out here.

Now uniquely, we participate in every part of that environment, in every one of those buckets. So the fourth lesson for Pearson is this: Gaining share, as we did so successfully again last year, against our traditional competitors, is still very important, but it cannot any longer be our primary measure of success. We can prosper, for example, by embracing open source, building the learning ecosystem around which we can provide a whole array of services and through which actually new entrants and other players can also prosper as well.

Structural change number five is this. In almost all parts of the developed world, as we saw last year, our customers face considerable funding pressure. Some of that pressure is clearly cyclical, and it may ease in time. But there are real structural forces at play, too. The pressures on American public spending, for example, are rising as an aging population drives health care and social security costs higher. Over the past decade, for example, school spending per student, college tuition fees in America have increased by around 1/3, more than 6x the rate of disposable income. And yet as this slide shows, despite that increased investment, student performance has barely moved. To be clear, these trends present long-term opportunity for Pearson, as well as a challenge. So given these pressures, it means that customers are more open to new ideas and fresh solutions to rethinking established ways of doing things. So lesson five for Pearson is that we have to work ever harder to help our customers to do more, better with less.

And that leads directly on to structural change number six. That is the intense interest in educational outcomes. The Economist reporting on the growth of international benchmarks, the need to understand why some school systems appear to achieve better results at lower cost gave this trend a memorable headline, as you see here.

For both providers and purchasers of education, the principle is clear. As you invest more in education and compete on a more international stage, you demand clear evidence of results. The urgent need is for analysis and programs that can demonstrate a clear return on investment where the return is measured by learning outcomes. So lesson six for Pearson is this: We have to focus much less on what we make and much, much more on the measurable impact of products and services actually deliver in improving learning outcomes.

We draw 2 conclusions from all these trends. The first, very simply, is that global education is a once-in-a-generation opportunity, an opportunity which Pearson is uniquely placed to grasp. And the second is that to seize the opportunity, we need to accelerate the execution of our strategy. It will certainly be a continuation of the 3 big themes that are familiar to you. It will be about digital; it will be about services; it will be about emerging markets. But just continuing won't be anywhere near enough. We need a dramatic surge in both the scale and pace of change across our company. And that's because for all the progress we've made, there are still large gaps between our company today and the company we will become.

The first gap. This past year, Pearson made almost GBP 3 billion of non-digital sales in textbooks and pen-and-paper testing. This activity is significant. It's valuable both in its own right, as an input into education and as the platform for much that we want to do in the future. But print-based materials are in decline, and so we need proportionately to reduce the level of resources we put into them.

Second gap. Our digital learning services are growing at over 20% per year, but they still only contribute 1/3 of our revenues. These are not an add-on to our traditional publishing businesses. They're the core of Pearson, they're the center of our growth strategy. So we're going to invest in a small group of global technology platforms and brands that we create once, and we can then adapt for local use.

Third gap, emerging markets today make up about 15% of our total sales as we heard. But we also heard they're home to more than half the world's students and to the vast majority of that new global middle class. In total, emerging markets account for 36% of global GDP today, and a forecast to make up 70% of global GDP growth between now and 2025.

So we need to close those 3 gaps and we need to close them very quickly. So we intend to radically shift Pearson's focus, our attention, our resources to those very big opportunities. And to do that, we need to change the way that Pearson thinks and behaves.

Pearson today is, of course, primarily now an education company, but it's one that operates in many geographic markets with multiple businesses and strategies. So we're going to become a single education operating company with a single global education strategy. And the restructuring program that Robin outlined earlier this morning is all about that and is designed to help us to achieve that.

So this year, we will take approximately, as you heard, GBP 150 million gross of restructuring charges, and we're really focusing on 2 things. First, the actions to separate Penguin from Pearson, given it's closely intertwined with many of our shared operations. Secondly, and much more significantly, actions to change our education company to free us up, to accelerate that move into emerging markets and to digital and to services, and to accelerate that shift from an education-holding company to an education operating company.

This is, of course, a significant program of change, and inevitably, it brings with it some execution risk. But those risks are far, far outweighed by the size of the prize. To win that prize, however, requires a new way of thinking about and organizing the company. So I'm working with Will Ethridge, with Robin Freestone, with the wider senior leadership team at Pearson to develop and refine a new framework, by which to organize Pearson to analyze opportunities, to allocate investment capital, to drive performance. We think it simplifies the organization, and it sets out both the context and the agenda for the changes that we are making.

First, we're now going to be focusing on 4 global businesses: school or pre-K-12; higher education; English; business education. We're taking an increasingly global view of educational needs, consumer trends and product development for those businesses. For each business, we're asking these questions and applying our resources accordingly. One, what are the really big unmet learning needs that are common around the world and which we, as an organization, are best placed to tackle. Two, how can we really maximize our efficacy and leverage, minimize internal redundancy and duplication by tackling these problems in a much more strategic way? And three, what are we going to stop doing completely, or at least do much less of or in a very different way, so that we can go after those big unmet learning needs, create the resources for us to go after them much more aggressively?

English is a good example of this approach. Here, we have an $800 million global business with good franchises and a strong market position. But whilst we may be one of the biggest fish in the global English ocean, we are, as you can see, still an absolute minnow, given the size of the opportunity. Our share is perhaps 2% of a $50 billion opportunity.

Historically, we've not thought of the market as being anywhere near as big as this because we were focusing on the much smaller publishing opportunity. Now we're focusing on a much bigger teaching and services market. We're attacking that opportunity in a globally coordinated way, by for example, rationalizing our portfolio and thousands of local products to a hundred or so globally commissioned, but locally tailored ones. And we're focusing our investment in resources on a handful of key markets in which the majority of the world's English-language learners live.

You'll notice, I hope, that business education is one of our 4 global businesses. And I want to talk about that for a moment and set out my perspective on the Financial Times group. First, every part of Pearson in every part of the world has to pay its way and have a compelling plan to grow, and the FT does have that.

Second, all of the time and of all of our businesses, we'll be asking ourselves, are we the best owners of this business? Are we best placed to help this business prosper?

Third, in my 16 years at Pearson, I actually can't remember a moment when the FT was more closely connected to our overall strategy or had more to contribute to it than it does now. And that's because, fourth, and most important of all, we believe business is potentially an important component of our once-in-a-lifetime opportunity. There is a substantial market for learning among globally minded, highly aspirational business people. And if there's one brand in the world that could turbocharge our ability to capture that market, it's the Financial Times. We are already embedding the FT brand in our direct-to-consumer learning businesses, and we're actively exploring further opportunities to take it further and deeper.

The second part of our framework is geographic focus. Like many international companies, we've been active in many markets for a long time. But just 8 countries generate 90% of our profits or thereabouts, and we have a long tail of small markets doing great work, but absorbing capital and attention and generating relatively low returns. So we're now applying a new model where we group markets or countries in 4 categories and allocate capital accordingly. They are: first, growth markets such as the U.S., the U.K., Brazil, China, India, South Africa, where we see the biggest opportunities today, and we'll place the lion's share of our resources over the next few years.

Second, watch markets. These will be countries, such as Indonesia, Turkey, Mexico, where we see potential for explosive growth, and we'll invest in local capacity when we see that potential crystallizing.

Third, maintain markets. These will be countries such as Australia, or Italy where we've really good businesses today, but we see more limited future growth. And so we're going to rely over time much more on the greater firepower of our global products with which to outgun local competitors and meet customer needs.

And fourth, what we call drive markets. This comprises a long tail of countries where we are and have been since the start of this year, actively dismantling our local infrastructure, and where in future, we will work through local partners. We are not exiting these countries. In fact, we think by focusing on a smaller number of really world-class products and services, delivering them through local distributors and partners, we'll meet the needs of those countries much more effectively, and that will play much more to our strengths.

Let's take China as an example of our approach to growth markets. We've transformed there in the past 5 years. We've grown sales from $80 million to $400 million, employees from 400 to 6,000. We're now a significant player in the Chinese education industry. But we are still, as you can see, barely scratching the surface of an opportunity that will grow very rapidly over the next decade. So we have to increase our investment in the talent and the infrastructure and the rate at which we open up new language schools in new cities and build our brand. We can't do that at the rate at which we need to, to fully grasp the opportunity, unless we finance it by taking resources out of countries and activities where we just don't see the same scale and growth potential.

The third part of our framework is to shift an increasing proportion of our investment into our faster growing and now proven, profitable service-oriented business models. And they are first, direct-to-consumer, building on the success of our language schools in China and around the world, our universities in South Africa or Mexico, our schools in India. This will primarily be an emerging market play, delivering high-quality education in a scalable capital-like manner, directly to the consumer, primarily to that rapidly growing middle class we talked about earlier.

Second, Pearson Inside. This is our shorthand for comprehensive institutional services. They could be sistemas in Brazil, our virtual schools in America or our full range of services supporting online graduate programs in the United States and elsewhere. This is also about delivering high-quality education also in a scalable capital-light manner, but doing it in partnership with public and private institutions. It delivers a range of services that are central to the delivery of high-quality learning.

Third, assessment and certification of students and professionals. This builds on our national assessment and testing organizations, our global business certification businesses, that enables governments and individuals to measure the return on their investment in education in a rigorous and relevant way, which is hugely important, as we discussed earlier, and to use educational data to improve learning outcomes.

And fourth, personalized learning system. These are systems of instruction, combined with measurement frameworks and diagnostic assessments, which deliver individual learning or provide information to a teacher, who can differentiate instruction. They require instructional design, progress monitoring, data collection, analytics, the ability to personalize learning pathways. And if we can connect all these things in the right way, we can reach students one-to-one and help struggling students succeed more effectively.

To do that, we depend heavily on our testing business, its formative assessment, so the starting point for personalized learning. And on our publishing business with structure and organized concept, hugely important point to help students learn and teachers to teach. However, as I said earlier, we do have to recognize that textbook publishing is the business model that is most challenged by structural change. And so we need to reduce our investment in print-only products more quickly, so we can migrate our textbook content to more digital interactive personal programs more quickly. And as we do so, we will increasingly provide content as a service rather than as a one-off purchase. So that means this is a fundamental part of the restructuring program. We need less content. But the content we create needs to be more high powered, and it needs to be at the center of the connected system of learning services.

Here's an example of that shift. The State of Kentucky is an early adopter of the new Common Core Standards you've all heard so much about. Under those standards, 1/3 fewer students in Kentucky are deemed proficient in Reading and Math than under the state's old standards. And that's because the Common Core calls for more sophisticated communication research and writing skills. And this is a trend that is going to play out in every state across America that adopts Common Core. So Kentucky solution is likely to find favor with many of the states in the years ahead. And Kentucky's education system has a simple solution to this problem. It wants students to spend more time learning. So they want to extend learning to evenings, weekends, holidays and make that learning more effective. To do that, every teacher and every student needs their own laptop or mobile device. That sounds like a simple idea. But to be effective, it requires much more than a digital textbook or some open educational resources. It requires a personalized learning environment with robust hardware and network infrastructure. It requires professional development and support for teachers to change the way they work. It requires a high degree of planning and project management. It has to be a holistic, integrated service. And it is where our ability to work across the educational supply chain in each of those 4 buckets that we talked about earlier is our biggest source of competitive advantage. And we can already see that today, because we are leading the charge on these types of initiatives with large-scale implementations in Huntsville, Alabama; in Jerseyville, Illinois; in Sunnyside, Arizona; and in Mooresville, North Carolina and many more will follow in the months and years ahead.

Now as well as improving learning outcomes, there are actually also financial benefits to us from this approach, because it means we're addressing a significantly larger market opportunity with a business model that is much less working capital intensive. We received less per student per content under a subscription model than the equivalent textbook purchasing model. But over time, this is largely mitigated by selling through to a higher proportion of the students in the school across more subjects. Overall, our revenue per student increases as we provide a greater range of products and services to all of those students.

And clearly, the more intensive the service, the closer the model is on the continuum from content as a service to Pearson Inside or direct to consumer, the more we increase the size of the market opportunity, the more attractive the financial characteristics are.

So by thinking about our business in terms of those 4 models, those key markets, those global businesses, it gives us a framework by which we can allocate capital and overheads much more rigorously. We can eliminate duplication, and we can build world-class capabilities. They build on our existing skills. They have attractive economic characteristics. And as I said earlier, they can help us meet some of the biggest needs in global education.

It's important to recognize that those 4 business models, these 4 business models, operate as a continuum. And they draw from the same Pearson reservoir of global research, development and innovation, a world-class curriculum, the development of global standards in key subjects and core capabilities, the application of gaming technology where it's relevant, personalized diagnostic mobile platforms, the quality of the user experience and the like. We also believe they can be highly effective in delivering better results for learners.

That brings me on to the last part of our strategy that I want to talk on today. Because for decades, centuries even, Pearson has provided inputs into the process of education. We've provided a textbook and assessment of course of qualification. We will put all of those things in the hands of an experienced teacher or an enthusiastic student. And yet in most cases, if we're honest, we would not actually be able to predict and certainly not able to measure the learning outcome that resulted.

Under the leadership of our Chief Education Advisor, Sir Michael Barber, we spent the last 2 years developing a framework and a set of tools, which will fundamentally change that. The Pearson efficacy framework is a unique rigorous scalable, quality-assurance system that checks that the necessary conditions are in place for an education program to deliver the intended learning outcomes. We've already applied the framework to around 100 Pearson programs, and we're already improving our products and service to the benefit of our customers and learners, who are seeing the difference as a result.

So we're now making this efficacy review a requirement for any new product investment before we approve it of more than $3 million. It will be a fundamental requirement of any acquisition proposal, and we will be working and are working very, very closely with our customers and with learners in its application. Over time, and it will take time, this is going to improve radically, I believe, our rate of internal innovation and invention, which is very, very important to us. But there's another reason why, of course, this idea of efficacy matters, and this chart might help explain it. It shows the scores on IDEB, which is Brazil's national measure of student achievement. And it shows that student achievement in public schools using the Pearson NAMA [ph] sistema is roughly 20% higher than the national average. And it's that sort of data that explains why a growing number of towns and cities across Brazil are choosing Pearson NAMA [ph] as their sistema of choice.

That achievement effect, our determination to support it, be accountable for it, to embed it in everything we do as a company is going to be the guiding principle of our strategy, our investment and our behavior.

So finally, to sum up. We see a huge opportunity for Pearson to be the world leader in global education. We are, therefore, accelerating dramatically and urgently the development of Pearson as a global education company. Our strategy is very deliberately centered on a much smaller number of much larger opportunities. It is a work in progress. We've a lot underway internally in each of these areas, and we'll be setting out our plans and progress in more detail as the year goes on. It accelerates the work that is already underway to change Pearson into the first truly global learning services company. It tilts the focus of the company more quickly on to those 3 big opportunities: digital services, digital services and the rapidly growing middle class. And it could mean that by 2015, around 70% of our sales are coming from digital and services and 25% of our sales from emerging markets. As we do that, we will create a leaner, more cash-generative, faster growing business, and one, which is much more directly accountable for helping people make progress in their lives through learning.

So thank you very much for listening. I'd now like to introduce a few colleagues who are with us today and to take your questions. First of all, I should say that Glen Moreno, our Chairman, very pleased to see him with us this morning. And then of course with me to answer questions is Robin Freestone; John Makinson, CEO of the Penguin Group; John Ridding, CEO of the FT Group; and Will Ethridge, CEO of Pearson North America.

So, who wants to go first on questions? Sami? Can we have a microphone down here, please?

Question-and-Answer Session

Sami Kassab - Exane BNP Paribas, Research Division

Sami Kassab at Exane BNP Paribas. I have 2 questions today, please, John. The first one is in the context of the emerging market opportunity. Can you give us a bit more color on how the operating profit margin within the International Education division should develop over the coming years? Do you expect margins to go down a lot as you invest, or do you expect the revenue growth opportunity to be enough to be reinvested and keep margins steady? And second, if I may. Could you comment on the outlook you see for 2013 for the K-12 market and more specifically for the instruction material market? In the context of what seems to be a better adoption year, some improvement in education budgets, and hopefully, some positive impact from the Common Core Standards.

John Fallon

Okay, all right. Well, in -- I'll take the first question, even though I am now the CEO of Pearson rather than running the International business. I think for the -- as you know, International business now 45% from emerging markets; the other 55% split fairly evenly between the U.K. and the rest of the world from a sales point of view. The businesses in emerging markets have a mix of margins depending partly on the business model and partly at the stage of the development. So for example, I think on the whole sistemas and universities would earn higher margins, margins in our language schools in China would be somewhat lower, but still decent. And the cash margin would be significantly better than the OI margin because of the business model and the way that we're building and developing the business. And I think, and Robin will -- may chip on this, broadly speaking, we'd expect the margins in our international business to continue as they are pretty much flat year-on-year, as we -- as the benefits we get from scale, we're reinvesting in growing the business. That, of course, is pre- the impact of restructuring charges this year. And then, Will, do you want to pick up on the -- I hear you want to talk about K-12, talk about the U.S. Schools market? Will, do you want to talk about the outlook for 2013 and maybe a bit of color on 2012?

William T. Ethridge

As I've said last several years, we're in this transition period in U.S. education. So we have the combination of very tough funding issues. We have the shift from printed, digital. And we have the policy change of really going to Common Core. As you've seen, we've been able to invest during that period. We've been able to take share during that period. And we've been able to increase margin during that period. So we feel good about it. I think we're starting to see the uplift in school, but you got to be careful because we still have the funding pressures. And we still have some uncertainty of people spending before Common Core, which really starts picking up in '14 and '15. We have been doing well with our move to services. We did very well. These one-to-one, I can talk more about that. Obviously, our investment and connection has played off well. So I do think we're seeing sort of the light at the end of the tunnel in terms of the Common Core. But it's still -- it's still overall, the big factors of funding, and people waiting until '14 and '15 is still there.

Sami Kassab - Exane BNP Paribas, Research Division

And your adoption last year, 380 this year, how much?

William T. Ethridge

We usually update -- we update our new adoption number at half year. We keep reminding people -- given how strong we are in services and technology and everything else, it's less and less a meaningful number. But we'll update you at the half year. I don't think it's going to be materially that big a change in terms of the overall portfolio. We're really doing well because of this whole move to services. But we'll update you Sami in the half year.

John Fallon

Mark?

Mark Braley - Deutsche Bank AG, Research Division

Thanks, it's Mark Braley, Deutsche Bank. Two questions and one clarification. The GBP 150 million of charges this year, can you give us a feel broadly for how we should think about that, splitting between people costs, presumably property costs and then other, I guess, accelerated depreciation of IT and those sort of things? Second question is you kind of referenced execution risk, I suppose. Should we think about this as a big IT project, or is it a big IT project, plus going out and finding new partnerships and new business relationships in some of that long tail of markets? How -- what are the big execution risks, I suppose, is my question? The clarification was just, Robin, on the Penguin settlement costs, those are not in the adjusted metrics for 2012?

John Fallon

I think you -- you want to deal do with that, first?

Robin Freestone

So you're right, Mark, in as much as -- I'll stand up -- in that we've taken in 2012 some initial costs of setting out the joint venture, legal costs, some of the finance costs, that sort of thing. And we've also -- because we need to settle the agency arrangements in the United States, made provision in 2012 for our best estimate of what that will take to do that? Now, that number's obviously commercially sensitive, so it's all wrapped into one number. But we wouldn't have incurred those costs, was it not for the fact that we're forming Penguin Random House. So we believe it entirely sensible to take those through in 2012, make provision for them and treat them as a statutory item, not an adjusted earnings item, in the same way as the profit on sale that we'll realized in 2013 when we form the joint venture won't be taken through our adjusted earnings number either.

John Fallon

Okay. I'll pick up on the -- what we spend on the restructuring and I'll then talk a little bit about implementation risk and then ask Will, perhaps, to add a few thoughts on that. So essentially, the restructuring charges this year are activity-led, by which I mean we're really looking at every element of the educational publishing supply chain around the world. So from product development, production, marketing, sales, customer service, distribution, warehousing. So it's right across the whole educational publishing supply chain, and it's pretty much all over the world. So you are right to assume that this will be primarily -- relate to roles, and clearly, that has some impact on property and asset write-downs as a result, but it is primarily activity-led. And just to reinforce the point that I made in the presentation, educational publishing will continue to be a very significant part of Pearson for many years to come, continue to contribute along in terms of profits of cash and it’s really important platform for migrating the business. We just need to be spending proportionately less on it than we are at the moment. And we have been doing that. So each year, we're shifting resources from the flat or slightly declining educational publishing businesses to the fast-growing digital services in emerging markets. But there's a limit to what you can do within the constraints of one annual budgeting round. And what this is doing really is accelerating that process and really enabling us to do something more like 5 years of what we've -- of restructuring that we would normally do to the annual budget process in one go. So it's a very significant shifting and tilting of our operating expense to where the big opportunity -- and in some ways, it's more -- it's akin to the sort of operating expenses catching up for where we've been reallocating the acquisition capital over the last few years. So given that, the execution risk is, as you can imagine, we've made some assumptions about our ability to sustain and manage sales through that process. Inevitably, it caused some uncertainty and anxiety within the company as you go through this process. I should say that quite a lot of this work is already underway, so quite a lot of this restructuring is being done as we speak or has already been done. But clearly, from a management point of view, it is a major challenge. I don't think I'd describe it to be like a major IT program in that way because I think it's much more containable in local markets around the world. But Will, I don't know if you want to add something to that in terms of how we manage our risk as we work through -- our way through this?

William T. Ethridge

Yes, I mean we have been doing this for a while. We've been anticipating this change. It's that things -- the markets are accelerating. We've seen the benefit of these new models we've done. So what we're really doing is accelerating. I think the risk is what's made us strong is we are so customer focused, we're so execution focused. So with more change, there's always that emphasis to make sure we're staying focused on customers. I have to say though that people are up for this. They see that the new models are working, and they see that we have to do it, so yes, there's a few more moving parts. And we got to be able to stay focused on that, but there's a real passion and a real energy, I think, that we have to do this. And so I think we're going to stay very focused on customers though while we do it.

John Fallon

And that last point Will has made is a very important one. So we've had in terms of developing this strategic framework I've been describing this morning, it has been developed led by Will, Robin and myself working with initially with the 30 most senior leaders of the education businesses around the world. And now we've engaged the next 120 senior people. So one of the big challenges to doing a -- one of the big risks in a program like this is getting buy-in [ph] engagement support commitment from senior management. And it's absolutely clear I, think, to the whole of the senior leadership of the company that this is the right thing to do and the right time, which I think gives us greater confidence we can manage the risks.

So Padi there and then a gentleman behind you, so Padi there and then right behind.

Vighnesh Padiachy - Goldman Sachs Group Inc., Research Division

It's Padi from Goldman Sachs. I've got 3 questions, John. The first one on the gross restructuring costs for 2013, what exactly relates to Penguin and what is part of this acceleration process? Can you give us an idea of that, please? The second, I think, Robin, you alluded to the cash costs. Could you give us a profile of the cash costs for the restructuring, because you said you didn't want to disrupt the 2013 sales process? And finally, a question for Will, on the U.S. college market. I think the market overall was down about 6%. Can you give us an idea what the sort of print textbooks actually declined within that?

John Fallon

Okay. Robin, do you want to take the first 2 questions and then Will on U.S. college?

Robin Freestone

Yes. So to be absolutely clear, in our GBP 150 million 2013 gross restructuring, GBP 100 million net because we'll get about $50 million back in terms of benefit. Penguin Random House has not been included in that, Padi. So that will come in 2014, because we're pretty clear now that the regulatory process is going to take us into the second half of the year before we can get started. And that is not a great time to be restructuring in Penguin when it's in the midst of their major selling season, particularly in quarter 4. So we've decided at the moment, I mean, this could change depending on when regulatory approval came through. But at the moment the design is those Penguin Random House bringing together costs and restructuring will be incurred in 2014 not in the 2013 GBP 150 million gross number. In terms of your cash question, as John has said, the vast bulk of the restructuring that we're looking at is activity driven, meaning that, I'm afraid, significant costs have incurred in people leaving us. And so we would expect the cash cost to be pretty close to the numbers I've given you. There's 1 or 2 sort of smaller property-related charges there but actually cash costs are going to be pretty close to the numbers we've already given you.

John Fallon

Okay. Will, do you want to pick up on the U.S. College question? And while you do, I should have said, I also some questions here from people that are e-mailing in. So there's a question from Shalini Gupta [ph], which is, "Can you please shed some light on the regulatory changes that are negatively affecting for-profit College enrollments?" So perhaps, Will, when you're talking about the overall outlook for Higher Ed how we performed in 2012 and the like, also pick up that question as well.

William T. Ethridge

Yes. What happened -- the 2 most important things that happened in Higher Ed this past year was one, a drop in enrollment. We expected a drop in the for-profit around 8% because of all these regulatory issues around the for-profit sector. The other thing that happened was a drop in 2-year. And that was a little bit in part of the funding crisis that schools had a harder time keeping up with demand and really supplying the number of courses to meet the students and a little bit students as it kind of picks up a bit, that countercyclical issue. The other big change was the growth of rental. So it's just another form of substitutes. We've had used books. Now we have rental. We think that is a temporary issue. Rental only exists if you have a physical product and that's why we are moving so quickly to the digital models, that's why content as a service as part of other models is so important. And it's why we've been here in the industry. I can't really comment on the overall. These are also AAP stats so we don't put some of our -- just be pure apples-to-apples and be really honest in some of our pure technology stuff we don't have in there. What we have is in all our MyLabs, all our textbooks and all of that, but we don't have things like Embanet, all those kinds of things. So it's clear that enrollments were down. It's clear that rental picked up but it's also clear that rental over time will go away and it really is about, do you have the learning systems that really help kids learn and people teach and as we go digital, that whole issue goes away.

John Fallon

And we'll pick up on the for-profit college enrollment regulation pressures?

William T. Ethridge

Yes, I mean what happened for-profit is there was concern that students were being recruited in, in the promise of jobs and other things. There's concern about how much debt the students were taking on. There was concern about the marketing practices of the for-profit sector. So there was a lot of attention about that and the for-profit sector became much more focused on making sure that whatever they take in is going to do well and meets the standards. So with that, you saw a drop in the enrollments in the for-profit sector, it had been growing very strongly and then it went the other way.

John Fallon

And Padi, could you just pass the microphone one back there.

Ian Whittaker - Liberum Capital Limited, Research Division

It's Ian Whittaker from Liberum. Three questions please. First of all, just on the free cash flow. If you exclude the restructuring charges, can you talk about how we should look at 2013 free cash flow, given the operating profit is going to be similar presumably you still have digital investments, I'm wondering whether there'll be any change on the outlook in the debtor days? The other 2 questions just really refer to the U.S. Higher Education market. The first one, sort of just wondering what contingency plans you have in place if the publishers lose the Kirtsaeng versus J. Wiley case that is in the U.S. Supreme Court at the moment? And sort of the potential implications of that for your model? And the second thing is just if you look at the sort of your talk of moving more and more to digital, if you look at most of the -- in fact if you look virtually all the polls in terms of U.S. Higher Education students, there is still a very strong preference for print, there's around a 75% preference for print on there. Now obviously you've increased the growth of your digital sales but sort of just wondering how successful your policy can be of moving from print to digital if you've still got the bulk of students even now still prefer the print product?

John Fallon

Okay. Robin, do you want to pick up on the free cash flow and then Will pick up on the 2 U.S. Higher Ed question?

Robin Freestone

I think, we've probably given you most of the kind of elements of free cash flow forecast on the way through. We've said that we'd expect our operating cash conversion to return to more normalized levels so closer to the 100% we've done in the last 5 years, rather than the numbers we did in 2012 so that's a sort of solid start. We've also said that the restructuring is mainly cash, so you can figure out where that's going to be, more or less it's 100% impact. And then the cash tax we've indicated is going to increase, cash tax was particularly low for the reasons I outlined in 2012. It would've been other than that, other than the Hurricane Sandy impacts, actually more or less in line with 2011, about the same as 2011. But of course, we're going to get a double whammy there because we're going to pay the cash outs we didn't pay in December in February 2013. So we've guided you on cash tax to a number similar to the ETR. And so I think that, that gives you all the elements to get to a free cash flow forecast.

John Fallon

Will is going to pick up on those 2 U.S. Higher Ed questions.

William T. Ethridge

Yes. So on the Wiley case, it's about reimportation that's already happening. So I mean I think if we lose it's not going to change what's already, in sense, already happening that much. And on the second issue, I think a lot of those surveys are about the print book versus the static eBook, and we don't think that there's a lot of belief that students are going to go to static eBook. They actually go to static e-Book for price reasons. Where we are getting growth is through the MyLabs, where you are serving up in a dynamic personalized way, instruction to the students, giving data back to students, giving back data, back to professor. And it's clear that it's been growing very, very well, and we see no reason, especially given the investments we're making for that to slow down. The second thing that's happened over the last 1.5 years is we're doing this content as a service. So that schools are going to us and saying we want your libraries of content, we want the MyLabs but we also want to bring in, in a more dynamic way, OER. We want to bring in our own user generated materials. And they're going to us to help them make that happen because we have the platforms like EQUELLA, which is the standard for managing content. We have the MyLabs. We have our eCollege. We're doing intervention, one of the things we found out is that if you contact the student at the right time, and we can see it now digitally and you give them that call, "Hey, we've noticed this." It has a big impact in terms of retention. So you're absolutely right that the stat eBook -- just digitizing print doesn't do much and students are quite smart. But when they see that they get better grades, when schools can see that it can improve retention, that's -- those are the kinds of services that are making a difference.

Ian Whittaker - Liberum Capital Limited, Research Division

Can I just go back to your answer for the second question? I mean, sort of the answer that it's happening now. I mean it is on the sort of small individual scale, but it's not really on groups and companies themselves that are important textbooks and cheaper markets because the legal situation is unclear. And it's almost as though there's the same legal principle here, which is Costco, for example, back in 2010. Sort of it was organizing mass imports of watches into the U.S. market to exploit the price arbitrage. If you sort of lose, if the publishers lose the case, is the concern not that you will get more established groups who would look to exploit the price arbitrage opportunities between cheaper markets overseas and the U.S.

William T. Ethridge

But again you're talking about the static book. And like I say, it can't get much worse with rental and everything else. There's a big supply already of textbooks out there. We've seen that for a long time. So yes, if we were just in the business of selling textbooks, then you have a lot of substitutes . But we're not in that business as much as we [indiscernible]. It's really we're growing so much here in that, so we are really about things like the MyLabs, contents and service, the customization. If that's much better learning, people will feel much more engaged if they've had some involvement in it. But you're right, the absolute pure substitute, whether it's reimportation or rental or used book, that's been around for a while. We're moving off of that model.

John Fallon

Okay, can you pass the microphone to the back there and then just while you're doing that, a few questions from Tim Nollen at Macquarie. "Will, I know you talked a bit about this on K-12 market before, but any updates you can give us on Common Core in the U.S. please, timing, what it means for you for sales in 2014 and beyond?"

William T. Ethridge

Yes, the Common Core is where there are new assessments that will be -- are being developed. We're one of the companies that are developing those new assessments. With the Common Core and the Common Core raises the standards, with it, there's the move to more online. And with it is the move to really fundamentally change your teaching practices and teacher effectiveness. So we will play in a variety of ways. One, we are bringing out new curriculum tied to the Common Core; two, we are providing the instructional improvement systems. There were a number of RFPs tied to the Race To The Top that was done in conjunction with the Common Core for schools and districts to implement new instructional improvement systems. We've won the big majority of those. We are creating the assessments. We won the contract for assessing online readiness for testing. And then we've been -- and we're starting to see it this year, I think, it'll start picking up in the following year. Schools are coming to us and saying, "Hey, we need your help in pulling this all together, bringing in the digital curriculum, helping the teachers change their practices in implementing these platforms." Two districts this year got national claim, Huntsville, Alabama and Mooresville, North Carolina. In fact, Mooresville, the superintendent was selected as Superintendent of the Year. Both superintendents said that we could not have pulled off these one-to-one initiatives without Pearson. What it meant was they got laptops or devices for every kid. They retrained their teachers. They brought in new systems, most of them, or many of them, are ours and they used us really as the general contractor. So that's the example of the move to services. And we think we'll see more of that, as well as we will be playing the so-called point solutions of curriculum and assessment and platforms.

John Fallon

Okay, Tim had 2 other questions which I'll just pick up very briefly. One was, "Do you foresee any need to raise capital through this process?" And I think, as Robin signaled, I think in terms of the headroom we've got to make bolt-on acquisitions the way we're confident this is going to deliver more cash generative business as a result. I think we're very comfortable with the capital in the business at the moment.

And then the other question was, "How should we quantify the growth opportunity in 2015 and beyond? And what is your outlook on the pricing environment on your operating margins in this brave new world?" And clearly, that there is very much from, in each of those 4 business models, I think for the fourth business model and the migration of our Textbook Publishing business is to more learning systems. I think in the pack, we've given you a pretty clear sense of what the pricing and how that impacts on our margins as we work through. And clearly, on the first 3, particularly on direct-to-consumer and the Pearson Inside, the more directly we engage with the customer, we create a bigger opportunity for ourselves. So there's an opportunity to take a bigger part of the supply chain. And broadly speaking, we'd expect the margins to be similar and the working capital requirements to be less as we work through that. And I think I signaled on 2015 and beyond, I don't think we'd be more specific other than to say the whole purpose of doing this is to create a faster growing business, to create a leaner business and more cash-generative and a more profitable business. And that's what we very strongly believe will happen.

Question right at the back there, and one here and one there.

Matthew Walker - Nomura Securities Co. Ltd., Research Division

It's Matthew Walker from Nomura. Just 2 questions please. Do you think you can get a decent level of organic growth in 2014? Obviously that requires you to think about what's going to happen in North American Ed. It sounds like North American Ed organically could be down again in 2013, but then you've got Common Core coming in, et cetera. So do you think you can get growth in 2014? And the second and last question is on the FT. It sounded like, from what you were talking about in terms of embedding some of the FT in some of your consumer products, you still, for the time being anyway, you want to retain ownership of that business. Apart from the use of the FT brand in terms of language training, et cetera, in China or, et cetera, what are the real synergies, and how do you weigh up keeping that versus maybe selling it for a premium price to someone else who wants a trophy business or thinks they can exploit the brand in another way?

John Fallon

Okay. On the FT, John Ridding, do you just want to talk a little about some of the ways in which the FT is engaged in the wider education structure and some of the things that we're looking at? And then I'll answer the other part of that question and then organic growth as well.

John Ridding

Sure. Just wanted to see where the question came from, but the FT's -- its activities in business education, are already developing pretty well so, you mentioned the English language training. So we're working with global English to use FT video in that course material. We're working with Wall Street English to use FT articles throughout their course material. There's a range of other specific initiatives, Newslines, which is a new service we sort of launched and developed last year, which is already making FT content available to students and to professors and faculty, to annotate FT articles and to create sort of realtime case studies, is now -- it's sort of more than half of the 50 world-leading business schools and we're working with Edexcel and Pearson Learning Solutions on a nonexecutive directors' training and certification program. Now all of these, there's lots more things in the pipeline, what they have in common is that they're using existing assets to build business quite quickly with fairly low overheads and then they're fairly profitable quite quickly. So there are some of the specific things. I think more generally some of things that John has been talking about in terms of the transformational transition, direct-to-consumer models, data analytics, mobile, which is now about 1/3 of the FT's traffic, these are all sort of the areas of sort of technology and skill and expertise, where we can share the FT's experience and assets with Pearson's, and we're finding a lot of scope for that.

John Fallon

And in terms of the broader question, I think I can add much to what I said earlier. Each and every part of Pearson needs to be a sustainably profitable business in its own right, all the time. We will constantly ask ourselves, of any business in Pearson, are we the best owners of it? And so that's the way we'll think about the FT just as the way we think about any other part of Pearson. I think, who else, we can take 3 more questions there, there and then Patrick.

Alexander Christian DeGroote - Panmure Gordon & Co. plc, Research Division

It's Alex DeGroote of Panmure Gordon. Just on dividend, I think the implication of this hiatus of earnings over the next 2 years would be that cover would shrink. So there's a chart in the pack, which relates to healthy divi growth over the last decade or so, but does this portend a period of flattish dividend?

John Fallon

Okay, Robin, do you want to pick that up and do you want to pick up on the question that we forgot to answer before, which is organic growth for 2014 as well?

Robin Freestone

I'm not going to answer that one but I'll try. Dividend that's an easy one. So we, as I said, are absolutely committed to our progressive dividend policy. What the policy embraces is maintaining a 2x cover over the long term, so you are going to see the cover come off a little bit in the short-term clearly after restructuring costs but we are absolutely committed to our progressive dividend policy. We'll continue to grow the dividend well, because we have confidence in the future and that the returns will come in from the restructuring that we've announced today. The only thing we won't start giving, we don't imply, we try not to give organic growth guidance, for a start, we give guidance at CER. We've said in 2013 that we do expect to see our North American business grow at CER. I don't think we want to start giving 2014 guidance at this stage. It's a little bit early.

Sarah Simon - Berenberg Bank, Research Division

Sarah Simon from Berenberg. Two questions, please. Just back on the restructuring, just to be clear, you've always made a virtue of the fact that your restructuring costs go above the line and there's always ongoing restructuring. So in terms of the FT acceleration to digital, is that in the GBP 150 million or not? And also the de-synergies of Penguin, you said the Penguin merger costs are falling into '14 but is the synergy elimination restructuring costs in the GBP 150 million? And then can you give us a kind of guidance as to how much you spent on restructuring overall in 2012? And then just on Common Core, obviously everyone is sort of pushing and pushing it, do you think that is also because beyond the fact that there is funding pressures to do with the materials themselves, there's also the massive costs associated with the technology? And do you think that could have implications for the way your business runs in terms of, for example, bundling hardware with software, any kind of pay-TV like model?

John Fallon

Robin, do you want to take the restructuring question?

Robin Freestone

Yes. So to be clear within the GBP 150 million, there is a small element of restructuring associated with the FT. It's pretty small and in fact, John is already doing it now, so it's really no more than it is already going on down at One Southwark Bridge. On the Penguin elements of it, there are subtly 2 slightly different elements here. One is preparing to unpick Penguin from our own infrastructure within the shared operations, shared services arenas that we talk -- that we have today. And that element is within the GBP 150 million. But what we try to make clear is the bringing together of Penguin and Random House, which as you can imagine is in itself a pretty big undertaking that John is planning for, is not in the GBP 250 million which we don't envisage those costs happening until 2014.

John Fallon

Okay. And I think I sort of answered your question before by saying this is really the equivalent of doing 5 years of normal year restructuring in 1. Will, I'm not sure there's a lot left to say on the Common Core, but do you want to briefly talk about perhaps the relationships with device manufacturers and between hardware and software just briefly? And then 2 final questions here. So if we can get the microphone down ready that will be great.

William T. Ethridge

Yes, I mean, obviously the device manufacturers are out trying to take advantage of Common Core. We work -- we don't work -- we work with many of them. One advantage we have is we can make it easy for the school to work with their existing hardware, with their existing systems and then we have the scale to make our content available in ways that work for them. So we've done things with Apple. We brought out a very exciting product this year called iLit, which is -- it's on the iPad. It's helping struggling students in reading. We're finding great engagement with the students, reading scores going up. But we work with other device makers as well. What's really helpful, though, is having a partner that can work with the teachers and the training given the data deal with a lot of those sort of last mile issues, and increasingly, we're seen as a company that can help do that rather than working with lots of companies. A lot of these districts are saying, "Let's go with Pearson and they can partner with others and make it easier for us to do it." Because it gets very, very time-consuming and complicated for these districts to deal with multiple vendors. so we're actually finding this is helping us a bit.

John Fallon

Okay, a question here and then either of you.

Giasone Salati - Espirito Santo Investment Bank, Research Division

It's Giasone Salati from Espirito. Two questions please. You mentioned in your introduction, John, a dramatic and urgent acceleration needed. Now I have always seen the glass half-full with Pearson and always thought that the company is very, very well invested. You mentioned on the American Education, rental, is that one of the reasons and could you actually strip out any other reasons, which make this transformation now dramatic and urgent compared to 6 or 12 months ago? A long question, I apologize. Second one, your guidance for EPS this year, and this is probably for Robin, what is your view on sequester? Have you included the worst-case scenario, everything just being delayed to 2013 and '14 and beyond? Or this could go worse if we go for sequester?

John Fallon

Okay. So I think, I mean, we can talk about this more later. But I think clearly, it's very much as I described it. I mean if you look at our results in 2012, you've got digital services, emerging markets growing rapidly. You've got the other half of the business, textbook publishing-led, outperforming the market probably as much, if not more than any point in the last 15 years, and the reward for that is with declining less slowly than the competition. Some of that is cyclical, but there are some structural factors there as well. I don't think, you don't really, I think, need to be that bright to work out that the logical thing to do is to fairly significantly allocate the process by which you take operating expenses out of the part of the business that is flat or declining and put them more aggressively into the parts that are growing and the reason now is the time to do it, I think, partly is for the reasons we outlined. Because we have now got the platform in place because of the bolt-on acquisitions that we've made a few years ago. We've now got that position in digital services and emerging markets. We've had a few years to get used to those services businesses, to make sure we understand them, the opportunities and the risks. We know that they work. We know that they're profitable and so now is the time to do it. And it's really just about bringing that greater sense of urgency to make the most of our opportunity and, therefore, also the framework really, the global businesses, the vertical business models, the greater geographic focus just brings it all together. So I think that's really the logic of it. Patrick, you have somehow managed to get yourself the last question. I don't know how you managed that.

Patrick Wellington - Morgan Stanley, Research Division

It's Patrick Wellington at Morgan Stanley. Just 3 questions. The first one, though at this late stage, you can leave if you like. On North American Education organic growth was minus 1 after 9 months and it's minus 4 after 12 months. I know the quarters are different sizes, but do we need to read anything negative into that? Secondly, I'm going to go back to Common Core, Will is picking up his papers as if it's all over, but it isn't. Very simple question. Forget Pearson. Do you think the schools market in North America is going to have a very good year in 2014 and '15 because of Common Core, or don't you think that? And the third question is as a result of everything you've talked about this morning, do you think you'll have, as a group, more or less revenue in 2014 and 2015?

John Fallon

Okay. Will, do you want to take the first 2, particularly on the, I think, we've sort of answered that part. It's partly the shift that's happening from December into January, I think it's part of that fact there.

William T. Ethridge

Yes. I think the figures are not exactly right correct but it is true that the fourth quarter weakened versus the first 3 quarters although not as much as I think you said. And that's going to keep happening because what we're seeing is a shift in December, which has been traditionally our biggest month into January. So we're actually doing pretty well in January, and that's because of deferred revenue. That's because of later ordering and all of that. I'm not going to comment on what the school market is going to be in '14 and '15. We just stay focus on what we're doing. I think it should be better, but it's a long ways off.

John Fallon

I think, Patrick, I was pretty clear in the conclusion that said the purpose of us doing this is to have the business that grows more quickly. So I think by definition, that would mean that we will have a -- we will have more sales in the future than we have currently.

Patrick Wellington - Morgan Stanley, Research Division

It's quite disruptive you were also saying into '13 and '14, so do you expect -- do you expect disruption to depress sales before the benefits come back?

John Fallon

I think we are -- we're not going to give more specific guidance than we've given already. But certainly by 2015, the whole purpose of doing this is we believe that by allocating the resources in the way we are to the faster growing opportunities, we can start to get the top line and the underlying growth of the business growing more rapidly than it did, for example, in 2012. That's the whole purpose of doing this.

Okay. On that note, thank you very much indeed. Thanks for coming, and Simon is around and will help out with anything else that we can deal with.

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