Pearson PLC (NYSE:PSO) Q4 2018 Trading Update Conference Call January 16, 2019 3:30 AM ET
John Fallon - CEO
Coram Williams - CFO
Conference Call Participants
Sami Kassab - Exane BNP Paribas
Katherine Tait - Goldman Sachs
Tom Singlehurst - Citigroup
Ian Whittaker - Liberum
Chris Collett - Deutsche Bank
Nick Dempsey - Barclays
Patrick Wellington - Morgan Stanley
Giasone Salati - Macquarie
Matthew Walker - Credit Suisse
Hello and welcome to the Pearson 2018 Fourth Quarter Trading Update. Throughout this, all participants will be in a listen-only mode and after that there is a question-and-answer session. Just to remind you, this is being recorded.
So today, I'm pleased to present John Fallon, CEO; and Coram Williams, CFO. Please begin.
Good morning, everybody. Thanks for joining us. As you just heard, John Fallon here and I have Coram Williams, our CFO with me. We will announce our full year results on Friday, February the 22nd. So for today, as usually, we just want to give you a very quick update on the key elements of our 2018 performance and how that shapes our guidance for 2019.
The headlines, as you can see here, we have returned Pearson to underlying profit growth last year with 2018 operating profits expected to be in the range of £540 million to £545 million. that’s in line with the guidance we gave on this call a year ago. The 25% of the Company that is U.S. Higher Education Courseware was at the bottom of our 0 to minus 5 guidance range. We have now had eight successive quarters of it performing in line with the market analysis that we set out on this call two years ago.
We accelerated the digital shift with 55% of our Higher Education Courseware sales now digital up from 35% five years ago, direct to consumer sales up 8% and a 40% increase in Inclusive Access deals. The rest of Pearson grew in aggregate with the real momentum and growing scale in our structural growth businesses. Online Program Management up 9%, Virtual Schools up 8% Pearson Test of English up 30%, and Pearson View of Professional Certification business up 4%. These are the businesses they are heart of the future Pearson.
We invested more last year through the P&L in our OPM, our Online Program Management business which is one of the most exciting of those opportunities and that in turn is building a stronger pipeline that will power future growth. We were able to fund that investment but still meet guidance and deliver a healthy increase in profits because we are outperforming on the cost savings that we achieved through simplifying Pearson and making it a leaner more efficient and more digital business.
In 2019, we are going to build on the progress we have made last year. We will deliver another year of underlying profit growth. We are running the Higher Education Courseware business now less than 25% of the Company on the basis that sales will again be in the 0 to minus 5 range with the further shift in revenue mix taking us another year closer to being a truly digital first business with a more commercially resilient subscription-based model.
We are running the rest of Pearson now more than 75% of the Company to again grow in aggregate, helped by the investments we've been making in our fastest growing opportunities and we will increase organic investment in those businesses again this year especially in Online Program Management to drive faster growth in 2020 and beyond. We can fund that extra investment though the P&L whilst delivering profit growth because we now expect to deliver more than the £300 million in annualized cost savings by the end of 2019 that we committed two years ago.
All of this underpinned by t strong balance sheet around £200 million of net dent at the end of last year, this enables us to invest in the digital platforms that create a simpler more efficient company, capitalizing more quickly on the growing number of possibilities we see to empower people to learn and prosper throughout their working lives.
And with that, I'll hand over to Coram.
Thank you, John, and good morning everyone. So let's start by taking a look at our sales performance by region. Revenue for the year was down 1% with a 1% decline in North America, flat performance in Core and revenue up 1% in our Growth segment. In North America, revenues were down 1% with good growth in OPM, Connections, and Professional Certification offset by 5% decline in our U.S. Higher Education Courseware business.
The decline of 5% in our U.S. Higher Education Courseware business reflects a continuation of the trends seen all year with great sales worse than expected due to continued cautious buying from the channel, but returns significantly better reflecting the actions we have taken to manage channel stock more effectively.
We have also seen the same shift of sales out of the fourth quarter and into the following first quarter that we have seen in prior years as our digital penetration increases and the business becomes more direct-to-consumer.
In Core, revenues were flat as strong growth continued in the Pearson Test of English, OPM services in Australia and the UK and in Professional Certification. This was offset by weaker performance in the UK driven by expected declines in AS levels as a result of policy changes and continued disruption in the UK apprenticeship market. And in Growth, sales were up 1% with strong growth in China, good growth in Brazil and other smaller markets partially offset by declines in South Africa.
Turning to operating profit, this Slide shows the operating profit bridge from 2017 to 2018. We expect to deliver 2018 adjusted operating profit in the range of £540 million to £545 million. That range reflects a £13 million to £18 million negative impact from trading driven by our U.S. Higher Education Courseware business being at the bottom of its expected range and a weaker than anticipated performance in the UK apprenticeship market and in the U.S. K-12 courseware.
Our restructuring savings of £130 million are ahead of plan due to an increase and acceleration of savings as a result of our ERP implementation. Other operating factors were £22 million and included additional investment in our strategic growth priorities as highlighted in our 2017 full year results. Finally we have seen roughly £50 million of inflation.
So, turning to guidance for 2019, this slide summarizes the profit and EPS guidance for the coming year. We expect adjusted operating profit of between £590 million and £640 million with the mid pointed guidance in line with consensus and representing continued underlying profit growth. In addition to the disposals and FX impact, our guidance reflects the accelerated and increased benefits of our restructuring programs, now expected to be incremental £130 million in 2019 and to deliver increased annualized cost savings in excess of £330 million by the end of 2019.
We are running the business on the basis that there will be ongoing headwinds in U.S. Higher Education Courseware where we expect revenue growth to be 0% to down 5% and for the rest of Pearson to continue growing in aggregate. We expect the normalized tax rate of 21% and the finance charge of £30 million.
And with that, I'll hand it back to you John.
Thanks Coram. The logic of the guidance that Coram has just talked to you through is the Companywide revenues should stabilize this year and grow thereafter. And in summary, we made good progress in 2018, returning Pearson to profit growth. Our strong balance sheet is enabling us to invest in the platforms that will help Pearson to achieve our full digital potential. There is a lot still to do but we are increasingly confident in our ability to grow and to prosper.
And with that, I'll hand back to Hugh and we will be happy to take your questions.
Thank you. [Operator Instructions] And we got our first question which is from the line of Sami Kassab of Exane BNP Paribas. Please go ahead, Sami your line is now open.
May I start with asking on the U.S. Higher Courseware division? John a year ago you suggested that that division could return to growth in 2020. Is that still the view of the business that you have? And secondly, could you quantify the impact included in your '19 guidance from the move towards the consignment model the 0 to minus 5 in U.S. Higher Ed? How much of that is driven by the impact of the one year associated impact of moving to consignment? And secondly, can you say a few words on the K-12 courseware performance? The market seems to have been down around 5%, is it in line with that performance? Any color on K-12 courseware please.
Coram, do you want to pick up on the consignment point and then give a little color on K-12 and then I'll up on Sami's broader point?
Sure, on the consignment, so the rental program increases from 150 to 400 titles. That does have a small drag on our revenues. It is built into our guidance. We will share the detailed bridge at the prelims time. And remember, there is also a small pick up from the 150 titles that were already in the program. So, this isn’t a huge negative in the overall bridge for Higher Ed, but we will share the detail at prelims.
In terms of K-12 courseware, actually you are right, the industry has had a difficult year and we have had a good competitive performance, but the challenges have been in Open Territories as a number of other players have been fighting with delayed purchases as people wait to see the impact of the new content that starts to flow through after the adoption cycles. The thing I would say is, we are feeling reasonably good about 2019 and it is a big year in terms of adoptions and we feel like we are well positioned to well in those adoptions. But you are right it's been a difficult year in 2018.
Thanks Coram. And on your broader point Sami I think as I said in the conclusion there, so Pearson as a whole over 100% of the Company, we are expecting revenues to stabilize in other words, not to decline further this year and for the Company to start to grow again as a whole in 2020. That happens because the 75% of Pearson that grew last year. It can bigger it's getting more sale momentum because the investment that we're putting into it and so the rates of growth there will improve.
The 25% of our revenues that come from Higher Education Courseware are becoming a smaller part of the Company. We're running the business on the basis of it could decline by just 5% again this year but that decline is happening on a smaller base. So the pure weight of the math is the 75% is getting bigger and growing quickly on the 25% to face the short term challenges is getting smaller. And that has fortunately less impact.
That said, 55% digital in Higher Ed Courseware now, 8% growth in direct consumer, 40% growth Inclusive Access deals, all of the things and initiatives that we're putting in place. As that business becomes more resilient and that it becomes more digital, it becomes more subscription based, it is going to stabilize and it will start growing again. But I think you understand it will give a better view on the outlook for 2020 on that specific business as we see how the year comes out. But for Pearson as a whole, it will be clear we expect revenues to stabilize this year and we expect the business as a whole to start growing the top line in 2020.
Okay, we now go to Goldman Sachs and Katherine Tait. So Katherine, please go ahead. Your line is now open.
Good morning everybody. And couple of questions for me. Firstly, on the flat to minus 5 market growth, I think previously you've sort of broken out and the various factors driving that. And would it comfortable to do the things going into next year? Just interested to see if any of them are changing or whether we're really sort of seeing very, very similar expectations going forward. Can you also give us any a bit color around any market shift that you've seen clearly in another quarter with the Cengage Unlimited product in place? So interesting to see, if there has been any and if you've seen any market share shift? And if you could also remind us on your market share in digital versus print as well that be very helpful? And then finally just on OPM, clearly very strong growth this year, and a lot of comments around and investments to sort of drive that growth. Can you help us understand how we should be thinking about this sort of longer term margin outlook for this business? I mean, is this a business that's still going to continue meeting more and more investment and any sort of your competitors have been equally investing more and more in this business. So can you just help us understand how you're thinking about the longer term margin outlook for that business, it'd be very helpful?
Okay Katherine. Well, I will sort of pick up on the market share and the competitive performance. And then Coram can pick bit more on the sort of dynamics of the higher cost where market and the profitability on our Online Program Management business. So I think we, as we've talked about previously, each month we get the data that enables us the NPI data that enables us to compare our performance against the rest of the major publishers in Higher Education of the other five major players.
Market share is pretty consistently within a 40 to 41 point something range. We've got the figures through the end of December, and it remains firmly in that range in about 40%. It's just around a little bit from month-to-month but it's remarkably consistent. So no, we didn't say, we can say with another quarter that we've not seen any sort of significant change. I think as we've talked about before, kind of be precise on digital share is not easy because everybody presents that digital numbers in slightly different ways, but I think I can say without fear of contraction that our share of the digital market remains significantly more than our 40% share of the overall market.
And actually, I think we’ve had a few years where frankly we've been to manage what was a relatively mature base of digital products. MyLabs, Mastering, first products in the market a decade ago and it's been sold out modest innovation on those things. We're excited by our first integrated digital product, Revel, that is now getting really critical mass. That will get extra power and on -- as we becomes the first product that we’ll launch commercially on the global learning platform this summer, we're looking to launch our first AI-inspired direct-to-consumer products in this summer and the pipeline of investment and innovation that we will have over the next three years is going to dwarf what we've been able to do in the last few.
So, our share remains high in digital and we remain confident that we're going to build and sustain that in the years ahead. I think for me it's fair to say that the dynamics, the moving parts of Higher Ed Courseware market are pretty much as we call them over last two years, but we want to just had a little bit of color on that and then talk about sort of underlying margins in the OPM business.
And John, I think that's absolutely right. I mean you know we've been describing it in the last two years, dynamics in our business where OER and enrollments are a sort of 1 to 2 point drag. And then we have a decline in the sort of high single to low double digits, digital rate in the mid single digits and benefits from returns. That's the sort of framework that we've been approaching this market within, and it's not completely precise, there are some movements year on year. But I think that is a good way to think about the breach that we will show you in February when we come out come out with the preliminary results and we give you the bridge for 2019.
A quick word on returns, I sometimes get asked whether the inventory correction is over and therefore whether there'll be no benefit going forward. I think it's important to remember that, yes we had a one-off inventory correction in '17, but actually we've also been managing the channel very effectively. The actions that we've taken around incentives and returns restocking charges have had a benefit on returns and that benefit can and will continue into 2019. So returns will be part of that bridge when we finalize it and show it to you in February.
In terms of the margins of OPM, I think we've touched on this before in the sense that over through the cycle this is a good margin business which is in line with Pearson’s overall margins. The contracts are long term though as you know. They can be seven years in some cases a little longer than that. And there is a significant investment phase upfront and then you get real profitability in the sort of second half of the contract.
So as you grow you do have to put that P&L investment through. But the returns on that investment are good. We’re very satisfied with that. And the reason we're upping investments at the moment is not because others are upping investment but because we see that there's an opportunity to really capitalize on a growing market and drive that top line in the way that John has described. So, I think that gives a sense of how we're thinking about OPM.
We’re going to see Tom Singlehurst. Please go ahead.
Morning, Tom, here from Citigroup. I thought I would jump in before Patrick with a sort of semantic question in the sense that you talked about another year of underlying profit growth, but of course the trading impact from 2018 ended up being negative when you hadn't anticipated slight growth. Can you just give a bit more sort of color on whether that was all just within the UK qualification business? Was it surprising in nature? Or was it something that you anticipated that you felt you could make up elsewhere? And then specifically, you talk about sort of I suppose a positive trading impact for 2019. How confident can we be that there won't be another slow off the ball incident? And that was the first question and the second one very quickly. Can you quantify the profits from K-12 from 2018 and so we have a sense of what the drag will be if and when you do sell it?
Thanks Tom. Coram, do you want to pick up on those two?
Yes, sure. Hi, Tom, so I think I flagged in my commentary in the script that there were two areas which were a little softer than we'd expected. So the first is the UK qualifications business where the pressures that we've seen in the past have around BTECs, but BTECs as we’ve highlighted have been stabilizing. But there were two issues this year both of which we've flagged through the year. These are not new news, but they do have an impact on profitability. The first one was around AS levels where the mood to decouple AS levels from A levels have led to a decline in AS level registration. That was a little worse than we'd anticipated, we saw the impact but it was, it's moved a little more quickly.
And the second area of pressure has been around UK apprenticeship where as we flagged in previous calls, the introduction of the apprenticeship levy has created quite a lot of disruption in this market in the short term. Longer term it's probably upside, because it means there is more funding available for apprenticeships but in the short term the market has struggled to respond and we've been a little caught up in that. And then the second area is actually the one that Sammy asked about earlier which is K-12 learning services where the pressure in infant territories I think it’s best to say have been worse than the industry was expecting as a whole. So those are the two areas that meant that the trading was a little bit worse than we have anticipated at the beginning of the year.
But to be clear we compensated for that by driving our cost saving program and generating more cross savings and these are not short term savings, these are all about improving the underlying health of Pearson, making it a more efficient and more manageable company. And therefore we think on that basis it is right to highlight underlying profit growth because that's exactly what we've got. Why would that happen this year? Well, you know, I think the -- we are guiding in a similar way this year so 0 to minus 5 in Higher Ed and growth in the rest of the Pearson in aggregate.
I think the key point is the one that John made earlier, which is Higher Ed is becoming ever smaller part of the business, and the 75% of Pearson that is growing is becoming a larger component. And we've been investing in it so it's really a momentum question and I think you can see it from businesses like OPM where revenue growth was 9%, but actually enrollment growth was 14% and that's a really good leading indicator for what’s coming through the pipe in the future, so I think we're seeing good about momentum.
And Tom, I'll just pick up on your off the ball comment because the one thing that we can guarantee, there will be at least one off the ball incident this year because that's what happens. What I'm proud about in these results is, I think, we're becoming much more resilient when faced with those off the ball incidents. And the fact that we did have some things that haven't been expected the fact that we did the biggest lift that any of those rather going to have to do in our lives in terms of implementing, enabling program and ripping out some very deeply rooted systems in our Higher Education business and replacing them with systems that will transform what we're capable to do. But it's still unbelievably difficult to do and we have the supply chain challenges that from that and still have deliver the underlying profit growth and delivered something in the top of our guidance range. I think that should tell you that we have much better place to have to deal with what happens off the ball than maybe we were in the past.
And just one final comment on K-12 profit we've quantified it as around £11 million on previous calls, and I think that's the right way to think about it still.
We are now over to Ian Whittaker of Liberum. Please go ahead, Ian. Your line is now open.
I have three questions please. First of call just come back question sort of I think it was Katherine just talking about returns. You said there will be benefit in '19. So that when does the returns benefit I actually went out because there is obviously a limit to what you can do. Will it be 2020? Will it be 2021 or sort of do you think could be longer?
The second question just has to sort of comeback just in terms of cost savings. If you look at the updates in the first half, you're talking then about £95 million of cost savings third quarter you said you're on track and then the full year obviously we've got 130. So obviously, there were something doesn't in Q4. Can you just tell us if trading is weaker so than expected in 2019, what is your capacity to actually implement extra cost savings sort of quickly? Can you do the same again sort of if you have sort of particular issues?
And I guess the third question. As it comes back to just calling sort of definitive base sort of 75% of the business is probably in Africa. Yes, there is obviously and that maybe the case, but obviously not some of those sort parts of 75% and also declined. So could you actually just sort of start the benefit of offers, sort of essential revenues sort of within your business that are actually declined in 2018? Obviously which seems the U.S. Higher Education sort of U.S. K-12 any other areas is well placed? Thanks.
Okay. Well, I'll pick up on the first point maybe and then Coram to chip in. I mean I think in an ongoing increase or declining returns rather is an ongoing structural change that is happening in our markets. 24% 1 in 4 students who bought the Pearson product last year bought it direct from us. That's growing at a rate of 8% per year that means that every year proportionately fewer students are buying Pearson products from campus bookstores. That's actually good thing because the more we drive that out the more we have a subscription base resilient business with much greater visibility and a much more adapt between our growth sales and our net sales.
So, inevitably, that means that campus bookstores having to reshape their own business models as a direct consequence of the strategy we're pursuing. And so each year, we should expect the gross sales through that channel is going to come down, but in turn the returns are also going to come down significantly as well because they are going to be managing their lower level of capital. And I think we can all agree that that's a much better business model because it gives you much higher levels of visibility and transparency as you work through.
But does that mean -- sorry. So does that mean 2020 will get a benefit from returns as well?
Yes, of course.
It means you can -- you are going to see every year, gross sales made through campus bookstores decline as sales made through direct-to-consumer and direct on an institutional-wide basis by universities increase. And because they are buying fewer books from us, they are going to return fewer books to us. That's the whole point. That is exactly the strategy that we are pursuing. Okay? Do you want to pick up, Coram, on the other two points.
Cost savings and the growth question. On the cost savings, I think we’ve highlighted, I highlighted in my commentary that you know having moved and done that heavy lift on the ERP in this summer, what we've been able to do is to use that new system to go more quickly in terms of the way that we're taking costs out of our back office. And the lion shares of the additional savings are coming from places like technology, HR, and finance. And it's really about our confidence that we can take those costs out. And in fact go further and that's what's driving the additional savings in this year. And it's what's driving the additional savings next year.
So I wouldn't want you to think that this was some kind of knee jerk response to trading pressures. I think we've been fighting in the trading challenges through the year and you know we've moved steadily systematically but quickly to get the costs out once we've implemented the system. So that's what's happening on the cost saving program. In terms of the sort of growth that Pearson’s top line. I think the best way to think about this there's 25% percent of Pearson which is declining. That is the Higher Ed business. We're very clear in our guidance on that and as John and I have both said, that will become proportionately less of a drag as the years progress.
There's about a third of the business which is what I would think of as the traditional core, that sort of testing and the other courseware businesses. And there have been some challenges in those in the past. But as we've been describing over the last couple of years they're stabilizing and they are becoming sort of steady generators of good profits and cash. And then there's a third of the business which is in the structural growth opportunities where we're seeing real momentum.
So the growth rates in OPM of 9%, roman growth of 14% vertical schools up 8%, PTA up 30% and professional certification up 4%. Those are all gaining momentum. We're investing in them and they are the reason why we're confident in our ability to deliver growth in the future.
Yes, thanks Coram. And Ian, I think your -- as Coram just started to unpack, I think that challenge of saying could you give us more sort of more sort of color and data around the different moving parts within that 75% I think it's absolutely right question and that's kind say a challenge. And we’ll look forward to sharing a lot more detail and giving more analysis and gauges to support different dynamics, for Coram has been talking about.
And it's actually something that we're really looking forward to talk about. It's one of the things I'm very proud of what we've achieved over the last few years is getting much better as a company as reallocating our investment to where the biggest growth opportunities in this business are. And the reason why we're really now able to sort of turn up the heat in areas like Online Program Management, Virtual Schools, Professional Certification because if we create a simpler more efficient business, that's run on a fewer number of digital first platforms, we get much better real time data and it's much easier to reallocate.
And as we know one of the ways in which you create sustainable growth over time is to get much better at reallocating cost and investment to your biggest growth opportunities and that’s what we are doing. So, we look forward to sharing more data on that with you when we get to the full year results.
We now go to Chris Collett at Deutsche Bank. Please go ahead, Chris. Your line is now open.
I just had a couple. One was just clarification on the cost savings. So you delivered very impressive 130 million cost savings this year. And then did you -- is it then going to be that figure again incremental in 2019 so therefore an incremental 70 million in 2020? Just want to check that. And then other question was just on Pearson Test of English. You've highlighted very impressive 30% growth. I think at the half year stage it was more like about 60% growth so just wondering if there are some timing factors or other factors at work there. Yes, I'll leave it there.
Thanks Chris. Unless Coram corrects me, I believe your math is completely sort of accurate, but I think the key point there is we also talked about in excess of the 330 million. So that’s the sort of the minimum you should expect in 2020. And clearly, I think you heard the way we are talking, we are the more that we do around creating a simpler more efficiency company. The more opportunities we see to do more. So, this is going to be a ongoing program and the more we feel the business on these fewer truly global and digital platforms the more opportunities there are to run the business ever more efficiently. And so you shouldn’t see this as a program that comes to an end in 2020. I think we will be constantly seeing opportunities to further improve efficiencies and to save costs.
And on the Pearson Test of English, I think we did benefit at the start of last year because we expanded our test center capacity in Australia to meet the demand there sort of you build out the capacity you get an immediate jump and then obviously the growth rate is still there, but it's not quite the same rate. There are still sort of big opportunities to expand the Pearson Test of English as we seek regulatory approval for the test here in the UK as we look for opportunities in Canada as we look to expand our footprint across China. So although, the growth in the Pearson Test of English has been very, very strong, we are still in the very early stages and there is a lot more we can do with this.
Before we go to the next question from the phones John and Coram, there are two which we received from the webcast. Both are from Mike Totton from Majedie Asset Management. The first one is. What was the swing between callout trading impacts of between £10 million to £50 million that delivered approximately £15 million less? Is this an OPM investment?
Coram, do you want to pick up on that?
Sure. Okay, I mean I think I touched on this briefly in the script. The reason why trading was lower than we originally expected at the beginning of the year was driven by those two challenges in the businesses that I touched on. So, the pressure in UK apprenticeships and the pressure in K-12 Courseware in the U.S., so that it's not an investment question, it's simply the drop through of a 1% decline on our top-line.
The investment in OPM actually goes through the other operating factors on average which is in our presentation. There are three things in there. There is investment in OPM. There is deal running costs as we keep these two systems running side-by-side while we're in the process of transforming the back office and a small benefit in as our incentive schemes normalize for '18 compared to '17.
We've shown you the bridge of £22 million. I think that's a decent proxy for the amount of additional investment that we've been putting in an OPM. So, I hope that gives you a sense of how much we've invested and where we put it.
Okay, thanks Mike. Hugh, where we're going next?
The next question from Mike is what revenue base European business Pearson's investing behind it might help with comparisons with TWOU?
Yes, so I mean we give revenue splits at the full year, but I think if you assume that the revenue base for the Pearson Online Solutions business is about $300 million that would be about right.
So, we're now over to Nick Dempsey at Barclays. Please go ahead, Nick. Your line is now open.
Yes, I got three questions left please. So the first one, your competitors are looking forward to a very good year in K-12 Courseware in 2019 when you talk about adoptions that kind of waiting in the lines I think for double digit growth in my area. So when you're talking about Pearson Group's being flattish in terms of revenues in 2019 about the 2018. Are you including in that this business which you're looking to sell, which is going to grow double digit and is 8% or 9% of group? In other words, are you expecting the rest of business to decline a bit? The second question, you mentioned that the program of savings is not going to come to an end in 2020. Does that mean that we should expect restructuring charges outside of P&L, but in the cash flow beyond 2020? And the third question is, other operational factors, you've been helpful there Coram is explaining what's in 2018. Is that still going to be part of the profit bridge in 2019 as a drag?
Okay. Let me pick up on the first couple of points and then Coram will pick up on the third. I think first of all, yes, you're right Nick that this is a very strong adoption year in Texas, California and Florida in particular when we are referencing what competitors decide. We just need to be clear that we are distinguishing clearly between billings and revenues because a lot of these contracts are sort of 5 to 7 years in duration. So, the billings don't necessarily all translate terms of revenues in year one. But in any event to be clear, we are saying that 75% of Pearson without the K-12 Courseware business will grow in underlying terms that top-line this year and it will grow.
So, basically, the Pearson -- the rest of Pearson excluding Higher Ed Courseware will grow with or without the K-12 Courseware business. And I think one of the points I was making is, as we consolidate from for example 50 different finance systems down on to one, and we run the business in a much more real-time data way, there will be ongoing opportunities to continue to simplify and run the business much more efficiently. I don't think those are savings that will require significant restructuring to achieve, but they will just be sort of incremental because we’re still at the point of just getting the stage one benefits as we do the heavy lifting. But every other company I talked to just once you've got these systems up and running, you just get ongoing benefits year and year after year as you get better running and operating them. And that's what we're saying.
And Coram, do you want to speak up on the third point.
Sure, so, if you think about the three factors I described in the -- that were included a number of operating factors in 2018, sort of deal running costs normalization of the incentive and the investment in OPM. One of the reasons why other operating factors is a bit less of a drag this year than it was in our original guidance is that those deal running costs are coming down faster than we thought. So there will be less of a drag in 2019.
The incentive payout is unlikely to be a major movement. 2017 was a slightly bigger incentive than normal but you will still see ongoing investment incremental investment in our OPM business because we see a significant opportunity to drive the top line there. So, I think Nick will show you the breach in February as we’re putting all of the package together but you should assume that there will be further investment in OPM and it'll probably be a similar amount or a little bit more than we've quantified this year.
Sorry, go ahead. Nick, if you had a follow-up. Please go ahead.
Oh, yes. Sorry, I was trying to squeeze another one. In the FX in your bridge in 2018, it's been higher than nothing I was modeling. I mean against the base of 5, 7, 6 minus £52, £24 million is a 4.5%. The pounds-dollar haven’t moved by much. So, is it that we're missing Brazil, South Africa or something else? Or is there anything funny going on in that £24 million FX? Sorry to squeeze another one in.
No problem, it’s a good question and you're right. If you would just doing this on the basis of the USD it would be a little bit lower than that, but because of the political uncertainty in the UK there's been a lot of movement on FX. Brazil has been one that's going into South Africa. You know there's been a series of quite significant movements in the basket of public currencies. So, 24 is where it's come out when we run the numbers.
I think the -- of those the movement in the real particularly in Q4 last year has been particularly significant. So…
We're now over to Patrick Wellington at Morgan Stanley. Please go ahead.
Morning everybody. Three things actually, just continuing because we’ve done most of the cost bridge now. Continuing with inflation I think Coram you've suggested as a cost base has dropped so rapidly maybe GBP 50 million is not necessarily the number that we need to be putting in here for inflation. So if you comment around that. And secondly when push comes to shove, the U.S. Higher Education courseware business was minus 3% in '17 it was minus 5% in '18. That's arguably a bit disappointing you've talked about light at the end of the tunnel and maybe getting back to flat in a couple of years. Do you think that's still possible? And in relation to that, if you are flat as a group in organic revenue growth terms in 2019 that will be 10 years that Pearson has failed to produce more than 1% organic revenue growth. How do you feel about that as you look out maybe the next five to 10 years? What do you think this business is capable of producing? And then finally 200 million of that you have got the K-12 business still to sell presumably you are going to sell it. How about a share buyback the balance sheet is not that efficient share buyback when you get the full year figures at the end of February?
Okay, three good questions Patrick. Coram, do you want to pick up on the first two and then I'll address the organic growth issue.
Sure and good morning, Patrick. So, in terms of the inflation I think what I would say is, 50 is a good number and there is two dynamics going on in there. One, the headcount is coming down so the sort of cost base on which the inflation is being applied is shrinking, but as we know there is inflationary pressure in the world economy and around wages. So I think it seems 50 million at least this year and next that’s a good number.
In terms of the debt and its around 200 million and that is a -- we are running the balance sheet in a conservative way but we are doing so because there is still a significant amount of change to deliver this -- in this business. And that balance sheet provides a real foundation for us to deliver on that change to invest in the business to make the most of the digital opportunity that we have got. So, we need the right balance sheet for the Company at this point in time.
And then, I think your challenge on organic revenue growth is absolutely the right one, I mean, clearly the big focus of management team over the last two to three years was really been to stabilize the business to start to get underlying profits growing again to create a much more simpler -- much simpler, much more efficient company, strong balance sheet of course is in good position to manage our way through this analog to digital transformation. I recognize given the sort of 10 year track record there is a healthy degree of skepticism there.
But I honestly believe, when I see now the sorts of growth rates that we are getting from our online program management as well as from virtual schools, from professional certification from the Pearson Test of English from the opportunities that we have really now to accelerate the rate of internal innovation, the ability we have to scale products much more quickly. One of my experiences in Pearson is one of our big challenges is when you have been running the business on such a sort of disparate range or systems and platforms even when you get a good product its very hard to scale it quickly.
We are just going to have so much more capacity to not just accelerate the rate of internal innovation but then to scale successful product quickly. So, our first challenge is to actually stop the revenues declining and get them growing again at all, which we will do stabilize this year start to grow again next year, and then I believe Patrick, that over the next decade we are going to surprise you on the positive side with the capacity and capability of this business.
And just on U.S. Higher Education, I mean, I think you have talked about a light at the end of the tunnel maybe getting back to zero on Courseware within a couple of years slight yield defined couple of years. Is that still the case having seen how the last two months have gone and the continued negative enrollment trends?
Yes, I mean, I think the opportunity and the challenge there is clear. We want to get that business to be in a truly digital first subscription based model as quickly as we possibly can. We are sort of over the hump of the majority so it's up to 55% of sales in that business, are purely digital. If we can get that within the next couple of years to 70% plus which I believe we will just with the momentum that we already have. And as I mentioned the new products and innovation is coming through, then yes is this that you can start to see stabilize and grow again.
But more importantly, I think is also and if you think about it you know we have just in the U.S. 14 million students a year who have a direct relationship with Pearson. At the moment those students are known to us. We know that they are student aid taking a course with Professor Smith. The new systems and the way that we're building the business now is we will have a direct and personal relationship with every one of those 14 million students. You've done well you've taken this marketing course, if you considered that whether you do this of course next in these career opportunities that are open to you.
And all the research tells us that this generation of learners, are much more focused on how they link education to employment learning to earning than they ever were before. So, we're starting to see a Higher Ed Courseware business not just as something we're going to stabilize and turn around in its own rights but becoming a platform with which we can build a like a relationship of sort of lifelong learning with people as they work through careers where they're going to be having to constantly rescale, retrain changed careers. This is an incredibly powerful opportunity for us. Well we can't talk relies on it unless we get those digital platforms in place first. And the great thing is by the end of this year will pretty much have all the platforms that we can of the pace of innovation.
Okay. We now go to the line of line of Giasone Salati of Macquarie. Please go ahead. Your line is open.
Three questions please. First to John, when you think about stable growth in 2019, would that be and also the case with minus 5 in North America? Is it built on the meet case for North American higher education or else? Secondly, on rental only, the link you make with the digital sales that is the transition to rental only, it kind of mixes up with a transition to rental only. Is it true that if all of the books were on rental only and we would have definite growth in North American Higher Education? And lastly coming back to the breakdown of North American Higher Ed in Q4, and when we look at a rudimentary are playing to be still the inventory? What actually went slightly worse than in the previous nine months or quite significantly worse in the previous nine months in Q4 please?
Okay. I'll take around the first and the last points. And then Coram can pass on impact of the sort of rental and digital sort of comments there. Yes, we are saying that even a Higher Education Courseware is at the bottom of our range down 5%, again this year we would expect that our revenues to be stable i.e. flat on prior year even with a 5% decline in Higher Ed Courseware that's the first points.
And then the on your final point, what happened in Q4? I think as Coram mentioned earlier. Each year we all see a sort of structural shift of revenues out of Q4 as we sell fewer textbooks into the channel ahead of back to school and a proportionate transfer of those sales in January as more of those students are buying a purely digital product and they buy it direct from Pearson, which they use on the day they start their class. So, that's really all that happened in Q4 is a continuation of that shift. Sales are just December into January and February. And then Coram, do you sort of unpack sort of a rental digital point.
Yes, and just to add to that final point that John made. We flagged this very clearly in the Q3 trading call. So I was clear that whilst there's a small supply chain benefit going into the quarter we would almost certainly see this move from Q4 to Q1. So I do want to just draw attention, to the fact that we flagged this, that this would happen.
In terms of sort of rental and digital I mean I guess there are sort of couple of points to make here. Firstly, the growth in digital is there and that reflects the investment that we're putting in plus a market which is moving that way and students to value the benefits of digital. And on the print side, you’re right, that the ongoing shift from an ownership to an access model is creating a greater drag on print revenues and if all physical books were going through a rental model with no timing effects then that revenue impact would be partially mitigated. But I would not go so far as to say that you would have a print businesses growing because there is still an underlying shift in preference from print to digital. So, that gives a sense of what's going on there.
Okay. We now go to Matthew Walker at Credit Suisse. Please go ahead. Your line is now open.
Thanks and good morning. Just a few questions please. The first is. Can you explain that digital growth of 2% in Higher Ed? I think it was significantly higher last year, so if you could just explain that? And comment on, how much is your digital direct access revenue grow? Second question is on Pearson Test of English test volumes were up 30%. What was revenue growth for Pearson Test of English? And then could you please also comment on with the 2019 bridge you basically built in as far as I can see for 2019 an additional probably GBP 80 million of savings. So what actually is and you basically put up a number which is roughly in line with where our current consensus is. So what is actually lower to basically explain that movement because the increase in savings is very significant? And do you think that you will basically do the same thing next year in terms of you know you've guided the Street for one number but it's going to be massively higher on savings.
Thanks Matthew. Coram will pick up on the second and third point just on the digital revenue growth of 2% in the Higher Ed Courseware business. I think there is three elements to our digital revenues. First is, those direct to consumer sales which I said are up 8% that means that’s now our biggest single channel to students. Second is the growth in the sort of Inclusive Access business where we saw a sort of 40% growth in universities but we're still in the relatively early days of turning those monetizing those agreements and translating them into revenues, they’ll start to come through more in 2019 and '20.
But then there's a -- the quirk if you like is that you also have we're still selling through the channel. So through sort of campus bookstores a sort of bundled product, which is a textbook but bundled with a MyLab or Mastering registration. So in a year when you say a big reduction in growth sales through the channel, that sort of range back the growth in digital because the digital element of that bundle is also sort of down significantly. That’s why I think you should sort of read through that headline number and look at what's happening to direct to consumer sales, what's happening to institutional sales, that’s where the big growth is and that will drive that digital revenue growth back number back overtime. So it’s a phasing issue really more than anything else. Coram do you want to pick up on the other six?
Yes, sure. So test volumes in PTE are a good proxy for revenue growth. Remember this -- of the four structural growth opportunities, this is the smallest, although it is growing rapidly. So there is no major difference between test volume growth and revenue growth. And in terms of the savings in 2019, I just want to be clear, we are going to £130 million of additional incremental savings in '19. Our previous guidance was for £105 million, so that is £25 million extra not £80 million. We are using that 20…
The 80 million was cumulative based on the over performance in '18 as well.
And remember that we said that in total cumulative terms we put up our expectations and we will be in excess of 330. So what we used in the additional 25 for in 2019 is to drive further investment in our OPM business and really capitalize on the opportunity that we see there.
So, I mean, Matthew just to sort of reinforce that point when we launched the £200 million cost saving program two years ago we committed that those £300 million of cost savings would flow through to the bottom line and they are. We are taking advantage of the fact that actually we are doing more than we expected so in excess of 330, and we are using that surplus above 300 to drive faster growing in the OPM business that we become increasingly confident in and where clearly because one of our big opportunities and challenges is now to get the top line growing again. The more we can allocate to our faster growing businesses the faster they will grow and the quicker we get the top line growing again.
So the incremental investment in OPM is around 25 basically, so that’s what you are saying? It was around -- it was the investment in OPM was about 20 in '18 and now you are doing an additional 25 in '19 is that right?
Those are roughly right, yes.
Okay, so we have time for one final question and that is a follow-up question. We are going back to Sami Kassab at Exane. Please go ahead.
It's on Inclusive Access. Can you elaborate a little bit on how this is going? I think you have said 7% of your H1 revenue is came from Inclusive Access, if not mistaken. Would you want to quantify how much of the U.S. Higher Ed Courseware revenues are now from institutional sales? And whether institution sales are included in the 23% U.S. sales or whether this is something different in your reporting please.
Coram, do you want to pick on that?
So, we will give you the revenue number for Inclusive Access in February when we provide all of the details for the top line. But I think you can see Sami that we have signed another 192 institutions in the second half of '18 and that will drive growth in our revenue there. And in terms of the direct to consumer sales no, that is a separate channel to the Inclusive Access the 23%. And what's interesting about this is it is now our biggest channel the single biggest channel by which we sell products in U.S. Higher Education is a different consumer channel and it represents 22% of all U.S. Higher Education sales.
And then the other point I just adding to, just to reinforce a point I made earlier. What you tend to find is you sign these partnerships you get the sort of framework agreement in place and then the real works is then translating that framework agreement into a widespread adoption across the institution. I think what we're excited about is the sell through and penetration of those deals is still in the relatively early stages so there's a lot of opportunity to drive that much more in the years to come. So though we signed the partnerships, you yet to see the real revenue benefits of those partnerships that will start come through this year and into '20 and '21.
Okay. So, I think back to you for any closing comments at this stage.
No, just to say, as ever, thank you for your interest in the Company Jo, Tom and Anjali joined us on the call today, if you've any follow up questions I know we'd love to hear from you. I look forward to catching up with you all in February at the preliminary results. Thanks again.
This now concludes the call. Thank you very much for attending and you can now disconnect.