Pearson Plc Annual Report 1998

M A R J O R I E spent f our year s as chiefexecutive of The Economist Group. Has set ambitious growth targets, committing Pearson togenerating double -digit ear nings growth ever y year to create a more durable and valuablecompany. Wants ever yone in Pearson to be a shareholder because she believes it to be “betterto be an owner than an employee.” Also takes a wider perspective of the business: “People wantto wor k for a company that cares for what they care about, doing something they think isimpor tant and having a good time”.J O H N, f or mer managing direc torof the Financial Times newspaper and before that founder of an investor relations firm, playsa key role in knit ting Pearson companies together. He is al so directing the Company’s dr iveto improve its systems and his commitment to leading the campaign for cash flow in 1998delivered the goods. His challenge for 1999 is more of the same: “Cash is cruc ial to Pearson– it ’s what gives us greater conf idence to make the revenue investment needed to build ourbusinesses.”D A V I D, chairman of the Financial Times and a member of the Pearson board, hastaken on a new Company- wide role as Director for People. His brief is to increase the resourcesand creativit y Pearson devotes to recruiting, motivating, developing and rewarding the peoplewho work in the Company. His vision is “to make Pearson simply the best company to work forin the world.” His key challenge in 1999: “To continue to develop a culture and an approachacr oss Pearson that entic es our most talented and creativ e people to make their careerswith us.”P E T E R has spent his whole career in educational publishing.He joined Pearson in August 1997 with the brief to create the world’s leading education business.The acquisition of the Simon & Schuster businesses, completed in November, fulf illed the briefin one fell swoop. Peter does not underestimate the challenge of successfully br inging thet wo companies together, but knows it can be done. He says: “These are the most exc itingtimes in education for 30 years. But we must always remember what we are all about: helpingstudents to learn and teachers to teach.”G R E G has spent most of his career in the televisionindustr y. A member of the Pearson board, he has led Pearson Television since 1995. Sees thekey challenge in 1999 as capitalising on the international success of the business to developnew formats and break into new markets: “With strong local talent, a good format and aninternational production team who know what they’re doing, we can deliver hit shows in anylanguage or culture. With All American fully integrated, we are set up to create successfulnew shows and break into new markets.”M I C H A E L has spent most of hiscareer in the film and book industries. He has led Penguin since late 1996 and he also leadsPearson’s cross-company Intellectual Propert y Rights exploitation. He is leading Penguin’s effortsto continue to build its front- list of repeat, best selling authors with new talent and to changethe economics of book publishing: “We are building a stronger global publishing house andwe’ll see the benef its of that in 1999. Printing on demand, new distribution technologies andinternet retailing are all changing the landscape of our business. We have to make those changeswork for us.”S T E P H E N was head of Pearson Gr oup st rateg y and ran the F T newspaper beforetaking on the F T Gr oup r ole. He sees the key challenge in 1999 as sharpening the F T ’scompetitiv e edge in inter national and elec t r onic mar kets: “We are all about dev elopingtrusted relationships with business people around the world. We don’t just tell them aboutwhat happened, but what it means for them and their business and, cruc iall y, we appl ya global perspec tiv e.”7

ourbusinessourbrandsourcontentis in things thatare some of the strongestmakes us players in theappeal to the mind.anywhere. Penguin is oneinternet age. The PearsonWhether it’s educational,of the most recognisableTechnology Centre, ourentertaining, orbrands in consumerin -house technologyinformative, whether itpublishing. The Financialhub, and Headland, ourmakes you laughTimes is a potent forcedigital publishing arm,or helps you get a jobin world business. Ourwork with businessesor pass a test, we areeducation imprints areacross the Companyin the business ofknown to teachers andto capture thefeeding or excitingstudents from Hong Kongoppor tunities. We areyour mind. This is theto Havana. Our televisionbuilding F T.com into onebusiness of all ourprogrammes commandof the leading portalscompanies. In additionaudience loyalt y yearon the web for globalto this, many thingsafter year. If we arestrategic information.bind them together –careful, we can makeThe internet gives Pearsonbrands, content, scale,these brands moreEducation the chancepeople, values.valuable by sharingto take educationalthem across the Company.publishing into a new age,For example, Pearsonwith greater and richerEducation and the F T arecontent and a degreecombining to launch aof interactivit y andnew managementimmediacy central toeducation business.teaching and learning.Pearson Television’s newInternet retailing offersanimation business drawsPenguin a chance toon Penguin’s extensivereach new customersrange of children’sand to show off its richcharacters. And Penguin’sback- list of more thanconsumer appeal adds25,000 titles. Pearsonto the allure ofTelevision uses the webour English Languageto exploit the on - lineTeaching business.equit y of its game shows.ThePearsoncompanyRevenues from internetactivities are still smallin proportion to thewhole. But the internetis becoming a moreimportant tool of bothcreativit y and distributionacross the Company.8

ourscaleourpeopleourvalueshelps to reduce costsare our most importanthold us together.as we share purchasesasset. We expect a lot ofWe are working hardand processes acrossourselves and, if Pearsonto communicate betterthe Company. Withas a company does well,across the Companythe Simon & Schusterwe want ever yone toso that ever yoneacquisition, Pearson isshare in the success.understands ournow one of the world’sSo over 20,000 staff instrategy, goals andlargest consumers of53 countries now haveways of doing business.paper, printinga direct stake in Pearson’sWe are doing much moreand binding, and afuture with the chanceto meet the challengemajor buyer of otherto participate inof finding, exciting andcommodities and ser vices.Company- wide bonusdeveloping the peopleA global sourcing teamand save -for- shares plans.who work in Pearson.manages the supplyRecord profits and realWe are clear about theprocesses across allprogress against our threeCompany we want to bePearson businesses.financial goal s in 1998– a company that acrossIn 1999, it will reduceresulted in our firstall its businesses andour costs substantially.Company- wide bonuscultures always strivesWe are also continuingand an award ofto be imaginative,to reduce the costs of15 Pearson shares tobrave and decent.doing business bycolleagues across theintegrating back officeCompany. The numberfunctions. Bringingof Pearson staff savingtogether the sharedto buy shares in theser vices initiativesCompany has moreof Pearson andthan doubled to 6,000.Simon & Schuster forAnd we aim to seeaccounting, transactionsthat number increaseand administrativesignificantly in thefunctions will save moneyyear ahead.and increase efficiency.9

The PearsongoalsIn 1997, ambitious for the future growth of our Company, we established a financial benchmarkfor our progress: we aimed to achieve double-digit growth in adjusted earnings per share everyyear. To underpin this objective, we chose three financial measures by which we could gaugethe annual performance of our Company. We aim to improve the rate of underlying salesgrowth; increase trading margins; and raise the proportion of profits that we convert intocash. We track the performance of each business against these measures and gear bonuspayments to them. In 1998, as in 1997, we made good progress.Adjusted earningsPER SHAREthe measure of our underlying earnings, grew by 20%, up from 34.9p in 1997 to 42.0p in 1998.On the strength of this, a dividend of 21p has been recommended by the board.SalesU N D E R LY I N G G R O W T Hwhich represents the year-on-year, like-for-like increase in sales (excluding portfolio changesand movements in exchange rates) was 6.7%, up marginally from 6.5% in 1997. Total salesincreased by 4%, with the increase in sales from the addition of the Simon & Schusterbusinesses in December more than offset by the loss of revenues from disposals made duringthe year.Trading marginThe trading margin, which is the proportion of sales turned into operating profit (excludingprofits from associates and passive investments), was 13.1%, up from 11.5% in 1997. Takinginto account changes in portfolio, restructuring charges and exchange rates, underlyingprofits increased by 26m (8%).Cash conversionthe proportion of operating profits received as cash in the full year, increased from 74%(after stripping out the exceptional impact on cash flow of the improper accounting at PenguinPutnam reported in the 1996 accounts but affecting 1997) to 101%. The much stronger cashperformance in 1998 was a direct result of the work all Pearson’s businesses, especially thosein book publishing, did to improve cash flow. It was also helped by non-recurring cash itemsand timing variances, that we would not expect to be repeated in 1999. Free cash flow beforeSimon & Schuster integation costs was 255m, more than adequate to fund dividend paymentsof 116m. Free cash flow per share increased by 89% to 43.2p.450EBITDA400earnings before interest, tax, depreciation and amortisation, is increasingly used by investors350as a measure of a company’s underlying performance. In 1998, EBITDA , before exceptional300items, increased by 16% to 455m. M.96** 97 98*EBITDA10

Adjusted earningsSalesPER %9711.5%969.2%98*101%U N D E R LY I N G G R O W T HTrading marginCash conversion* Before exceptional costs** Before impact of Penguin improper accounting9 7 **74%9678%11

SalesPearson EducationFT GroupPenguin GroupPearson Television702683523343Profit B Y S E C T O R *Pearson EducationFT GroupPenguin GroupPearson TelevisionLazardSalesTheResultsB Y S E C T O R ( M )( M )99118486142B Y R E G I O N ( M )North AmericaUnited KingdomEuropeAsia/PacificRest of world1,07849746116154Underlying sales analysisSimon & SchusterProfitB Y R E G I O N * ( M )North AmericaUnited KingdomEuropeAsia/PacificRest of world18151114166120Other portfolio changes–99Foreign exchange–45Underlying increase126102TOTA LUnderlying profit analysis22–3–6Simon & SchusterForeign exchangeRestructuring & other costs26TOTA L( M )Other portfolio changes22* Before goodwill and other items( M )Underlying increase61

In 1998, Pearson’s sales grew from 2,293m to 2,395m and operating profit, before goodwilland other items, from 328m to 389m. Profits at the FT Group rose by 9%, despite the disposalof non-core activities and substantial investment in the growth of the newspaper and electronicservices. The continuing success of the Financial Times newspaper again contributed stronglyto the overall performance. Pearson Education also increased its operating profits by 28%, beforetaking account of the contribution made in December by the Simon & Schuster businessesand the related integration charges. This growth was driven by the success of our US schoolbusiness and the benefit of lower restructuring charges. The Simon & Schuster businesses,acquired at the end of November, recorded operating profits of 22m during December. Theoperating profit of the Penguin Group fell by 17%, due principally to several non-recurringitems, including a 4m provision for the closure of the Ladybird site at Loughborough. PenguinUK, in particular, had a very strong year. Pearson Television’s operating profits more thandoubled to 61m, thanks in large part to a full year contribution from All American Communications, acquired at the end of 1997, and to a reduction in start-up losses from our investmentin Channel 5.120011001000900800700.As we continued to sharpen operations across Pearson in 1998, so we also continued to reshapethe Company by building stronger market positions in a smaller number of businesses. We soldbusinesses that either lacked real market scale or which we believed were worth more to othersthan to Pearson. And we continued to dispose of passive investments which brought us nostrategic value. We sold the Tussauds Group, Mindscape, Pearson New Entertainment, ourspecialist law, tax and medical publishing operations, our 20% stake in the Canadian FinancialPost, our 6.3% stake in SES (the owners of the Astra satellite system), our stake in Flextech,and made a number of smaller disposals. In total, we raised 983m from these disposals.J F M A M J J A S O N DPearson Share PriceIn 1998 (in pence)PEARSONWe also continued to invest in building businesses in markets with good growth prospectswhere we have a chance to become a leading player. We’d begun this process with theacquisitions of Putnam Berkley in 1996 and All American Communications in 1997, whichenabled Penguin and Pearson Television to build strong positions in consumer publishing andinternational television production. And we’d also started to make substantial revenueinvestment in the international and electronic expansion of the Financial Times. In 1998, wemade our single biggest investment with the acquisition of the Simon & Schuster education,business & professional and reference divisions from Viacom Inc. for 2.9bn.FTSE 100 REBASEDMEDIA SECTORREBASEDWith this further tightening of our portfolio, focusing on a smaller number of larger, more activelymanaged and complementary businesses, where and how we make our sales and profits continuesto shift. For example, in 1998, 31% of our sales were in education. In 1999, we expect thatmore than half will be. In 1998, 48% of sales from continuing operations were earned in NorthAmerica and this is likely to increase significantly in 1999 as we consolidate the first full yearresults from the Simon & Schuster businesses.As the changes in the Company’s portfolio increased the proportion of sales and profits earnedin overseas currencies, the strength of sterling had a modest but negative impact on ourpublished results. If exchange rates had remained at 1997 levels, it is estimated that totalsales would have been higher by 45m and operating profits by 6m. Stripping out the benefitof lower restructuring costs and portfolio changes and the adverse impact of exchange rates,underlying operating profit increased by 8%.On the pages that follow, we describe our major businesses, reviewing their performance in1998 and their plans for future growth.13

PearsonEducationEducation is a great growth industry.Global demand for educational materials and programmes is strong, consistently outstripping rises in GDP. Favourable demographics, the spread of publicAstronomy TodayPRENTICE HALLComes complete witheducation in the developing world, and increasing demand to learn English areall factors driving this growth.CD-ROM providinganimation and videos,integrated links toIn addition, governments, parents and students are all spending more on education.a text-specific websiteA worldwide drive to improve educational standards is generating a growing needand an interactive,self-scoring multimedia guidefor more effective teaching programmes. And the burgeoning use of computersin schools, colleges and at home stimulates the development of new productsand services.Baku RekodAmali SainsLONGMANPractical science Level1 workbook is our bestselling title in MalaysiaIn the US, demand is expected to grow at around 8% per year over the next fiveyears with estimates of some 6bn spent on printed and electronic educationalmaterials in elementary, secondary and higher education in 1998. Outside theUS, the international market in English Language Teaching (ELT) materials isof growing significance, with the British Council calculating that, around theLongman ActiveStudy Dictionar yLONGMANIf you’re serious aboutlearning English, this isworld, there are some one billion people learning English. In indigenous markets,growth is more variable. In the short term, growth rates in some Asian and LatinAmerican countries are being held back by the current economic conditions.But there is tremendous longer term potential. In Europe, annual growth of upthe dictionary for you.to 10% is expected over the next few years, particularly in central and easternThis best selling title isEuropean markets.aimed at intermediatelearners of English as asecond languageBringing the Addison Wesley Longman (AWL) and Simon & Schuster businessestogether to create Pearson Education has to be done with imagination, vigourThe KnowZoneSCOTT FORESMANADDISON WESLEYMakes the process oflearning math inter-– and great care. We have to achieve the efficiencies and economies of scalewhich will realise the anticipated savings and significantly improve tradingmargins. Most importantly, we must deliver the quality and relevance teachersand students alike expect from the world’s leading educational publisher.active and enjoyable –and helps Americanschoolchildren passtheir standardised testsAWL performed well in 1998. Underlying sales increased by 8.5%, with operatingprofits, boosted by lower restructuring costs and tighter cost control, up by 28%.15

In the US, AWL capitalised on strong market growth. It was the first year of major new mathadoptions from kindergarten through to grade 8 in a number of Southern states. AWL’s newmath programme was a winner, gaining market share. Its competitiveness was enhanced by thelaunch of the KnowZone, a new internet based product. And another new electronic product,the Waterford Early Reading Program, contributed to good sales growth. The school businessalso did well in new biology and foreign language programmes. And by investing both in newauthors and new technology, the higher education publishing group made strong progress.In the US, 20 states,which account for over50% of the totalUS school populationof some 52 millionstudents, buyeducationalOutside the US, the international business as a whole had to work hard just to mitigate theimpact of lower growth rates in Asia and Latin America. There was a strong performance in theUK; the school publishing business gained market share in Hong Kong; and, although the ELTbusiness did suffer in Asia, the fact that trading held up better than the economy as a whole,is encouraging for future years.The Simon & Schuster businesses got off to a strong start with Pearson, contributing revenuesof 120m and profits of 22m in December. Although the integration process started somemonths later than we had hoped, it is progressing well with a number of key milestones alreadymet. It is on track to deliver 130m of annual costs savings by the end of the year 2000.And, as we run this dynamic business, we will also be committed to serving the cause ofeducation and seizing our chance to play a full role in helping people learn all around the world.programmes by meansof a periodic statewide‘adoption’. These covernew programmes incore subject areas.A state committee orcommission selects ashort-list of educationprogrammes, fromwhich the schooldistricts choose theirpreferred programmes.In the ‘open territories’Pearson Edu

2 Financial highlights 3 Chairman’s statement 4 Chief executive’s review 6 The management team 8 The Pearson Company 10 The Pearson goals 12 The results 14 Pearson Education 18 The Penguin Group 22 Pearson Television 26 The Financial Times Group 30 Recoletos 32 Associates 33 Financial review 36 Financial policy 39 Board of directors