O U R S T R ATEGY To find out more about our business strategy go to page 06 O U R P E R F O R M A N C E For an in-depth analysis of how we performed in 2012 go to page 11 O U R I M PAC T O N SO C I E T Y For an explanation of our approach to corporate responsibility go to page 34 ANNUAL REPORT AND ACCOUNTS 2012 Always learning Pearson is the world’s leading learning company. We have 48,000 people in more than 70 countries, helping people of all ages to make progress in their lives through all kinds of learning. W E H AV E T H R E E WO R L D - L E A D I N G B U S I N ES S ES: Education We provide learning materials, technologies, assessments and services to teachers and students of all ages and in more than 70 countries. Consumer publishing Penguin publishes thousands of fiction and non-fiction books each year – on paper, on screens and in audio formats – for readers of all ages. It is one of the world’s leading consumer publishing businesses and an iconic global brand. Business information The FT Group provides news, data, comment and analysis to the international business community. It is known around the world for its independent and authoritative information. E R E P O RTI N G C E NTR E: V I S IT O U R O N L I N E R E P O RTI N G C E N TR E: n Learn more e com ar2012.pearson.com S U M M A RY R E P O RT esentation Quick, visual presentation hlights of the year’s highlights V I D EO CO N TE N T Interviews with: Moreno › Chairman Glen Moreno ohn Fallon › Chief executive John Fallon fficer Robin Freestone › Chief financial officer Robin Freestone m Global trends film DOW N LOA D S porate responsibility Annual and corporate responsibility r by section reports, in full or by section S E A RC H ve search Use our predictive search need quickly to find what you need quickly Heading one 01 01 1 Overview A summary of who we are and what we do, including performance highlights, our business strategy and key areas of investment and focus. 02 Financial highlights 04 Chairman’s introduction 06 Chief executive’s strategic overview i w e v e r s s e n i s u B t r o p e r ’ s r o t c e r i D 2 Our performance An in-depth analysis of how we performed in 2012, the outlook for 2013 and the principal risks and uncertainties affecting our businesses. 11 Our performance 12 14 2013 Outlook Education: North America, International, Professional 22 Business information: FT Group 24 Consumer publishing: Penguin 27 Other financial information 31 Principal risks and uncertainties 3 Our impact on society Explains Pearson’s approach to corporate responsibility, giving a summary of our work in 2012 and our plans for 2013. 34 Introduction 36 Raising literacy levels 37 Improving learning outcomes 38 Contributing to competitiveness 39 42 Responsible business practice Seven commitments 4 Governance Provides details of the board, its policies and procedures and the report on directors’ remuneration. 44 Board of directors 47 Chairman’s letter 48 Board governance 64 Report on directors’ remuneration 5 Financial statements Detailed financial statements for both the Group and the parent company, including an analysis of the key measures used by the Group in its management of the business. 93 94 Financial statements: contents Independent auditors’ report 96 Group accounts 166 Parent company accounts 175 Principal subsidiaries 176 Five-year summary 178 Corporate and operating measures 181 Shareholder information 183 Principal offices worldwide O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 02 Pearson plc Annual report and accounts 2012 Financial highlights In financial terms, Pearson’s goal is to achieve sustainable growth on three key financial goals – earnings, cash and return on invested capital, and reliable cash returns to our investors through healthy and growing dividends. Over the past five years, we have produced consistent and considerable growth on all measures. In 2012, though we performed well competitively in tough market conditions, headline earnings and cash were lower than the previous year. Our return on invested capital was level at 9.1% and we are proposing a 7% dividend increase. 2 012 £m 2 011 £m H E A D L I N E G ROW TH C E R G ROW TH U N D E R LY I N G G ROW TH 5% 1% (1)% (2)% Business performance* Sales 6,112 5,862 Adjusted operating profit 936 942 Adjusted earnings per share Operating cash flow Free cash flow 84.2p 86.5p 788 657 983 772 Free cash flow per share 81.7p 96.5p Return on invested capital 9.1% 9.1% 4% (1)% (3)% (20)% (15)% (15)% – Net debt (918) (499) (84)% Statutory results Sales Operating profit Profit before tax 5,059 4,817 515 434 1,118 1,047 Basic earnings per share 40.5p 119.6p 5% (54)% (59)% (66)% Cash generated from operations 916 1,093 (16)% Dividend per share 45.0p 42.0p 7% *Total business (Includes Penguin, which is discontinued in our statutory accounts.) Note Pearson’s 2011 statutory results include a £412m profit on the sale of our 50% stake in FTSE International. The 2012 statutory results include £113m in closure costs related to Pearson in Practice. Throughout this document: a) Growth rates are stated on a constant exchange rate (CER) basis unless otherwise stated. Where quoted, underlying growth rates exclude both currency movements and portfolio changes. Sales and operating profit are stated on a continuing basis, unless otherwise stated. b) The ‘business performance’ measures are non-GAAP measures and reconciliations to the equivalent statutory heading under IFRS are included in notes 2, 8 and 34 to the annual report. 2 012 S A L E S £6.1bn +5% 2 012 A DJ U S TE D O P E R ATI N G P RO F IT £936m +1% O U R F I V E-Y E A R R ECO R D Average annual growth in headline terms 2007–2012 Adjusted earnings per share Operating cash flow +13% +3% +7% Dividend Section 1 Overview 03 6% 59% 7% 76% 13% 2012 by region North America £3,604m Europe £1,334m Asia £786m RoW £388m 22% 74% 7% 7% 12% 2012 by region North America £692m Europe £109m Asia £66m RoW £69m 17% 2012 by business Education £4,616m Penguin £1,053m FT Group £443m 5% 84% 11% 2012 by business Education £789m Penguin £98m FT Group £49m Sales £m Adjusted operating profit £m 7000 6000 5000 4000 3000 2000 1000 0 Pearson Education Penguin FT Group 07 08 09 10 11 12 1000 800 600 400 200 0 Pearson Education Penguin FT Group 07 08 09 10 11 12 O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 04 Pearson plc Annual report and accounts 2012 Chairman’s introduction Watch an interview with Glen Moreno, Chairman of Pearson. ar2012.pearson.com The basic direction of our strategy is unchanged, and we are travelling faster in our transformation. Dear shareholders, 2012 was a year of significant leadership transition at Pearson. Marjorie Scardino retired on 31 December, after a remarkable 16-year tenure as chief executive, and John Fallon assumed the role on 1 January of this year. Marjorie’s contribution to Pearson has been defining: › she led the transformation of a traditional family holding company into a modern global enterprise; › she established a clear company purpose: to help people improve their lives through learning; › she developed a company culture – to be brave, imaginative and decent – which will be a lasting legacy; › and she leaves behind a thriving company which has benefited customers, staff and shareholders. We all are hugely grateful for her efforts and accomplishments. CEO succession CEO succession is a very important board responsibility, and one that we have been working on for several years. In 2012, the nomination committee spent a great deal of time evaluating candidates and planning for a seamless handover of duties. We are confident that John Fallon is the right person to lead Pearson in its next phase of development, and his leadership over the past few months has reinforced that confidence. We are now focused on the future development of our board, which I address in the Governance section of this report. Pearson’s transformation so far Over the past decade or so, Pearson has focused on three fundamental transformations: › from a media holding company to an integrated education company; › from a largely Anglo-American company to a truly global enterprise; › from an analogue print publisher to a digital content and services company. S H A R E P R I C E P E R F O R M A N C E One year % change Pearson FTSE 100 FTSE All-Share Media STOXX 600 Media Three year % change Pearson FTSE 100 FTSE All-Share Media STOXX 600 Media Five year % change Pearson FTSE 100 FTSE All-Share Media STOXX 600 Media Source: Datastream to 31 December 2012 TOTA L S H A R E H O L D E R R E T U R N One year % change Pearson FTSE 100 FTSE All-Share Media STOXX 600 Media Three year % change Pearson FTSE 100 FTSE All-Share Media STOXX 600 Media Five year % change Pearson FTSE 100 FTSE All-Share Media STOXX 600 Media Source: Datastream to 31 December 2012 Section 1 Overview 05 The driving forces behind these transformations are building. They include the recognised need for more effective and affordable education, especially from the growing middle class across the globe, and the inexorable tide of “disruptive” technologies which are transforming education models. These forces provide Pearson with huge opportunities, but also challenges. A challenging 2012 As CFO Robin Freestone outlines in his report on our financial performance, 2012 was a challenging year for many of our businesses, offset by encouraging growth in our newer global and digital initiatives. These challenges were reflected in our share price performance, which underperformed our indices. On a longer-term basis, our share price and total shareholder return continue to reflect outperformance. (See charts opposite.) Transformation and acceleration As John explains in his CEO report, the basic direction of Pearson’s strategy will not change. Indeed, our efforts to transform the company will accelerate. Significant restructuring (including the Penguin Random House merger), accelerated technology investment and increased operating efficiency will enable us to reach our strategic goals more rapidly. As a shareholder, I am very confident about Pearson’s future. All great businesses are based on fundamental customer demand, and the global demand for affordable, effective education is huge and growing. We believe that Pearson, as the world’s leading education company, is uniquely positioned to help meet that demand – and we are rapidly transforming the company to do so effectively and profitably. We are determined to succeed, and our efforts will be of great benefit to both our customers and our shareholders. Glen Moreno Chairman O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S -1.8% 5.8% 19.0% 17.4% 33.3% 9.0% 39.6% 19.0% 62.3% -8.7% 18.3% -16.1% 1.9% 10.0% 23.1% 22.5% 48.6% 21.2% 53.2% 34.8% 99.3% 10.6% 39.9% 4.1% 06 Pearson plc Annual report and accounts 2012 Pearson’s strategy: John Fallon, Chief executive Watch an interview with John Fallon, Chief executive of Pearson. ar2012.pearson.com As the world’s leading learning company, Pearson has a once-in-a- generation opportunity. To seize it, we must transform the company again. Our strategy is settled and sound; we are now accelerating its implementation. Dear shareholders, I really do consider it to be a great privilege to be writing to you for the first time as Pearson’s chief executive. I had the good fortune to join the company 16 years ago; since then I’ve worked for Pearson in London, New York and Harlow and travelled to all corners of the world as we’ve built our education business. I’ve learned many things in that time, but above all that this is a very special company, with a great sense of purpose and many talented and dedicated people. In the months since my appointment was announced, I’ve spent a good deal of time talking to a wide range of stakeholders – customers, shareholders, colleagues and partners – about the company. Faster into digital, services and emerging markets My conclusion – based on what I’ve heard in recent months and learned first hand over the past 16 years – is very straightforward. The Pearson strategy is settled and sound, and we need to accelerate its implementation. We need to move faster in our digital transformation, our move into services and the building of our presence in emerging markets. O U R S TR AT EGY 1 Four global businesses We are focusing on school, higher education, English language learning and business education. We are taking an increasingly global view of educational needs and trends. 2 Four types of geographic market We will carefully evaluate when we offer global products and services, when we customise for local needs, and when we require a true local approach. We will focus our investment on markets with the biggest growth opportunities. 3 Four business models We will channel our investment into four proven business models: direct-to-consumer; ‘Pearson Inside’ (our shorthand for institutional services to schools and universities); assessment; and learning systems. Section 1 Overview 07 I want to use this letter to explain why we need to accelerate, and how we will do it. If you’ve read Marjorie’s letters over the years, you’ll be familiar with the key tenets of our strategy and the progress that Pearson has already made. Under her leadership, Pearson set out to become a world-leading education company, and that is a privilege and responsibility we now enjoy. We wanted to make a radical shift from traditional print products to digital and services businesses, and, for the first time in Pearson’s history, those now account for half of our revenues. We aimed to become a significant player in the world’s most dynamic education markets, and Pearson is now a meaningful education company in China, India, Brazil and Southern Africa. And we’ve achieved this transformation while sustaining a disciplined approach to capital allocation. Structural change in the world of education This is a powerful set of advantages with which to tackle a changing external environment. We continue to see significant structural change, including a shift from print to digital content and from classroom instruction to online learning. Spending on textbooks is flat or declining, while mobile devices, personalised learning and MOOCs (massive open online courses) are on the rise. This shift to digital is profoundly changing the business model for content: it means one-off sales will diminish while subscription sales, most bundled with services, will grow. That same shift to digital causes considerable change and consolidation in the retail channel, with a dramatic shift to online sales and different sales patterns for physical and digital formats. I’m not going to dwell on the 2012 results here, because Robin Freestone covers them in detail in the next section. But in 2012 we saw plenty of evidence to suggest that those structural changes are gathering speed and force. In many of our traditional publishing markets, we posted another excellent competitive performance. Yet the reward for those efforts was that in some markets we declined at a slower rate than our rivals. At the same time, we draw confidence from strong growth in some of our ‘emerging’ markets. (We see our fast-growing markets as categories as much as geographies – they are digital products and services, learning systems, the direct delivery of effective education and learning; as well as fast- growing economies.) U N I Q U E M A R K E T P O S ITI O N 2011 Education revenues Pearson Apollo Group Benesse Education Laureate Kaplan McGraw-Hill Career Education Corp Corinthian Colleges Cengage Learning HMH Santillana ETS Anhanguera New Oriental K12 Inc Lagardere Education Blackboard Scholastic Kroton Education Infinitas Learning Holtzbrinck (Macmillan) Sanoma Education Educomp $7.0bn $4.5bn $3.7bn $3.2bn $2.5bn $2.3bn $1.8bn $1.7bn $1.6bn $1.2bn $1.0bn $0.9bn $0.7bn $0.7bn $0.6bn $0.6bn $0.5bn $0.5bn $0.4bn $0.4bn $0.4bn $0.4bn $0.3bn O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 08 Pearson plc Annual report and accounts 2012 Pearson’s strategy: John Fallon, Chief executive continued Trends P R I N T TO D I G ITA L Number of US college students taking at least one online course % total enrolments/millions 32.0% 29.2% 27.3% 11 10 09 08 07 06 05 04 03 02 13.5% 11.7% 9.6% 24.1% 21.6% 19.6% 18.2% Source: Babson annual online learning survey T H E R I S E O F T H E M I D D L E C L A S S Numbers of middle class people millions 09 20 Middle class consumption, $bn (2005$) 09 20 6.7m 6.1m 5.6m 4.6m 3.9m 3.3m 3.2m 2.3m 2.0m 1.6m 1,845m 3,249m $21,284bn $35,045bn North America Europe Central & South America Asia Pacific Sub-Saharan Africa Middle East & North Africa Source: The Brookings Institution TH E CO N S U M E R E D U C ATI O N M A R K E T Household income spent on education % China Turkey India Brazil Indonesia Saudi Arabia Russia South Afri ica US UK Source: Bureau of Labor Statistics, Office of National Statistics, Credit Suisse 13.1% 11.4% 11.1% 9.8% 9.5% 8.6% 6.8% 5.5% 2.1% 1.6% Our motto, as you might know, is ‘always learning’ and there are some lessons for us to learn from all this. We have to manage disruption in our traditional businesses while building direct relationships with learners and leading the digital transformation of education. Our future customers will be consumers, or learners, just as much as the institutions that serve them. We have to tilt the company more quickly toward the biggest sources of future demand. We have to work ever harder to help our customers do more, and better, with less. And we have to focus less on what we make, and much more on the measurable impact our products and services can actually deliver. Global education is a once-in-a-generation opportunity If that all sounds a little daunting, there is another side to the Pearson story. We think education will turn out to be the great growth industry of the 21st Century. People the world over increasingly understand the fundamental truth perhaps best expressed by Benjamin Franklin: ‘An investment in knowledge always pays the best interest.’ The economic returns to education are very clear. For example, 90% of the fastest-growing jobs in the US economy require a college degree and a college graduate will earn, on average over their career lifetime, one million dollars more than a high- school drop-out. Our growth prospects are also fuelled by a remarkable socio-economic trend: in this decade, the global middle class will almost double in size to more than three billion people. Nearly all of that growth will be in the developing world. That’s important to many industries but especially to ours, because as consumers join the middle class and earn higher incomes, they tend to invest more in education – either to advance their careers or give their children a good start in life. We draw two conclusions from those kinds of trends. The first is that global education is a once-in-a- generation opportunity and Pearson is uniquely placed to grasp it. The second is that, to seize that opportunity, we need to transform the company again. Our business S TR E N GTH I N H I G H - G ROW TH M A R K E T S $m Pearson emerging markets revenues $m Pearson n emerging markets revenues 12 12 11 11 10 10 09 09 08 08 07 07 1,241m 1,241m 1,036m 1,036m 834m 834m 648m 648m 513m 513m 471m 471m China/H China/Hong Kong Hong Kong India India Africa Africa Central/Latin America Central/Latin America Middle East Middle East S H I F T TO D I G ITA L A N D S E RV I C ES Pearson’s digital and services revenues % sales/£m 12 11 10 09 08 07 50% 45% 3,039m 2,633m 2,266m 1,917m 1,481m 1,174m 40% 37% 34% 31% TH E N E E D F O R TR A N S F O R M ATI O N – W H E R E A R E O U R C U S TO M E R S? Pearson revenues 2012 Pearson n revenues 2012 £bn £bn K-20 % of students K-20 % of students (% CAGR 1998-2010) (% CAGR 1998-2010) Emerg Emerging ging Devel Developed oped £0.8bn £0.8bn £5.3bn £5.3bn North America & Europe North America & Europe 0.2% 0.2% RoW RoW Emerging markets Emerging markets 0.6% 0.6% 3.1% 3.1% Source: P Source: Pearson, UNESCO earson, UNESCO Section 1 Overview 09 Transforming the company again Digital learning services now account for around one- third of our sales. They are growing at more than 20%, but we need to make them a much bigger part of Pearson. Emerging markets are another 15% of our sales. But they already account for more than one- third of the world economy and are forecast to produce more than two-thirds of global growth over the next decade. So, we must radically shift our focus, attention and resources to those very big opportunities. And that is the reason for the changes in the company that we announced with our 2012 results. We need to shift resources more quickly from textbook publishing activities, primarily in the developed world, where demand is flat or declining, so we can invest more quickly in our fast-growing digital and services businesses, with a special emphasis on emerging markets. Our transformation includes a focus on four global businesses: School, Higher Education, English and Business Education. We are taking an increasingly global view of educational needs, consumer trends and product development for these businesses. We are applying a new model where we group markets, or countries, in four categories and allocate capital accordingly: ‘growth’ markets where we see the biggest opportunities; ‘watch’ markets where we see potential for big growth; ‘maintain’ markets where we have good businesses but see more modest future growth; and ‘drive’ markets where we will work through local partners to meet those countries’ needs more effectively. Our framework also involves shifting an increasing proportion of investment into our faster-growing and proven service-oriented models. They are: direct to consumer, building on the success of initiatives such as our language schools in China; ‘Pearson Inside,’ shorthand for comprehensive institutional services such as our virtual schools in the US and school systems in Brazil; assessment and certification of students and professionals; and personalised learning systems, which deliver individual learning through systems of instruction combined with measurement frameworks and diagnostic assessment. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 10 Pearson plc Annual report and accounts 2012 Pearson’s strategy: John Fallon, Chief executive continued An important part of that transformation is the merger of our consumer publishing business, Penguin, with Bertelsmann’s Random House, which we expect to complete this year. Penguin has been part of Pearson for more than four decades. It is a special company that is deeply intertwined with Pearson’s culture and operations. But it had become increasingly clear that, in a rapidly-changing consumer books industry, Penguin’s creative and financial success could best be secured in combination with Random House, which we viewed as the ideal partner. This will be an excellent business and we will be active long-term partners in it. Another important component will be business education, which we see as part of our once-in-a- generation opportunity. There is a substantial market for learning for globally minded, highly aspirational business people, and if there is one brand in the world that could turbo-charge our ability to capture that market, it is the Financial Times. We are actively exploring this opportunity. A focus on outcomes There is one other major component to the changes we are making. For decades, Pearson has provided inputs into the process of education: a textbook, an assessment, a course, a qualification. We would put all of those things in the hands of an experienced teacher or an enthusiastic student. In most cases, we would not be able to predict or measure learning outcomes. Under the leadership of our chief education advisor, Sir Michael Barber, we have spent the past two years developing a framework and a set of tools that will change that. The Pearson efficacy framework is a unique, rigorous and scalable quality assurance system that checks that the necessary conditions are in place for an education programme to deliver the intended learning outcomes. We have reviewed almost 100 Pearson programmes under this framework, and we are improving our products and services by acting on the findings. We also are now making an efficacy review a requirement for any new product investment of $3m or more, and for any acquisition proposal. Over time, this will also improve our rate of innovation and invention. Building on our record of strong performance Those measures on efficacy complement our more traditional financial measures and goals but they do not, of course, replace them. We will build on Pearson’s record of consistently strong financial performance, because profits and cash will fuel the transformational investments that we need to make. Meeting those financial measures will require us to make hard choices about where we choose to invest and what we have to do less of or stop doing altogether. For, if 2012 was tough, then there are many reasons – cyclical, structural, competitive, consumer led – why 2013 is likely to be tougher still. Many of our markets – especially in the developed economies and where we are particularly dependent on our more traditional product models – have been in decline for some years now. All this change is going to be challenging for Pearson. It is not a revolution: Marjorie’s own leadership of the company was characterised by constant, restless change. However, we do need to accelerate that change – into emerging markets, into services and in our digital transformation – very quickly now. As we do that, we very much appreciate and rely on the support of our shareholders. By investing in Pearson, you’ve made an investment in knowledge and education. We will be working as hard as we possibly can to be sure that Benjamin Franklin’s words apply to your investment, too. And we’ll be inspired, too, by Marjorie’s great achievement – demonstrating time and time again that the best and most sustainable way for a company to prosper is to meet an important need in society and to do it really well. We’ll be striving very hard to live up to her example. John Fallon Chief executive Our performance: 2012 financial overview Section 2 Our performance 11 K E Y F I N A N C I A L GOA L S Adjusted earnings per share Pence 12 11 10 09 08 07 Watch an interview with Robin Freestone, Chief financial officer of Pearson. ar2012.pearson.com Average annual growth (headline) 13%. £m Operating cash flow £m Operat ting cash flow In 2012, Pearson increased sales by 4% in headline terms to £6.1bn generating a total adjusted operating profit of £936m (2011: £942m). The headline growth rates were reduced by currency movements and helped by acquisitions. Currency movements reduced sales by £27m and operating profits by £11m. This was the result of non-dollar currency depreciation relative to sterling. At constant exchange rates (i.e. stripping out the impact of those currency movements), our sales and adjusted operating profit grew 5% and 1% respectively. Acquisitions, primarily in our education company, contributed £318m to sales and £39m to operating profits. This includes integration costs and investments related to our newly-acquired companies, which we expense. The disposal of our 50% stake in FTSE International in 2011 reduced operating profits by £20m. Our underlying revenue and adjusted operating profit (i.e. stripping out the impact of both portfolio changes and currency movements) declined by 1% and 2% respectively. Our tax rate in 2012 was 23.1% compared to 22.4% in 2011 reflecting movements in tax settlements with revenue authorities in each year. Adjusted earnings per share were 84.2p (2011: 86.5p). 12 12 11 11 10 10 09 09 08 08 07 % Return on invested capital % Return on invested capital 12 12 11 11 10 10 09 09 08 08 07 Average capital/actual cash tax Cash generation Headline operating cash flow declined by £195m due to longer debtor days, currency fluctuations and increased investment in new education programmes. Free cash flow declined by £115m to £657m, additionally reflecting from lower tax payments. Our average working capital to sales ratio improved by a further 0.4 percentage points to 13.8% reflecting the benefits from our shift to more digital and service- orientated businesses. Return on invested capital Our return on average invested capital was 9.1%, well ahead of our cost of capital and level with 2011. ROIC was affected by profit decline at Pearson in Practice and the sale of FTSE International (one of our least capital-intensive businesses), offset by a lower cash tax charge. 84.2p 84.2p 86.5p 86.5p 77.5p 77.5p 65.4p 65.4p 57.7p 46.7p £788m £788m £983m £983m £1,057m £1,057m £913m £913m £796m £796m £684m 9.1% 9.1% 9.1% 9.1% 10.3% 10.3% 8.9% 8.9% 9.2% 9.2% 8.9% O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 12 Pearson plc Annual report and accounts 2012 Our performance: 2012 financial overview continued Outlook: 2013 Statutory results Our statutory results show a decrease of £603m in operating profit to £515m, from £1,118m in 2011, reflecting the absence in 2012 of the £412m profit on the sale of FTSE International in 2011 and the £113m closure-related costs on Pearson in Practice in 2012. Basic earnings per share similarly fell to 40.5p in 2012, down from 119.6p in 2011. Balance sheet Our net debt increased to £918m (£499m in 2011) reflecting acquisition investment of £759m and sustained organic investment in our business, partly offset by cash generation. Since 2000, Pearson’s net debt/EBITDA ratio has fallen from 3.9x to 0.9x and our interest cover has increased from 3.1x to 18.0x. Dividend The board is proposing a dividend increase of 7% to 45.0p, subject to shareholder approval. 2012 will be Pearson’s 21st straight year of increasing our dividend above the rate of inflation. Over the past ten years we have increased our dividend at a compound annual rate of 7%, returning more than £2.5bn to shareholders. We have a progressive dividend policy: we intend to sustain our dividend cover at around 2.0x over the long term, increasing our dividend more in line with earnings growth. Pence Dividend per share paid in fiscal year Pence Dividen nd per share paid in fiscal year 12 12 11 11 10 10 09 09 08 08 07 45.0p 45.0p 42.0p 42.0p 38.7p 38.7p 35.5p 35.5p 33.8p 33.8p 31.6p We expect the external environment to remain challenging for our developed world and publishing businesses in 2013 owing to a combination of cyclical and structural factors: pressures on education budgets and college enrolments; retail consolidation; the shift in our business model from print sales to digital subscriptions; changing consumer behaviour and a dynamic competitive landscape. In general, we expect market conditions to remain favourable for our businesses in developing economies and education software and services. In order to reshape the company to take advantage of significant growth opportunities, we will expense approximately £150m of restructuring costs in 2013 (the restructuring cost will be approximately £100m net of cost savings achieved in the year). This investment has two objectives: 1. to accelerate our transition from print to digital business models and from developed to developing economies; and 2. to separate Penguin activities from Pearson central services and operations, and to reduce fixed cost infrastructure in Pearson, in preparation for the Penguin Random House merger. We expect this transformation programme to generate approximately £100m of annual cost savings from 2014. In 2014, we intend to reinvest the £100m of cost savings in the organic development of our fast-growing digital, services and emerging markets businesses and further restructuring, including the Penguin Random House integration. We expect these businesses to contribute to faster organic growth, improving margins and improved cash flow and capital intensity from 2015. The precise phasing of restructuring costs and benefits will depend on timing of completion of the Penguin Random House combination, which remains subject to regulatory approval and which we expect to complete in the second half of 2013. At this early stage in the year we expect Pearson 2013 operating profits and adjusted EPS to be broadly level with 2012 before expensing these restructuring costs (compared to 2012 adjusted EPS of 82.6p under revised IAS 19 which we will adopt in 2013) and including Penguin for the full year. This guidance is struck at the 2012 average exchange rate of £1:$1.59 and reflects the following outlook: Education In Education, we expect to achieve modest revenue growth in 2013 with margins similar to 2012. North America In North America, we anticipate modest growth with challenging cyclical and structural market conditions in publishing offset by growth in digital and services. International We expect our International education business to show good growth. Austerity measures will continue to affect education spending in much of the developed world and we expect a slower year for UK examinations and qualifications. However, we see significant opportunity in emerging markets in Asia, Latin America, the Middle East and Sub-Saharan Africa – which together accounted for 45% of our International education revenues in 2012. Professional Our Professional education business will reflect the closure of our UK professional training business and continued growth from our professional certification business. FT Group We expect the FT Group to benefit from continued growth in digital and subscription revenues in 2013 but advertising to remain weak and volatile with profits reflecting further actions to accelerate the shift from print to digital. Mergermarket will benefit from its high subscription renewal rates, with market activity likely to boost its core product offerings. Section 2 Our performance 13 Penguin As previously announced, subject to regulatory approval, we expect Penguin’s combination with Random House to be completed in the second half of 2013. We believe that the combined organisation will have a stronger platform and greater resources to invest in rich content, new digital publishing models and high-growth emerging markets. The organisation will generate synergies from shared resources such as warehousing, distribution, printing and central functions. We expect market conditions to remain similar to 2012 with a tough environment in the physical bookstore channel but helped by good growth in digital. Interest and tax In 2013, our net interest charge to adjusted earnings will exclude pension income and charges following the adoption of IAS 19 revised and be similar to the £65m reported in 2012 on a comparable basis. We anticipate our P&L tax charge against adjusted earnings to be in the 23–25% range with our cash tax rates around the same level. Exchange rates Pearson generates approximately 60% of its sales in the US. A five cent move in the average £:$ exchange rate for the full year (which in 2012 was £1:$1.59) has an impact of approximately 1.4p on adjusted earnings per share. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 14 Pearson plc Annual report and accounts 2012 North American Education K E Y P E R F O R M A N C E I N D I C ATO R S North American Education is Pearson’s largest business, with 2012 sales of £2.7bn and operating profit of £536m. Sales 2012 2011 £2,658m 2012 £2,584m 2011 Adjusted operating profit Headline growth CER growth 3% 2% Headline growth CER growth Underlying growth (4)% Underlying growth £536m £493m 9% 8% 3% C A S E S T U DY Online learning Pearson’s pioneering ‘MyLab’ digital learning, homework and assessment programmes grew well with student registrations in North America up 11% to almost 10 million, with graded submissions up 12% to almost 320 million across the globe. Evaluation studies show that the use of MyLab programmes can significantly improve student test scores and institutional efficiency. http://bit.ly/ymMMAi Total number of MyLab registrations 9.9m 2012 8.9m 2011 Section 2 Our performance 15 C A S E S T U DY eCollege registrations Student registrations at eCollege grew 3% to 8.7 million, despite pressure in the for-profit college market. We won new online enterprise learning contracts with California State University and Rutgers University. Our strong managed enrolment services and student marketing product offering, coupled with continued strong growth at Arizona State University, helped our online enterprise learning business to grow 150% to almost 44,000 enrolments. In November 2012, we acquired EmbanetCompass for $650 million which provides a full range of services targeted towards online graduate programmes. In 2012, our strength in digital and services businesses and tight cost control enabled us to perform ahead of our more traditional print publishing markets, which declined by 10% for the industry as a whole and were adversely affected by state budget pressures and declines in college enrolments. Higher Education highlights in 2012 include: › In Higher Education, the publishing market declined by 6% net in 2012, according to the Association of American Publishers. Total US College enrolments were 2% lower in 2012 than in 2011, affected by rising employment rates, state budget pressures and regulatory change affecting the for-profit sector. In a difficult trading environment Pearson gained share for the 14th consecutive year, again benefiting from our lead in technology and customisation. › We launched Pearson Workforce Education which delivers more than 60 online courses in high demand occupational training areas from IT and Healthcare to management and soft skills courses; and Propero, which combines on-demand tutoring, student support and online courses to expand access to higher education and support degree completion. › We announced the acquisition of a 5% stake in NOOK Media for $89.5m in December 2012 with the option to purchase up to an additional 5%, subject to certain conditions. This strategic investment will help accelerate customer access to digital content by pairing the company’s leading expertise in online learning with NOOK Media’s expertise in online distribution and customer service. This will facilitate improved discovery of available digital content and services, as well as seamless access. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 16 Pearson plc Annual report and accounts 2012 North American Education continued Assessment and Information highlights in 2012 include: › At our Assessment and Information business, revenues were flat in 2012. State funding pressures and the transition to Common Core assessments continued to make market conditions tough for our state assessment and teacher testing businesses. › The Partnership for Assessment of Readiness for College and Careers (PARCC), a consortium of 23 states, awarded Pearson and Educational Testing Service (ETS) the contract to develop test items that will be part of the new English and mathematics assessments to be administered from the 2014–2015 school year. The assessments will be based on what students need to be ready for college and careers, and will measure and track their progress along the way. › We continued to produce strong growth in secure online testing, an important market for the future. We increased online testing volumes by more than 10%, delivering 6.5 million state accountability tests, 4.5 million constructed response items and 21 million spoken tests. We now assess oral proficiency in English, Spanish, French, Dutch, Arabic and Chinese. We also launched the Online Assessment Readiness Tool for the PARCC and the Smarter Balance Assessment Consortium (SBAC) Common Core consortia to help 45 states prepare for the transition to online assessments. › We won new state contracts in Colorado and Missouri and a new contract with the College Board to deliver ReadiStep, a middle school assessment that measures and tracks college readiness skills. We extended our contract with the College Board to deliver the ACCUPLACER assessment, a computer- adaptive diagnostic, placement and online intervention system that supports 1,300 institutions and 7 million students annually. C A S E S T U DY Connections Education Connections Education, which operates online K-12 schools in 22 states and a nationwide charter school programme, served more than 43,000 students in 2012, up 31% from 2011 and broadened its product offering to include virtual classrooms for public school campuses. Connections Academy Schools have consistently high performance ratings, particularly in states focused on measuring growth in student learning. Section 2 Our performance 17 › We won five Race To The Top (RTTT) state deals (Kentucky, Florida, Colorado, North Carolina and New York) led by Schoolnet. PowerSchool won three state/province-level contracts (North Carolina, New Brunswick and Northwest Territories). We launched our mobile PowerSchool applications and grew our third-party partner ecosystem to over 50 partners. PowerSchool supports more than 12 million students, up more than 20% on 2011 while Schoolnet supports 8.3 million students, up almost 160% on 2011. › Pearson gained share in very tough market conditions, taking an estimated 31% of new adoptions where we competed. enVisionMATH continued to perform strongly, with a recent What Works Clearing House study showing that students using the programme outperformed peers by between six and eight percentiles in maths across a broad range of student populations. iLit, our new digital reading intervention programme, was successfully implemented in 20 districts with early results showing strong reading gains. › Our clinical assessment business was boosted by strong growth at AIMSweb, our progress monitoring service which enables early intervention and remediation for struggling students. AIMSweb delivered 58 million assessments in 2012, up 12%. School highlights in 2012 include: › In School, the textbook publishing market declined 15% in 2012, according to the Association of American Publishers. There were several pressures on the industry including weakness in state budgets, a lower new adoption opportunity (total opportunity of $380m in 2012 against $650m in 2011) and delays in purchasing decisions during the transition to the new Common Core standards. C A S E S T U DY OpenClass OpenClass, Pearson’s free learning management system, has been installed by almost 1,300 K-12 and college institutions in the US and now serves approximately 100,000 users. In November 2012, we launched Project Blue Sky, a cloud-based content service that allows college instructors to combine Open Educational Resources (OER) with instructor- created and Pearson content. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 18 Pearson plc Annual report and accounts 2012 International Education K E Y P E R F O R M A N C E I N D I C ATO R S Our businesses in emerging markets continued to perform strongly, supported by good enrolment trends and sustained investment. Sales 2012 2011 £1,568m 2012 £1,424m 2011 Adjusted operating profit Headline growth CER growth Underlying growth 10% 13% 7% Headline growth CER growth Underlying growth £216m £196m 10% 16% 11% C A S E S T U DY Businesses in China In China, student enrolments at Wall Street English increased 15% to almost 61,000, boosted by good underlying demand and the launch of ten new centres taking the total to 66. Our students rapidly acquired high-level English skills with average grade levels achieved rising by 8% during 2012. Enrolments at Global Education, our test preparation services for English language qualifications, increased 16% to more than 1 million, through 73 owned and 372 franchised learning centres. Wall Street English student enrolments in China 61,000 2012 53,000 2011 Our businesses in emerging markets continued to perform strongly, supported by good enrolment trends and sustained investment. Our UK business was resilient during the year despite significant regulatory and policy changes across vocational and general qualifications, apprenticeships and higher education. In the rest of the world, a recovery in Japan following the 2011 tsunami and a strong competitive performance in Italy more than offset weak market conditions in Spain. Key highlights in 2012 include: › In English Language Learning, Wall Street English (WSE), Pearson’s worldwide chain of English language centres for professionals, opened a net of 11 new centres around the world, bringing the total number to 460. Student numbers fell by 2% to more than 191,000, primarily due to the closure of a large franchise centre in Chile with approximately 7,000 students. MyEnglishLabs enrolments grew 60% to 263,000 supported by the launch of our next generation platform which supports 13 languages and 43 new courses. We acquired GlobalEnglish, a leading provider of cloud-based, on-demand Business English learning, assessment and performance support software, for $90m in cash in July 2012. C A S E S T U DY Sistema success in Brazil In Brazil, we ended 2012 with 533,000 students in our public and private sistemas (or learning systems) and added 24,000 students in our two largest private sistemas, COC and Dom Bosco, up 8% on 2011. Our public sistema, NAME, includes the top performing lower secondary school in Brazil and test scores for all our public school students are, on average, 20% above the 2011 national IDEB standard for 4th and 8th grade students. Section 2 Our performance 19 › More than 1.1 million students registered for our MyLab digital learning, homework and assessment programmes, an increase of 18%, with good growth in school, ELT and institutional selling in higher education. United Kingdom highlights in 2012 include: › In the United Kingdom, we marked more than 6.3 million GCSE, A/AS Level and other examinations with 90% using onscreen technology and more than 3.8 million test scripts for over half a million pupils taking National Curriculum Tests at Key Stage Two in 2012. We launched our Next Generation BTECs which are now the leading vocational qualification on the new funding and accountability frameworks in schools. Our vocational qualifications business grew well with the continued popularity of BTEC amongst employers and universities and a strong performance in work-based learning (with registrations now up to 170,000) further boosted by a good performance from EDI. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 20 Pearson plc Annual report and accounts 2012 International Education continued › In South Africa we held share in school publishing in market conditions which were tougher than expected despite a year of major curriculum reform. Student enrolments grew strongly at CTI, up 19% to more than 10,000. We partnered with UNISA, South Africa’s largest university and the largest distance learning provider in Africa, to provide 30,000 students with access to our MyLabs software, digital resources and customised eBooks. › In India, TutorVista is now managing 35 schools and its multimedia teaching solution Digiclass is installed in approximately 17,000 classrooms. ActiveTeach, our digital learning platform for schools, was adopted by 200 schools serving approximately 100,000 students. › In the Middle East, the Abu Dhabi Education Council purchased our print and digital Maths and Science resources for all schools from grades 6 to 10, the American University of Sharjah adopted MyLabs for four mathematics courses and three science courses, and we are providing access to digital course content for 5,000 students at Abu Dhabi’s Higher Colleges of Technology through our Pearson e-texts iPad app. C A S E S T U DY New online university launch in Mexico In Mexico, we partnered with local curriculum and technology experts INITE to launch UTEL, a new university enabling Mexicans to enrol in online degree courses in management, IT, marketing, engineering and computer science. UTEL enrolled 2,500 undergraduate students and 4,000 learners in shorter corporate training or continuing professional education courses. UTEL’s services arm, Scala, signed its first contract to provide online learning services to an existing higher education institution. Professional Education K E Y P E R F O R M A N C E I N D I C ATO R S Our Professional Education business is focused on publishing, training, testing and certification for professionals. Sales 2012 2011 £390m 2012 £382m 2011 Adjusted operating profit Headline growth CER growth 2% 2% Headline growth CER growth Underlying growth (9)% Underlying growth £37m £66m (44)% (44)% (54)% Our Professional Education business is focused on publishing, training, testing and certification for professionals. The weakness in our UK training business, Pearson in Practice, had a significant negative impact on our 2012 performance and resulted in our decision to exit the business. Other parts of the Professional division performed well. Professional testing highlights in 2012 include: › Professional testing continued to see good revenue and profit growth with test volumes at Pearson VUE up 7% on 2011 to almost 8 million with Certiport adding an additional 2.3 million tests, up 13% on 2011. There were key renewals of the National Council of State Boards of Nursing contract running until 2019 and the Computing Technology Industry Association contract was secured with Pearson VUE as the single vendor running through to 2017. Section 2 Our performance 21 › We won a number of new contracts including a ten-year contract to administer all computer and paper-based tests for the Australia CPA Professional exams and five-year contracts with the National Center for Assessment in Saudi Arabia and the National Council of State Boards of Nursing to provide the NCLEX-RN in Canada beginning in 2015 for ten Canadian registered nurse (RN) regulatory bodies. › The partnership with the American Council on Education to develop an online General Educational Development (GED) test aligned with new Common Core standards has now launched computer-based testing in 37 jurisdictions. › Continuing our digital transformation, we adapted our booking service for the Driving Standards Agency (DSA) to work on mobile devices. We also introduced one-to-many biometric matching technology into testing centres to enhance fraud detection. Professional training › Professional training was very weak with our UK adult training business, Pearson in Practice, facing a dramatic fall in demand as a result of changes to the apprenticeships programme. We believe this business no longer has a sustainable model and announced in January that we are to exit Pearson in Practice. The cost of exit and impairment is £113m and is reported as a loss on closure in Pearson’s 2012 statutory accounts. › TQ continues to make significant progress in the direct delivery of training services overseas. In Saudi Arabia, we extended the contract to operate the Saudi Petroleum Services Institute for five years and won a five-year contract to run a new Institute at Al Khafji. In Oman, a TQ-led consortium won the bid to provide training to BP, including a wide range of technical and English language training for BP workers as they prepare to open up the Khazzan oilfield for full scale production in 2016. Professional publishing highlights in 2012 include: › Professional publishing grew modestly with good profit growth. In the US, growth of eBook sales and other digital products and services continued to outpace ongoing challenges in the traditional retail channel. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 22 Pearson plc Annual report and accounts 2012 Financial Times Group K E Y P E R F O R M A N C E I N D I C ATO R S The FT Group is a leading provider of essential information in attractive niches of the global business information market. Sales 2012 2011 £443m 2012 £427m 2011 Adjusted operating profit* Headline growth CER growth Underlying growth 4% 4% 4% Headline growth CER growth Underlying growth £49m £76m (36)% (32)% (7)% * Reflects the absence in 2012 of the £20m 2011 profit from Pearson’s stake in FTSE International following its sale. C A S E S T U DY Growth in digital readership The Financial Times digital readership continues to grow strongly with digital subscriptions increasing 18% to almost 316,000 and with 3.5 million FT web app users. Financial Times digital subscriptions 316,000 2012 267,000 2011 Section 2 Our performance 23 Digital and services revenues accounted for 50% of FT Group revenues (31% in 2008). Content revenues comprised 61% of revenues (48% in 2008), while advertising accounted for 39% of FT Group revenues (52% in 2008). Financial Times highlights in 2012 include: › The Financial Times digital readership continues to grow strongly with digital subscriptions increasing 18% to almost 316,000 and with 3.5 million FT web app users. The FT’s total paid circulation was more than 602,000 across print and online, modestly up on 2011, with digital subscriptions exceeding print circulation for the first time. The FT now has almost 2,800 direct corporate licences, up 40% on 2011. › We continued to invest in new products and innovation, including launching a Windows 8 app and the FT web app on Chrome for Android; a bespoke web app for Latin America; a rebrand of the conferences division, FT Live, with the introduction of live streaming at key events; and the launch of GatekeeperIQ, a new subscription service to track large, retail investment platforms. › Advertising was generally weak and volatile with poor visibility but the FT grew market share with mobile, luxury and business education showing good growth. Digital revenues benefited from the launch of FT SmartMatch, which automatically puts client content such as articles, white papers and videos in front of FT.com users while they’re reading related FT news stories. › FT Live, our events business, continued to grow strongly and launch new events, including the Global Commodities Summit, delivering more than 200 events that attracted over 17,000 delegates. We launched a digital portal that offers on-demand webinars, livestreamed events and social media tools. C A S E S T U DY Growth in mobile Mobile devices now account for 30% of FT.com traffic and 15% of new subscriptions. › Educational services are an important area of expansion. The FT Non-Executive Director Certificate (in partnership with Pearson Learning Studio and Edexcel) was attended by over 150 candidates across five intakes. FT Newslines, an annotations tool on FT.com that allows students and faculties from around the world to create and share annotations on FT articles, is now being used at many business schools. The new FTChinese MBA Gym App, which features tailored training courses categorised by topic, has ranked among the top paid-for education apps on the iTunes Store and was recognised as one of the ‘App Store Best of 2012’ by Apple in China. › Money-Media revenues and profits continued to grow well boosted by a strong subscription performance, with the number of individual users growing 6% year on year to 220,000, and new product launches, including Ignites Retirement Research which broadens Money-Media’s product offering into the investment industry research sector. Economist Group highlights in 2012 include: › In The Economist Group (50% owned by Pearson), The Economist launched three HTML5-powered apps in collaboration with FT Labs. The Economist’s worldwide print and digital circulation increased by 2% to 1.67 million (at 31 December 2012) of which 150,000 customers bought digital-only copies. The Economist Intelligence Unit acquired Clearstate in Singapore and Bazian, a London-based healthcare research company, as part of its strategy to build a healthcare information business. Mergermarket highlights in 2012 include: › Mergermarket grew well, despite challenging markets, due to a good performance from Debtwire, mergermarket, Xtract and Remark underpinned by a strong offering following investment in its product breadth, strong editorial analysis and global presence. We launched several new products and services, including a new mergermarket Android app, a Debtwire Analytics platform in Europe and Policy and Regulatory Report (PaRR), a global intelligence, analysis and proprietary data product focused on competition law, IP and trade law, and sector-specific regulatory change. We also expanded our coverage in faster growth markets such as Latin America, China and the Middle East, generating new business and extending our international reach. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 24 Pearson plc Annual report and accounts 2012 Penguin K E Y P E R F O R M A N C E I N D I C ATO R S Penguin is one of the most famous brands in book publishing, known around the world for the quality of its publishing and its consistent record of innovation. Sales 2012 2011 £1,053m 2012 £1,045m 2011 Adjusted operating profit Headline growth CER growth 1% 1% Headline growth CER growth Underlying growth (2)% Underlying growth C A S E S T U DY US bestsellers No. 12 11 UK bestsellers No. 255 255 254 254 12 11 The number of Penguin books entering the Top Ten bestseller lists in the US (New York Times). The number of Penguin books entering the Top Ten besteller lists in the UK (Nielsen Bookscan Top Ten). eBook sales % of sales eBook revenue grew strongly in 2012 and accounted for 17% of Penguin’s global revenue 17% 2012 12% 2011 £98m £111m (12)% (11)% (14)% 90 90 78 78 Section 2 Our performance 25 › In the UK, we published 90 Bookscan bestsellers, our best year on record (and compared to 78 in 2011) including Sylvia Day’s Bared to You; Jamie Oliver’s 15 Minute Meals; Clare Balding’s My Animals and Other Family and Daniel Kahneman’s Thinking, Fast and Slow. › eBook revenue grew strongly in 2012 and accounted for 17% of Penguin’s global revenue (12% in 2011), and almost 30% in the US (20% in 2011). We continued to invest in digital publishing programmes, making eBooks available in new markets including Australia, India, Brazil and China; launching a number of digital-only imprints around the world and expanding our eSpecials list. Global app sales grew by more than 200% driven by brands including Wreck this App, Mad Libs, Moshi Monsters and LEGO®. DK was Apple’s only trade publisher launch partner for the January launch of the iBooks Author 2 platform and now has more than 50 interactive titles available. In October 2012, Pearson and Bertelsmann announced an agreement to create the world’s leading consumer publishing company by combining Penguin and Random House. Pearson will own 47% of the combined organisation, which is subject to regulatory approval and is expected to complete in the second half of 2013. We believe that the combined organisation will have a stronger platform and greater resources to invest in rich content, new digital publishing models and high-growth emerging markets. In market conditions that remained challenging, Penguin had a solid year with momentum and share improving in the second half of the year. It also made several moves to offer a broader range of services to more authors across more platforms in more markets. Key highlights in 2012 include: › In the United States, we published 255 New York Times bestsellers (254 in 2011) including No Easy Day: The Firsthand Account of the Mission that Killed Osama bin Laden by ‘Mark Owen’, Bared to You by Sylvia Day and Nate Silver’s The Signal and the Noise as well as new titles from bestselling authors including Ken Follett, Nora Roberts, Tom Clancy and Harlan Coben. C A S E S T U DY Strong publishing list for 2013 Penguin has a strong publishing list for 2013 with major new books from authors including Khaled Hosseini, Elizabeth Gilbert, Sylvia Day, Nora Roberts, Nathaniel Philbrick and Sarah Dessen in the US, and Jamie Oliver, John Le Carré, Jennifer Saunders, Malcolm Gladwell, Steven D Levitt & Stephen J Dubner, Jeremy Paxman, Jonathan Coe and John Green in the UK. DK will launch more LEGO® titles, including the LEGO® Play book, and Mary Berry’s Cookery Course. New apps for 2013 include Anne Frank: The Diary of a Young Girl, I’m Ready to Spell and Poems by Heart. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 26 Pearson plc Annual report and accounts 2012 Penguin continued › In Brazil, we acquired 45% of Companhia das Letras, a leading trade book publisher. In India, we launched a local eBook programme and enjoyed considerable success in commercial fiction with bestselling authors including Ravinder Singh and Shobhaa De. In China, we expanded our local publishing programmes in both Chinese and English with more than 100 titles now available, including a first local language top ten title, tennis player Li Na’s autobiography, and we launched our first list of eBooks. › DK performed strongly and grew share globally led by our LEGO® publishing list. In the UK, DK celebrated a number one bestseller with Mary Berry’s Complete Cookbook, which has sold more than one million copies worldwide. BradyGames had bestsellers with Borderlands 2, Skylanders Giants and Call of Duty: Black Ops II. › Author Solutions, which we acquired in July 2012 for $116m, had a good start. It is the world’s leading provider of professional self-publishing services and broadens our expertise in online marketing, consumer analytics, professional services and user-generated content. In February 2013 Penguin India launched Partridge, a new self-publishing imprint, in partnership with Author Solutions. C A S E S T U DY Pick of the year In 2012, Penguin enjoyed bestseller success around the world, including publishing 255 New York Times bestsellers and 90 top ten bestsellers in the UK. Here’s a taste of the highlights: Other financial information Net finance costs Net interest payable Finance income in respect of employee benefit plans Net finance costs reflected in adjusted earnings Other net finance costs Total net finance costs 2 012 £m 2 011 £m (65) (55) 13 (52) (29) (81) 3 (52) (19) (71) Net finance costs reported in our adjusted earnings comprise net interest payable and net finance income relating to post-retirement plans. Net interest payable in 2012 was £65m, up from £55m in 2011. Although our fixed rate policy reduces the impact of changes in market interest rates, we were still able to benefit from low average US dollar and sterling interest rates during the year. Year-on-year, average three month LIBOR (weighted for the Group’s net borrowings in US dollars and sterling at each year end) rose by 0.2% to 0.5%. This increase in floating market interest rates combined with an increase in the Group’s average net debt helped drive the Group’s higher interest charge. These factors combined with a decrease in interest income on deposits and the impact of new notes issued in 2012 created an increase in the Group’s average net interest payable from 6.5% to 7.0%. The Group’s average net debt rose by £92m, largely reflecting the acquisition activity during 2012. Net finance income relating to post-retirement plans was £13m in 2012 compared to £3m in 2011. Also included in the statutory definition of net finance costs are finance costs on put options and deferred consideration associated with acquisitions, foreign exchange and other gains and losses. Finance costs for put options and deferred consideration are excluded from adjusted earnings as they relate to future earn outs and similar payments on acquisitions and therefore do not reflect cash expended. Foreign exchange and other gains and losses are excluded from adjusted earnings as they represent short-term fluctuations in market value and are subject to significant volatility. These other gains and losses may not be realised in due course as it is normally the intention to hold the related instruments to maturity. In 2012, the total of these items excluded from adjusted earnings was a loss of £29m compared Section 2 Our performance 27 to a loss of £19m in 2011. The majority of the loss in 2012 relates to movements in the valuation of put options associated with acquisitions. In 2011 the loss relates mainly to foreign exchange differences on a proportion of the unhedged US dollar proceeds from the Interactive Data sale in 2010. Funding position and liquid resources The Group finances its operations by a mixture of cash flows from operations, short-term borrowings from banks and commercial paper markets, and longer-term loans from banks and capital markets. Our objective is to secure continuity of funding at a reasonable cost from diverse sources and with varying maturities. The Group does not use off-balance sheet special purpose entities as a source of liquidity or for any other financing purposes. The net debt position of the Group is set out below. Cash and cash equivalents 1,062 1,369 2 012 £m 2 011 £m Marketable securities Net derivative assets Bonds Bank loans and overdrafts Finance leases 6 178 9 174 (2,200) (1,955) (55) (17) (78) (18) Net debt – continuing (1,026) (499) Net cash classified as held for sale Total net debt 108 (918) – (499) Acquisition activity in 2012, is a large contributor to the increase in the Group’s net debt. Reflecting the geographical and currency split of our business, a large proportion of our debt is denominated in US dollars (see note 19 for our policy). The strengthening of sterling against the US dollar during 2012 (from $1.55 to $1.63:£1) decreases the sterling equivalent value of our reported net debt. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 28 Pearson plc Annual report and accounts 2012 Other financial information continued The Group’s credit ratings remained unchanged during the year. The long-term ratings are Baa1 from Moody’s and BBB+ from Standard & Poor’s, and the short-term ratings are P2 and A2 respectively. The Group’s policy is to strive to maintain a rating of Baa1/ BBB+ over the long term. In May 2012, the Group accessed the capital markets, raising $500m through the sale of notes maturing in May 2022 and bearing interest at 3.75%. The notes were swapped to floating rate to conform with the policy described in note 19. The Group has a $1,750m committed revolving credit facility which matures in November 2015. At 31 December 2012 this facility was undrawn. The facility is used for short-term drawings and providing refinancing capabilities, including acting as a back-up for our US commercial paper programme. This programme is primarily used to finance our US working capital requirements, in particular our US educational businesses which have a peak borrowing requirement in June. At 31 December 2012, no commercial paper was outstanding. The Group also maintains other committed and uncommitted facilities to finance short-term working capital requirements in the ordinary course of business. Further details of the Group’s approach to the management of financial risks are set out in note 19 to the financial statements. Taxation The effective tax rate on adjusted earnings in 2012 was 23.1% as compared to an effective rate of 22.4% in 2011. Our overseas profits, which arise mainly in the US, are largely subject to tax at higher rates than that in the UK (which had an effective statutory rate of 24.5% in 2012 and 26.5% in 2011). These higher tax rates were offset by amortisation-related tax deductions and by prior year adjustments including those arising from settlements with tax authorities. The reported tax charge on a statutory basis was £148m (34.1%) compared to a charge of £162m (15.5%) in 2011. The increase in the statutory rate is largely due to the lack of tax relief on the loss on closure of Pearson in Practice together with the effect of a low tax charge in 2011 on the gain on disposal of FTSE International. Tax paid in 2012 was £65m compared to £151m in 2011. The reduction in the 2012 tax paid is largely the result of the permitted deferral of US tax payments into 2013 following Hurricane Sandy. Discontinued operations In October 2012, Pearson and Bertelsmann announced an agreement to create a new consumer publishing business by combining Penguin and Random House. The transaction is expected to complete in 2013 and, at that point, Pearson will no longer control the Penguin Group of companies but will equity account for its 47% associate interest. The loss of control results in the Penguin business being classified as held for sale on the Pearson balance sheet at 31 December 2012 and the results for both 2011 and 2012 have been included in discontinued operations. Also included in discontinued operations are the costs associated with the formation of the Penguin Random House venture including provision for the settlement of litigation associated with the agency arrangements for ebooks. Non-controlling interest There are non-controlling interests in the Group’s businesses in South Africa, China and India although none of these are material to the Group numbers. Other comprehensive income Included in other comprehensive income are the net exchange differences on translation of foreign operations. The loss on translation of £238m in 2012 compares to a loss in 2011 of £44m. The Group is principally exposed to movements in the US dollar as a significant proportion of the Group’s operations are based in the US. In 2011 the US dollar strengthened only slightly from an opening rate of £1:$1.57 to a closing rate at the end of that year of £1:$1.55. Other currency movements were relatively more significant in 2011 causing a small loss. In 2012 the US dollar has weakened to close at £1:$1.63 and was the most significant contributor to the increase in the loss. Also included in other comprehensive income in 2012 is an actuarial loss of £122m in relation to post- retirement plans. This loss arose largely because of unfavourable changes in the discount rate and other assumptions used in the actuarial valuation that offset Section 2 Our performance 29 by continuing asset returns and deficit funding. In total, our worldwide deficit in respect of pensions and post- retirement benefits increased from £141m in 2011 to £198m at the end of 2012; this amount includes a deficit of £26m which specifically relates to Penguin and has been classified as a liability held for sale. Acquisitions In May 2012, the Professional business acquired Certiport Inc. for $140m. Certiport is based in the US and is a leading provider of certification and assessment programmes in IT and digital literacy. In July 2012, the International Education business completed the purchase of GlobalEnglish Corporation, a leading provider of cloud-based, on demand business English learning, assessment and performance support software for a net cash consideration of $90m. Also in July 2012, Penguin acquired Author Solutions, Inc., the world’s leading provider of professional self-publishing services, for $116m in cash. The $650m acquisition of EmbanetCompass by the North American Education business was completed in November 2012. EmbanetCompass partners with leading non-profit colleges in North America to provide online learning solutions for university programmes. Net cash consideration for all acquisitions made in the year ended 31 December 2012 was £759m and provisional goodwill recognised was £505m. In total, acquisitions completed in the year contributed an additional £45m of sales and £5m of operating profit before acquisition costs and intangible amortisation. Return on invested capital (ROIC) Our ROIC is calculated as total adjusted operating profit less cash tax, expressed as a percentage of average gross invested capital. ROIC remained flat at 9.1% in both 2011 and 2012. The impact of lower cash tax payments in 2012 has been offset by slightly lower profit and increased investment in new acquisitions. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S the effect of continuing asset returns and deficit funding in the UK plan. In 2011 the loss of £64m was also due to discount rate and other assumption changes outweighing improved asset returns and deficit funding. Dividends The dividend accounted for in our 2012 financial statements totalling £346m represents the final dividend in respect of 2011 (28.0p) and the interim dividend for 2012 (15.0p). We are proposing a final dividend for 2012 of 30.0p, bringing the total paid and payable in respect of 2012 to 45.0p, a 7% increase on 2011. This final 2012 dividend was approved by the board in February 2013, is subject to approval at the forthcoming AGM and will be charged against 2013 profits. For 2012, the dividend is covered 1.9 times by adjusted earnings. We seek to maintain a balance between the requirements of our shareholders for a rising stream of dividend income and the reinvestment opportunities which we identify around the Group and through acquisitions. The board expects to raise the dividend above inflation, more in line with earnings growth, thereby maintaining dividend cover at around two times earnings in the long term. Pensions Pearson operates a variety of pension plans. Our UK Group plan has by far the largest defined benefit section. We have some smaller defined benefit sections in the US and Canada but, outside the UK, most of our companies operate defined contribution plans. The charge to profit in respect of worldwide pensions and post-retirement benefits for continuing operations amounted to £84m in 2012 (2011: £82m) of which a charge of £97m (2011: £85m) was reported in operating profit and a net benefit of £13m (2011: £3m) was reported against net finance costs. In addition to these amounts, in 2012 a charge of £11m (2011: £11m) has been reported in operating profit in respect of discontinued operations. The overall surplus on the UK Group plan of £25m at the end of 2011 has become a deficit of £19m at 31 December 2012. The deficit has arisen due to unfavourable movements in the discount rate and other assumptions used to value the liabilities, offset 30 Pearson plc Annual report and accounts 2012 Other financial information continued Capital expenditure Supplier payment policy Operating companies are responsible for agreeing the terms and conditions under which business transactions with their suppliers are conducted. These supplier payment terms vary by operating company, reflecting the different industries and countries in which they operate. It is company policy that suppliers are aware of such terms of payment and that payments to them are made in accordance with these, provided that the supplier is also complying with all the relevant terms and conditions. Group trade creditors at 31 December 2012 were equivalent to approximately 34 days of purchases during the year ended on that date. The company does not have any significant trade creditors and therefore is unable to disclose average supplier payment terms. Net capital expenditure in the year on property, plant equipment and software amounted to £152m. The analysis of capital expenditure and details of capital commitments are shown in notes 10, 11 and 36 of the financial statements. Related party transactions Transactions with related parties are shown in note 37 of the financial statements. Post balance sheet events In January 2013, the Group completed the purchase of a 5% equity investment in NOOK Media, LLC for $89.5m. NOOK Media is a new company consisting of Barnes & Noble’s digital businesses including its NOOK e-reader and tablets, the NOOK digital bookstore and its 674 college bookstores across America. In February 2013 the Group completed the purchase of the remaining minority interest in Tutorvista, the Bangalore-based tutoring services company for £17m. Principal risks and uncertainties Our principal risks and uncertainties are outlined below. These are the most significant risks that may adversely affect our business strategy, financial position or future performance. The risk assessment process evaluates the probability of the risk materialising and the financial or strategic impact of the risk. Those risks which have a higher probability and significant impact on strategy, reputation or operations or a financial impact greater than £40 million are identified as principal risks. The risk assessment and reporting criteria are designed to provide the board with a consistent, Group-wide perspective of the key risks. The reports to the board, which are submitted twice per year, include an assessment of the probability and impact of risks materialising, as well as risk mitigation initiatives and their effectiveness. Section 2 Our performance 31 We conduct regular risk reviews to identify risk factors which may affect our business and financial performance and to assist management in prioritising their response to those risks. Our Group internal audit and risk assurance function facilitates risk reviews with each business, shared service operations and corporate functions, identifying measures and controls to mitigate these risks. These reviews are designed so that the different businesses are able to tailor and adapt their risk management processes to suit their specific circumstances. Management is responsible for considering and executing the appropriate action to mitigate these risks whenever possible. It is not possible to identify every risk that could affect our businesses, and the actions taken to mitigate the risks described below cannot provide absolute assurance that a risk will not materialise and/or adversely affect our business or financial performance. P R I N C I PA L R I S K S – I M PAC T A N D P RO B A B I L IT Y T C A P M I B R AN D/ R E P U TATI O N PERC EP TION EDUC ATION R EG U L ATI O N A N D F U N DI N G TEC H N O LOGY C H A N G ES ECON O M IC U N C ERTA I NTI ES DATA PR IVAC Y B R E AC H I NTELLEC TUA L PRO PERT Y R I G HT S ACQ U I S ITI ON S AN D M ERG ERS TES TI N G FA I LU R ES E M ERG I N G M A R K E T S P RO B A B I L IT Y O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 32 Pearson plc Annual report and accounts 2012 Principal risks and uncertainties continued Principal risks TEC H N O LOGY C H A N G E S Mitigating factors We are transforming our products and services for the digital environment along with managing our print inventories. Our content is being adapted to new technologies across our businesses and is priced to drive demand. We develop new distribution channels by adapting our product offering and investing in new formats. We continue to monitor contraction in the consumer book market to minimise the impact of customer bankruptcy. We mitigate IT risks by establishing strong IT policies and operational controls, employing project management techniques to manage new software developments and/or systems implementations and have implemented an array of security measures to protect our IT assets from attacks or failures that could impact the confidentiality, availability or integrity of our systems. In the US we actively monitor changes through participation in advisory boards and representation on standard setting committees. Our customer relationship teams have detailed knowledge of each state market. We are investing in new and innovative ways to expand and combine our product and services to provide a superior customer offering when compared to our competitors, thereby reducing our reliance on any particular funding stream in the US market. We work through our own government relations team and our industry trade associations including the Association of American Publishers. We are also monitoring municipal funding and the impact on our education receivables. In the UK we maintain relationships with those government departments and agencies that are responsible for policy and funding. We work proactively with them to ensure our education, training and apprenticeship programmes meet existing and new government objectives at the right quality. Changes in the UK government’s funding policy for apprenticeships affected the business model for the Pearson in Practice adult training business. As a result, in January 2013 we announced that we will exit this particular business. We will continue to provide training and support for young adults who wish to develop skills and enter the UK workforce through our qualifications and curriculum businesses. The Group’s approach to funding is described on page 27 and the Group’s approach to the management of financial risks is set out in note 19 to the financial statements. Our education, business information and book publishing businesses will be impacted by the rate of and state of technological change, including the digital revolution and other disruptive technologies. We operate in markets which are dependent on Information Technology (IT) systems and technological change. E D U C ATI O N R EG U L ATI O N A N D F U N D I N G Our US educational solutions and assessment businesses and our UK training businesses may be adversely affected by changes in government funding resulting from either general economic conditions, changes in government educational funding, programmes, policy decisions, legislation and/or changes in the procurement processes. ECO N O M I C U N C E RTA I N TI E S Global economic conditions may adversely impact our financial performance. A significant deterioration in Group profitability and/ or cash flow caused by prolonged economic instability could reduce our liquidity and/or impair our financial ratios, and trigger a need to raise additional funds from the capital markets and/or renegotiate our banking covenants. We generate a substantial proportion of our revenue in foreign currencies, particularly the US dollar, and foreign exchange rate fluctuation could adversely affect our earnings and the strength of our balance sheet. Section 2 Our performance 33 Principal risks Mitigating factors I N TE L L EC T UA L P RO P E RT Y R I G H T S If we do not adequately protect our intellectual property and proprietary rights our competitive position and results may be adversely affected and limit our ability to grow. E M E RG I N G M A R K E T S Our investment into inherently riskier emerging markets is growing and the returns may be lower than anticipated. DATA P R I VAC Y B R E AC H Failure to comply with data privacy regulations and standards or weakness in internet security could result in a major data privacy breach causing reputational damage to our brands and financial loss. TES TI N G FA I LU R ES A control breakdown or service failure in our school assessment businesses could result in financial loss and reputational damage. Our professional services and school assessment businesses involve complex contractual relationships with both government agencies and commercial customers for the provision of various testing services. Our financial results, growth prospects and/or reputation may be adversely affected if these contracts and relationships are poorly managed. ACQ U I S ITI O N S A N D M E RG E R S Failure to generate anticipated revenue growth, synergies and/or cost savings from acquisitions, mergers and other business combinations could lead to goodwill and intangible asset impairments. B R A N D/ R E P U TATI O N P E RC E P TI O N Our business depends on a strong brand, and any failure to maintain, protect and enhance our brand would hurt our ability to retain or expand our business. We seek to mitigate this type of risk through general vigilance, co-operation with other publishers and trade associations, advances in technology, as well as recourse to law as necessary. Digital rights management standards and monitoring programmes have been developed. We have a piracy task force to identify weaknesses and remediate breaches. We monitor activities and regulations in each market for developments in copyright/intellectual property law and enforcement and take legal action where necessary. We draw on our experience of developing businesses outside our core markets and our existing international infrastructure to manage specific country risks. We continue to strengthen our financial control and managerial resources in these markets to manage expansion. The diversification of our international portfolio, and relative size of ‘emerging markets’ in relation to the Group, further minimises the effect any one territory could have on the overall Group results. Through our global security team we have established various data privacy and security programmes. We constantly test and re-evaluate our data security procedures and controls across all our businesses with the aim of ensuring personal data is secured and we comply with relevant legislation and contractual requirements. We pursue appropriate privacy accreditations, e.g., TRUSTe Privacy and Safe Harbor Seal. We regularly monitor regulation changes to assess impact on existing processes and programmes. We seek to minimise the risk of a breakdown in our student marking with the use of robust quality assurance procedures and controls and oversight of contract performance, combined with our investment in technology, project management and skills development of our people. In addition to the internal business procedures and controls implemented to ensure we successfully deliver on our contractual commitments, we also seek to develop and maintain good relationships with our customers to minimise associated risks. We also look to diversify our portfolio to minimise reliance on any single contract. We perform pre-transaction due diligence and closely monitor actual performance to ensure we are meeting operational and financial targets. Any divergence from these plans will result in management action to improve performance and minimise the risk of any impairments. Executive management and the board receive regular reports on the status of acquisition and mergers. In October 2012, we announced an agreement with Bertelsmann to combine our respective consumer publishing businesses in a newly- created venture named Penguin Random House. The combination is subject to customary regulatory and other approvals and is expected to complete in the second half of 2013. We mitigate this risk through the development of comprehensive processes to enable our business units to effectively manage relationships with stakeholders, customers, communities and employees. We have an ongoing process to understand and evaluate potential brand threats and monitor and evaluate information about our brand across media sources. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 34 Pearson plc Annual report and accounts 2012 Our impact on society We believe our commercial goals and our social purpose are mutually reinforcing. Across many industries, a strong sense of fundamental purpose is a characteristic shared by many leading businesses. Pearson’s purpose is to help people make progress in their lives through learning. This purpose informs and shapes our company strategy and is the starting point of our responsibility framework: P E A R S O N ’ S P U R P O S E Our purpose is to help people make progress in their lives through learning. O U R F OC U S In 2010, we defined three key issues as the focus of Pearson’s corporate responsibility strategy: literacy, learning outcomes and contributing to competitiveness. These three key issues are where Pearson can make a unique contribution to people’s social and economic wellbeing on a global scale. R ES P O N S I B L E B U S I N E S S P R AC TI C E Beyond these three issues, we have a wider agenda of responsible business practice. This covers areas such as nurturing and developing talent and diversity, environmental responsibility and supporting the work of the Pearson Foundation. O U R VA LU E S Our approach to ethics and how we behave is grounded by our culture and values – to be brave, imaginative and decent. We continue to be recognised in external benchmarks as a leader in corporate responsibility – a testament to the commitment and efforts of our people. We were (for a fourth year) ranked gold in the Dow Jones Sustainability Index. 2013 will be a year of considerable change as we merge Penguin with Random House and develop our global education strategy. Our commitment to helping people make progress in their lives through learning is enduring. However, against that wider backdrop of change, we will ask some key questions about our responsibility framework this year: › What are the big unmet educational needs which we can help tackle? › How should we measure and report the educational impact of our products and services? › Are the three key issues still the right ones for us to focus on? › What commitments and targets should we set ourselves? If you have thoughts on these four questions or would like to play a part in helping us find the answers, please let us know and contact our head of corporate responsibility at peter.hughes@pearson.com Robin Freestone Chief financial officer (and board member responsible for corporate responsibility) Section 3 Our impact on society 35 Overview We have developed our own responsible business framework to reflect what we do, where we can have the most impact and the expectations that our investors, customers and the people who work at Pearson have of us. It is unique to Pearson. It is also dynamic – we will update the framework to reflect how we change as a company and the views and priorities of our stakeholders. O U R P U R P O S E To help people make progress in their lives through learning O U R F OC U S Three priority issues where we can make the most difference A LWAYS L E A R N I N G 1 R A I S I N G L I T E R AC Y L E V E L S 2 I M P ROV I N G L E A R N I N G O U TCO M ES 3 CO N TR I B U TI N G TO CO M P E TITI V E N ES S AT H O M E O U R PROG R A M M ES PER SON A L PROG R ES S I N TH E C L A S S ROO M C LOS I N G AC H I E V EM ENT GA P S I N F OR M ED B U S I N ES S W ITH O U R PARTN ER S S H A R I N G W H AT WOR K S B U S I N ES S S TR ATEGY R ES P O N S I B L E B U S I N ES S P R AC TI C E LO NG -TERM ORGAN IC I N V ESTM ENT I N CONTENT DIG ITA L PRODUCTS AN D S ERV IC ES B U S I N ES S ES I NTER N ATI O N A L E X PAN S I ON EF F IC I EN C Y To learn more about our business strategy, visit the Our strategy section, page 06 in this report EN V I RO N M ENT S U PPLY C H A I N M A N AG EM ENT PEO PLE O U R C U S TO M E R S CO M M U N ITI ES O U R VA LU ES B R AV E , I M AG I N ATI V E , D EC ENT O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 36 Pearson plc Annual report and accounts 2012 Our impact on society continued 1 R A I S I N G LITER AC Y L E V E L S The economic and social cost of illiteracy is immense – affecting as many as two billion people – it may be as high as one trillion US dollars per year. Illiteracy is a global challenge affecting both developed and emerging countries. For example, in the UK, 22% of the population are deemed as functionally illiterate, struggling with basic tasks, such as applying for a job by e-mail or reading their child’s school report. The cost to the UK alone is estimated at £8 billion a year. Our approach Raising literacy levels is one of our three focus areas because: › Good reading skills are the basic cornerstone essential for people to learn. › All our businesses depend on the premise that people can read and enjoy doing so. › Our mix of businesses means that we can make a unique contribution to tackling illiteracy. We play a part in three main ways: › Our reading programmes – both print and digital – are found in classrooms the world over. › For many, the first story that they read or that is read aloud to them will be a Penguin title. › We partner with others to run projects and campaigns to give books and to inspire reading. Reading in the classroom We have a full range of reading programmes designed to help students learn to read. Whether print or online, whole school or for students that need a little extra help, they all share a commitment to improving the reading standards of individual learners. C A S E S T U DY iLit (inspire Literacy) iLit is the first reading programme built and delivered completely on the iPad. Launched in the United States, it targets readers aged 9 to 16 and supports, rewards and instructs based around the needs of the individual reader. iLit is currently available for readers aged 14 to 16. For more information about iLit and the research evidence that underpins it, visit: www.redefiningliteracy.com Reading in the home Enthusiastic readers are inspired by great stories. Our Penguin books for children – Puffin, Frederick Warne and Ladybird books – all provide plenty of options. In this digital age, how we read and write may change radically, but the ability to do so is more important than ever. We believe in offering stories that are engaging and fun, regardless of format, for parents and their children to read at home or on the move. C A S E S T U DY Ladybird: I’m ready for phonics app Giving a child a reading head-start before they start school helps build confident readers. New apps such as Ladybird’s ‘I’m Ready for Phonics!’ gives parents new ways to help prepare a child for synthetic phonics learning at school. Partnering with others to encourage reading Tackling illiteracy demands that we work together in an open and collaborative way. We have focused on building partnerships that extend access to books and opportunities for shared reading. Highlights include: › We gave our eight millionth book under our Booktime programme which sees every child starting school in England and Wales receive a book pack containing two free books to take home and keep. › We Give Books, the digital reading challenge run by the Pearson Foundation, exceeded 1.5 million books donated to literacy charities around the world as chosen by online readers. › We gave our one millionth book to Book Aid, the charity that supports the development of libraries in schools and communities in Sub-Saharan Africa. We were the largest book donor to Book Aid in 2012. Section 3 Our impact on society 37 2 I M PROV I N G LE A R N I N G O U TCO M ES Our responsibility as a company is to play our full part in informing, shaping and making learning effective for people of all ages, abilities and locations. This focus on learning outcomes is a critical part of our responsibility vision. In the past, there were limitations on the extent to which a textbook publisher selling products to education institutions could measure their impact on learning outcomes. Our strategy is to become an education technology and solutions provider with global reach. As the strategy gathers pace, so do the opportunities to help understand what works best to help students succeed. We recognise that as we become more directly involved in the process of learning, we are more accountable for outcomes. We have: › Conducted nearly 50 reviews to assess and improve learning outcomes and trained over 100 people in the process. › Run a series of events reaching over 1,200 people and presented on our approach at the company senior strategy conference and to the next generation of our leaders. We will: › Conduct at least 100 additional reviews to assess the learning outcomes from our programmes and services. › Make it a precondition of any new investment of US$3m or more that it is assessed for its impact on learning. › Make a series of commitments around how we will deepen and accelerate our approach to assessing learning outcomes. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 38 Pearson plc Annual report and accounts 2012 Our impact on society continued C A S E S T U DY Pearson Affordable Learning Fund A global challenge is how we can all ensure that every child can benefit from learning, but with over 60 million children not in school, there is a need for urgent innovation. We believe that low-cost private education is part of the answer and that there is a need to encourage new ideas, models and ways of working. So, we have launched the Pearson Affordable Learning Fund whose purpose is to make minority equity investments in for-profit companies that help meet a burgeoning demand for affordable education services in Africa, Asia and Latin America. The fund launched in July 2012 with $15 million of initial Pearson capital, and made its first investment in a chain of private schools in Ghana. See more at: www.affordable-learning.com 3 CO NTR I B U TI N G TO CO M PE TITIV EN ES S The connection between education and long-term economic growth is well-documented and increasingly well understood. Helping individuals get ready for work Getting a job depends on having relevant skills. As many countries continue to wrestle with the economic, social and personal cost of unemployment, particularly for the young, it is even more important that we help people develop the skills they need for work. Securing a professional or vocational qualification is an important factor in getting a job. We create and administer millions of admissions, tests, certifications, vocational assessments and general qualifications including: › BTEC, the vocational qualification recognised by schools, colleges, universities, employers and professional bodies across the United Kingdom and in over 100 countries worldwide. › The Graduate Management Admission Test (GMAT), the leading test for entrance to business schools and management programmes worldwide. › NCLEX Nursing examination, required to obtain a licence necessary to apply for work as a nurse in the United States. C A S E S T U DY Next Generation BTECs Pearson launched Next Generation BTECs, which meet new regulator and Department for Education criteria to make BTEC the best represented vocational qualification on the new accountability framework for schools in England. Sharing knowledge and investing in research Few companies participate in education on a global scale so we have a responsibility to support educational improvement and to actively share our experience on models that work and those that do not. We have: › Mapped current research activity and laid the foundation to launch our online research portal. › Convened a Pearson Executive Research Council bringing together the research professionals within Pearson. › Launched two publications with international acclaim – The Learning Curve and Oceans of Innovation: www.pearson.com/oceans We will: › Invest in research to help advance education as well as inform the products and services we develop. › Partner with a range of organisations to conduct educational research and promote the dissemination of knowledge. › Promote open discussion through participating in and convening conferences and events. › Make research outcomes publicly available via: www.pearson.com/research Section 3 Our impact on society 39 We also believe that the wider private sector has an important contribution to make in developing education and learning policy. We supported and helped fund in 2012 the Global Business Coalition for Education. The aim is to help focus the wider business community on helping tackle the challenges faced by developing countries to promote learning: http://gbc-education.org/about-us Doing informed business The FT Group is the leading provider of essential information, insight and analysis to the global business and opinion-forming community. Access to trusted and informed information is the basis on which businesses make effective decisions. The FT plays a unique global role in providing that information. R ES P ON S I B LE B U S I N ES S PR AC TIC E Under the current responsible business framework at Pearson, we focus on the three areas where we believe we have a unique opportunity to make a positive impact – literacy, learning outcomes and competitiveness. In addition, we adopt a broad and holistic definition of ‘responsible business’ that captures a series of priorities that are common across many industries and individual companies. These include commitments to: › Deliver against stakeholder expectations on the key area of climate change and to seek to make better use of resources. › Extend our principles on labour standards, human rights and environmental responsibility to include our suppliers and business partners. › Ensure that our products and services are inclusive to those with reading disabilities, appropriate in content to the age and location of the student and are safe to use. › Provide a safe, healthy workplace, where our employees are able to realise their own individual potential and aspirations and where there is respect for their privacy, dignity and life outside work. › Provide opportunities for Pearson people to be good citizens and to get involved in their local communities. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S C A S E S T U DY The Learning Curve This year, we supported the Economist Intelligence Unit (EIU) in the development of The Learning Curve. The initiative brought together in one place a wide range of data sets designed to enable researchers and policymakers to correlate education outcomes with wider social and economic impact more easily than ever before. As international benchmarking of education systems has become ever more prevalent, the Learning Curve has the potential to add to our understanding of what successful education systems look like and how success can be achieved: thelearningcurve.pearson.com Contributing to debate We are committed to playing an active role in helping shape and inform the global debate around education and learning policy. With the 2015 deadline for achieving the Millennium Development Goals and Education for All Goals fast approaching, it is certainly time to take stock on the role that education has played and should play for the future. We have joined with a range of organisations as an active member of the Global Compact on Learning. Ways we are helping include contributing to developing and agreeing common metrics to measure the success of the Global Compact: www.brookings.edu/learningmetrics We are active participants in the Global Partnership for Education, having been one of the first companies to join the initiative and make a pledge at its replenishment conference. GPE brings together over 50 developing countries, donor governments, international organisations, the private sector, teachers, and civil society/NGO groups to support developing countries with their education sector plans through financial assistance and technical expertise: www.globalpartnership.org 40 Pearson plc Annual report and accounts 2012 Our impact on society continued Highlights of our activities in 2012 include: › Pearson and the FT committed to a $1m three-year Environment: Climate change and avoiding deforestation Climate change remains a focus for us as one of the most serious issues facing the planet. Minimising our own environmental impact is not just the right thing to do; it is fundamental to our future as a sustainable business and helps deliver cost savings. We continue to be climate neutral, a commitment which focuses the company on carbon reduction. Pearson is preparing for the introduction of mandatory Greenhouse Gas reporting in 2014. We have just been accredited against the Carbon Trust Standard globally – one of only two companies that currently hold that status. Our second focus area is forests. As a purchaser of paper and newsprint for our books, magazines and newspapers, security and sustainability of supply are very important to us. We have focused on actively encouraging responsible forest management and being more efficient in how we use paper. › Pearson was named the 32nd largest purchaser of renewable energy in the United States in the US Environmental Protection Agency Green Power Partnership list. We offset 100% of the electricity we use in North America through the purchase of wind power credits from across the United States and have invested in a project to install solar panels in schools in California. Our UK buildings – where we are responsible for purchasing utilities – are also powered by green electricity. › Pearson came top in the 2012 Corporate Renewable Energy Index (CREX) produced by Bloomberg New Energy Finance. We were one of 35 global companies to achieve a maximum score of 100%. › Pearson businesses in the UK and Australia are certified against ISO 14001, the environmental management standard. › In the US, Pearson facilities are focusing on securing LEED – Leadership in Energy and Environmental Design certification. LEED recognises excellence in the design, construction, and operation of high performance green buildings. Over 800,000 sq ft across six Pearson buildings are LEED certified. › We now have 2.3MW in on-site renewable energy assets (solar panels and wind) at our facilities. rainforest partnership in Colombia. We also continued to invest in Woodland Carbon offsets offered by the Woodland Trust in the UK and in a Nature Conservancy Council forest offset project in the United States. › The Financial Times has reduced the volume of newsprint and magazine papers it uses by over 50% in five years. A key initiative has been to reduce the base weight of the papers used. C A S E S T U DY Tom Delay, Chief Executive, Carbon Trust “As only the second organisation ever to achieve global certification to the Carbon Trust Standard – by no means an easy task – Pearson is demonstrating real leadership in how to measure, manage and reduce carbon emissions year-on-year.” REDUCING CO2 YEAR ON YEAR Our customers, our people and our communities Responsible business practice cuts across all aspects of our company and our focus is to integrate this into the way we manage our businesses. This benefits our customers, suppliers, the people that work at Pearson and the communities in which we operate. Highlights of our activities in 2012 are: › Pearson continued with its programme of Student Advisory Boards, providing an opportunity for students to input and influence our strategy in return for mentoring and company internships. › Building on Pearson operations in the UK becoming accredited against ISO 18001, the international health and safety standard, a two-year project to review and update our global approach to health & safety management was started in 2012. › Pearson in the US has been included in Working Mother magazine’s 100 Best Companies list for its twelfth year. › The Pearson Diversity Summer Internship Programme won the ‘Widening the Talent Pool’ category in the Race for Opportunity awards. Section 3 Our impact on society 41 › Providing an opportunity for our employees to share in the success of the company through owning a part of it is important to us. Over 37,000 people in 98 countries have the opportunity to acquire and hold Pearson shares through participation in our employee share programmes. 1 in 5 employees participate. › Pearson, alongside charity partner Booktrust, won a 2012 Lord Mayor’s Dragon Award in the education category for the Booktime programme. › The Financial Times seasonal appeal raised $4.89m on behalf of The Global Fund for Children, a charity working to transform the lives of the world’s most vulnerable children. C A S E S T U DY The Pearson Foundation The Pearson Foundation is an independent charity that aims to make a difference by promoting literacy, learning, and great teaching. The Pearson Foundation is the charity partner of choice for Pearson and we are its major funder. Three highlights from the Pearson Foundation year in 2012 were: › The launch of ‘Five Things I’ve Learned’. The project shares the thoughts of education leaders drawn from decades of real-world experience and insights about learning, teaching, and helping others. Available at www.thefivethings.org › Read for the Record broke two world records. Nearly 2.4 million people read Lady Bug Girl and the Bug Squad on the same day with almost 400,000 of them reading the book online at www.wegivebooks.org. Read for the Record is run in partnership with the charity Jumpstart. › BridgeIT, a partnership between the Pearson Foundation and Nokia has reached over 1 million children and their teachers across ten developing and emerging countries. BridgeIT uses mobile phones to deliver professional development materials and educational resources to teachers. Values, principles and behaviour The bedrock of corporate responsibility is the culture of the company. We are defined by our values – in everything we do, we aspire to be brave, imaginative and decent. Our values are underpinned by our Code of Conduct that covers, among other things, individual conduct, the environment, employees, community and society. We make sure everyone is aware of and understands the code. Once a year, everyone working for Pearson gets a copy from the CEO, either electronically or on paper and is asked to read it. Everyone is asked to confirm that they have read it, understood it and that the company complies with it and, as a further check, it is mandatory for over 2,000 of our most senior people to respond to that request. The code forms a part of induction and an online training module is available. If anyone has concerns, these can be raised with a line manager or through a free, confidential telephone line/website. Pearson has a zero tolerance policy towards bribery and corruption. Our policy introduced in 2011 sets out our standards; we carry out risk assessments and have a network of designated managers across the business responsible for compliance with our policy. We are committed to making sure our people understand how we are doing as a company, including how world trends might affect both them and the businesses. This means providing comprehensive relevant information in a variety of ways – including regular presentations from senior executives – and consulting where appropriate so that we can learn and take into account the views of our people. We will always aim to seek the best candidate for a role: career progression will be without regard for race, gender, age, physical ability, religion or sexual orientation; and we will continue to monitor and benchmark our progress on diversity and inclusion. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 42 Pearson plc Annual report and accounts 2012 Our impact on society continued External benchmarks One way we assess how we are doing as a responsible business is to maintain our position in key indices and benchmarks of social responsibility: 2 012 2 011 2 010 2 0 0 9 Dow Jones Sustainability Indexes Gold class Gold class and global sector leader BITC Corporate Responsibility Index Platinum (retained) Platinum Platinum (retained) Inclusion in FTSE4Good Yes Seven commitments Last year, we set out seven challenging aspirations and targets to help focus the business on achieving our responsible business vision while minimising our environmental impact. We believe this is a responsible and sustainable approach. We report on our progress against these and other commitments as part of our online Impact on Society report at http://cr2012.pearson.com E N V I RO N M E N T Challenges Our commitment How we measure progress Climate change Resource use 1 To maintain our commitment to climate neutrality in 2013. Last year marked our third year of climate neutrality Through carbon reduction; purchase of renewable energy; renewable energy generation at our sites and the purchase of carbon offsets Electricity from renewable sources Mwh 12 11 10 09 08 Climate change data is published in April *100% from renewable sources up from 84% in 2011 2 To be ever more efficient in how we use paper as the most significant natural resource for us We track the total metric tonnes of paper we use and how that compares to revenue The paper used per £1m of non-digital revenue increased in 2012 reflecting a shift to digital services Total paper used Metric tonnes 12 11 10 09 08 218,500 Mwh* 218,500 Mwh* 166,900 Mwh 166,900 Mwh 170,700 Mwh 170,700 Mwh 170,229 Mwh 170,229 Mwh 3,255 Mwh 3,255 Mwh 287,500 MT 287,500 MT 319,500 MT 319,500 MT 338,000 MT 338,000 MT 339,000 MT 339,000 MT 360,000 MT 360,000 MT Section 3 Our impact on society 43 E N V I RO N M E N T Challenges Our commitment How we measure progress Avoiding global deforestation 3 To use FSC papers where we can and our own grading system S O C I A L Investing in content 4 To make sustained investment in new content Access to learning, literacy and great teaching 5 To maintain our total community investment at 1% or more of operating profit 6 Using 2010 as our base, to expand our book gifting activities Literacy We track and report the FSC volume we purchase and the grading system we use to meet our requirement to purchase from known, responsible sources Pre-publication expenditure and authors’ advances One way we extend our reach is through partnerships with literacy and learning charities. We report on our community investment spend Number of books donated to schools, libraries and literacy charities Paper by source % 12 11 11% 7% FSC Graded Ungraded/unwanted 79% 83% 10% 10% Investing in content $m 12 11 10 09 08 $835m $835m $794m $794m $816m $816m $794m $794m $775m $775m Community investment spend £m 12 11 10 09 08 1.2% 1.2% 1.6% 1.4% £11.4m £11.4m £11.5m £11.5m £13.1m £13.1m £10.5m £10.5m £7.7m £7.7m 1.1% Number of books donated Millions 12 11 10 09 08 7 Growing take-up of digital-based reading Unlike traditional print programmes, we can track the number of users of our digital reading programmes Reading programmes Users million 12 11 2.10m 2.10m 1.99m 1.99m 1.66m 1.66m 1.71m 1.71m 1.74m 1.74m 4.45m 4.45m 3.75m 3.75m O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 44 Pearson plc Annual report and accounts 2012 Board of directors Pearson’s board brings a wide range of experience, skills and backgrounds. C H A I R M A N E X EC U TI V E D I R EC TO R S Glen Moreno Chairman aged 69, appointed 1 October 2005 John Fallon Chief executive aged 50, appointed 3 October 2012 Chairman of the nomination committee and member of the remuneration committee Glen has more than three decades of experience in business and finance, and is currently deputy chairman of The Financial Reporting Council Limited in the UK and non-executive director of Fidelity International Limited. Previously, Glen was deputy chairman and senior independent director at Lloyds Banking Group plc, senior independent director of Man Group plc and acting chairman of UK Financial Investments Limited, the company set up by HM Treasury to manage the government’s shareholdings in British banks. Member of the nomination committee John became Pearson’s chief executive on 1 January 2013. Since 2008 he had been responsible for the company’s education businesses outside North America, and a member of the Pearson management committee. He joined Pearson in 1997 as director of communications and was appointed president of Pearson Inc., a role he combined with his communications responsibilities, in 2000. In 2003, he was appointed CEO of Pearson’s educational publishing businesses for Europe, Middle East & Africa (EMA) and gradually took on a broader international education brief. Prior to joining Pearson, John was director of corporate affairs at Powergen plc, where he was also a member of the company’s executive committee. Earlier in his career, John held senior public policy and communications roles in UK local government. Will Ethridge Chief executive, Pearson North American Education aged 61, appointed 1 May 2008 Will has three decades of experience in education and educational publishing, including a decade and a half at Pearson where he formerly headed our Higher Education, International and Professional Publishing business. Prior to joining Pearson in 1998, Will was a senior executive at Prentice Hall and Addison- Wesley, and before that an editor at Little, Brown and Co. where he published in the fields of economics and politics. Will is a board member and former chairman of the Association of American Publishers (AAP) and board chairman of CourseSmart, a consortium of electronic textbook publishers. Section 4 Governance 45 Rona Fairhead Chairman of the Financial Times Group aged 51, appointed 1 June 2002 Rona, who has headed the Financial Times Group since 2006 and is a former finance director of Pearson, will step down from the Pearson board and leave the company at the annual general meeting in April 2013. She previously held senior management roles at specialty chemicals company ICI plc, and in aerospace with Bombardier/Shorts. She has an MBA from Harvard Business School. Rona currently serves as non- executive director of The Cabinet Office of UK government and of HSBC Holdings plc, where she chairs the risk committee. She is also a member of the Cambridge University Library Visiting Committee. She was made a Commander of the British Empire in 2012. Robin Freestone Chief financial officer aged 54, appointed 12 June 2006 Robin’s experience in management and accounting includes a previous role as group financial controller of Amersham plc (now part of General Electric) and senior financial positions with ICI plc, Zeneca and Henkel UK. He joined Pearson in 2004 as deputy chief financial officer and became chief financial officer in June 2006. Robin qualified as a chartered accountant with Touche Ross (now Deloitte), and is currently a non-executive director and founder shareholder of eChem Limited. Robin sits on the Advisory Group of the ICAEW’s Financial Reporting Faculty and is chairman of The Hundred Group of Finance Directors. John Makinson Chairman and chief executive of The Penguin Group aged 58, appointed 15 March 1996 John’s diverse background spans business, consultancy, financial journalism and publishing. He was finance director of Pearson before heading Penguin, and previously served as managing director of the Financial Times newspaper, where he had earlier served as editor of the popular Lex column. John co-founded Makinson Cowell, an international financial consultancy, and was vice chairman of the US holding company of advertising firm Saatchi & Saatchi. John is chairman of the National Theatre and has been named chairman-designate of Penguin Random House, the consumer publishing venture planned by Pearson and Bertelsmann. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 46 Pearson plc Annual report and accounts 2012 Pearson plc Annual report and accounts 2012 Board of directors continued N O N - E X EC U TI V E D I R EC TO R S David Arculus Non-executive director aged 66, appointed 28 February 2006 Vivienne Cox Senior independent director aged 53, appointed 1 January 2012 Susan Fuhrman Non-executive director aged 68, appointed 27 July 2004 Chairman of the remuneration committee and member of the audit and nomination committees David has experience in banking, telecommunications and publishing in a long career in business. Currently he is chairman of Aldermore Bank plc, Numis Corporation plc and the Advisory Board of the British Library. David’s previous roles include the chairmanship of O2 plc, Severn Trent plc and IPC Group, as well as chief operating officer of United Business Media plc, group managing director of EMAP plc and a non- executive director of Telefonica S.A. David served from 2002 to 2006 as chairman of the British government’s Better Regulation Task Force, which worked on reducing burdens on business. Member of the audit, remuneration and nomination committees Member of the audit and nomination committees Susan’s extensive experience in education includes her current role as president of Teachers College at Columbia University, America’s oldest and largest graduate school of education. She is president of the National Academy of Education, and was previously dean of the Graduate School of Education at the University of Pennsylvania and on the board of trustees of the Carnegie Foundation for the Advancement of Teaching. Vivienne has wide experience in energy, natural resources and business innovation. She worked for BP plc for 28 years, in Britain and continental Europe, in posts including executive vice president and chief executive of BP’s Gas, Power & Renewables business and its Alternative Energy unit. She is non- executive director of mining company Rio Tinto plc, energy company BG Group plc, and Vallourec, which supplies tubular systems for the energy industry. She is also lead independent director at the UK Department for International Development. Vivienne sits on the board of INSEAD and is a commissioner of the Airports Commission, which was set up by the UK government to examine any requirements for additional UK airport capacity. Ken Hydon Non-executive director aged 68, appointed 28 February 2006 Josh Lewis Non-executive director aged 50, appointed 1 March 2011 Chairman of the audit committee and member of the remuneration and nomination committees Ken’s experience in finance and business includes roles in electronics, consumer products and healthcare. He is a non- executive director of Reckitt Benckiser Group plc, one of the world’s leading manufacturers and marketers of branded products in household cleaning and health and personal care. From 2004 to 2013 he was a non-executive director of Tesco plc. Previously, Ken was chief financial officer of Vodafone Group plc and financial director of subsidiaries of Racal Electronics. Member of the audit and nomination committees Josh’s experience spans finance, education and the development of digital enterprises. He is founder of Salmon River Capital LLC, a New York-based private equity/venture capital firm focused on technology-enabled businesses in education, financial services and other sectors. Over a 25 year career in active, principal investing, he has been involved in a broad range of successful companies, including several pioneering enterprises in the education sector. In addition, he has long been active in the non-profit education sector, with associations including New Leaders, New Classrooms, and the Bill & Melinda Gates Foundation. He is also a non-executive director of eVestment and Axioma, both financial technology companies, Parchment, an education data company, and PeriGen, a healthcare information technology provider. Chairman’s letter Dear shareholders This year, we are reporting, as is required, against the 2010 edition of the UK Corporate Governance Code (the Code). We have endeavoured, where possible, to report in the spirit of the 2012 Code which will only apply for reporting periods beginning on or after 1 October 2012. As I have highlighted elsewhere within this report, Pearson is currently undergoing a period of transition in its leadership following the appointment of John Fallon as our new chief executive, and I would like to take this opportunity to share with you further details of the recent and forthcoming changes to our board as well as providing an insight into how the board operates. The Pearson board consists of senior executive management alongside a strong group of non-executive directors drawn from successful international businesses and education institutions with experience of corporate strategy, education, consumer marketing and technology. We are continually assessing and refreshing the board to ensure we maintain an appropriate balance and diversity of skills and experience. In addition to Marjorie Scardino’s departure as chief executive, at the end of 2012 we also said goodbye to Patrick Cescau, who served on the board for over ten years, including three years as our senior independent director. The board joins me in thanking Patrick for his commitment and invaluable contribution to Pearson as we have navigated our international expansion. Following Patrick’s departure, we are pleased to confirm that Vivienne Cox has been appointed as senior independent director. We welcome Vivienne to the role and believe that her broad commercial knowledge and experience both as an executive and non-executive director make her highly suitable for this position. As announced late last year, Rona Fairhead will be stepping down from the board, and from her role as chairman of The Financial Times Group, to pursue other opportunities. Rona handed over her responsibilities as chief executive of the FT to John Ridding at the end of 2012. Rona has played an important role during her 12-year career at Pearson having held a number of senior roles within the group, and we wish her continued success in the next phase of her career. Section 4 Governance 47 Pearson has a wealth of talent within its workforce with a diverse and experienced senior management team heading the company’s operations. To complement our strong management structure, we believe that the most effective board is one which maximises the contributions of non-executive directors, adding a wide range of valuable external perspectives and encouraging robust, open debate over significant business issues. Our goal is to improve the balance of independent non-executive directors on the board, while retaining an overall board size which is manageable and effective. To this end, we are actively seeking additional non-executive directors who bring expertise in education, emerging markets and digital technologies to continue to drive our strategy and vision, whilst ensuring the board adheres to Pearson’s core values. We are keen to maintain the gender diversity of the board in light of recent and forthcoming departures and, consequently, the nomination committee is actively seeking to identify suitable female candidates. The board is deeply engaged in developing and measuring the company’s long-term strategy, performance and value. We organise our work around four major themes where we believe the board can add value: governance, strategy, business performance and people. Our board calendar and agenda provide ample time to focus on these themes and we have set out some examples of the business considered by the board, as well as the governance practices to which we adhere, on the pages that follow. We hope this report clearly sets out how your company is run, and how we align governance and our board agenda with the strategic direction of Pearson. We always welcome questions or comments from shareholders, either via our website (www.pearson.com) or in person at our annual shareholders’ meeting. Glen Moreno Chairman O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 48 Pearson plc Annual report and accounts 2012 Board governance Corporate governance Introduction The board believes that during 2012 the company was in full compliance with the UK Corporate Governance Code (the Code). A detailed account of the provisions of the Code can be found on the FRC’s website at www.frc.org.uk and we encourage readers to view our compliance schedule on the company website at www.pearson.com/investors/shareholder- information/governance The board embraces the Code’s underlying principles with regard to board balance and diversity and the nomination committee, led by the chairman, is actively seeking additional suitable candidates who possess the right mix of knowledge, skills and experience to enhance debate and decision-making. Composition of the board The board currently consists of the chairman, Glen Moreno, five executive directors including the chief executive, John Fallon, and five independent non-executive directors. As reported, Rona Fairhead will step down from the board at the forthcoming AGM. Additionally, subject to completion of the Penguin Random House venture, John Makinson will be appointed as chairman of Penguin Random House and it is intended that he will step down from the Pearson board at that time. Chairman and chief executive There is a defined split of responsibilities between the chairman and the chief executive. The chairman is primarily responsible for the leadership of the board and ensuring its effectiveness; the chief executive is responsible for the operational management of the business and for the development and implementation of the company’s strategy as agreed by the board. The roles and responsibilities of the chairman and chief executive are clearly defined, set out in writing and reviewed and agreed by the board annually. Chairman In May 2012, Glen Moreno stood down from his role as deputy chairman and senior independent director of Lloyds Banking Group. Apart from this, there were no changes to the chairman’s significant commitments during the course of 2012. Senior independent director Vivienne Cox is the company’s senior independent director, having been appointed to the role on 1 January 2013 following Patrick Cescau’s resignation from the board. Vivienne’s role will include meeting regularly with the chairman and chief executive to discuss specific issues, e.g. strategy, attending meetings with major shareholders to understand any issues or concerns they may have, as well as being available to shareholders generally if they should have concerns that have not been addressed through the normal channels. In her first year with Pearson, Vivienne has been instrumental in the introduction of the board’s reputation and responsibility committee, which she chairs, and in improving the quality of health and safety reporting to the board. During 2012, Patrick Cescau held separate sessions with the other non-executive directors and the chief executive to appraise the performance of the chairman, including in relation to the effectiveness of the nomination committee. Following his departure in December, Patrick was invited back in February 2013 to conduct similar sessions in respect of the chairman’s performance during 2012 as part of the annual board evaluation process. Vivienne, as senior independent director, will then take responsibility for appraising the chairman’s performance during 2013 and beyond. The senior independent director would be expected to chair the nomination committee in the event that it was considering succession to the role of chairman of the board. Independence of directors All of the non-executive directors were considered by the board to be independent for the purposes of the Code during the year ended 31 December 2012. The board reviews the independence of each of the non-executive directors annually. This includes reviewing their external appointments and any potential conflicts of interest as well as assessing their individual circumstances in order to ensure that there are no relationships or circumstances likely to affect their character or judgement. Susan Fuhrman has now served on the board for more than eight years. Throughout that time, Susan, as a leader in educational reform and efficacy, has made a very positive contribution to our board and committee work. Susan has indicated that she intends to stand down from the board at the 2014 AGM. Section 4 Governance 49 Length of tenure of non-executive directors Years GOVERNANCE AND SHAREHOLDER MATTERS: 26 AND 27 APRIL 2012, LONDON Arculus Cox 1 Fuhrman Hydon Lewis 2 7 7 8 Conflicts of interest Since October 2008, directors have had a statutory duty under the Companies Act 2006 (the Act) to avoid conflicts of interest with the company. The company’s Articles of Association (Articles) allow the directors to authorise conflicts of interest. The company has established a procedure to identify actual and potential conflicts of interest, including all directorships or other appointments to, or relationships with, companies which are not part of the Pearson Group and which could give rise to actual or potential conflicts of interest. Once notified to the chairman or company secretary, such conflicts are considered for authorisation by the board at its next scheduled meeting. The relevant director cannot vote on an authorisation resolution, or be counted in the quorum, in relation to the resolution relating to his/her conflict or potential conflict. The board reviews any authorisations granted on an annual basis. Board meetings The board held six scheduled meetings in 2012, with some meetings taking place over two or more days. In recent years, we have developed our board meeting agenda to ensure that board discussion and debate is centred on the key strategic issues facing the company. Over the course of 2012 the major items covered by the board included: BUSINESS PERFORMANCE: 23 FEBRUARY 2012, LONDON ›(cid:3)2011 report and accounts and dividend recommendation ›(cid:3)2012 operating plan ›(cid:3)Risk assessment and review of mitigating actions ›(cid:3)Annual review of authorised conflicts ›(cid:3)Review of division of responsibilities between chairman and chief executive ›(cid:3)Review of treasury policy ›(cid:3)Presentation by Sir Michael Barber on efficacy, research and educational reform ›(cid:3)Focus on forthcoming AGM and review of shareholder issues ›(cid:3)Findings of external report on shareholders’ views ›(cid:3)Review of corporate social responsibility ›(cid:3)Board effectiveness review ›(cid:3)Acquisition of Certiport ›(cid:3)Acquisition of Global English STRATEGY: 4, 5 AND 6 JUNE 2012, SÃO PAULO ›(cid:3)Strategy discussions – review of Brazilian education business ›(cid:3)Review of Pearson’s ‘Leading on Standards’ publication on the future of examinations in Britain ›(cid:3)Acquisition of Author Solutions, Inc. BUSINESS PERFORMANCE: 25 AND 26 JULY 2012, LONDON ›(cid:3)Interim results and dividend approval ›(cid:3)Post-acquisition reviews ›(cid:3)Discussion on formation of reputation and responsibility committee ›(cid:3)Acquisition of Inframation Group STRATEGY: 4 OCTOBER 2012, LONDON ›(cid:3)Trading update ›(cid:3)Five-year strategic plan ›(cid:3)Review of standing committee terms of reference ›(cid:3)Acquisition of EmbanetCompass ›(cid:3)Discussion of Penguin Random House venture ›(cid:3)John Fallon’s first meeting following his appointment to the board STRATEGIC PLAN: 6 DECEMBER 2012, NEW YORK ›(cid:3)Strategic plan – India business ›(cid:3)Options for Pearson in Practice business ›(cid:3)Risk assessment and review of mitigating actions ›(cid:3)Triennial valuation of UK defined benefit pension fund ›(cid:3)Annual review of chief executive authorisation limits and procedures ›(cid:3)Review of chief executive transition In addition to the six scheduled meetings, the board held one further full meeting to approve the Penguin Random House venture and undertook discussions as required to consider the terms of corporate transactions. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 50 Pearson plc Annual report and accounts 2012 Board governance continued The following table sets out the attendance of the company’s directors at board and committee meetings during 2012: found on the company website at www.pearson.com/investors/shareholder- information/governance Board meetings (max 6) Audit committee meetings (max 4) Rem. committee meetings (max 6) Nom. committee meetings (max 6) Chairman Glen Moreno Executive directors Marjorie Scardino Will Ethridge John Fallon* Rona Fairhead Robin Freestone John Makinson Non-executive directors David Arculus Patrick Cescau** Vivienne Cox Susan Fuhrman Ken Hydon Josh Lewis 6 6 6 2 5 6 6 6 6 5 6 6 6 – – – – – – – 4 2 4 4 4 4 6 – – – – – – 6 3 5 – 6 – 6 6 – – – – – 6 6 5 6 6 6 *appointed to the board on 3 October 2012. **stood down from audit and remuneration committees on 30 April 2012. The role and business of the board The board is deeply engaged in developing and measuring the company’s long-term strategy, performance and value. We believe that it adds a valuable and diverse set of external perspectives and that robust, open debate about significant business issues brings a valuable additional discipline to major decisions. A schedule of formal matters reserved for the board’s decision and approval is available on our website, at www.pearson.com/investors/shareholder- information/governance A standing committee of the board has been established to approve certain ordinary course of business items such as banking matters, guarantees, intra-group transactions and employee share plan matters. The committee has written terms of reference, reviewed and approved annually, which clearly set out its authority and duties. These can be The board receives timely, regular and necessary financial, management and other information to fulfil its duties. Comprehensive board papers are circulated to the board and committee members at least one week in advance of each meeting and the board receives monthly reports from the chief executive. In addition to meeting papers, a library of current and historic corporate information is made available to directors electronically to support the board’s decision-making process. Directors can obtain independent professional advice, at the company’s expense, in the performance of their duties as directors. All directors have access to the advice and services of the company secretary. Non-executive directors meet with local senior management every time board and committee meetings are held at the locations of operating companies. This allows the non-executive directors to share their experience and expertise with senior managers and also enables the non-executive directors to better understand the abilities of senior management, which in turn will help them assess the company’s prospects and plans for succession. Succession planning The board views succession planning – not only at board and executive committee level but for all key positions throughout the business – as one of its prime responsibilities. This is especially the case in a creative business like Pearson which is heavily dependent on talented people. It is our intention to devote one full meeting each year to organisation structure and succession planning, and how they support the delivery of our strategic goals. During 2012, the board’s succession planning activities focused on the role of chief executive. In a typical year however, we look in detail at 20 to 30 of the most senior roles in Pearson, ensuring that there are several credible candidates for each role. Those candidates will be well known to the board – who spend considerable time visiting our businesses and people outside the regular schedule of board meetings – and will have development plans in place to round out their experience and skills and give them every possible chance of progressing their careers. Section 4 Governance 51 Board evaluation The board conducts an annual review of its effectiveness. For the review of 2011, conducted during the early part of 2012, the chairman met with each of the directors, executive and non-executive, on a one-to-one basis to discuss the board’s effectiveness and progress made against objectives. He also took the opportunity to discuss with each director their individual training and development needs. Following that review, the chairman presented his findings at the April 2012 board meeting. He noted that from his one-to-one sessions with each of the directors he was able to conclude that the board members believe that they work well together, that the board culture is good, that they add value as a board, focus on the right things and that they have a good mix of both people and skills. He also detailed how the board might improve its effectiveness, and explained that a common theme in his discussions related to the board’s understanding of reputational and other risks. Following that review the senior management team was tasked with thinking about how the board might gain a deeper understanding of the reputational risks that affect the business, and later in the year, as a direct result of their recommendation, the board formed the reputation and responsibility committee. The purpose of this committee is to have oversight of Pearson’s strategy and our plans to build and protect our corporate reputation, and the reputation of our major brands. The committee membership includes two non-executive directors, the chief executive and the director of communications; it reports regularly to the board and meets on a quarterly basis. The committee held its first meeting in December 2012, and the agenda for that meeting included a consideration of Pearson’s major reputational risks, and a focus on the public affairs team in North America. During the course of the year the executive directors were also evaluated by the chief executive on their performance against personal objectives under the company’s appraisal mechanism. A proportion (which for 2012 may be up to 20%) of the total annual incentive opportunity is based on functional, operational, strategic and non-financial objectives relevant to the executives’ specific area of responsibility. The chairman leads the assessment of the chief executive and the non-executive directors, led by the senior independent director, conduct a review of the chairman’s performance. In addition to the review of the board and individual directors, the audit and remuneration committees each undergo an annual evaluation process to review their performance and effectiveness. The process covers areas such as roles and responsibilities, quality and timeliness of meeting materials, opportunity for discussion and debate, dialogue with management and access to independent advice. For the board effectiveness review of 2012, the chairman is planning to spend time with the senior independent director talking about their plans for the board in terms of structure and focus for the coming year as well as reviewing the previous board evaluation to ensure that recommendations have been followed through. They will also start to plan a more structured, external evaluation of 2013. Last year, we reported that the board’s evaluation process had highlighted a need to deepen the board’s knowledge of emerging markets. Building on this, the board visited Brazil in 2012 to learn first hand about the Group’s Latin American operations and strategy. CASE STUDY Brazil In June 2012, the Pearson board held a three day meeting in São Paulo, Brazil. The purpose of this board meeting was to review our businesses in Brazil, and to better understand the opportunities in the Latin American education market. During their three day stay, the board met with key local management of all our businesses operating in Brazil, including the recently acquired Companhia das Letras business (Pearson acquired 45% in January 2012), as well as with senior executives and the regional heads of Pearson’s Latin America operation. The board also met with former President Lula to discuss Brazilian education policy. Whilst in Brazil, the board visited a school to learn first-hand about the benefits of the Brazilian sistema method of education, and a university where an interactive panel session was held involving university professors, business students and certain board members. During 2013 the board plans to have similar meetings with local businesses in South Africa and the US. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 52 Pearson plc Annual report and accounts 2012 Board governance continued Directors’ training and induction Directors receive a significant bespoke induction programme and a range of information about Pearson when they join the board. This includes background information on Pearson and details of board procedures, directors’ responsibilities and various governance-related issues, including procedures for dealing in Pearson shares and their legal obligations as directors. The induction also includes a series of meetings with members of the board, presentations regarding the business from senior executives and a briefing on Pearson’s investor relations programme. The directors’ training is supplemented with presentations about the company’s operations, by holding board meetings at the locations of operating companies and by encouraging the directors to visit operating companies and local management as and when their schedule allows. The company secretary monitors developments in governance and directors’ fiduciary duties and updates the board on such matters as agreed with the chairman. Directors can also make use of external courses. Directors’ indemnities In accordance with section 232 of the Act, the company grants an indemnity to all of its directors. The indemnity relates to costs incurred by them in defending any civil or criminal proceedings and in connection with an application for relief under sections 661(3) and (4) or sections 1157(1)-(3) of the Act, so long as monies are repaid not later than when the outcome becomes final if: (i) they are convicted in the proceedings; (ii) judgment is given against them; or (iii) the court refuses to grant the relief sought. The company has purchased and maintains directors’ and officers’ insurance cover against certain legal liabilities and costs for claims in connection with any act or omission by such directors and officers in the execution of their duties. Shareholder engagement Pearson has an extensive programme of communication with all of its shareholders – large and small, institutional and private. In 2012, we continued with our shareholder outreach programme, seeing approximately 650 institutional and private investors at more than 350 different institutions in Australia, Canada, China, Continental Europe, Japan, Malaysia, Singapore, South Korea, the UK and the US. There are five trading updates each year and the chief executive and chief financial officer present our preliminary and interim results updates. They also attend regular meetings throughout the year with investors both in the UK and around the world, tailored to investor requirements, to discuss the performance of the company, the company’s strategy, structural changes in our markets and risks and opportunities for the future. The chairman meets regularly with significant shareholders to understand any issues and concerns they may have. This is in accordance with both the Code and the UK Stewardship Code. The non-executive directors meet informally with shareholders both before and after the AGM and respond to shareholder queries and requests as necessary. The chairman ensures that the board is kept informed of principal investors’ and advisers’ views on strategy and corporate governance. We also have an established programme of educational seminars for our institutional shareholders focusing on individual parts of Pearson. These seminars are available to all shareholders via webcast on www.pearson.com Private investors represent over 80% of the shareholders on our register and we make a concerted effort to engage with them regularly. Shareholders who cannot attend the AGM are invited to email questions to the chairman in advance at glenmoreno-agm@pearson.com We encourage our private shareholders to become more informed investors and have provided a wealth of information on our website about managing Pearson shareholdings, see www.pearson.com/investors/shareholder-information for further information, or turn to p181 of this report. We also encourage all shareholders, who have not already done so, to register their email addresses through our website and with our registrar. This enables them to receive email alerts when trading updates and other important announcements are added to our website. We post all company announcements on our website, www.pearson.com, as soon as they are released, and major shareholder presentations are made accessible via webcast or conference call. Our website contains a dedicated investor relations section with an extensive archive of past announcements and presentations, historical financial performance, share price data and a calendar of events. It also includes information about all of our businesses, links to their websites and details of our corporate responsibility policies and activities. Section 4 Governance 53 We are committed to ensuring that all our shareholders receive their dividends and during 2012 we informed any shareholder who had outstanding unclaimed dividends of the amounts owed to them and how they could claim these. To this end, during the year, we also reminded shareholders of our dividend mandate service which enables UK and many overseas shareholders to receive dividends directly into their nominated bank account, and we invite any shareholders who have not yet done so to consider using this method for dividend payments. We recently provided shareholders with smaller holdings the opportunity to use our registrar’s low-cost share dealing service, giving them the chance to add to or reduce their stake in Pearson at significantly reduced dealing rates, or to donate shares to charity with ease. This service proved very popular with shareholders, and consequently we intend to offer this service again at a future date. We believe it is important that our employees have a shared interest in the direction and achievements of Pearson and are pleased to say that a large number of our employees are shareholders in the company. Our AGM – which will be held on 26 April this year – is an opportunity for all shareholders to meet the board and to hear presentations about Pearson’s businesses and results. B OA R D A N D CO M M IT TE E F R A M E WO R K Board committees The board has established three formal committees: the nomination committee, the remuneration committee and the audit committee. The chairmen and members of these committees are appointed by the board on the recommendation (where appropriate) of the nomination committee and in consultation with each relevant committee chairman. In addition to these board committees, three further committees operate with board input: the Pearson management committee (PMC), the standing committee and the recently-established reputation and responsibility committee. NOMINATION COMMITTEE Chairman Glen Moreno Members David Arculus, Vivienne Cox, John Fallon, Susan Fuhrman, Ken Hydon, Josh Lewis and Glen Moreno The nomination committee meets at least once a year and as and when required. The committee primarily monitors the composition and balance of the board and its committees, and identifies and recommends to the board the appointment of new directors and/or committee members. BOARD – Chairman – Five executive directors – Five non-executive directors AUDIT COMMIT TEE REMUNER ATION COMMIT TEE NOMINATION COMMIT TEE CHIEF EXECUTIVE Chaired by Ken Hydon Chaired by David Arculus Chaired by Glen Moreno – Five non-executive directors – Chairman – Three non-executive directors – Chairman – Chief executive – Five non-executive directors STANDING COMMIT TEE REPUTATION AND RESPONSIBILIT Y COMMIT TEE PEARSON MANAGEMENT COMMIT TEE The schedule of matters reserved for the board and the terms of reference of the audit, remuneration, nomination and standing committees are available at www.pearson.com/investors/shareholder-information/governance O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 54 Pearson plc Annual report and accounts 2012 Board governance continued During 2012, the committee’s primary focus was the appointment of Pearson’s new chief executive following Marjorie Scardino’s decision to step down at the end of 2012, and consequently the committee met six times during the course of the year. At its February meeting, the committee reviewed succession planning for non-executive and executive board positions and senior management, as well as board committee membership. The committee ensures that the directors of Pearson demonstrate a broad balance of skills, experience, independence, knowledge and diversity (including gender diversity). There are currently three female directors on the board, one of whom is an executive director. The committee and the board always take account of diversity when considering board appointments and will continue to do so, whilst ensuring that appointments are made based on merit and relevant experience. The plan for 2013 is to continue to develop programmes and relationships that help attract talented diverse people into our business and retain them and to continue to track our progress. In particular, Pearson intends to commence work on a comprehensive gender diversity strategy, and to develop a global diversity strategy focusing on the key emerging markets of India, China and Brazil. Pearson continues to show evidence of progress in relation to the retention of people with diverse backgrounds for both entry level and management positions and has made significant progress over the years in advancing women and culturally diverse people. As at December 2012, 25% of Pearson’s top managers were women, and 41% of successors for such roles were female, including an increasing number of business leaders as well as functional roles such as HR and finance, ensuring that the pipeline of talented women within Pearson remains strong. To support this pipeline, a diversity toolkit for managers was launched in the UK, to provide managers with advice and guidance on developing their diversity management skills. We hope to launch a US version during 2013. Gender balance % Board Top managers 27% 25% Successors 41% 73% 75% 59% Female Male Whilst the chairman of the board chairs the nomination committee, he is not permitted to chair meetings when the appointment of his successor is being considered or during a discussion regarding his performance. At such times, the senior independent director will chair the meetings. The committee has written terms of reference which clearly set out its authority and duties. These can be found on the company website at www.pearson.com/investors/shareholder- information/governance REMUNERATION COMMITTEE Chairman David Arculus Members David Arculus, Vivienne Cox, Ken Hydon and Glen Moreno The remuneration committee reports to the full board and a letter from the chairman of the remuneration committee and its report on directors’ remuneration, which has been considered and adopted by the board, is set out on pages 64 to 92. The committee met six times during the year, and has written terms of reference which clearly set out its authority and duties. These can be found on the company website at www.pearson.com/ investors/shareholder-information/governance Section 4 Governance 55 Members All of the audit committee members are independent non-executive directors and have financial and/or related business experience due to the senior positions they hold or have held in other listed or publicly traded companies and/or similar public organisations. Ken Hydon, chairman of the committee, is the company’s designated financial expert. He is a Fellow of the Chartered Institute of Management Accountants, the Association of Chartered Certified Accountants and the Association of Corporate Treasurers. He also serves as audit committee chairman for Reckitt Benckiser Group plc, and until recently for Tesco plc and Royal Berkshire NHS Foundation Trust. The qualifications and relevant experience of the other committee members are detailed on page 46. Role and responsibilities The committee has written terms of reference which clearly set out its authority and duties. These are reviewed annually and can be found on the company website at www.pearson.com/investors/shareholder- information/governance The committee has been established by the board primarily for the purpose of overseeing the accounting, financial reporting, internal control and risk management processes of the company and the audit of the financial statements of the company. The committee is responsible for assisting the board’s oversight of the quality and integrity of the company’s external financial reporting and statements and the company’s accounting policies and practices. The Group’s internal and external auditors have direct access to the committee to raise any matter of concern and to report on the results of work directed by the committee. The committee reports to the full board at every board meeting immediately following a committee meeting. It also reviews the independence of the external auditors, including the provision of non-audit services (further details of which can be found on pages 59 and 60), and ensures that there is an appropriate audit relationship and that auditor objectivity and independence is upheld. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S AUDIT COMMITTEE Chairman Ken Hydon Members David Arculus, Vivienne Cox, Susan Fuhrman, Ken Hydon and Josh Lewis As I described last year, in my role as audit committee chairman, I consider the key role of the committee to be in providing oversight and reassurance to the board, specifically with regard to the integrity of the company’s financial reporting, accounting policies, risk management and internal control processes and governance framework. Fundamental to this role is the committee’s access to local management. Once again, committee meetings have been attended by the chief financial officer and head of Group internal audit and risk assurance, and often by the chief executive and chairman. Individual managers have joined meetings for specific topics, e.g. treasury, tax or business continuity planning. In total, 16 managers attended one or more meetings during the year. During the board’s visit to São Paulo, members of the committee met with local senior financial management to discuss risk management, financial control and the Pearson code of conduct. In July, the committee met with the company’s chief information officer and director of digital strategy to discuss the approach taken to data protection. Finally, in December, in its first ‘risk deep-dive’ session aimed at making the risk review process more tangible, the committee met with the president of the US assessment and information group to discuss risks and mitigation strategy related to the testing and assessment business. This approach worked well, and I am keen that the committee holds additional sessions in 2013 focusing on key risks within Pearson, as well as continuing to meet local management throughout the year and whenever the board is scheduled to meet in overseas locations. The committee has a healthy interaction with group internal audit and PwC, who attend all of our regular committee meetings. Again, I see this as fundamental to the role of the committee and to my position as chairman. We always need to be learning, as the business progresses and the environments in which we operate change. Ken Hydon 56 Pearson plc Annual report and accounts 2012 Board governance continued External audit Based on management’s recommendations, the committee reviews the proposal on the appointment of the external auditors. The committee reviewed the effectiveness and independence of the external auditors during 2012 and remains satisfied that the auditors provide effective independent challenge to management. The committee will continue to review the performance of the external auditors on an annual basis and will consider their independence and objectivity, taking account of all appropriate guidelines. There are no contractual obligations restricting the committee’s choice of external auditors. In any event, the external auditors are required to rotate the audit partner responsible for the Group audit every five years. The current lead audit partner has been in place for five years and consequently will rotate following completion of the Group’s 2012 year end audit. In accordance with our external auditor policy, Group internal audit performs an annual assessment of audit fees, services and independence. This review forms the basis for a recommendation by the committee to the board in respect of the appointment and compensation of our external auditor. Having previously conducted a full tender exercise in 1996, and considered re-tendering in subsequent years, we intend to give consideration during 2013 to the timing of our next formal tender, mindful of the 2012 Code requirement to undertake a formal tendering process at least once every ten years. During the year, the committee discussed the planning, conduct and conclusions of the external audit as it proceeded. At the July 2012 audit committee meeting, the committee discussed and approved the auditors’ group audit plan and identified the following key risks of misstatement of the Group’s financial statements, which were updated at the December 2012 committee meeting: ›(cid:3)Revenue recognition, in light of a number of products and services sold by Pearson where revenue recognition practices are complex and management assumptions and estimates are necessary; ›(cid:3)Accounting for acquisitions in light of material transactions in 2011 and 2012, in particular, valuation of acquired intangibles which involves significant judgement; and ›(cid:3)Disposal accounting, in particular relating to proposed Penguin Random House venture. The committee discussed these issues with the auditors at the time of their review of the half year interim financial statements in July 2012 and again at the conclusion of their audit of the financial statements for the year in February 2013. In December 2012, the committee discussed with the auditors the status of their work, focusing on their work in relation to internal controls. As the auditors concluded their audit, they explained to the committee: ›(cid:3)The work they had conducted over revenue, which included targeted procedures at businesses which were considered to have more complex revenue recognition, such as the assessment and testing businesses; ›(cid:3)The results of their review of acquisition accounting for all significant acquisitions, encompassing assessment of management’s valuations of intangible assets as well as other purchase price adjustments; ›(cid:3)The work they had done to test management’s assumptions and estimates in relation to balance sheet judgements and calculations (encompassing provisions for doubtful debts and inventory, recoverability of pre- publication assets and authors’ advances, reserves for sales returns, estimates of current and deferred tax and pension liabilities and other contingencies) and how they had satisfied themselves that these were reasonable; ›(cid:3)The impact of the board’s decision on the future options for the Pearson in Practice business; ›(cid:3)The results of their review of the impairment model, including their challenge of management’s underlying cash flow projections and consideration of key assumptions such as discount rates and perpetuity rates and sensitivities, which indicated that all cash- generating units had adequate headroom; ›(cid:3)The results of their controls testing to date for Sarbanes-Oxley Act section 404 reporting purposes and in support of their financial statements audit; and ›(cid:3)The review of the company’s ‘going concern’ reports. The auditors also reported to the committee the misstatements that they had found in the course of their work, which were insignificant, and the committee confirmed that there were no material items remaining unadjusted in these financial statements. Training The committee receives regular technical updates as well as specific or personal training as appropriate. During 2012, two committee members took advantage of a personal training session provided by PwC. Section 4 Governance 57 Committee members also meet with local management on an ongoing basis in order to gain a better understanding of how Group policies are embedded in operations. For example, during its visit to São Paulo in June 2012, the committee met with local senior finance managers. ›(cid:3)Pearson’s anti-corruption programme; ›(cid:3)Pearson’s data protection programme; ›(cid:3)Review of the committee’s terms of reference; ›(cid:3)Annual internal audit plan; ›(cid:3)Risk deep-dive: testing and assessment business; ›(cid:3)Review of company risk returns including Social, Meetings The committee met four times during the year with the following in attendance: the chief financial officer; head of Group internal audit and risk assurance; members of the senior management team; and the external auditors. The committee also met regularly in private with the external auditors and the head of Group internal audit and risk assurance. At every meeting, the committee considered reports on the activities of the Group internal audit function, including the results of internal audits, risk reviews, project assurance reviews and fraud and whistleblowing reports. The committee also monitored the company’s financial reporting, internal controls and risk management procedures and considered any significant legal claims and regulatory issues in the context of their impact on financial reporting. Specifically, the committee considered the following matters during the course of the year: ›(cid:3)The 2011 annual report and accounts: preliminary announcement, financial statements and income statement; ›(cid:3)The Group accounting policies; ›(cid:3)Compliance with the UK Corporate Governance Code; ›(cid:3)Form 20-F and related disclosures including the annual Sarbanes-Oxley Act section 404 attestation of financial reporting internal controls; ›(cid:3)Receipt of the external auditors’ report on the Form 20-F and on the year end audit; ›(cid:3)Assessment of the effectiveness of the Group’s internal control environment; ›(cid:3)Reappointment, remuneration and engagement letter of the external auditors; ›(cid:3)Provision of non-audit services by PwC; Review of the interim financial statements and announcement; ›(cid:3)Annual re-approval of the Group internal audit mandate; ›(cid:3)Compliance with SEC and NYSE requirements including Sarbanes-Oxley Act; ›(cid:3)Reviews of the effectiveness of the audit committee, the external auditors and the Group internal audit function; Ethical and Environmental (SEE) risks; ›(cid:3)Group tax strategy review; and ›(cid:3)Annual review of treasury policy. In February 2013, the committee also considered the 2012 annual report and accounts, including the preliminary announcement, financial statements, business review, directors’ report and corporate governance compliance statement. Internal control and risk management The directors confirm they have conducted a review of the effectiveness of the group’s systems of risk management and internal controls, including strategic, financial, operational and compliance controls and risk management systems, in accordance with the UK Corporate Governance Code and the Turnbull guidance as revised. These systems have been operating throughout the year and to the date of this report. The key elements and procedures that have been established to provide effective risk management and internal control systems are described below: Control environment The board of directors has overall responsibility for Pearson’s system of internal control, which is designed to manage, and where possible mitigate, the risks facing the Group, safeguard assets and provide reasonable, but not absolute, assurance against material financial misstatement or loss. Responsibility for monitoring financial management and reporting and risk management and internal control systems has been delegated to the audit committee by the board. At each meeting, the audit committee considers reports from management, Group internal audit and the external auditors, with the aim of reviewing the effectiveness of the internal financial and operating control environment of the Group. The identification and mitigation of significant business risks is the responsibility of Group senior management and operating company management. Each operating company, including the corporate centre, maintains internal controls and procedures appropriate to its structure, business environment and risk assessment, O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 58 Pearson plc Annual report and accounts 2012 Board governance continued whilst complying with Group policies, standards and guidelines. Financial management and reporting There is a comprehensive strategic planning, budgeting and forecasting system with an annual operating plan approved by the board of directors. Monthly financial information, including trading results, balance sheets, cash flow statements, capital expenditures and indebtedness, is reported against the corresponding figures for the plan and prior years, with corrective action outlined by the appropriate senior executive. Group senior management meet, on a quarterly basis, with operating company management to review their business and financial performance against plan and forecast. Major business risks relevant to each operating company as well as performance against the stated financial and strategic objectives are reviewed in these meetings. We have an ongoing process to monitor the risks and effectiveness of controls in relation to the financial reporting and consolidation process including the related information systems. This includes up-to-date Group financial policies, formal requirements for business unit finance functions, Group consolidation reviews and analysis of material variances, group finance technical reviews, including the use of technical specialists, and review and sign-off by senior finance managers. These processes are monitored and assessed during the year by the Group internal audit and Group compliance functions. These controls include those over external financial reporting which are documented and tested in accordance with the requirements of section 404 of the Sarbanes-Oxley Act, which is relevant to our US listing. The effectiveness of key financial controls is subject to management review and self certification and independent evaluation by Group internal audit. A risk management framework is in place to identify, evaluate and manage risks, including key financial reporting risks. Operating companies undertake semi-annual risk reviews to identify new or potentially under-managed risks. Throughout the year, risk sessions facilitated by the head of Group internal audit and risk assurance are held with Group and operating company management to identify the key risks the company faces in achieving its objectives, to assess the probability and impact of those risks and to document the actions being taken to manage those risks. The Pearson management committee reviews the output of these sessions, focusing on the significant risks facing the business. Management has the responsibility to consider and execute appropriate action to mitigate these risks whenever possible. The results of these reviews are reported to the board in detail via the audit committee. Group internal audit The Group internal audit function is responsible for providing independent assurance to management on the design and effectiveness of internal controls to mitigate strategic, financial, operational and compliance risks. The risk-based annual internal audit plan is approved by the audit committee. Recommendations to improve internal controls and to mitigate risks, or both, are agreed with operating company management after each audit. Formal follow-up procedures allow Group internal audit to monitor operating companies’ progress in implementing its recommendations and to resolve any control deficiencies. The Group internal audit function also has a remit to monitor significant Group projects, in conjunction with the central project management office and to provide assurance that appropriate project governance and risk management strategies are in place. Group internal audit has a formal collaboration process in place with the external auditors to ensure efficient coverage of internal controls. Regular reports on the work of Group internal audit are provided to executive management and, via the audit committee, to the board. The head of Group internal audit is jointly responsible with the Group legal counsel for monitoring compliance with our Code of Conduct, and investigating any reported incidents including ethical, corruption and fraud allegations. The Pearson anti- bribery and corruption programme provides the framework to support our compliance with various anti-bribery and corruption regulations such as the UK Bribery Act 2010 and the US Foreign Corrupt Practices Act. Treasury management The treasury department operates within policies approved by the board and its procedures are reviewed regularly by the audit committee. Major transactions are authorised outside the department at the requisite level, and there is an appropriate segregation of duties. Frequent reports are made to the chief financial officer and regular reports are prepared for the audit committee and the board. Section 4 Governance 59 Insurance Insurance is provided through Pearson’s insurance subsidiary, Spear Insurance Limited, and/or externally, depending on the scale of the risk and the availability of cover in the external market, with the objective of achieving the most cost-effective balance between insured and uninsured risks. Going concern Having reviewed the Group’s liquid resources and borrowing facilities and the Group’s 2013 and 2014 cash flow forecasts, the directors believe that the Group has adequate resources to continue as a going concern. For this reason, the financial statements have, as usual, been prepared on that basis. Information regarding the Group’s borrowing liabilities and financial risk management can be found in notes 18 and 19 on pages 135 to 143. Share capital Details of share issues are given in note 27 to the accounts on page 156. The company has a single class of shares which is divided into ordinary shares of 25p each. The ordinary shares are in registered form. As at 31 December 2012, 817,042,980 ordinary shares were in issue. At the AGM held on 27 April 2012, the company was authorised, subject to certain conditions, to acquire up to 81,597,867 ordinary shares by market purchase. Shareholders will be asked to renew this authority at the AGM on 26 April 2013. Information provided to the company pursuant to the Financial Services Authority’s Disclosure and Transparency Rules is published on a Regulatory Information Service and on the company’s website. As at 5 March 2013, being the last practicable date before the publication of this report, the company had been notified under DTR5 of the following significant voting rights in its shares: Number of voting rights 40,975,445 BlackRock, Inc. Legal & General Group plc 32,385,175 Libyan Investment Authority 24,431,000 Annual General Meeting (AGM) Percentage 5.01% 3.98% 3.01% The notice convening the AGM, to be held at 12 noon on Friday, 26 April 2013 at IET London, 2 Savoy Place, London WC2R 0BL, is contained in a circular to shareholders to be dated 21 March 2013. Registered auditors In accordance with section 489 of the Act, a resolution proposing the reappointment of PricewaterhouseCoopers LLP (PwC) as auditors to the company will be proposed at the AGM, at a level of remuneration to be agreed by the directors. Auditors’ independence In line with best practice, our relationship with PwC is governed by our external auditors policy, which is reviewed and approved annually by the audit committee. The policy establishes procedures to ensure the auditors’ independence is not compromised, as well as defining those non-audit services that PwC may or may not provide to Pearson. These allowable services are in accordance with relevant UK and US legislation. The audit committee approves all audit and non-audit services provided by PwC. Certain categories of allowable non-audit services have been pre- approved by the audit committee subject to the authorities below: ›(cid:3)Pre-approved non-audit services can be authorised by the chief financial officer up to £100,000 per project, subject to a cumulative limit of £500,000 per annum; ›(cid:3)Acquisition or disposal transactions and due diligence up to £100,000 per project may be performed by our external auditors, in light of the need for confidentiality. Any project/transaction generating fees in excess of £100,000 must be specifically approved by the audit committee; ›(cid:3)Tax compliance and related activities up to the greater of £1,000,000 per annum or 50% of the external audit fee; and ›(cid:3)For forward-looking tax planning services we use the most appropriate adviser, usually after a tender process. Where we decide to use our independent auditors, authority, up to £100,000 per project subject to a cumulative limit of £500,000 per annum, has been delegated by the audit committee to management. Services provided by PwC above these limits and all other allowable non-audit services, irrespective of value, must be approved by the audit committee. Where appropriate, services will be tendered prior to a decision being made as to whether to award work to the auditors. The audit committee receives regular reports summarising the amount of fees paid to the auditors. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 60 Pearson plc Annual report and accounts 2012 Board governance continued During 2012, the significant non-audit work performed by PwC was: ›(cid:3)Tax compliance services related to a routine audit by the US Internal Revenue Service; ›(cid:3)Tax advisory services associated with the planned creation of the venture between Penguin and Random House; ›(cid:3)Assurance services on a corporate bond issued in May 2012; and ›(cid:3)Other assurance services which were individually less than £100,000 per project. In each case, PwC was selected as they were best able to provide the services we required at a reasonable fee and within the terms of our external auditors policy. To assist in ensuring that independence and objectivity is maintained, for forward-looking tax planning and due diligence work PwC assign a different partner from the one leading the external audit. A full statement of the fees for audit and services is provided in note 4 to the accounts on page 114. Statement of directors’ responsibilities The directors are responsible for preparing the annual report, the report on directors’ remuneration and the financial statements in accordance with applicable law and regulations. The Act requires the directors to prepare financial statements for each financial year. The directors have prepared the Group and parent company financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union. Under the Act the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the company and the Group and of the profit or loss of the Group for that period. In preparing these financial statements, the directors are required to: ›(cid:3)Select suitable accounting policies and then apply them consistently; ›(cid:3)Make judgements and accounting estimates that are reasonable and prudent; ›(cid:3)State that the financial statements comply with IFRSs as adopted by the European Union or disclose and explain any material departures from those IFRSs; and ›(cid:3)Prepare the financial statements on a going concern basis, unless it is inappropriate to presume that the company and/or the group will continue in business. The directors are responsible for keeping adequate accounting records that are sufficient to show and explain the company’s transactions and disclose with reasonable accuracy at any time the financial position of the company and the Group. This enables them to ensure that the financial statements and the report on directors’ remuneration comply with the Act and, as regards the Group financial statements, Article 4 of the IAS Regulation. They are also responsible for safeguarding the assets of the company and the Group and for taking reasonable steps for the prevention and detection of fraud and other irregularities. The directors are responsible for the maintenance and integrity of the company’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. Each of the directors, whose names and functions are listed on pages 44 to 46, confirm that to the best of their knowledge and belief: ›(cid:3)The Group financial statements, prepared in accordance with IFRSs as adopted by the European Union, give a true and fair view of the assets, liabilities, financial position and profit of the group and company; and ›(cid:3)The directors’ report contained in the annual report includes a fair review of the development and performance of the business and the position of the company and Group, together with a description of the principal risks and uncertainties that they face. The directors also confirm that, for all directors in office at the date of this report: a) so far as the directors are aware, there is no relevant audit information of which the company’s auditors are unaware; and b) they have taken all the steps that they ought to have taken as directors in order to make themselves aware of any relevant audit information and to establish that the company’s auditors are aware of that information. Approved by the board on 7 March 2013 and signed on its behalf by Philip Hoffman Secretary Section 4 Governance 61 Additional information for shareholders Set out below is other statutory and regulatory information that Pearson is required to disclose in its directors’ report. Amendment to Articles of Association Any amendments to the Articles of Association of the company (the Articles) may be made in accordance with the provisions of the Companies Act 2006 (the Act) by way of a special resolution. Rights attaching to shares The rights attaching to the ordinary shares are defined in the Articles. A shareholder whose name appears on the company’s register of members can choose whether his/her shares are evidenced by share certificates (i.e. in certificated form) or held electronically (i.e. uncertificated form) in CREST (the electronic settlement system in the UK). Subject to any restrictions below, shareholders may attend any general meeting of the company and, on a show of hands, every shareholder (or his/her representative) who is present at a general meeting has one vote on each resolution for every ordinary share of which they are the registered holder. A resolution put to the vote at a general meeting is decided on a show of hands unless before, or on the declaration of the result of, a vote on a show of hands, a poll is demanded. A poll can be demanded by the chairman of the meeting, or by at least three shareholders (or their representatives) present in person and having the right to vote, or by any shareholders (or their representatives) present in person having at least 10% of the total voting rights of all shareholders, or by any shareholders (or their representatives) present in person holding ordinary shares on which an aggregate sum has been paid up of at least 10% of the total sum paid up on all ordinary shares. At this year’s AGM voting will again be conducted on a poll, consistent with best practice. Shareholders can declare a final dividend by passing an ordinary resolution but the amount of the dividend cannot exceed the amount recommended by the board. The board can pay interim dividends on any class of shares of the amounts and on the dates and for the periods they decide. In all cases the distributable profits of the company must be sufficient to justify the payment of the relevant dividend. The board may, if authorised by an ordinary resolution of the shareholders, offer any shareholder the right to elect to receive new ordinary shares, which will be credited as fully paid, instead of their cash dividend. Any dividend which has not been claimed for 12 years after it became due for payment will be forfeited and will then belong to the company, unless the directors decide otherwise. If the company is wound up, the liquidator can, with the sanction of a special resolution passed by the shareholders, divide among the shareholders all or any part of the assets of the company and he/she can value assets and determine how the division shall be carried out as between the shareholders or different classes of shareholders. The liquidator can also, with the same sanction, transfer the whole or any part of the assets to trustees upon such trusts for the benefit of the shareholders. Voting at general meetings Any form of proxy sent by the shareholders to the company in relation to any general meeting must be delivered to the company (via its registrars), whether in written or electronic form, not less than 48 hours before the time appointed for holding the meeting or adjourned meeting at which the person named in the appointment proposes to vote. No shareholder is, unless the board decides otherwise, entitled to attend or vote either personally or by proxy at a general meeting or to exercise any other right conferred by being a shareholder if he/she or any person with an interest in shares has been sent a notice under section 793 of the Act (which confers upon public companies the power to require information with respect to interests in their voting shares) and he/she or any interested person failed to supply the company with the information requested within 14 days after delivery of that notice. The board may also decide, where the relevant shareholding comprises at least 0.25% of the nominal value of the issued shares of that class, that no dividend is payable in respect of those default shares and that no transfer of any default shares shall be registered. Pearson operates two employee benefit trusts to hold shares, pending employees becoming entitled to them under the company’s employee share plans. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 62 Pearson plc Annual report and accounts 2012 Board governance continued There were 10,101,860 shares so held as at 31 December 2012. Each trust has an independent trustee which has full discretion in relation to the voting of such shares. A dividend waiver operates on the shares held in these trusts. Pearson also operates a nominee shareholding arrangement known as Sharestore which holds shares on behalf of employees. There were 4,710,567 shares so held as at 31 December 2012. The trustees holding these shares seek voting instructions from the relevant employee as beneficial owner, and voting rights are not exercised if no instructions are given. Transfer of shares The board may refuse to register a transfer of a certificated share which is not fully paid, provided that the refusal does not prevent dealings in shares in the company from taking place on an open and proper basis. The board may also refuse to register a transfer of a certificated share unless (i) the instrument of transfer is lodged, duly stamped (if stampable), at the registered office of the company or any other place decided by the board, and is accompanied by the certificate for the share to which it relates and such other evidence as the board may reasonably require to show the right of the transferor to make the transfer; (ii) it is in respect of only one class of shares; and (iii) it is in favour of not more than four transferees. Transfers of uncertificated shares must be carried out using CREST and the board can refuse to register a transfer of an uncertificated share in accordance with the regulations governing the operation of CREST. Variation of rights If at any time the capital of the company is divided into different classes of shares, the special rights attaching to any class may be varied or revoked either: (i) with the written consent of the holders of at least 75% in nominal value of the issued shares of the relevant class; or (ii) with the sanction of a special resolution passed at a separate general meeting of the holders of the shares of the relevant class. Without prejudice to any special rights previously conferred on the holders of any existing shares or class of shares, any share may be issued with such preferred, deferred, or other special rights, or such restrictions, whether in regard to dividend, voting, return of capital or otherwise as the company may from time to time by ordinary resolution determine. Appointment and replacement of directors The Articles contain the following provisions in relation to directors: Directors shall number no less than two. Directors may be appointed by the company by ordinary resolution or by the board. A director appointed by the board shall hold office only until the next AGM and shall then be eligible for reappointment, but shall not be taken into account in determining the directors or the number of directors who are to retire by rotation at that meeting. The board may from time to time appoint one or more directors to hold executive office with the company for such period (subject to the provisions of the Act) and upon such terms as the board may decide and may revoke or terminate any appointment so made. The Articles provide that, at every AGM of the company, at least one-third of the directors shall retire by rotation (or, if their number is not a multiple of three, the number nearest to one-third). The first directors to retire by rotation shall be those who wish to retire and not offer themselves for re-election. Any further directors so to retire shall be those of the other directors subject to retirement by rotation who have been longest in office since they were last re-elected but, as between persons who became or were last re-elected on the same day, those to retire shall (unless they otherwise agree among themselves) be determined by lot. In addition, any director who would not otherwise be required to retire shall retire by rotation at the third AGM after they were last re-elected. Notwithstanding the provisions of the Articles, the board has resolved that all directors should offer themselves for re-election annually, in accordance with the UK Corporate Governance Code. The company may by ordinary resolution remove any director before the expiration of his/her term of office. In addition, the board may terminate an agreement or arrangement with any director for the provision of his/her services to the company. Section 4 Governance 63 Powers of the directors Subject to the company’s Articles, the Act and any directions given by special resolution, the business of the company will be managed by the board who may exercise all the powers of the company, including powers relating to the issue and/or buying back of shares by the company (subject to any statutory restrictions or restrictions imposed by shareholders in general meeting). Significant agreements The following significant agreements contain provisions entitling the counterparties to exercise termination or other rights in the event of a change of control of the company: Under the $1,750,000,000 revolving credit facility agreement dated November 2010 which matures in November 2015 between, amongst others, the company, HSBC Bank plc (as facility agent) and the banks and financial institutions named therein as lenders (the Facility), any such bank may, upon a change of control of the company, require its outstanding advances, together with accrued interest and any other amounts payable in respect of such Facility, and its commitments, to be cancelled, each within 60 days of notification to the banks by the facility agent. For these purposes, a ‘change of control’ occurs if the company becomes a subsidiary of any other company or one or more persons acting either individually or in concert, obtains control (as defined in section 1124 of the Corporation Tax Act 2010) of the company. Shares acquired through the company’s employee share plans rank pari passu with shares in issue and have no special rights. For legal and practical reasons, the rules of these plans set out the consequences of a change of control of the company. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 64 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration Dear shareholders I am pleased to present our report on directors’ remuneration for 2012, which will be put forward for your consideration and approval at the annual general meeting on 26 April 2013. The remuneration committee believes that the purpose of its remuneration policy is to support the company’s strategy and to help deliver sustained performance and consistent long-term value creation in the interests of all stakeholders. Performance in 2012 Performance has been resilient in very tough conditions and the company has delivered: ›(cid:3)strong competitive performance ›(cid:3)operating profit broadly level with the record profits in 2011 ›(cid:3)return on invested capital above our cost of capital ›(cid:3)Pearson’s 21st straight year of increasing our dividend above the rate of inflation. Over the past ten years we have increased our dividend at a compound annual rate of 7%, returning more than £2.5bn to shareholders Principles of remuneration policy Our reward policy is aligned with the interests of all stakeholders in providing: ›(cid:3)competitive base salaries that reflect the market and individual roles and contribution ›(cid:3)a high proportion of variable remuneration that is directly linked to the annual and long-term performance of the company ›(cid:3)annual incentives that reward achievement of strategic goals ›(cid:3)long-term incentives that drive long-term earnings and share price growth and encourage people to acquire and hold Pearson shares in line with shareholders’ interests ›(cid:3)many people at Pearson with the opportunity to share in the company’s success through cash-based annual incentives and bonuses and worldwide participation in share ownership plans, continuing practices first started in 1998 Market conditions The remuneration committee is sensitive to the current social and economic environment surrounding executive compensation. We welcome the coalition government’s proposals to improve the clarity and transparency of remuneration disclosure. Although the regulations have not yet been finalised, we have adopted many of the recommendations in this year’s report. We hope that these changes will continue to demonstrate the link between our remuneration policy and practice and the company’s strategy and performance, as well as our commitment to shareholder engagement. We continue to keep our remuneration policy under review in light of the prevailing economic conditions and the impact of these on the company’s objectives and strategy. What we’ve planned for 2013 Looking forward, for 2013: ›(cid:3)we undertook a periodic review of base salaries for 2013 taking into account general economic and market conditions, the level of increases made across the company as a whole, the remuneration of executives in similar positions in comparable companies and individual performance ›(cid:3)we reviewed and established an appropriate starting remuneration package for the new CEO comprising base salary, annual and long-term incentives, allowances and benefits ›(cid:3)we reviewed and amended the service agreements for those executive directors, including the CEO, who will continue to serve throughout 2013. The consequence of this review has been to remove any entitlement to annual incentive from the calculation of any compensation that might be payable on termination of employment by the company without notice or cause Section 4 Governance 65 What we did in 2012 Looking back to some specific aspects of policy and practice in 2012: ›(cid:3)we undertook a periodic review of base salaries for 2012 and, in light of the prevailing economic conditions and consistent with the action that continues to be taken across the company to control costs, the committee endorsed the recommendation of the executive directors and other members of the Pearson Management Committee that they receive no increase in base salaries ›(cid:3)annual incentives paid to executives for 2012 performance were significantly lower than for 2011, reflecting performance in a tough business environment and more challenging incentive targets ›(cid:3)we reduced the number of shares awarded to the Pearson Management Committee as their long- term incentives Our policy and implementation is summarised in more detail in the remainder of this report. Finally, I would like to thank my fellow members of the committee and the people who have assisted us for their contribution over the past year and to give special appreciation to Patrick Cescau who stood down from the committee during 2012. David Arculus Chairman, Remuneration Committee O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 66 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration continued Introduction The rest of this report on directors’ remuneration comprises: ›(cid:3)a policy report – a forward-looking statement on remuneration policy for 2013 and beyond; and ›(cid:3)an implementation report – a report on remuneration practice in 2012 Together, this report complies with Schedule 8 of the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 and was approved by the board of directors on 7 March 2013. The committee believes that the company has complied with the provisions regarding remuneration matters contained within the UK Corporate Governance Code. Where required under current regulations, the following tables have been subject to audit: ›(cid:3)total remuneration (page 80) ›(cid:3)pension entitlements and pension-related benefits (page 83) ›(cid:3)movements in directors’ interests in restricted shares (pages 86 to 88) ›(cid:3)movements in directors’ interests in share options (page 89) Section 4 Governance 67 Policy report Summary of remuneration policy The following table summarises the company’s policy on directors’ remuneration that applies to executive directors and other members of the Pearson Management Committee for 2013 and, so far as practicable, for subsequent years. We have taken account of the coalition government’s proposed regulations on the disclosure of remuneration policy but the format and level of detail in the policy table may evolve in subsequent years in line with the final disclosure requirements. Remuneration policy and business strategy The committee considers that a successful remuneration policy needs to be sufficiently flexible to take account of future changes in the company’s business environment and in remuneration practice. Our starting point continues to be that total remuneration should reward both short- and long- term results, delivering competitive rewards for target performance but outstanding rewards for exceptional performance. Our goal as a company is to be the world’s leading learning company and to help people of all ages make progress in their lives through all kinds of learning. Pearson’s strategy has for some years focused on growth in digital products, educational services and emerging markets. We are now accelerating the implementation of that strategy through: ›(cid:3)four global businesses – we are focusing on school, higher education, English-language learning and business education. We are taking an increasingly global view of educational needs and trends ›(cid:3)four types of geographic market – we will carefully evaluate when we offer global products and services, when we customise for local needs, and when we require a true local approach. We will focus our investment on markets with the biggest growth opportunities ›(cid:3)four business models – we will channel our investment into four proven business models: direct-to-consumer; ‘Pearson Inside’ (our shorthand for institutional services such as our school systems in Brazil); assessment; and learning systems Those measures complement our more traditional financial measures and goals but they do not, of course, replace them. In financial terms, Pearson’s goal is to achieve sustainable growth on three key financial goals – earnings, cash and return on invested capital, and reliable cash returns to our investors through healthy and growing dividends. We believe those are, in concert, good indicators that we are building the long-term value of Pearson. So those measures (or others that contribute to them, such as sales, profit, and working capital) form the basis of our annual budgets and plans, and the basis for bonuses and long- term incentives. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 68 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration: Policy table Introduction Total remuneration is made up of fixed and performance-linked elements, with each element supporting different strategic objectives. Total remuneration is normally reviewed annually and benchmarked against total remuneration for similar positions in comparable companies. Base salary P U R P O S E A N D L I N K TO S TR AT EGY P E R F O R M A N C E P E R I O D › Helps to recruit, reward and retain. › Reflects competitive market level, role, skills, experience and individual contribution. O P E R ATI O N Normally reviewed annually for the following year taking into account general economic and market conditions, the level of increases made across the company as a whole, the remuneration of executives in similar positions in comparable companies and individual performance. O P P O RT U N IT Y Normally reviewed in line with increases across the company as a whole, subject to particular circumstances such as changes in role, responsibilities or organisation, current remuneration relative to the mid-market position across our comparator groups and the level of increases for executives generally. P E R F O R M A N C E CO N D ITI O N S None, although performance of both the company and the individual are taken into account when determining an appropriate level of base salary increase each year. None. I M P L E M E N TAT I O N There were no increases to base salaries in 2012 for executive directors and other members of the Pearson Management Committee. Base salaries for 2012 are reported in the total remuneration table on page 80. For 2013, we reviewed base salaries consistent with our policy set out above. OTH E R E M P LOY E E S The approach to setting base salary increases elsewhere in the company takes into account economic factors, competitive market rates, roles, skills, experience and individual performance. The increase in wages and salaries for the company as a whole is reported in note 5 to the financial statements on page 115. Allowances and benefits P U R P O S E A N D L I N K TO S TR AT EGY P E R F O R M A N C E CO N D ITI O N S › Help to recruit and retain. › Reflect local competitive market. O P E R ATI O N Include inter alia cash allowances and non-cash benefits such as health and welfare and car benefits. Allowances and benefits do not form part of pensionable earnings. None. P E R F O R M A N C E P E R I O D None. I M P L E M E N TAT I O N No change on prior year. Allowances and benefits for 2012 are reported in the total remuneration table on page 80. O P P O RT U N IT Y OTH E R E M P LOY E E S The provision and level of allowances and benefits are competitive and appropriate in the context of the local market. Allowances and benefits for employees reflect the local labour market in which they are based. Retirement benefits P U R P O S E A N D L I N K TO S TR ATEGY › Help to recruit and retain. › Recognise long-term commitment to the company. O P E R ATI O N New employees in the UK are eligible to join the Money Purchase 2003 section of the Pearson Group Pension Plan. New employees in the US are eligible to join the 401(k) plan. Under the Money Purchase 2003 section of the Pearson Group Pension Plan in the UK, normal retirement age is 62, but, subject to company consent, retirement is currently possible from age 55 or earlier in the event of ill-health. During service, the company and the employee make contributions into a pension fund. Account balances are used to provide benefits at retirement. Pensions for a member’s spouse, dependent children and/or nominated financial dependants are payable on death. Under the 401(k) plan in the US, which is a defined contribution plan, account balances will be used to provide benefits at retirement. In the event of death before retirement, the account balances will be used to provide benefits for designated beneficiaries. Longer serving directors with legacy arrangements may participate in the defined benefit Pearson Inc. Pension Plan in the US or the Final Pay section of the Pearson Group Pension Plan in the UK, which are closed to new members. Under the Final Pay section of the Pearson Group Pension Plan in the UK, normal retirement age is 62, but, subject to company consent, retirement is currently possible from age 55 or earlier in the event of ill-health. During service, the employee makes a contribution of 5% of pensionable salary and the pension fund builds up based on final pensionable salary and pensionable service. The accrued pension is reduced on retirement prior to age 60. Pensions for a member’s spouse, dependent children and/or nominated financial dependants are payable on death. In the US, the defined benefit Pearson Inc. Pension Plan provides a lump sum benefit that is convertible to an annuity on retirement. The lump sum benefit accrued at an age dependent percentage of capped compensation until 31 December 2001 when further benefit accruals ceased for most employees. Section 4 Governance 69 Employees who satisfied criteria of age and service as of 30 November 1998 continue to earn benefits under an alternative formula that provides for 1.5% of final average earnings, adjusted for US Social Security. The benefit paid to these employees is the maximum of the lump sum benefit converted to an annuity and the benefit earned under the alternative final average earnings formula. Executive directors and other executives across the company are entitled to additional pension benefits to take account of the cap on the amount of benefits that can be provided from the all-employee pension arrangements in the US and the UK. O P P O RT U N IT Y In the UK, company contributions to the Money Purchase 2003 section of the Pearson Group Pension Plan amount up to 16% of pensionable salary (double the amount of the employee contribution, which is limited according to certain age bands). In the US, company contributions to the 401(k) plan amount to 100% of the first 3% of eligible compensation contributed by the employee and 50% of the next 3%, plus a basic annual company contribution of 1.25% of eligible compensation. Pearson Inc. Pension Plan participants who were at least age 40 at 31 December 2001 can receive an additional 0.5% – 1.5% of pay. P E R F O R M A N C E CO N D ITI O N S None. P E R F O R M A N C E P E R I O D None. I M P L E M E N TAT I O N No change. Retirement benefits are reported on page 83. OTH E R E M P LOY E E S Executive directors participate in the same pension arrangements that have been set up for Pearson employees in the US and the UK. Note 1 Members of the Pearson Group Pension Plan who joined after May 1989 are subject to an upper limit of earnings that can be used for pension purposes, known as the earnings cap. This limit, £108,600 as at 6 April 2006, was abolished by the Finance Act 2004. However the Pearson Group Pension Plan has retained its own ‘cap’, which will increase annually in line with the UK Government’s Index of Retail Prices (All Items). The cap was £137,400 as at 6 April 2012. Note 2 As a result of the UK Government’s A-Day changes effective from April 2006, UK executive directors and other members of the Pearson Group Pension Plan who are, or become, affected by the lifetime allowance may be provided with a cash supplement as an alternative to further accrual of pension benefits on a basis that is broadly cost neutral to the company. Effective from 6 April 2011, the annual allowance (i.e. the maximum amount of pension saving that benefits from tax relief each year) reduced from £255,000 to £50,000. Effective 6 April 2012, the lifetime allowance (i.e. the maximum amount of pension and/or lump sum that can benefit from tax relief) reduced from £1.8m to £1.5m. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 70 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration: Policy table continued Annual incentives P U R P O S E A N D L I N K TO S TR AT EGY P E R F O R M A N C E CO N D ITI O N S › Motivate achievement of annual strategic goals and personal objectives. › Provide focus on key financial metrics. › Reward individual contribution to the success of the company. O P E R ATI O N Up to 90% of total opportunity is based on financial performance at the corporate and business unit level. Up to 50% of total opportunity is based on performance against personal objectives. The committee establishes threshold, target and maximum levels of performance for different levels of payout. Performance is measured separately for each item. Annual incentive payments do not form part of pensionable earnings. O P P O RT U N IT Y For the chief executive, maximum opportunity is 180% of base salary. For other members of the Pearson Management Committee, individual incentive opportunities take into account their membership of that committee and the relative contribution of their businesses or roles to the company’s overall goals, with a maximum opportunity of up to 175% of salary. For the chief executive and other members of the Pearson Management Committee, there is normally no payout for performance at threshold. The performance range sets a careful balance between upside opportunity and downside risk and is normally based on targets in accordance with the operating plan. Annual incentive plans are discretionary and the committee reserves the right to make adjustments to payments up or down if it believes exceptional factors warrant doing so. Subject to the achievement of targets for sales, growth in underlying earnings per share for continuing operations at constant exchange rates (for Pearson plc) or operating profit (for the operating companies), average working capital as a ratio to sales, operating cash flow and personal objectives. The selection and weighting of performance measures takes into account the strategic objectives and the business priorities relevant to each operating company and to Pearson overall each year. Personal objectives are agreed with the chief executive (or, in the case of the chief executive, the chairman) and may be functional, operational, strategic and non- financial and include inter alia objectives relating to environmental, social and governance issues. P E R F O R M A N C E P E R I O D One year. I M P L E M E N TAT I O N Annual incentive payments for 2012 are reported in the total remuneration table on page 80. For 2013, the maximum annual incentive opportunity for the chief executive remains at 180% of base salary and up to 175% of base salary for the other members of the Pearson Management Committee. OTH E R E M P LOY E E S Many people participate in some form of cash-based annual incentive, bonus, profit-share or sales commission plan. Annual incentive plans for the Pearson Management Committee form the basis of the annual incentive plans below the level of the principal operating companies and establish performance measures and standards and set the ceiling for individual incentive opportunities. Long-term incentives P U R P O S E A N D L I N K TO S TR ATEGY › Help to recruit, reward and retain. › Drive long-term earnings and share price growth and value creation. › Align interests of executives and shareholders. › Encourage long-term shareholding and commitment to the company. › Link corporate performance to management’s long- term reward in a flexible way. O P E R ATI O N Last approved by shareholders in 2011. Awards may be delivered in restricted shares and/or share options, although it is not the committee’s intention to grant share options for the foreseeable future. Awards for executive directors and other members of the Pearson Management Committee vest on a sliding scale based on performance against stretching corporate performance targets. 75% of the vested award is released at the end of the three-year performance period and the remaining 25% only vests if the participant retains the after-tax number of shares for a further two years. Restricted shares may be granted without performance conditions to satisfy recruitment and retention objectives, but not to any of the current executive directors. Where shares vest, participants also receive additional shares representing the gross value of dividends that would have been paid on these shares during the performance period and reinvested. Pearson’s reported financial results for the relevant periods are used to measure performance. The committee has discretion to make adjustments taking into account exceptional factors that distort underlying business performance. In exercising such discretion, the committee is guided by the principle of aligning shareholder and management interests. No such adjustments were made for performance periods ending in 2012. O P P O RT U N IT Y We set the level of individual awards by taking into account: › the face value of individual awards at the time of grant, assuming that performance targets are met in full; › market practice for comparable companies and market assessments of total remuneration from our independent advisers; Section 4 Governance 71 › individual roles and responsibilities; and › company and individual performance. P E R F O R M A N C E CO N D ITI O N S Subject to the achievement of targets for relative total shareholder return, return on invested capital and earnings per share growth, with normally one third of the award based on each. The committee determines the performance measures and targets governing an award of restricted shares prior to grant. P E R F O R M A N C E P E R I O D Three years. I M P L E M E N TAT I O N No change. Awards are reported in the movements in directors’ interests in restricted shares and share options tables on pages 86 to 89. OTH E R E M P LOY E E S Approximately 6% of the company’s employees below the Pearson Management Committee – selected on the basis of their role, performance and potential – currently hold time-vesting shares under the long-term incentive plan. All employees (including executive directors) are also eligible to participate in savings-related share acquisition programmes in the UK, US and rest of world, which are not subject to any performance conditions. Note 3 Total shareholder return (TSR) is the return to shareholders from any growth in Pearson’s share price and reinvested dividends over the performance period. For long-term incentive awards, TSR is measured relative to the constituents of the FTSE World Media Index over a three-year period. Companies that drop out of the index are normally excluded i.e. only companies in the index for the entire period are counted. Share price is averaged over 20 days at the start and end of the performance period, commencing on the date of Pearson’s results announcement in the year of grant and the year of vesting. Dividends are treated as reinvested on the ex-dividend date, in line with the Datastream methodology. The vesting of shares based on relative TSR is subject to the committee satisfying itself that the recorded TSR is a genuine reflection of the underlying financial performance of the business. The committee chose TSR relative to the constituents of the FTSE World Media Index because, in line with many of our shareholders, it felt that part of executive directors’ rewards should be linked to performance relative to the company’s peers. Note 4 Return on invested capital (ROIC) is adjusted operating profit less cash tax expressed as a percentage of gross invested capital (net operating assets plus gross goodwill). We chose ROIC because, over the past few years, the transformation of Pearson has significantly increased the capital invested in the business (mostly in the form of goodwill associated with acquisitions) and required substantial cash investment to integrate those acquisitions. Note 5 Adjusted earnings per share (EPS) is calculated by dividing the adjusted earnings attributable to equity shareholders of the company by the weighted average number of ordinary shares in issue during the year, excluding any ordinary shares purchased by the company and held in trust (see note 8 of the financial statements for a detailed description of adjusted earnings per share). EPS growth is calculated using the point-to-point method. This method compares the adjusted EPS in the company’s accounts for the financial year ended prior to the grant date with the adjusted EPS for the financial year ending three years later and calculates the implicit compound annual growth rate over the period. We chose EPS growth because strong bottom-line growth is imperative if we are to improve our TSR and our ROIC. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 72 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration: Policy table continued Bonus share matching P U R P O S E A N D L I N K TO S TR AT EGY P E R F O R M A N C E CO N D ITI O N S › Encourages executive directors and other senior managers to acquire and hold Pearson shares. › Aligns interests of executives and shareholders. O P E R ATI O N First approved by shareholders in 1998; last approved by shareholders in 2008. Senior managers across the company are invited to invest up to 50% of their after-tax annual incentive in Pearson shares and hold these shares for three years, in return for the opportunity to earn additional free matching shares and dividend shares, depending on performance against the earnings per share performance condition. Where matching shares vest, participants also receive additional shares representing the gross value of dividends that would have been paid on the matching shares during the performance period and reinvested. O P P O RT U N IT Y Maximum matching award is equal to the number of shares that could have been acquired with the amount of pre-tax annual bonus invested in Pearson shares (i.e. one matching share for every one invested share, grossed up for tax). Maximum matching award is achieved if the company’s earnings per share increase in real terms by 5% per annum compound over the three-year performance period. 50% of the maximum matching award is released if the company’s adjusted earnings per share increase in real terms by 3% per annum compound over the same period. Matching shares are calculated on a straight-line basis for performance between threshold and maximum. P E R F O R M A N C E P E R I O D Three years. I M P L E M E N TAT I O N No change. Awards are reported in the movements in directors’ interests in restricted shares table on pages 86 to 88. OTH E R E M P LOY E E S Around 450 senior managers across the company are eligible to participate in this plan, typically direct reports to the operating company CEOs, their senior management teams, and anyone who has a direct and significant influence on corporate strategy and financial performance. Note 6 Earnings per share growth is calculated using the point-to-point method, which compares the adjusted earnings per share in the company’s accounts for the financial year ended prior to the grant date with the adjusted earnings per share for the financial year ending three years later and calculates the implicit compound annual growth rate over the period. Real growth is calculated by reference to the UK Government’s Retail Prices Index (All Items). Share ownership guidelines P U R P O S E A N D L I N K TO S TR AT EGY P E R F O R M A N C E CO N D ITI O N S › Align interests of executives and shareholders. None. O P E R ATI O N Executive directors are expected to build up a substantial shareholding in the company in line with the policy of encouraging widespread employee ownership. Shares that count towards these guidelines include any shares held unencumbered by the executive, their spouse and/or dependent children plus any shares vested but held pending release under a restricted share plan. Executive directors have five years from the date of appointment to reach the guideline. O P P O RT U N IT Y Target holding is two times salary for the chief executive and 1.25 times salary for the other executive directors, consistent with median practice in FTSE 100 companies that operated such arrangements when the guideline was set. P E R F O R M A N C E P E R I O D None. I M P L E M E N TAT I O N No change. Directors’ interests are reported on page 90. All executive directors comfortably exceeded these guidelines in 2012. OTH E R E M P LOY E E S There are no mandatory share ownership guidelines below executive director level, although employees are encouraged to become shareholders in the company by retaining shares acquired through the company’s discretionary and all-employee stock programmes. Section 4 Governance 73 Service agreements P U R P O S E A N D L I N K TO S TR ATEGY P E R F O R M A N C E P E R I O D Provide an appropriate level of protection for the executive and the company by: › setting out individual entitlements to elements of remuneration consistent with policy › summarising notice periods and compensation on termination of employment by the company without notice or cause › describing the obligations in relation to confidentiality, data protection, intellectual property and restraint on certain activities O P E R ATI O N The policy on executive directors’ service agreements was reviewed in 2008, 2010 and again in 2012. In accordance with long established policy, all executive directors have rolling service agreements under which, other than by termination in accordance with the terms of these agreements, employment continues until retirement. There are no special provisions for notice or compensation in the event of a change of control of Pearson. On termination of employment, executive directors’ entitlements to any vested or unvested awards under Pearson’s discretionary share plans are treated in accordance with the terms of the relevant plan. O P P O RT U N IT Y The company may terminate executive directors’ service agreements by giving no more than 12 months’ notice. As an alternative, the company may at its discretion pay in lieu of that notice. Payment-in-lieu of notice may be made in instalments and may be subject to mitigation. Longer serving directors with legacy agreements are entitled to liquidated damages if the company terminates their agreement without notice or cause. For executive directors whose service will continue throughout 2013, compensation on termination of employment by the company without notice or cause comprises 100% of the annual salary at the date of termination and the annual cost to the company of providing pension and all other benefits. P E R F O R M A N C E CO N D ITI O N S None. None. I M P L E M E N TAT I O N The service agreements for the executive directors, including the CEO, who will continue to serve throughout 2013 were reviewed and amended. The consequence of this review has been to remove any entitlement to annual incentive from the calculation of any compensation that might be payable in the event of termination of employment by the company without notice or cause. Details of each individual’s service agreement are reported in the notes below. OTH E R E M P LOY E E S Employment agreements for other employees below the Pearson Management Committee are determined according to local labour law and market practice. Note 7 We summarise the service agreements that will apply to directors serving during 2013 as follows: Name Date of agreement Notice periods Glen Moreno 29 July 2005 12 months from the director; 12 months from the company Compensation on termination of employment by the company without notice or cause Payment-in-lieu of notice of 100% of annual fees at the date of termination John Fallon 31 December 2012 Will Ethridge 31 December 2012 Robin Freestone 17 December 2012 John Makinson 21 December 2012 Six months from the director; 12 months from the company Payment-in-lieu of notice of 100% of annual salary at the date of termination and the annual cost of pension and all other benefits Six months from the director; 12 months from the company Severance payments of 100% of annual salary at the date of termination and the annual cost of pension and all other benefits Six months from the director; 12 months from the company Payment-in-lieu of notice of 100% of annual salary at the date of termination and the annual cost of pension and all other benefits Six months from the director; 12 months from the company Liquidated damages of 100% of annual salary at the date of termination and the annual cost of pension and all other benefits Note 8 Marjorie Scardino served under her service agreement dated 27 February 2004 until she left employment on 31 December 2012. This agreement provided for notice periods of six months from the director and 12 months from the company and compensation on termination of employment by the company without notice or cause of 100% of annual salary at the date of termination, the annual cost of pension and all other benefits and 50% of potential annual incentive. Note 9 Rona Fairhead’s service agreement dated 24 January 2003 continues in effect for the first four months of 2013 until she leaves the company on 30 April 2013. This agreement provides for notice periods of six months from the director and 12 months from the company and compensation on termination of employment by the company without notice or cause of 100% of annual salary at the date of termination, the annual cost of pension and all other benefits and 50% of potential annual incentive. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S Market assessments against the three groups take account of key factors which Towers Watson’s research shows differentiate remuneration for jobs of a similar nature, such as financial size, board membership, reporting relationships and international activities. For benchmarking purposes and for the performance scenarios below, the main elements of remuneration are valued as follows: Element of remuneration Valuation Base salary Allowances, retirement and other benefits Annual incentive Long-term incentive Bonus share matching Actual base salary Cost to company of providing allowances, retirement and other benefits Target level of annual incentive Expected value of long-term incentive award Expected value of matching award based on target level of annual incentive and assuming maximum amount (50% of annual incentive) is invested Total remuneration Sum of all elements of remuneration Expected value means Towers Watson’s assessment of the awards’ net present value taking into account the vesting schedule and the probability that any performance targets will be met. 74 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration continued Recruitment The committee determines the remuneration package for any new appointment to the Pearson Management Committee, either from within or outside of Pearson. Remuneration includes base salary, annual and long-term incentive entitlements and awards, and pension arrangements. The committee carefully considers factors such as the relative size and contribution of the role, the individual’s skills and experience, the availability of skills and experience in the market, the individual’s current remuneration package, the market rate for the job and internal comparisons within Pearson before determining an appropriate remuneration package for a new appointment. Occasionally this requires a degree of flexibility so that the remuneration policy boundaries are wider than under usual circumstances but at all times the committee seeks to minimise internal disparities and to avoid pay for poor performance. For someone joining from outside of Pearson, the offer may include compensation for the forfeiture of awards from a previous employer on a comparable basis, taking account of performance achieved or likely to be achieved, the proportion of performance period remaining and the form of the award. Benchmarking For benchmarking purposes, we review remuneration by reference to three separate comparator groups. First, we use a select peer group of FTSE 100 companies with very substantial overseas operations, excluding financial services. These companies are of a range of sizes relative to Pearson, but the method our independent advisers, Towers Watson, use to make comparisons on remuneration takes this variation in size into account. Secondly, we look at a broad media industry group of US companies. And thirdly, we look at the FTSE 20-50, excluding financial services. We use these companies because they represent the wider executive talent pool from which we might expect to recruit externally and the pay market to which we might be vulnerable if our remuneration was not competitive. Section 4 Governance 75 Pay and performance Consistent with its policy, the committee places considerable emphasis on the performance-linked elements i.e. annual incentives, bonus share matching and long-term incentives. The committee considers what each director can expect to receive under different performance scenarios, based on the following definitions of performance: Performance scenario Elements of remuneration Maximum Target Fixed Base salary, allowances, benefits, retirement benefits, maximum annual incentive, maximum bonus share matching and maximum long-term incentive Base salary, allowances, benefits, retirement benefits, target annual incentive, target bonus share matching and target long-term incentive Base salary, allowances, benefits and retirement benefits only The relative importance of fixed and performance- related remuneration for the chief executive and other executive directors is typically as follows: Chief executive 13% 1% 23% 63% 22% 2% 21% 55% 92% 8% Maximum Target Fixed Other executive directors Maximum Target Fixed 15% 4% 25% 56% 24% 7% 21% 48% 78% 22% Base salary, allowances and benefits Retirement benefits Annual incentive Long-term incentives We will continue to review the mix of fixed and performance-linked remuneration on an annual basis, consistent with our overall philosophy. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 76 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration continued Chairman’s remuneration The committee’s policy is that the chairman’s pay should be set at a level that is competitive with those of chairmen in similar positions in comparable companies. He is not entitled to any annual or long- term incentive, retirement or other benefits. Following the committee’s last review in 2010, the chairman’s remuneration was increased to its current level with effect from 1 April 2011. The next review will take place in 2014. Non-executive directors Fees are determined by the full board having regard to market practice and within the restrictions contained in the company’s Articles of Association. Non-executive directors receive no other pay or benefits (other than reimbursement for expenses incurred in connection with their directorship of the company) and do not participate in the company’s equity-based incentive plans. With effect from 1 July 2010, the structure and fees are as follows: Non-executive director Chairmanship of audit committee Chairmanship of remuneration committee Membership of audit committee Membership of remuneration committee Senior independent director Fees payable from 1 July 2010 £65,000 £25,000 £20,000 £10,000 £5,000 £20,000 A minimum of 25% of the basic fee is paid in Pearson shares that the non-executive directors have committed to retain for the period of their directorships. Non-executive directors serve Pearson under letters of appointment and do not have service contracts. There is no entitlement to compensation on the termination of their directorships. Relative importance of pay spend We show below the year-on-year change in the relative importance of pay spend compared to the return to shareholders (dividends) and reinvestment in the company (adjusted operating profit for continuing operations). 2012 2011 Year-on-year change £m £m £ % 936 346 942 318 (6) 28 1,659 1,531 128 (1%) 9% 8% (2) (25%) 6 8 Operating profit Dividends Wages and salaries Directors’ salaries/fees, annual incentives, allowances and benefits Note 1 Wages and salaries include continuing operations only and exclude Penguin. 2011 is restated on the same basis. Employee numbers for continuing operations for 2012 were 42,980 (2011: 37,964). Further details are set out in note 5 to the financial statements on page 115. Note 2 Directors’ salaries/fees, annual incentives, allowances and benefits exclude retirement benefits and long-term incentives consistent with wages and salaries. Employee engagement In accordance with the committee’s charter and terms of reference, the committee’s remit does not include remuneration matters below that of the chief executive, the other executive directors and other members of the Pearson Management Committee. However, before the remuneration packages for the Pearson Management Committee are set for the year ahead, the committee considers a report from the chief executive and director for people on general pay trends in the market and the level of pay increases across the company as a whole. This helps to ensure that executive remuneration packages are reviewed in the context of the wider organisation. The company consults with various employee representative bodies – including trade unions and works councils in some jurisdictions – about the company’s strategy, competitiveness and performance of the business and other matters affecting employees. The company also conducts an employee engagement survey to find out how people feel about working for Pearson, what they think about the work they do, the opportunities they have and the rewards they get (including a section on pay and benefits). The company uses all of this feedback to inform decisions on people- related activities, resources and investment, local management action plans and wider business unit and organisational strategies. It is the company’s intention to continue to engage with employees and employee representatives in this way in the future. Section 4 Governance 77 Shareholder engagement The company consults regularly with shareholders on all matters affecting its strategy and business operations. As part of that process, we also engage with shareholders on matters relating to executive remuneration. In 2012, the committee amended the service contracts for all executive directors continuing to serve throughout 2013. The consequence of this review has been to remove any entitlement to annual incentive from the calculation of any compensation that might be payable on termination of employment by the company without notice or cause, in line with the prevailing view of best practice amongst shareholders and their representatives. The committee continues to be aware of and respond to best practice guidelines of shareholders and their representative bodies. Misstatement or misconduct In 2011, the committee reviewed the company’s powers to adjust and reclaim variable remuneration in exceptional circumstances of misstatement or misconduct. The committee already has long-standing discretionary powers to make downward adjustments under the annual and long-term incentive plans, as described in the remuneration policy table on pages 70 and 71. The company will follow its legal rights and reclaim rewards gained in the event of proven wrong doing which led to misstatement of the company’s accounts. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 78 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration continued Implementation report The committee’s duties are also: ›(cid:3)to review and approve corporate goals and objectives relevant to executive compensation and to evaluate performance in light of those goals and objectives ›(cid:3)to approve the company’s long-term incentive and other share plans ›(cid:3)to advise and decide on general and specific arrangements in connection with the termination of employment of executive directors and other members of the Pearson Management Committee ›(cid:3)to have delegated responsibility for determining the remuneration and benefits package of the chairman of the board ›(cid:3)to ensure that all provisions regarding disclosure of information are fulfilled ›(cid:3)to appoint and set the terms of reference for any remuneration consultants who advise the committee and monitor the cost of such advice The committee’s full charter and terms of reference are available on the company’s website. Annually, the committee reviews its own performance, constitution and charter and terms of reference to ensure it is operating at maximum effectiveness and recommend any changes it considers necessary to the board for approval. The committee participated in a survey to review its performance and effectiveness in July 2012, looking at areas such as the clarity of roles and responsibilities, the composition of the committee, the use of time, the quality and timeliness of meeting materials, the opportunity for discussion and debate, dialogue with management and access to independent advice. The committee concluded that it is operating effectively and noted the challenges for the year ahead. The remuneration committee and its activities David Arculus chaired the remuneration committee for the year 2012; the other members were Patrick Cescau (who stood down from the committee at the AGM), Vivienne Cox (who joined the committee during the year), Ken Hydon and Glen Moreno. David Arculus, Patrick Cescau, Vivienne Cox and Ken Hydon are independent non-executive directors. Glen Moreno, chairman of the board, is a member of the committee as permitted under the UK Corporate Governance Code. Marjorie Scardino, chief executive, Robin Freestone, chief financial officer, Robin Baliszewski, director for people, Robert Head, director for executive reward, and Stephen Jones, head of company secretarial and deputy secretary, provided material assistance to the committee during the year. They attended meetings of the committee, although none of them was involved in any decisions relating to his or her own remuneration. To ensure that it receives independent advice, the committee has appointed Towers Watson to supply survey data and to advise on market trends, long-term incentives and other general remuneration matters. Towers Watson also advised the company on health and welfare benefits in the US and provided consulting advice directly to certain Pearson operating companies. Towers Watson are members of the Remuneration Consultants’ Group, the body which oversees the code of conduct in relation to executive remuneration consulting in the UK. The committee’s principal duty is to determine and regularly review, having regard to the UK Corporate Governance Code and on the advice of the chief executive, the remuneration policy and the remuneration and benefits packages of the executive directors and other members of the Pearson Management Committee comprising CEOs of principal operating businesses and senior heads of strategic corporate functions. This includes base salary, annual and long-term incentives, retirement and any other benefits. The committee met six times during 2012. The matters discussed and actions taken were as follows: 20 AND 24 FEBRUARY 2012 ›(cid:3)Reviewed and approved 2011 annual incentive plan payouts ›(cid:3)Reviewed and approved 2009 long-term incentive plan payouts and release of shares ›(cid:3)Approved vesting of 2007 and 2009 annual bonus share matching awards and release of shares ›(cid:3)Reviewed base salaries for the Pearson Management Committee and endorsed the recommendation of the executive directors and other members of the Pearson Management Committee that they receive no increase in base salaries for 2012 ›(cid:3)Reviewed and approved 2012 Pearson and operating company annual incentive plan targets ›(cid:3)Reviewed and approved 2012 individual annual incentive opportunities for the Pearson Management Committee ›(cid:3)Reviewed and approved 2012 long-term incentive awards and associated performance conditions for the Pearson Management Committee ›(cid:3)Reviewed and approved 2011 report on directors’ remuneration ›(cid:3)Noted company’s use of equity for employee share plans ›(cid:3)Reviewed and approved the remuneration package for the chief executive 27 APRIL 2012 ›(cid:3)Reviewed and approved 2012 long-term incentive awards for the Pearson Management Committee ›(cid:3)Noted the company’s response to the UK pension tax relief changes for high earners 26 JULY 2012 ›(cid:3)Noted the activity of the Standing Committee of the Board in relation to the operation of the company’s equity-based reward programmes ›(cid:3)Ratified the 2012 annual incentive plans for Pearson plc and the operating companies ›(cid:3)Discussed Towers Watson's overview of the current remuneration environment ›(cid:3)Reviewed committee’s charter and terms of reference Section 4 Governance 79 3 OCTOBER 2012 ›(cid:3)Noted the activity of the Standing Committee of the board in relation to the operation of the company’s equity-based reward programmes ›(cid:3)Noted the appointment of John Fallon to the board and reviewed his remuneration package ›(cid:3)Approved 2012 long-term incentive awards for executives and managers ›(cid:3)Reviewed committee’s performance and effectiveness ›(cid:3)Reviewed remuneration policy and practice and the implications of the new reporting regulations 5 DECEMBER 2012 ›(cid:3)Discussed Towers Watson’s overview of the current remuneration environment ›(cid:3)Considered Towers Watson’s report on remuneration for the Pearson Management Committee for 2013 ›(cid:3)Reviewed status of outstanding long-term incentive awards ›(cid:3)Considered 2013 annual incentive plan metrics ›(cid:3)Considered the approach to 2013 long-term incentive plan awards for the Pearson Management Committee ›(cid:3)Noted the recommended format for the 2012 report on directors’ remuneration taking account of the proposed reporting regulations ›(cid:3)Reviewed and approved the service agreement for John Fallon’s appointment as chief executive ›(cid:3)Reviewed and approved the leaving arrangements for Marjorie Scardino, Rona Fairhead and one other member of the Pearson Management Committee O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 80 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration continued Total remuneration Total remuneration for the directors in 2012 was as follows: Salaries/ fees Annual incentive Allowances Benefits Sub-total Retirement benefits Long- term incentives 2012 Total (single figure) Sub-total Retirement benefits Long- term incentives 2011 Total (single figure) 500 – – – 500 – – 500 488 – – 488 993 658 529 146 432 293 192 63 60 – – – 65 1,550 951 – 746 25 213 4 712 4,088 6,350 2,455 302 1,532 2,785 1,390 999 267 1,109 2,122 – 594 317 64 706 5,719 8,880 575 3,196 5,161 182 1,574 2,755 – – – 500 549 252 238 – 211 15 767 16 1,014 151 1,461 2,379 1,094 – 1,081 2,095 1,417 150 2,087 3,331 346 1,571 3,334 95 90 80 – – – – – – – – – 95 90 80 – – – – – – 95 90 80 95 100 – – – – – – – 95 100 – 75 95 75 – – – 4,385 1,470 4,139 3,752 – – – 75 – 95 – 75 – 271 125 6,251 64 8,271 316 – – – 75 95 63 1,496 9,588 17,335 8,271 75 95 75 – – – – – – 75 95 63 1,959 14,147 24,377 – – – All figures in £000s Chairman Glen Moreno Executive directors Marjorie Scardino Will Ethridge Rona Fairhead John Fallon (appointed 3 October 2012) Robin Freestone John Makinson Non-executive directors David Arculus Patrick Cescau Vivienne Cox (appointed 1 January 2012) Susan Fuhrman Ken Hydon Josh Lewis Total Total 2011 Note 1 For the full year, John Fallon’s remuneration reflected nine months in his role as CEO, Pearson International and three months as Pearson CEO designate and was: salary/fees – £506; annual incentive – £259; benefits – £16; sub-total – £781; retirement benefits – £262; long-term incentives – £1,306; total – £2,349 (all figures in £000s). Note 2 In anticipation of the proposed reporting regulations, we show a ‘single figure’ of total remuneration, which includes retirement benefits and long-term incentives in addition to the other elements of remuneration that have been shown in previous reports. Consistent with the methodology proposed by the Financial Reporting Council at the time of writing, retirement benefits include the increase in the value of the pension fund during the year, comprising company contributions to the plan during the year for defined contribution plans and the increase in the pension fund offset for inflation and multiplied by 20 for defined benefit plans, as well as other pension-related costs (see the retirement benefits table on page 83 for further detail). Long-term incentives include all awards under the long-term incentive plan, bonus share matching plan or all-employee share plan that vested during the year or that have not yet vested but where performance is known at year-end as well as dividend shares accruing and released on such shares in the year (see the tables on movements in restricted shares and share options on pages 86 to 89 for further detail). Note 3 The company provided gifts to Patrick Cescau and Marjorie Scardino after they stepped down from the board. In the case of Patrick Cescau, the value of the gifts was £21,700. Ma for £12,000, which has an estimated value of approximately £50,000 – £100,000. ardino received a painting originally purchased by the company rjorie Sc Section 4 Governance 81 Salaries/fees Salaries/fees paid by the company are reported in the table on total remuneration of the directors. Fees paid by other companies to the executive directors for their non-executive directorships elsewhere are reported separately on page 92. Fees paid to non-executive directors in 2012 were comprised as follows: All figures in £000s David Arculus Patrick Cescau Vivienne Cox Susan Fuhrman Ken Hydon Josh Lewis Basic fee Committee chairmanship Committee membership Senior independent directorship Total 65 65 65 65 65 65 20 – – – 25 – 10 5 15 10 5 10 – 20 – – – – 95 90 80 75 95 75 Annual incentive For 2012, annual incentive opportunities were based on the following performance measures and performance against these measures (designated as: between target and maximum and above maximum) was as follows: between threshold and target, below threshold, > < Weighting of performance measures (% of maximum opportunity) Performance in 2012 Pearson plc Operating company/companies Name Marjorie Scardino Will Ethridge Pearson plc 90% 30% Rona Fairhead 30% John Fallon 30% Robin Freestone 80% 30% John Makinson Operating company/ companies Personal objectives – 10% 10% 10% 10% 20% 10% 60% Pearson North America 50% Professional Assessment & Training 10% FT Publishing 60% Pearson International – 50% Penguin Group 10% India Underlying growth in adjusted EPS Sales Average working capital to sales ratio Operating cash flow Sales Operating profit Average working capital to sales ratio Operating cash flow Payout in 2012 (% of salary) < < < < < < > > > > > > < < > < > < < 43.5% 44.5% 36.4% 51.1% 50.4% 43.4% Allowances Allowances for Marjorie Scardino include £49,570 in respect of housing costs and a US payroll supplement of £9,985. John Makinson is entitled to a location and market premium in relation to the management of the business of the Penguin Group in the US and received £210,937 for 2012. Benefits Benefits include company car, car allowance and UK healthcare premiums. US health benefits for Marjorie Scardino and Will Ethridge are self-insured and the cost is tax free to employees. For Marjorie Scardino, benefits include £48,600 for pension planning and financial advice. Marjorie Scardino, Rona Fairhead and John Makinson have the use of a chauffeur. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 82 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration continued Retirement benefits Description of the directors’ pension entitlements are as follows: Director Retirement benefits Marjorie Scardino Member of the Pearson Inc. Pension Plan (under which her benefit accruals ceased at the end of 2001) and the approved 401(k) plan. Until 2010, additional benefits were provided through an unfunded unapproved defined contribution plan. Since 2010, additional pension benefits are provided through a taxable and non-pensionable cash supplement in place of the unfunded plan, a funded defined contribution plan approved by HM Revenue and Customs as a corresponding plan, and amounts in the legacy unfunded plan. In aggregate, the cash supplement and contributions to the funded plan are based on a percentage of salary and a fixed cash amount index-linked to inflation. The notional cash balance of the legacy unfunded plan increases annually by a specified notional interest rate. The unfunded plan also provides the opportunity to convert a proportion of this notional cash account into a notional share account reflecting the value of a number of Pearson ordinary shares. The number of shares in the notional share account is determined by reference to the market value of Pearson shares at the date of conversion. Member of the Pearson Inc. Pension Plan (under which he continues to accrue benefits under the alternative formula because he satisfied criteria of age and service) and the approved 401(k) plan. He also participates in an unfunded, non-qualified Supplemental Executive Retirement Plan (SERP) that provides an annual accrual of 2% of final average earnings, less benefits accrued in the Pearson Inc. Pension Plan and US Social Security. Additional defined contribution benefits are provided through a funded, non-qualified Excess Plan. Member of the Pearson Group Pension Plan. Her pension accrual rate is 1/30th of pensionable salary per annum, restricted to the plan earnings cap. Until April 2006, the company also contributed to a Funded Unapproved Retirement Benefits Scheme (FURBS) on her behalf. Since April 2006, she has received a taxable and non-pensionable cash supplement in replacement of the FURBS. John Fallon Member of the Pearson Group Pension Plan. His pension accrual rate is 1/30th of pensionable salary Rona Fairhead Will Ethridge Robin Freestone John Makinson per annum, restricted to the plan earnings cap. Until April 2006, the company also contributed to a Funded Unapproved Retirement Benefits Scheme (FURBS) on his behalf. Since April 2006, he has received a taxable and non-pensionable cash supplement in replacement of the FURBS. Member of the Money Purchase 2003 section of the Pearson Group Pension Plan. Company contributions are 16% of pensionable salary per annum, restricted to the plan earnings cap. Until April 2006, the company also contributed to a Funded Unapproved Retirement Benefits Scheme (FURBS) on his behalf. Since April 2006, he has received a taxable and non-pensionable cash supplement in replacement of the FURBS. Member of the Pearson Group Pension Plan under which his pensionable salary is restricted to the plan earnings cap. The company ceased contributions on 31 December 2001 to his FURBS arrangement and the benefits were withdrawn in 2012, reducing the benefits payable under the UURBS. During 2002 it set up an Unfunded Unapproved Retirement Benefits Scheme (UURBS) for him. The UURBS tops up the pension payable from the Pearson Group Pension Plan and the closed FURBS to target a pension of two-thirds of a revalued base salary on retirement at age 62. The revalued base salary is defined as £450,000 effective at 1 June 2002, increased at 1 January each year by reference to the increase in the UK Government’s Index of Retail Prices (All Items). In the event of his death a pension from the Pearson Group Pension Plan and the UURBS will be paid to his spouse or nominated financial dependant. Early retirement is currently possible from age 55, with company consent. Section 4 Governance 83 Details of the directors’ pension entitlements and pension-related benefits during the year are as follows: Accrued pension at 31 Dec 12 1 £000 Age at 31 Dec 12 Directors’ pensions Increase/ (decrease) in accrued pension over the period 2 £000 Transfer value at 31 Dec 11 3 £000 Transfer value at 31 Dec 12 4 £000 Increase/ (decrease) in transfer value over the period 5 £000 Increase/ (decrease) in accrued pension over the period 6 £000 Transfer value of the increase in accrued pension at 31 Dec 12 £0005/6 Other pension costs to the company over the period 7 £000 Other allowances in lieu of pension 8 £000 Other pension related benefit costs 9 £000 Value in 2012 single figure £00010 Marjorie Scardino Will Ethridge Rona Fairhead John Fallon Robin Freestone John Makinson 65 3.7 (1.0) 49.5 48.8 (0.7) (1.1) – 10.5 665.1 58.3 712 60 212.0 17.6 2,039.3 2,502.0 462.7 13.4 157.8 32.7 – 1.7 302 51 50 54 48.6 65.5 6.4 7.1 579.3 815.7 700.8 965.9 115.0 143.7 5.4 5.9 72.0 80.0 – – 133.9 131.4 25.3 267 64 13.0 – – – – – – – 20.7 123.3 6.7 151 58 221.2 (86.8) 5,906.5 4,420.9 (1,492.0) (93.6) – – – 17.7 – Note 1 The accrued pension at 31 December 2012 is the deferred pension to which the member would be entitled on ceasing pensionable service on 31 December 2012. For Marjorie Scardino this is the approximate pension payable in respect of her frozen benefit in the US plan. For Will Ethridge this is his pension from the US plan and the US SERP. For Rona Fairhead and John Fallon it relates to the pension payable from the UK plan. For John Makinson it relates to the pension from the UK Plan and his unapproved arrangements in aggregate. Robin Freestone does not accrue defined benefits. Note 2 This is the change in accrued pension over the year compared with the accrued pension at the end of the previous year. Note 3 This is the transfer value quoted at the end of the previous year. Note 4 The UK transfer values at 31 December 2012 are calculated using the assumptions for cash equivalents payable from the UK plan and are based on the accrued pension at that date. There were no changes in the transfer value methodology over the year although the discount rates are updated each month to reflect changes in market conditions. For the US SERP, transfer values are calculated using a discount rate equivalent to current US long-term bond yields. The US plan is a lump sum plan and the accrued balance is included where applicable. Note 5 Less directors’ contributions. Note 6 Net of UK inflation (where inflation is the increase in CPI to the previous September, subject to a minimum of 0% pa and a maximum of 5% pa). In the case of John Makinson, the accrued pension over the period has decreased because of a transfer made as a result of a pension sharing order. Note 7 This column comprises contributions to defined contribution arrangements for UK benefits. For US benefits, it includes company contributions to funded defined contribution plans and notional contributions to unfunded defined contribution plans. Note 8 This column represents the cash allowances paid in lieu of the previous unfunded defined contribution plan for Marjorie Scardino and of the previous FURBS arrangements for Rona Fairhead, John Fallon and Robin Freestone. John Makinson’s deferred FURBS entitlement is referred to in note 1 above. Note 9 This column comprises life cover and long-term disability insurance not covered by the retirement plans. Note 10 The single figure of total remuneration includes the following elements from the table on retirement benefits: the increase in accrued pension over the period offset for inflation and multiplied by 20 (defined benefit plans), other pension costs to the company over the period (the company’s contributions to defined contribution plans), other allowances in lieu of pension (cash allowances paid in lieu of previous plans for Marjorie Scardino, Rona Fairhead, John Fallon and Robin Freestone) and other pension-related benefit costs (additional life cover and long-term disability insurance not covered by the retirement plans). In the case of John Fallon, the value included in the single figure of total remuneration is pro-rated to reflect his appointment to the board from 3 October 2012. In the case of John Makinson, the value for the single figure of total remuneration is nil because the decrease in accrued pension over the period offsets the other pension-related benefit costs. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 84 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration continued Long-term incentives Details of awards made, outstanding, held or released under the annual bonus share matching plan are as follows: Date of award Share price on date of award Vesting Status of award 15 May 2012 1,152.0p 20 April 2011 1,129.0p 21 April 2010 1,024.1p 16 April 2009 670.0p 22 May 20071 899.9p 15 May 2015 Outstanding subject to 2011 to 2014 performance 20 April 2014 Outstanding subject to 2010 to 2013 performance 21 April 2013 Performance condition for release of 84.5% of matching award met. Real compound annual growth in earnings per share for 2009 to 2012 of 4.4% against a range of 3% to 5%. Shares held pending release on 21 April 2013. 16 April 2012 Target met as reported in report on directors’ 100% on 22 May 2012 remuneration for 2011. Shares released on 15 May 2012 Target met as reported in report on directors’ remuneration for 2011. Shares released on 22 May 2012 Note 1 For awards made prior to 2008, the annual bonus share matching plan operated on the basis of a 50% match after three years and 100% match after five years, subject to the earnings per share growth targets being met over the relevant performance periods. Note 2 For all awards, Pearson’s reported financial results for the relevant period were used to measure performance and no discretion was exercised. Section 4 Governance 85 Details of awards made, outstanding, vested and held or released under the long-term incentive plan are as follows: Share price on date of award Vesting date Date of award Performance measures (award split equally across three measures) Performance period Payout at threshold Payout at maximum Actual performance % of award vested Status of award 02/05/12 1,161.0p 02/05/15 Relative TSR 2012 to 30% at median 100% at upper – ROIC 2015 2014 EPS growth 2014 compared to 2011 quartile 100% for ROIC of 10.5% 100% for EPS growth of 12.0% – – 0% for ROIC of 8.5% 30% for EPS growth of 6.0% 03/05/11 1,149.0p 03/05/14 Relative TSR 2011 to 30% at median 100% at upper – ROIC 2014 2013 EPS growth 2013 compared to 2010 03/03/10 962.0p 03/03/13 Relative TSR 2010 to quartile 100% for ROIC of 10.5% 100% for EPS growth of 12.0% 25% for ROIC of 9.0% 30% for EPS growth of 6.0% 30% at median 100% at upper – – – 2013 quartile – – – – – – – Outstanding Outstanding 25% for ROIC of 8.5% 100% for ROIC of 10.5% 9.1% 47.5% 8.8% 62.5% ROIC 2012 EPS growth 2012 compared to 2009 03/03/09 654.0p 03/03/12 Relative TSR 2009 to ROIC 2012 2011 EPS growth 2011 compared to 2008 100% for EPS growth of 12.0% 30% for EPS growth of 6.0% 30% at median 100% at upper quartile 100% for ROIC of 10.5% 100% for EPS growth of 12.0% 25% for ROIC of 8.5% 30% for EPS growth of 6.0% Outstanding Marked as (cid:125) in the movements in restricted shares table Vested and remain held pending release. Marked as (cid:122) in the movements in restricted shares table 60th percentile 57.4% 9.1% 47.5% 14.4% 100% 68.3% of shares vested. Three-quarters released on 3 April 2012. If after tax number of shares are retained for a further two years, the remaining quarter will be released on 3 March 2014. The part based on relative TSR is marked as (cid:125) and the part based on ROIC and EPS growth as (cid:122) in the movements in restricted shares table Note 1 For all awards, Pearson’s reported financial results for the relevant period were used to measure performance and no discretion was exercised. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 86 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration continued Movements in directors’ interests in restricted shares (designated as: ABSMP annual bonus share matching plan; LTIP long-term incentive plan; Dividends where dividend-equivalent shares were added to the released shares; (cid:122) for the two-thirds of the award based on ROIC and EPS growth and (cid:125) for the one third of the award based on relative TSR; we show these parts of the award separately where performance is known for only part of the award at year-end). Date of award Marjorie Scardino Plan 1 Jan 12 Awarded Released Lapsed 31 Dec 12 Market value at date of award Earliest release date Date of release Market value at date of release Number of shares in 2012 single figure Value in 2012 single figure £000 22/5/07 ABSMP 60,287 60,287 0 899.9p 22/5/12 22/5/12 1,148.0p 21/4/10 ABSMP 63,497 20/4/11 ABSMP 71,446 30/7/07 4/3/08 3/3/09 (cid:122) 3/3/09 (cid:125) 3/3/10 (cid:122) 3/3/10 (cid:125) 3/5/11 2/5/12 9,850 53,647 1,024.1p 21/4/13 53,647 £649 23,816 47,630 1,129.0p 20/4/14 84,000 0 778.0p 2/3/10 31/7/12 1,196.0p 97,500 649.5p 4/3/11 165,938 55,312 654.0p 3/3/12 3/4/12 1,184.0p 64,620 63,840 21,540 654.0p 3/3/12 3/4/12 1,184.0p 86,160 £1,020 119,976 146,691 962.0p 3/3/13 146,691 £1,776 133,333 962.0p 3/3/13 133,334 266,666 1,149.0p 3/5/14 250,000 166,667 83,333 1,161.0p 2/5/15 32,048 32,048 21,252 21,252 0 1,184.0p 3/4/12 3/4/12 1,184.0p 32,048 £379 0 1,190.0p 30/7/12 30/7/12 1,190.0p 21,252 £253 LTIP LTIP 84,000 97,500 LTIP 221,250 LTIP 150,000 LTIP 266,667 LTIP 133,333 LTIP 400,000 LTIP 0 0 0 Total 1,547,980 303,300 428,145 517,483 905,652 339,798 £4,077 3/4/12 Dividends 30/7/12 Dividends Will Ethridge 22/5/07 ABSMP 2,508 16/4/09 ABSMP 112,515 21/4/10 20/4/11 ABSMP ABSMP 7,880 4,517 15/5/12 ABSMP 15/5/12 Dividends 0 0 30,000 36,562 86,042 58,333 LTIP LTIP LTIP LTIP LTIP 100,000 LTIP 50,000 LTIP 150,000 LTIP 30/7/07 4/3/08 3/3/09 (cid:122) 3/3/09 (cid:125) 3/3/10 (cid:122) 3/3/10 (cid:125) 3/5/11 2/5/12 2,508 112,515 0 0 899.9p 22/5/12 22/5/12 1,148.0p 670.0p 16/4/12 15/5/12 1,152.0p 1,222 6,658 1,024.1p 21/4/13 6,658 £81 4,485 13,053 13,053 30,000 4,517 1,129.0p 20/4/14 4,485 1,152.0p 15/5/12 0 1,152.0p 15/5/12 15/5/12 1,152.0p 13,053 £150 0 778.0p 2/3/10 31/7/12 1,196.0p 36,562 649.5p 4/3/11 64,531 21,511 654.0p 3/3/12 3/4/12 1,184.0p 25,130 24,827 8,376 654.0p 3/3/12 3/4/12 1,184.0p 33,506 £397 44,991 55,009 962.0p 3/3/13 55,009 £666 3/4/12 Dividends 30/7/12 Dividends 0 0 0 100,000 12,463 12,463 7,590 7,590 50,000 962.0p 3/3/13 150,000 1,149.0p 3/5/14 100,000 1,161.0p 2/5/15 0 1,184.0p 3/4/12 3/4/12 1,184.0p 12,463 £148 0 1,190.0p 30/7/12 30/7/12 1,190.0p 7,590 £90 Total 638,357 137,591 267,790 71,040 437,118 128,279 £1,532 Section 4 Governance 87 Date of award Rona Fairhead Plan 1 Jan 12 Awarded Released Lapsed 31 Dec 12 Market value at date of award Earliest release date Date of release Market value at date of release Number of shares in 2012 single figure Value in 2012 single figure £000 30/7/07 LTIP 25,000 25,000 0 778.0p 2/3/10 31/7/12 1,196.0p 4/3/08 3/3/09 (cid:122) 3/3/09 (cid:125) 3/3/10 (cid:122) 3/3/10 (cid:125) 3/5/11 2/5/12 LTIP 30,468 LTIP 73,750 LTIP 50,000 LTIP 83,333 LTIP 41,667 LTIP 165,000 LTIP 0 100,000 30,468 649.5p 4/3/11 55,313 18,437 654.0p 3/3/12 3/4/12 1,184.0p 21,540 21,280 7,180 654.0p 3/3/12 3/4/12 1,184.0p 28,720 37,492 45,841 962.0p 3/3/13 45,841 £340 £555 41,667 962.0p 3/3/13 165,000 1,149.0p 3/5/14 100,000 1,161.0p 2/5/15 3/4/12 Dividends 30/7/12 Dividends 0 0 10,683 10,683 6,325 6,325 0 1,184.0p 3/4/12 3/4/12 1,184.0p 10,683 £126 0 1,190.0p 30/7/12 30/7/12 1,190.0p 6,325 £75 Total John Fallon 469,218 117,008 118,861 58,772 408,593 91,569 £1,096 16/4/09 ABSMP 21/4/10 ABSMP 20/4/11 ABSMP 15/5/12 ABSMP 15/5/12 Dividends 7,595 8,275 4,539 0 0 8,917 882 4/3/08 3/3/09 (cid:122) 3/3/09 (cid:125) 3/3/10 (cid:122) 3/3/10 (cid:125) 3/5/11 2/5/12 LTIP 24,375 LTIP 86,042 LTIP 58,333 LTIP 100,000 LTIP 50,000 LTIP 150,000 LTIP 0 100,000 7,595 0 670.0p 16/4/12 15/5/12 1,152.0p 1,284 6,991 1,024.1p 21/4/13 6,991 £85 4,539 1,129.0p 20/4/14 8,917 1,152.0p 15/5/15 882 0 1,152.0p 15/5/12 15/5/12 1,152.0p 882 £10 24,375 649.5p 4/3/11 64,531 21,511 654.0p 3/3/12 3/4/12 1,184.0p 25,130 24,827 8,376 654.0p 3/3/12 3/4/12 1,184.0p 33,506 44,991 55,009 962.0p 3/3/13 55,009 £397 £666 50,000 962.0p 3/3/13 150,000 1,149.0p 3/5/14 100,000 1,161.0p 2/5/15 3/4/12 Dividends 0 12,463 12,463 0 1,184.0p 3/4/12 3/4/12 1,184.0p 12,463 £148 Total 489,159 122,262 110,601 71,102 429,718 Total (pro-rated for 2012 single figure, to reflect appointment 3 October 2012) 108,851 £1,306 26,427 £317 O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 88 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration continued Date of award Plan 1 Jan 12 Awarded Released Lapsed 31 Dec 12 Market value at date of award Earliest release date Date of release Market value at date of release Number of shares in 2012 single figure Value in 2012 single figure £000 Robin Freestone 22/5/07 ABSMP 16/4/09 ABSMP 21/4/10 ABSMP 20/4/11 ABSMP 15/5/12 ABSMP 15/5/12 Dividends 4,708 35,446 31,114 29,049 0 0 17,833 4,112 30/7/07 4/3/08 3/3/09 (cid:122) 3/3/09 (cid:125) 3/3/10 (cid:122) 3/3/10 (cid:125) 3/5/11 2/5/12 LTIP LTIP LTIP LTIP LTIP LTIP 25,000 30,468 73,750 50,000 83,333 41,667 LTIP 125,000 LTIP 3/4/12 Dividends 30/7/12 Dividends Total John Makinson 30/7/07 4/3/08 3/3/09 (cid:122) 3/3/09 (cid:125) 3/3/10 (cid:122) 3/3/10 (cid:125) 3/5/11 2/5/12 LTIP LTIP LTIP LTIP LTIP LTIP 20,000 30,468 73,750 50,000 83,333 41,667 LTIP 125,000 LTIP 3/4/12 Dividends 30/7/12 Dividends 4,708 35,446 4,112 25,000 0 0 899.9p 22/5/12 22/5/12 1,148.0p 670.0p 16/4/12 15/5/12 1,152.0p 4,827 26,287 1,024.1p 21/4/13 26,287 £318 29,049 1,129.0p 20/4/14 17,833 1,152.0p 15/5/15 0 1,152.0p 15/5/12 15/5/12 1,152.0p 4,112 £47 0 778.0p 2/3/10 31/7/12 1,196.0p 30,468 649.5p 4/3/11 55,313 18,437 654.0p 3/3/12 3/4/12 1,184.0p 21,540 21,280 7,180 654.0p 3/3/12 3/4/12 1,184.0p 28,720 £340 37,492 45,841 962.0p 3/3/13 45,841 £555 0 0 0 100,000 10,683 10,683 6,325 6,325 41,667 962.0p 3/3/13 125,000 1,149.0p 3/5/14 100,000 1,161.0p 2/5/15 0 1,184.0p 3/4/12 3/4/12 1,184.0p 10,683 £126 0 1,190.0p 30/7/12 30/7/12 1,190.0p 6,325 £75 529,535 138,953 163,127 63,599 441,762 121,968 £1,461 20,000 0 778.0p 2/3/10 31/7/12 1,196.0p 30,468 649.5p 4/3/11 55,313 18,437 654.0p 3/3/12 3/4/12 1,184.0p 21,540 21,280 7,180 654.0p 3/3/12 3/4/12 1,184.0p 28,720 £340 37,492 45,841 962.0p 3/3/13 45,841 £555 0 0 0 100,000 10,683 10,683 5,060 5,060 41,667 962.0p 3/3/13 125,000 1,149.0p 3/5/14 100,000 1,161.0p 2/5/15 0 1,184.0p 3/4/12 3/4/12 1,184.0p 10,683 £126 0 1,190.0p 30/7/12 30/7/12 1,190.0p 5,060 £60 Total Total 424,218 115,743 112,596 58,772 368,593 4,098,467 934,857 1,201,120 840,768 2,991,436 90,304 £1,081 798,342 £9,564 Note 1 The number of shares shown represents the maximum number of share that may vest, subject to any performance conditions being met. Note 2 No variations to terms and conditions of plan interests were made during the year. Note 3 Performance conditions and vesting for awards under the bonus share matching and long-term incentive plans are described in the long-term incentive tables on pages 84 and 85. Note 4 Marjorie Scardino left the company on 31 December 2012. In the case of the bonus share matching award made on 21 April 2010 and the long-term incentive awards made on 4 March 2008 and 3 March 2009, the performance period has ended and the number of shares held at 31 December 2012 will be released to Marjorie in 2013. Section 4 Governance 89 In the case of the bonus share matching award on 20 April 2011 and the long-term incentive awards made on 3 March 2010, 3 May 2011 and 2 May 2012, outstanding awards have been pro-rated according to the number of months worked in the performance period to the date of leaving and we show the remaining shares as lapsed. The shares held at 31 December 2012 remain outstanding subject to performance and will be released in line with the normal vesting schedule. Note 5 In the case of the long-term incentive awards made on 3 March 2009 and 3 March 2010, we detail separately the parts based on ROIC and EPS growth (two-thirds of the total award) and the part based on relative TSR (one-third of the total award), because of the time lag in the corresponding performance periods. We disclosed the lapsed part of the 2009 award (based on ROIC and EPS growth) in the 2011 report as performance was known at year-end but the vesting of the part based on relative TSR is disclosed together with the release of shares in the 2012 report (as above). Similarly, for the 2010 award, we disclose the lapse of the parts based on ROIC and EPS growth but the vesting of the part based on relative TSR and the release of shares will be disclosed in the 2013 report. Note 6 The below notes have been prepared in anticipation of the proposing reporting regulations. All awards released during the year are included in the single figure of total remuneration for that year, unless they were subject to a performance condition (other than a stay-in-employment) and performance against that condition was known in an earlier reporting period. Awards that have not yet vested but where performance is known at year-end are also included in the single figure of total remuneration. In the case of the long-term incentive award made on 3 March 2009, only the part based on relative TSR is included in the 2012 single figure of total remuneration (under the proposed single figure methodology, the part based on ROIC and EPS growth would have been included in the 2011 single figure of total remuneration and disclosed in the 2011 report). In the case of the long-term incentive award made on 3 March 2010, only the parts based on ROIC and EPS growth are included in the 2012 single figure of total remuneration (the part based on relative TSR will be included in the 2013 single figure of total remuneration and disclosed in the 2013 report). The value of shares included in the single figure of total remuneration is the number of shares multiplied by the share price on release (or, if the shares have not yet been released, the average share price over the final quarter of the year which for 2012 was 1,210.4p). Movements in directors’ interests in share options (all under the worldwide save for shares plan) are as follows: Date of grant 1 Jan 12 Granted Exercised Lapsed 31 Dec 12 Option price Earliest exercise date Expiry date Date of exercise Price on exercise Value in 2012 single figure £000 Gain on exercise £ Marjorie Scardino 8/5/09 Total Rona Fairhead 4/5/07 Total John Fallon 7/5/10 Total Robin Freestone 4/5/12 Total Total 1,672 1,672 2,371 2,371 1,930 1,930 0 0 0 0 0 5,973 990 990 990 0 2,371 2,371 0 0 2,371 1,672 547.2p 1/8/12 1/2/13 0 0 0 0 0 £0 690.4p 1/8/12 1/2/13 31/10/12 1,245.0p £13,150 £13,150 £11 £11 £13 £13 1,930 805.6p 1/8/15 1/2/16 0 1,930 990 990 4,592 0 0 909.0p 1/8/15 1/2/16 £0 £0 £0 £13,150 £0 £24 Note 1 No variations to terms and conditions of share options were made during the year. Note 2 The acquisition of shares under the worldwide save for shares plan is not subject to a performance condition. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 90 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration continued Note 3 Marjorie Scardino contributed US$1,000 per month (the maximum allowed) to the US employee stock purchase plan. The terms of this plan allow participants to make monthly contributions for six month periods and to acquire shares twice annually at the end of these periods at a price that is the lower of the market price at the beginning or the end of each period, both less 15%. Note 4 The market price on 31 December 2012 was 1,188.0p per share and the range during the year was 1,111.0p to 1,294.0p. Note 5 All share options that became exercisable during the year are included in the single figure of total remuneration for that year. The value included in the single figure of total remuneration is the number of options multiplied by the difference between the market value on the earliest exercise date (1,230.0p on 1 August 2012) and the option price. Payments for loss of office There were no payments for loss of office during 2012. As announced on 3 October 2012, Marjorie Scardino stepped down from the board and left the company on 31 December 2012. She served the company under her service agreement dated 27 February 2004, the details of which are described in the policy table on page 73. There was no payment for loss of office. As announced on 27 November 2012, Rona Fairhead is stepping down from the board at the annual general meeting on 26 April 2013 and leaving the company on 30 April 2013. Her service agreement dated 24 January 2003 provides for notice periods of six months from the director and 12 months from the company and compensation on termination of employment by the company without notice or cause of 100% of annual salary at the date of termination, the annual cost of pension and all other benefits and 50% of potential annual incentive. The committee and the board determined that her leaving employment was a consequence of the planned incorporation of the professional education division overseen by Rona into other parts of Pearson's education business, coupled with the smaller size of the Financial Times Group owing to recent major divestments. The company therefore intends to pay compensation amounting to approximately £1.146m comprising the elements described above to Rona in 2013. Interests of directors and value of shareholdings Ordinary shares at 1 Jan 12 (or date of appointment, if later) Ordinary shares at 31 Dec 12 Conditional shares at 31 Dec 12 Total number of ordinary and conditional shares at 31 Dec 12 Value (x salary) Guideline (x salary) Guideline met Chairman Glen Moreno Executive directors Marjorie Scardino Will Ethridge Rona Fairhead John Fallon (appointed 3 October 2012) Robin Freestone John Makinson Non-executive directors David Arculus Patrick Cescau Vivienne Cox Susan Fuhrman Ken Hydon Josh Lewis 150,000 150,000 – – – – 1,346,618 405,295 425,023 218,546 1,550,745 505,635 440,522 218,546 308,731 438,667 408,814 510,213 14,798 7,117 0 12,927 14,028 3,891 15,560 7,886 670 14,476 17,111 4,886 374,690 128,116 101,926 116,262 128,213 101,926 1,925,435 633,751 542,448 334,808 537,027 612,139 23.6 11.7 12.5 6.8 13.1 13.6 2.00 1.25 1.25 1.25 1.25 1.25 – – – – – – – – – – – – – – – – – – – – – – – – – (cid:57) (cid:57) (cid:57) (cid:57) (cid:57) (cid:57) – – – – – – Section 4 Governance 91 Note 1 Conditional shares means shares which have vested but remain held subject to continuing employment for a pre-defined holding period. Note 2 The current value of the executive directors’ holdings of ordinary and conditional shares is based on the middle market value of Pearson shares of 1,216.0p on 22 February 2013 (which is the latest practicable date before the results announcement) against base salaries in 2012. All executive directors comfortably exceeded the shareholding guidelines. The shareholding guidelines do not apply to the chairman and non-executive directors. Note 3 Ordinary shares include both ordinary shares listed on the London Stock Exchange and American Depositary Receipts (ADRs) listed on the New York Stock Exchange. The figures include both shares and ADRs acquired by individuals investing part of their own after-tax annual bonus in Pearson shares under the annual bonus share matching plan. Note 4 From 2004, Marjorie Scardino is also deemed to be interested in a further number of shares under her unfunded pension arrangement described in this report, which provides the opportunity to convert a proportion of her notional cash account into a notional share account reflecting the value of a number of Pearson shares. Note 5 The register of directors’ interests (which is open to inspection during normal office hours) contains full details of directors’ shareholdings and options to subscribe for shares. The market price on 31 December 2012 was 1,188.0p per share and the range during the year was 1,111.0p to 1,294.0p. Note 6 At 31 December 2012, Patrick Cescau held 168,000 Pearson bonds. Note 7 There were no movements in ordinary shares between 1 January 2012 and a month prior to the sign-off of this report. Note 8 Ordinary shares do not include any shares vested but held pending release under a restricted share plan. Marjorie Scardino Will Ethridge Rona Fairhead John Fallon Robin Freestone John Makinson 0 200 400 600 800 1,000 1,200 1,400 1,600 1,800 2,000 Number of shares (000) Shareholding guideline Ordinary shares Conditional shares Dilution and use of equity We can use existing shares bought in the market, treasury shares or newly-issued shares to satisfy awards under the company’s various stock plans. For restricted stock awards under the long-term incentive plan and matching share awards under the annual bonus share matching plan, we would normally expect to use existing shares. There are limits on the amount of new-issue equity we can use. In any rolling ten-year period, no more than 10% of Pearson equity will be issued, or be capable of being issued, under all Pearson’s share plans, and no more than 5% of Pearson equity will be issued, or be capable of being issued, under executive or discretionary plans. At 31 December 2012, stock awards to be satisfied by new-issue equity granted in the last ten years under all Pearson share plans amounted to 1.7% of the company’s issued share capital. No stock awards granted in the last ten years under executive or discretionary share plans will be satisfied by new-issue equity. In addition, for existing shares no more than 5% of Pearson equity may be held in trust at any time. Against this limit, shares held in trust at 31 December 2012 amounted to 1.2% of the company’s issued share capital. The headroom available for all Pearson plans, executive or discretionary plans and shares held in trust is as follows: Headroom 2012 2011 2010 All Pearson plans Executive or discretionary plans Shares held in trust 8.3% 8.3% 7.6% 5.0% 5.0% 4.1% 3.8% 3.2% 3.3% O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 92 Pearson plc Annual report and accounts 2012 Report on directors’ remuneration continued Executive directors’ non-executive directorships Total shareholder return: 5 years to 31 Dec 2012 The committee’s policy is that executive directors may, by agreement with the board, serve as non-executives of other companies and retain any fees payable for their services. The following executive directors served as non- executive directors elsewhere and received fees or other benefits for the period covered by this report as follows: Company Nokia Corporation Marjorie Scardino MacArthur Foundation Rona Fairhead HSBC Holdings plc Fees/benefits €150,000 $31,750 £200,000 Other executive directors served as non-executive directors elsewhere but did not receive fees. Shareholder engagement 200 175 150 125 100 75 50 2007 2008 2009 2010 2011 2012 Pearson FTSE All-Share Approved by the board and signed on its behalf by The voting results for prior reports on directors’ remuneration over the previous five years are presented below: David Arculus Director 7 March 2013 Year Date of AGM 2011 27 April 2012 2010 28 April 2011 2009 30 April 2010 2008 1 May 2009 2007 25 April 2008 Votes for Votes against 4.99% 89.20% 3.40% 94.07% 92.37% 4.97% 66.32% 23.36% 75.31% 10.42% This table expresses as a percentage the votes cast, ignoring any formal instructions to withhold. Total shareholder return performance In compliance with current regulations, we set out below Pearson’s total shareholder return performance relative to the FTSE All-Share index on an annual basis over the five-year period 2007 to 2012. Section 6 Financial statements 93 Financial statements: contents Consolidated financial statements Independent auditors’ report to the members of Pearson plc Consolidated income statement Consolidated statement of comprehensive income Consolidated balance sheet Consolidated statement of changes in equity Consolidated cash flow statement Notes to the consolidated financial statements 1 Accounting policies 2 Segment information 3 Discontinued operations 4 Operating expenses 5 Employee information 6 Net finance costs 7 Income tax 8 Earnings per share 9 Dividends 10 Property, plant and equipment 11 Intangible assets 12 Investments in joint ventures and associates 13 Deferred income tax 14 Classification of financial instruments 15 Other financial assets 16 Derivative financial instruments 17 Cash and cash equivalents (excluding overdrafts) 18 Financial liabilities – Borrowings 19 Financial risk management 20 Intangible assets – Pre-publication 21 Inventories 22 Trade and other receivables 23 Provisions for other liabilities and charges 24 Trade and other liabilities 25 Retirement benefit and other post-retirement obligations 26 Share-based payments 27 Share capital and share premium 28 Treasury shares 29 Other comprehensive income 30 Business combinations 31 Disposals including business closures 32 Held for sale 33 Transactions with non-controlling interest 34 Cash generated from operations 35 Contingencies 36 Commitments 37 Related party transactions 38 Events after the balance sheet date 39 Accounts and audit exemptions Company financial statements Company balance sheet Company statement of changes in equity Company cash flow statement Notes to the company financial statements Principal subsidiaries Five year summary Corporate and operating measures O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 94 96 97 98 100 101 102 109 113 113 115 116 117 119 121 122 124 127 129 131 133 133 134 135 137 144 144 145 146 146 147 154 156 156 157 157 159 160 160 161 162 162 163 163 164 166 167 168 169 175 176 178 94 Pearson plc Annual report and accounts 2012 Independent auditors’ report to the members of Pearson plc We have audited the consolidated and company financial statements (together the ‘financial statements’) of Pearson plc for the year ended 31 December 2012. The consolidated financial statements comprise the consolidated income statement, the consolidated statement of comprehensive income, the consolidated balance sheet, the consolidated statement of changes in equity, the consolidated cash flow statement and the related notes to the consolidated financial statements. The company financial statements comprise the company balance sheet, the company statement of changes in equity, the company cash flow statement and the related notes to the company financial statements. The financial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the European Union and, as regards the company financial statements, as applied in accordance with the provisions of the Companies Act 2006. Respective responsibilities of directors and auditors As explained more fully in the statement of directors’ responsibilities set out in the Governance section of the directors’ report, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors. This report, including the opinions, has been prepared for and only for the company’s members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing. Scope of the audit of the financial statements An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the Group’s and the company’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the directors; and the overall presentation of the financial statements. In addition, we read all the financial and non-financial information in the annual report and accounts to identify material inconsistencies with the audited financial statements. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report. Opinion on financial statements In our opinion: ›(cid:3)The financial statements give a true and fair view of the state of the Group’s and of the company’s affairs as at 31 December 2012 and of the Group’s profit and Group’s and company’s cash flows for the year then ended; ›(cid:3)The consolidated financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union; ›(cid:3)The company financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006; and ›(cid:3)The financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the consolidated financial statements, Article 4 of the lAS Regulation. Section 6 Financial statements 95 Opinion on other matters prescribed by the Companies Act 2006 In our opinion: ›(cid:3)The part of the report on directors’ remuneration to be audited has been properly prepared in accordance with the Companies Act 2006; and ›(cid:3)The information given in the directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements. Matters on which we are required to report by exception We have nothing to report in respect of the following: Under the Listing Rules we are required to review: ›(cid:3)The directors’ statement set out in the Governance section of the directors’ report in relation to going concern; ›(cid:3)The parts of the corporate governance statement relating to the company’s compliance with the nine provisions of the UK Corporate Governance Code specified for our review; and ›(cid:3)Certain elements of the report to shareholders by the board on directors’ remuneration. Ranjan Sriskandan (Senior Statutory Auditor) For and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London Under the Companies Act 2006 we are required to report to you if, in our opinion: 7 March 2013 ›(cid:3)Adequate accounting records have not been kept by the company, or returns adequate for our audit have not been received from branches not visited by us; or ›(cid:3)The company financial statements and the part of the report on directors’ remuneration to be audited are not in agreement with the accounting records and returns; or ›(cid:3)Certain disclosures of directors’ remuneration specified by law are not made; or ›(cid:3)We have not received all the information and explanations we require for our audit. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 96 Pearson plc Annual report and accounts 2012 Consolidated income statement Year ended 31 December 2012 All figures in £ millions Notes 2012 2011 Sales Cost of goods sold Gross profit Operating expenses Profit on sale of associate Loss on closure of subsidiary Share of results of joint ventures and associates Operating profit Finance costs Finance income Profit before tax Income tax Profit for the year from continuing operations Profit for the year from discontinued operations Profit for the year Attributable to: Equity holders of the company Non-controlling interest Earnings per share for profit from continuing and discontinued operations attributable to equity holders of the company during the year (expressed in pence per share) – basic – diluted Earnings per share for profit from continuing operations attributable to equity holders of the company during the year (expressed in pence per share) – basic – diluted 2 4 4 12 12 2 6 6 7 3 8 8 8 8 5,059 (2,224) 2,835 (2,216) – (113) 9 515 (113) 32 434 (148) 286 43 329 4,817 (2,072) 2,745 (2,072) 412 – 33 1,118 (96) 25 1,047 (162) 885 71 956 326 3 957 (1) 40.5p 40.5p 119.6p 119.3p 35.2p 35.1p 110.7p 110.5p Consolidated statement of comprehensive income Year ended 31 December 2012 Section 6 Financial statements 97 All figures in £ millions Profit for the year Net exchange differences on translation of foreign operations Actuarial losses on retirement benefit obligations – Group Actuarial losses on retirement benefit obligations – associate Tax on items recognised in other comprehensive income Other comprehensive expense for the year Total comprehensive income for the year Attributable to: Equity holders of the company Non-controlling interest Notes 25 12 7 2012 329 (238) (119) (3) 55 (305) 24 23 1 2011 956 (44) (56) (8) 3 (105) 851 858 (7) O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 98 Pearson plc Annual report and accounts 2012 Consolidated balance sheet As at 31 December 2012 All figures in £ millions Notes 2012 2011 Assets Non-current assets Property, plant and equipment Intangible assets Investments in joint ventures and associates Deferred income tax assets Financial assets – Derivative financial instruments Retirement benefit assets Other financial assets Trade and other receivables Current assets Intangible assets – Pre-publication Inventories Trade and other receivables Financial assets – Derivative financial instruments Financial assets – Marketable securities Cash and cash equivalents (excluding overdrafts) Assets classified as held for sale Total assets Liabilities Non-current liabilities Financial liabilities – Borrowings Financial liabilities – Derivative financial instruments Deferred income tax liabilities Retirement benefit obligations Provisions for other liabilities and charges Other liabilities Current liabilities Trade and other liabilities Financial liabilities – Borrowings Financial liabilities – Derivative financial instruments Current income tax liabilities Provisions for other liabilities and charges Liabilities directly associated with assets classified as held for sale Total liabilities Net assets 10 11 12 13 16 25 15 22 20 21 22 16 14 17 32 18 16 13 25 23 24 24 18 16 23 32 327 6,218 15 229 174 – 31 79 7,073 666 261 1,104 4 6 1,062 3,103 1,172 383 6,342 32 287 177 25 26 151 7,423 650 407 1,386 – 9 1,369 3,821 – 11,348 11,244 (2,010) – (601) (172) (110) (282) (3,175) (1,556) (262) – (291) (38) (2,147) (316) (1,964) (2) (620) (166) (115) (325) (3,192) (1,741) (87) (1) (213) (48) (2,090) – (5,638) 5,710 (5,282) 5,962 Section 6 Financial statements 99 All figures in £ millions Notes 2012 2011 Equity Share capital Share premium Treasury shares Translation reserve Retained earnings Total equity attributable to equity holders of the company Non-controlling interest Total equity 27 27 28 204 2,555 (103) 128 2,902 5,686 24 5,710 204 2,544 (149) 364 2,980 5,943 19 5,962 These financial statements have been approved for issue by the board of directors on 7 March 2013 and signed on its behalf by Robin Freestone Chief financial officer O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 100 Pearson plc Annual report and accounts 2012 Consolidated statement of changes in equity Year ended 31 December 2012 Equity attributable to equity holders of the company All figures in £ millions At 1 January 2012 Profit for the year Other comprehensive expense Equity-settled transactions Tax on equity-settled transactions Issue of ordinary shares under share option schemes Purchase of treasury shares Release of treasury shares Put options over non-controlling interest Changes in non-controlling interest Dividends At 31 December 2012 All figures in £ millions At 1 January 2011 Profit for the year Other comprehensive expense Equity-settled transactions Tax on equity-settled transactions Issue of ordinary shares under share option schemes Purchase of treasury shares Release of treasury shares Put options over non-controlling interest Changes in non-controlling interest Dividends At 31 December 2011 Share capital Share premium Treasury shares Translation reserve Retained earnings 204 – – – – – – – – – – 204 2,544 – – – – 11 – – – – – 2,555 (149) – – – – – – 46 – – – (103) 364 – (236) – – – – – – – – 128 Equity attributable to equity holders of the company Share capital Share premium Treasury shares Translation reserve Retained earnings Non- controlling interest 19 3 (2) – – – – – Total 5,943 326 (303) 32 (6) 11 – – Total equity 5,962 329 (305) 32 (6) 11 – – 2,980 326 (67) 32 (6) – – (46) 39 (10) (346) 2,902 39 (10) (346) 5,686 – 6 (2) 24 39 (4) (348) 5,710 Non- controlling interest 67 (1) (6) – – – – – Total 5,538 957 (99) 40 3 21 (60) – Total equity 5,605 956 (105) 40 3 21 (60) – 2,546 957 (61) 40 3 – – (48) (63) (76) (318) 2,980 (63) (76) (318) 5,943 – (40) (1) 19 (63) (116) (319) 5,962 203 – – – – 1 – – – – – 204 2,524 – – – – 20 – – – – – 2,544 (137) – – – – – (60) 48 – – – (149) 402 – (38) – – – – – – – – 364 The translation reserve includes exchange differences arising from the translation of the net investment in foreign operations and of borrowings and other currency instruments designated as hedges of such investments. Consolidated cash flow statement Year ended 31 December 2012 Section 6 Financial statements 101 All figures in £ millions Notes 2012 2011 Cash flows from operating activities Net cash generated from operations Interest paid Tax paid Net cash generated from operating activities Cash flows from investing activities Acquisition of subsidiaries, net of cash acquired Acquisition of joint ventures and associates Purchase of investments Purchase of property, plant and equipment Purchase of intangible assets Disposal of subsidiaries, net of cash disposed Proceeds from sale of associates Proceeds from sale of investments Proceeds from sale of property, plant & equipment Proceeds from sale of intangible assets Proceeds from the sale of liquid resources Investment in liquid resources Interest received Dividends received from joint ventures and associates Net cash used in investing activities Cash flows from financing activities Proceeds from issue of ordinary shares Purchase of treasury shares Proceeds from borrowings Proceeds from the sale of liquid resources Liquid resources acquired Repayment of borrowings Finance lease principal payments Dividends paid to company’s shareholders Dividends paid to non-controlling interest Transactions with non-controlling interest Net cash used in financing activities Effects of exchange rate changes on cash and cash equivalents Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year The consolidated cash flow statement includes discontinued operations (see note 3). 34 30 31 12 34 27 28 9 33 17 916 (75) (65) 776 (716) (39) (10) (78) (73) (11) – – 1 3 23 (19) 9 27 (883) 11 – 327 – (1) – (8) (346) (2) (4) (23) (24) (154) 1,291 1,137 1,093 (70) (151) 872 (779) (9) (12) (67) (77) (6) 428 75 9 3 – – 10 30 (395) 21 (60) – 2 – (318) (8) (318) (1) (108) (790) (60) (373) 1,664 1,291 O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 102 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements General information Pearson plc (the company) and its subsidiaries (together the Group) are international media businesses covering education, business information and consumer publishing. The company is a public limited company incorporated and domiciled in England. The address of its registered office is 80 Strand, London WC2R 0RL. The company has its primary listing on the London Stock Exchange and is also listed on the New York Stock Exchange. These consolidated financial statements were approved for issue by the board of directors on 7 March 2013. 1. Accounting policies The principal accounting policies applied in the preparation of these consolidated financial statements are set out below. a. Basis of preparation These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) and IFRS Interpretations Committee interpretations as adopted by the European Union (EU) and with those parts of the Companies Act 2006 applicable to companies reporting under IFRS. In respect of the accounting standards applicable to the Group there is no difference between EU-adopted and IASB-adopted IFRS. These consolidated financial statements have been prepared under the historical cost convention as modified by the revaluation of financial assets and liabilities (including derivative financial instruments) to fair value through profit or loss. 1. Interpretations and amendments to published standards effective 2012 The following amendments and interpretations were adopted in 2012 and have not had an impact on the Group financial statements: ›(cid:3)Amendments to IFRS 7 ‘Financial Instruments: Disclosures’. ›(cid:3)Amendments to IFRS 1 ‘First-time Adoption’. ›(cid:3)Amendments to IAS 12 ‘Income Taxes’. 2. Standards, interpretations and amendments to published standards that are not yet effective The Group has not early adopted the following new pronouncements that are not yet effective: ›(cid:3)Amendments to IAS 19 ‘Employee Benefits (2011)’, effective for annual reporting periods beginning on or after 1 January 2013. The amendments include the elimination of the corridor approach, changes to the calculation of the net interest and service cost components and changes to disclosure. If the 2012 accounts had been prepared using IAS 19 (2011) the service cost would have been £4m higher and the net interest income would have been £15m lower. ›(cid:3)IFRS 9 ‘Financial Instruments’, effective for annual reporting periods beginning on or after 1 January 2015. The new standard details the requirements for the classification and measurement of financial assets and liabilities. ›(cid:3)The IASB issued a ‘package of five’ new and amended standards together. IFRS 10 ‘Consolidated Financial Statements’, IFRS 11 ‘Joint Arrangements’ and IFRS 12 ‘Disclosures of Involvement with Other Entities’ have been issued. IAS 27 ‘Separate Financial Statements’ (Revised 2011) has been amended following the issuance of IFRS 10 and retains the guidance for separate financial statements, IAS 28 ‘Investments in Associates and Joint Ventures’ (Revised 2011) has been amended following the issuance of IFRS 10 and IFRS 11. All three new standards and two amended standards are effective for annual reporting periods beginning on or after 1 January 2013. ›(cid:3)IFRS 13 ‘Fair Value Measurement’, effective for annual reporting periods beginning on or after 1 January 2013. The standard defines fair value and provides guidance on its determination, and introduces disclosure requirements on fair value measurements. ›(cid:3)Amendments to IAS 1 ‘Presentation of Financial Statements’ – Presentation of Items and Other Comprehensive Income, effective for annual reporting periods beginning on or after 1 July 2012. The amendments require the grouping of items in other comprehensive income into those that may be reclassified to profit or loss in subsequent periods, and those that will not. With the exception of IAS 19 ‘Employee Benefits (2011)’, the changes in new pronouncements applicable from 1 January 2013 are not expected to have a material impact on the consolidated financial statements. 1. Accounting policies continued a. Basis of preparation continued 3. Critical accounting assumptions and judgements The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting assumptions. It also requires management to exercise its judgement in the process of applying the Group’s accounting policies. The areas requiring a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements, are discussed in the relevant accounting policies under the following headings: Intangible assets: Goodwill Intangible assets: Pre-publication assets Royalty advances Taxation Employee benefits: Pension obligations Revenue recognition b. Consolidation 1. Business combinations The acquisition method of accounting is used to account for business combinations of the Group with an acquisition date on or after 1 January 2010. The consideration transferred for the acquisition of a subsidiary is the fair value of the assets transferred, the liabilities incurred and the equity interest issued by the Group. The consideration transferred includes the fair value of any asset or liability resulting from a contingent consideration arrangement. Acquisition related costs are expensed as incurred in the operating expenses line of the income statement. Identifiable assets and contingent assets acquired and identifiable liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date. For material acquisitions, the fair value of the acquired intangible assets is determined by an external, independent valuer. The excess of the consideration transferred, the amount of any non-controlling interest in the acquiree and the acquisition date fair value of any previous equity interest in the acquiree over the fair value of the identifiable net assets acquired is recorded as goodwill. Section 6 Financial statements 103 See note 1e(1) for the accounting policy on goodwill. If this is less than the fair value of the net assets of the subsidiary acquired, in the case of a bargain purchase, the difference is recognised directly in the income statement. On an acquisition-by-acquisition basis, the Group recognises any non-controlling interest in the acquiree either at fair value or at the non-controlling interest’s proportionate share of the acquiree’s net assets. 2. Subsidiaries Subsidiaries are entities over which the Group has the power to govern the financial and operating policies, generally accompanying a shareholding of more than one half of the voting rights. Subsidiaries are fully consolidated from the date on which control is transferred to the Group and are de-consolidated from the date that control ceases. 3. Transactions with non-controlling interests Transactions with non-controlling interests are treated as transactions with shareholders. Any surplus or deficit arising from disposals to a non-controlling interest is recorded in equity. For purchases from a non-controlling interest, the difference between consideration paid and the relevant share acquired of the carrying value of the subsidiary is recorded in equity. 4. Joint ventures and associates Joint ventures are entities in which the Group holds an interest on a long-term basis and which are jointly controlled, with one or more other venturers, under a contractual arrangement. Associates are entities over which the Group has significant influence but not the power to control the financial and operating policies, generally accompanying a shareholding of between 20% and 50% of the voting rights. Investments in joint ventures and associates are accounted for by the equity method and are initially recognised at cost. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 104 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 1. Accounting policies continued b. Consolidation continued The Group’s share of its joint ventures’ and associates’ post-acquisition profits or losses is recognised in the income statement and its share of post-acquisition movements in reserves is recognised in reserves. The Group’s share of its joint ventures’ and associates’ results is recognised as a component of operating profit as these operations form part of the core publishing business of the Group and are an integral part of existing wholly-owned businesses. The cumulative post-acquisition movements are adjusted against the carrying amount of the investment. When the Group’s share of losses in a joint venture or associate equals or exceeds its interest in the joint venture or associate the Group does not recognise further losses unless the Group has incurred obligations or made payments on behalf of the joint venture or associate. c. Foreign currency translation 1. Functional and presentation currency Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (the ‘functional currency’). The consolidated financial statements are presented in sterling, which is the company’s functional and presentation currency. 2. Transactions and balances Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement, except when deferred in equity as qualifying net investment hedges. 3. Group companies The results and financial position of all Group companies that have a functional currency different from the presentation currency are translated into the presentation currency as follows: i) assets and liabilities are translated at the closing rate at the date of the balance sheet; ii) income and expenses are translated at average exchange rates; iii) all resulting exchange differences are recognised as a separate component of equity. On consolidation, exchange differences arising from the translation of the net investment in foreign entities, and of borrowings and other currency instruments designated as hedges of such investments, are taken to shareholders’ equity. The Group treats specific inter-company loan balances, which are not intended to be repaid in the foreseeable future, as part of its net investment. When a foreign operation is sold, such exchange differences are recognised in the income statement as part of the gain or loss on sale. The principal overseas currency for the Group is the US dollar. The average rate for the year against sterling was $1.59 (2011: $1.60) and the year end rate was $1.63 (2011: $1.55). d. Property, plant and equipment Property, plant and equipment are stated at historical cost less depreciation. Land is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate their cost less their residual values over their estimated useful lives as follows: Buildings (freehold): Buildings (leasehold): Plant and equipment: 20–50 years over the period of the lease 3–10 years The assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date. The carrying value of an asset is written down to its recoverable amount if the carrying value of the asset is greater than its estimated recoverable amount. e. Intangible assets 1. Goodwill For the acquisition of subsidiaries made on or after 1 January 2010 goodwill represents the excess of the consideration transferred, the amount of any non-controlling interest in the acquiree and the acquisition date fair value of any previous equity interest in the acquiree over the fair value of the identifiable net assets acquired. For the acquisition of subsidiaries made from the date of transition to IFRS to 31 December 2009 goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identifiable assets acquired. Goodwill on acquisitions of subsidiaries is included in intangible assets. Goodwill on acquisition of associates and joint ventures represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identifiable assets acquired. Goodwill on Section 6 Financial statements 105 1. Accounting policies continued e. Intangible assets continued acquisitions of associates and joint ventures is included in investments in associates and joint ventures. Goodwill is tested annually for impairment and carried at cost less accumulated impairment losses. An impairment loss is recognised to the extent that the carrying value of goodwill exceeds the recoverable amount. The recoverable amount is the higher of fair value less costs to sell and value in use. These calculations require the use of estimates and significant management judgement. A description of the key assumptions and sensitivities is included in note 11. Goodwill is allocated to cash-generating units for the purpose of impairment testing. The allocation is made to those cash-generating units that are expected to benefit from the business combination in which the goodwill arose. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold. 4. Acquired intangible assets Acquired intangible assets include customer lists and relationships, trademarks and brands, publishing rights, content and technology. These assets are capitalised on acquisition at cost and included in intangible assets. Intangible assets acquired in material business combinations are capitalised at their fair value as determined by an independent valuer. Intangible assets are amortised over their estimated useful lives of between two and 20 years, using an amortisation method that reflects the pattern of their consumption. 5. Pre-publication assets Pre-publication assets represent direct costs incurred in the development of educational programmes and titles prior to their publication. These costs are recognised as current intangible assets where the title will generate probable future economic benefits and costs can be measured reliably. Pre-publication assets are amortised upon publication of the title over estimated economic lives of five years or less, being an estimate of the expected operating life cycle of the title, with a higher proportion of the amortisation taken in the earlier years. IFRS 3 ‘Business Combinations’ has not been applied retrospectively to business combinations before the date of transition to IFRS. The investment in pre-publication assets has been disclosed as part of cash generated from operations in the cash flow statement (see note 34). 2. Acquired software Software separately acquired for internal use is capitalised at cost. Software acquired in material business combinations is capitalised at its fair value as determined by an independent valuer. Acquired software is amortised on a straight-line basis over its estimated useful life of between three and eight years. 3. Internally developed software Internal and external costs incurred during the preliminary stage of developing computer software for internal use are expensed as incurred. Internal and external costs incurred to develop computer software for internal use during the application development stage are capitalised if the Group expects economic benefits from the development. Capitalisation in the application development stage begins once the Group can reliably measure the expenditure attributable to the software development and has demonstrated its intention to complete and use the software. Internally developed software is amortised on a straight-line basis over its estimated useful life of between three and eight years. The assessment of the recoverability of pre-publication assets and the determination of the amortisation profile involve a significant degree of judgement based on historical trends and management estimation of future potential sales. An incorrect amortisation profile could result in excess amounts being carried forward as intangible assets that would otherwise have been written off to the income statement in an earlier period. Reviews are performed regularly to estimate recoverability of pre-publication assets. The carrying amount of pre-publication assets is set out in note 20. f. Other financial assets Other financial assets, designated as available for sale investments, are non-derivative financial assets measured at estimated fair value. Changes in the fair value are recorded in equity in the fair value reserve. On the subsequent disposal of the asset, the net fair value gains or losses are taken to the income statement. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 106 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 1. Accounting policies continued g. Inventories Inventories are stated at the lower of cost and net realisable value. Cost is determined using the first in first out (FIFO) method. The cost of finished goods and work in progress comprises raw materials, direct labour, other direct costs and related production overheads. Net realisable value is the estimated selling price in the ordinary course of business, less estimated costs necessary to make the sale. Provisions are made for slow moving and obsolete stock. h. Royalty advances Advances of royalties to authors are included within trade and other receivables when the advance is paid less any provision required to adjust the advance to its net realisable value. The realisable value of royalty advances relies on a degree of management judgement in determining the profitability of individual author contracts. If the estimated realisable value of author contracts is overstated, this will have an adverse effect on operating profits as these excess amounts will be written off. The recoverability of royalty advances is based upon an annual detailed management review of the age of the advance, the future sales projections for new authors and prior sales history of repeat authors. The royalty advance is expensed at the contracted or effective royalty rate as the related revenues are earned. Royalty advances which will be consumed within one year are held in current assets. Royalty advances which will be consumed after one year are held in non-current assets. i. Newspaper development costs Investment in the development of newspaper titles consists of measures to increase the volume and geographical spread of circulation. The measures include additional and enhanced editorial content, extended distribution and remote printing. These costs are expensed as incurred as they do not meet the criteria under IAS 38 ‘Intangible Assets’ to be capitalised as intangible assets. j. Cash and cash equivalents Cash and cash equivalents in the cash flow statement include cash in hand, deposits held on call with banks, other short-term highly liquid investments with original maturities of three months or less, and bank overdrafts. Bank overdrafts are included in borrowings in current liabilities in the balance sheet. Short-term deposits and marketable securities with maturities of greater than three months do not qualify as cash and cash equivalents. Movements on these financial instruments are classified as cash flows from financing activities in the cash flow statement where these amounts are used to offset the borrowings of the Group or as cash flows from investing activities where these amounts are held to generate an investment return. k. Share capital Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of new shares or options are shown in equity as a deduction, net of tax, from the proceeds. Where any Group company purchases the company’s equity share capital (treasury shares) the consideration paid, including any directly attributable incremental costs, net of income taxes, is deducted from equity attributable to the company’s equity holders until the shares are cancelled, reissued or disposed of. Where such shares are subsequently sold or reissued, any consideration received, net of any directly attributable transaction costs and the related income tax effects, is included in equity attributable to the company’s equity holders. l. Borrowings Borrowings are recognised initially at fair value, which is proceeds received net of transaction costs incurred. Borrowings are subsequently stated at amortised cost with any difference between the proceeds (net of transaction costs) and the redemption value being recognised in the income statement over the period of the borrowings using the effective interest method. Accrued interest is included as part of borrowings. Where a debt instrument is in a fair value hedging relationship, an adjustment is made to its carrying value in the income statement to reflect the hedged risk. Interest on borrowings is expensed in the income statement as incurred. m. Derivative financial instruments Derivatives are recognised at fair value and re- measured at each balance sheet date. The fair value of derivatives is determined by using market data and the use of established estimation techniques such as discounted cash flow and option valuation models. The Group designates certain of the derivative instruments within its portfolio to be hedges of the fair value of its bonds (fair value hedges) or hedges of net investments in foreign operations (net investment hedges). Section 6 Financial statements 107 1. Accounting policies continued m. Derivative financial instruments continued Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with any changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. The effective portion of changes in the fair value of derivatives that are designated and qualify as net investment hedges are recognised in other comprehensive income. Gains and losses accumulated in equity are included in the income statement when the corresponding foreign operation is disposed of. Gains or losses relating to the ineffective portion are recognised immediately in finance income or finance costs in the income statement. Certain derivatives do not qualify or are not designated as hedging instruments. Such derivatives are classified at fair value and any movement in their fair value is recognised immediately in finance income or finance costs in the income statement. n. Taxation Current tax is recognised on the amounts expected to be paid or recovered under the tax rates and laws that have been enacted or substantively enacted at the balance sheet date. Deferred income tax is provided, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts. Deferred income tax is determined using tax rates and laws that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred tax asset is realised or the deferred income tax liability is settled. Deferred tax assets are recognised to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilised. Deferred income tax is provided in respect of the undistributed earnings of subsidiaries other than where it is intended that those undistributed earnings will not be remitted in the foreseeable future. Current and deferred tax are recognised in the income statement, except when the tax relates to items charged or credited directly to equity or other comprehensive income, in which case the tax is also recognised in equity or other comprehensive income. The Group is subject to income taxes in numerous jurisdictions. Significant judgement is required in determining the estimates in relation to the worldwide provision for income taxes. There are many transactions and calculations for which the ultimate tax determination is uncertain during the ordinary course of business. The Group recognises liabilities for anticipated tax audit issues based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the income tax and deferred tax provisions in the period in which such determination is made. Deferred tax assets and liabilities require management judgement in determining the amounts to be recognised. In particular, significant judgement is used when assessing the extent to which deferred tax assets should be recognised with consideration given to the timing and level of future taxable income together with any future tax planning strategies. o. Employee benefits 1. Pension obligations The retirement benefit asset and obligation recognised in the balance sheet represents the net of the present value of the defined benefit obligation and the fair value of plan assets at the balance sheet date. The defined benefit obligation is calculated annually by independent actuaries using the projected unit credit method. The present value of the defined benefit obligation is determined by discounting estimated future cash flows using yields on high quality corporate bonds which have terms to maturity approximating the terms of the related liability. The determination of the pension cost and defined benefit obligation of the Group’s defined benefit pension schemes depends on the selection of certain assumptions, which include the discount rate, inflation rate, salary growth, longevity and expected return on scheme assets. Actuarial gains and losses arising from differences between actual and expected returns on plan assets, experience adjustments on liabilities and changes in actuarial assumptions are recognised immediately in other comprehensive income. The service cost, representing benefits accruing over the year, is included in the income statement as an operating cost. The unwinding of the discount rate on the scheme liabilities and the expected return on scheme assets are presented as finance costs or finance income. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 108 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 1. Accounting policies continued o. Employee benefits continued Obligations for contributions to defined contribution pension plans are recognised as an operating expense in the income statement as incurred. 2. Other post-retirement obligations The expected costs of post-retirement healthcare and life assurance benefits are accrued over the period of employment, using a similar accounting methodology as for defined benefit pension obligations. The liabilities and costs relating to significant other post-retirement obligations are assessed annually by independent qualified actuaries. 3. Share-based payments The fair value of options or shares granted under the Group’s share and option plans is recognised as an employee expense after taking into account the Group’s best estimate of the number of awards expected to vest. Fair value is measured at the date of grant and is spread over the vesting period of the option or share. The fair value of the options granted is measured using an option model that is most appropriate to the award. The fair value of shares awarded is measured using the share price at the date of grant unless another method is more appropriate. Any proceeds received are credited to share capital and share premium when the options are exercised. p. Provisions Provisions are recognised if the Group has a present legal or constructive obligation as a result of past events, it is more likely than not that an outflow of resources will be required to settle the obligation and the amount can be reliably estimated. Provisions are discounted to present value where the effect is material. The Group recognises a provision for deferred consideration at fair value. The Group recognises a provision for onerous lease contracts when the expected benefits to be derived from a contract are less than the unavoidable costs of meeting the obligations under the contract. The provision is based on the present value of future payments for surplus leased properties under non- cancellable operating leases, net of estimated sub- leasing income. q. Revenue recognition Revenue comprises the fair value of the consideration received or receivable for the sale of goods and services net of sales taxes, rebates and discounts, and after eliminating sales within the Group. Revenue from the sale of books is recognised when title passes. A provision for anticipated returns is made based primarily on historical return rates. If these estimates do not reflect actual returns in future periods then revenues could be understated or overstated for a particular period. Circulation and advertising revenue is recognised when the newspaper or other publication is published. Subscription revenue is recognised on a straight-line basis over the life of the subscription. Where a contractual arrangement consists of two or more separate elements that can be provided to customers either on a stand-alone basis or as an optional extra, such as the provision of supplementary materials with textbooks, revenue is recognised for each element as if it were an individual contractual arrangement. Revenue from multi-year contractual arrangements, such as contracts to process qualifying tests for individual professions and government departments, is recognised as performance occurs. The assumptions, risks, and uncertainties inherent in long-term contract accounting can affect the amounts and timing of revenue and related expenses reported. Certain of these arrangements, either as a result of a single service spanning more than one reporting period or where the contract requires the provision of a number of services that together constitute a single project, are treated as long-term contracts with revenue recognised on a percentage of completion basis. Losses on contracts are recognised in the period in which the loss first becomes foreseeable. Contract losses are determined to be the amount by which estimated total costs of the contract exceed the estimated total revenues that will be generated by the contract. On certain contracts, where the Group acts as agent, only commissions and fees receivable for services rendered are recognised as revenue. Any third-party costs incurred on behalf of the principal that are rechargeable under the contractual arrangement are not included in revenue. Section 6 Financial statements 109 1. Accounting policies continued q. Revenue recognition continued Income from recharges of freight and other activities which are incidental to the normal revenue generating activities is included in other income. r. Leases Leases of property, plant and equipment where the Group has substantially all the risks and rewards of ownership are classified as finance leases. Finance leases are capitalised at the commencement of the lease at the lower of the fair value of the leased property and the present value of the minimum lease payments. Each lease payment is allocated between the liability and finance charges to achieve a constant rate on the finance balance outstanding. The corresponding rental obligations, net of finance charges, are included in financial liabilities – borrowings. The interest element of the finance cost is charged to the income statement over the lease period to produce a constant periodic rate of interest on the remaining balance of the liability for each period. The property, plant and equipment acquired under finance leases are depreciated over the shorter of the useful life of the asset or the lease term. Leases where a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases by the lessee. Payments made under operating leases (net of any incentives received from the lessor) are charged to the income statement on a straight-line basis over the period of the lease. s. Dividends Dividends are recorded in the Group’s financial statements in the period in which they are approved by the company’s shareholders. Interim dividends are recorded in the period in which they are approved and paid. t. Assets and liabilities held for sale Assets and liabilities are classified as held for sale and stated at the lower of carrying amount and fair value less costs to sell if it is intended to recover their carrying amount principally through a sale transaction rather than through continuing use. No depreciation is charged in respect of non-current assets classified as held for sale. Amounts relating to non-current assets and liabilities held for sale are classified as discontinued operations in the income statement where appropriate. u. Trade receivables Trade receivables are stated at fair value after provision for bad and doubtful debts and anticipated future sales returns (see also note 1q). 2. Segment information The Group is organised into the following business segments: Continuing operations: North American Education Educational publishing, assessment and testing for the school and higher education market within the USA and Canada; International Education Educational publishing, assessment and testing for the school and higher education market outside of North America; Professional Business and technology publishing, training, testing and certification for professional bodies; FT Group Publisher of the Financial Times, business magazines and specialist information; Discontinued operations: Penguin Consumer publisher with brand imprints such as Penguin, Putnam, Berkley, Viking and Dorling Kindersley. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 110 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 2. Segment information continued In October 2012, Pearson and Bertelsmann announced an agreement to create a new consumer publishing business by combining Penguin and Random House. The transaction is expected to complete in 2013 and, at that point, Pearson will no longer control the Penguin group of companies but will equity account for its 47% associate interest. The loss of control results in the Penguin business being classified as held for sale in the Pearson balance sheet at December 2012 and the results for both 2011 and 2012 have been included in discontinued operations. For more detail on the services and products included in each business segment refer to the business review. North American Education International Education Notes Professional Group Corporate FT Discontinued operations Group 2012 All figures in £ millions Continuing operations Sales (external) Sales (inter-segment) Adjusted operating profit Intangible charges Acquisition costs Other net gains and losses Operating profit Finance costs Finance income Profit before tax Income tax Profit for the year from continuing operations Segment assets Joint ventures Associates Total assets 2,658 5 536 (66) (7) – 463 1,568 1 216 (73) (8) – 135 390 12 37 (37) (1) (123) (124) 443 – 49 (4) (4) – 41 – – – – – – – – 5,059 18 – 838 – (180) – (20) – (123) – 515 – (113) 32 434 (148) 286 6 6 7 12 12 5,449 – 1 5,450 2,390 7 4 2,401 631 – – 631 (11) 16 7 8 45 445 1 2 448 1,246 – – 1,246 1,145 11,306 8 34 1,172 11,348 – 27 23 26 – 8 16 – – – – – – 11 31 7 39 9 152 364 80 553 Other segment items Share of results of joint ventures and associates Capital expenditure Pre-publication investment Depreciation Amortisation 12 10, 11 20 10 11, 20 – 66 250 41 311 (3) 33 76 16 142 2. Segment information continued All figures in £ millions Continuing operations Sales (external) Sales (inter-segment) Adjusted operating profit Intangible charges Acquisition costs Other net gains and losses Operating profit Finance costs Finance income Profit before tax Income tax Profit for the year from continuing operations Segment assets Joint ventures Associates Total assets Section 6 Financial statements 111 North American Education Notes International Education Professional FT Group Corporate Discontinued operations Group 2011 2,584 3 493 (57) (2) 29 463 1,424 – 196 (60) (9) (6) 121 382 9 66 (11) – – 55 427 – 76 (8) (1) 412 479 – – – – – – – – 4,817 12 – 831 – (136) – – (12) 435 – – 1,118 (96) 25 1,047 (162) 885 6 6 7 12 12 5,198 – 1 5,199 2,388 16 8 2,412 626 – – 626 1 17 2 8 16 424 1 4 429 1,555 – – 1,555 1,021 11,212 18 14 1,023 11,244 1 1 34 19 – 4 20 – – – – – – 12 32 8 45 33 156 331 70 518 Other segment items Share of results of joint ventures and associates Capital expenditure Pre-publication investment Depreciation Amortisation 12 10, 11 20 10 11, 20 – 75 237 36 309 (2) 33 60 14 128 In 2012, sales from the provision of goods were £2,946m (2011: £3,009m) and sales from the provision of services were £2,113m (2011: £1,808m). Sales from the Group’s educational publishing, consumer publishing and newspaper business are classified as being from the provision of goods and sales from its assessment and testing and other service businesses are classified as being from the provision of services. Included in other net gains and losses in 2012 in the Professional segment is the loss on closure of Pearson in Practice (£113m) and an impairment loss on a joint venture (£10m). In 2011 other net gains and losses includes a gain on sale of FTSE International (£412m) in the FT Group, a gain on the sale of investments in the North American Ed International Ed ucation business (£29m) and a net loss of £6m on acquisition and disposal transactions in the ucation business. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 112 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 2. Segment information continued Corporate costs are allocated to business segments including discontinued operations on an appropriate basis depending on the nature of the cost and therefore the segment result is equal to the Group operating profit. Inter- segment pricing is determined on an arm’s-length basis. Segment assets consist of property, plant and equipment, intangible assets, inventories, receivables, deferred taxation and other financial assets and exclude cash and cash equivalents and derivative assets. Corporate assets comprise cash and cash equivalents, marketable securities and derivative financial instruments. Capital expenditure comprises additions to property, plant and equipment and software (see notes 10 and 11). Property, plant and equipment and intangible assets acquired through business combination were £296m (2011: £404m) (see note 30). Capital expenditure, depreciation and amortisation include amounts relating to discontinued operations. The Group operates in the following main geographic areas: All figures in £ millions Continuing operations UK Other European countries USA Canada Asia Pacific Other countries Total continuing Discontinued operations UK Other European countries USA Canada Asia Pacific Other countries Total discontinued Total 2012 705 391 2,800 145 647 371 5,059 160 78 603 56 139 17 1,053 6,112 Sales 2011 713 394 2,707 150 514 339 4,817 152 77 606 59 132 19 1,045 5,862 Non-current assets 2012 2011 803 234 4,496 307 524 275 6,639 – – – – – – – 6,639 1,237 225 4,325 226 570 325 6,908 – – – – – – – 6,908 Sales are allocated based on the country in which the customer is located. This does not differ materially from the location where the order is received. The geographical split of non-current assets is based on the subsidiary’s country of domicile. This is not materially different to the location of the assets. Non-current assets comprise property, plant and equipment, intangible assets, investments in joint ventures and associates and trade and other receivables. Section 6 Financial statements 113 3. Discontinued operations Discontinued operations relate to Penguin. An analysis of the results and cash flows of discontinued operations is as follows: All figures in £ millions Sales Operating profit Profit before tax Attributable tax expense Profit after tax from discontinued operations Operating cash flows Investing cash flows Financing cash flows Total cash flows 2012 2011 Penguin 1,053 Penguin 1,045 62 62 (19) 43 83 (81) 10 12 108 108 (37) 71 107 (13) (71) 23 Included in operating profit in 2012 are costs associated with the formation of Penguin Random House of £32m, including a provision for the settlement of litigation associated with the agency arrangement for eBooks. 4. Operating expenses All figures in £ millions By function: Cost of goods sold Operating expenses Distribution costs Administrative and other expenses Other income Total net operating expenses Total 2012 2011 2,224 2,072 177 2,111 (72) 2,216 4,440 190 1,999 (117) 2,072 4,144 Included in other income in 2011 is a profit of £29m on the sale of an investment and a gain of £8m on a stepped acquisition. Both these items are excluded from adjusted earnings. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 114 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 4. Operating expenses continued All figures in £ millions By nature: Utilisation of inventory Depreciation of property, plant and equipment Amortisation of intangible assets – Pre-publication Amortisation of intangible assets – Other Acquisition costs Employee benefit expense Operating lease rentals Other property costs Royalties expensed Advertising, promotion and marketing Information technology costs Other costs Other income Total Notes 2012 2011 21 10 20 11 8 5 512 72 283 230 20 1,916 171 33 245 247 82 701 (72) 4,440 585 63 292 181 12 1,778 164 37 260 234 74 581 (117) 4,144 During the year the Group obtained the following services from the Group’s auditors: All figures in £ millions 2012 2011 The audit of parent company and consolidated financial statements The audit of the company’s subsidiaries Total audit fees Other assurance services Total assurance services Tax compliance services Tax advisory services Total tax services Corporate finance services not covered above Total non-audit services Total Reconciliation between audit and non-audit service fees is shown below: 4 2 6 1 1 1 1 2 – 3 9 4 2 6 – – 1 1 2 1 3 9 All figures in £ millions Group audit fees including fees for attestation under section 404 of the Sarbanes-Oxley Act Non-audit fees Total 2012 2011 6 3 9 6 3 9 Fees for attestation under section 404 of the Sarbanes-Oxley Act are allocated between fees payable for the audits of consolidated and subsidiary accounts. Section 6 Financial statements 115 5. Employee information All figures in £ millions Employee benefit expense Wages and salaries (including termination benefits and restructuring costs) Social security costs Share-based payment costs Retirement benefits – defined contribution plans Retirement benefits – defined benefit plans Other post-retirement benefits Total Notes 2012 2011 1,659 132 28 71 22 4 1,916 1,531 126 36 62 20 3 1,778 26 25 25 25 The details of the emoluments of the directors of Pearson plc are shown in the report on directors’ remuneration. Average number employed Employee numbers North American Education International Education Professional FT Group Other Continuing operations 2012 2011 18,552 16,751 3,706 3,088 883 42,980 16,133 13,646 4,561 2,765 859 37,964 The employee benefit expense relating to discontinued operations was £211m (2011: £205m) and the average number employed was 4,542 (2011: 3,557). O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 116 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 6. Net finance costs All figures in £ millions Interest payable Finance cost of put options, deferred consideration associated with acquisitions and other interest charges related to transactions Net foreign exchange losses Other losses on financial instruments in a hedging relationship: – fair value hedges Other losses on financial instruments not in a hedging relationship: – derivatives Finance costs Interest receivable Net finance income in respect of retirement benefits Net foreign exchange gains Other gains on financial instruments in a hedging relationship: – fair value hedges Other gains on financial instruments not in a hedging relationship: – amortisation of transitional adjustment on bonds – derivatives Finance income Net finance costs Analysed as: Net interest payable Net finance income in respect of retirement benefits Net finance costs reflected in adjusted earnings – continuing operations Other net finance costs Total net finance costs Notes 25 25 2012 (75) (27) (8) 2011 (65) (4) (22) (1) – (2) (113) 10 13 9 (5) (96) 10 3 11 – – – – 32 (81) (65) 13 (52) (29) (81) 1 – 25 (71) (55) 3 (52) (19) (71) The net loss of £1m on fair value hedges in 2012 (2011: £nil) comprises a gain of £7m (2011: loss of £39m) on the underlying bonds, offset by a loss of £8m (2011: gain of £39m) on the related derivative financial instruments. Section 6 Financial statements 117 7. Income tax All figures in £ millions Current tax Charge in respect of current year Adjustments in respect of prior years Total current tax charge Deferred tax In respect of temporary differences Other adjustments in respect of prior years Total deferred tax charge Total tax charge Notes 2012 2011 (154) 18 (136) (48) 36 (12) (148) (187) 36 (151) (15) 4 (11) (162) 13 The tax on the Group’s profit before tax differs from the theoretical amount that would arise using the UK tax rate as follows: All figures in £ millions 2012 2011 Profit before tax Tax calculated at UK rate (2012: 24.5%, 2011: 26.5%) Effect of overseas tax rates Joint venture and associate income reported net of tax Net (expense)/income not subject to tax (Loss)/gain on sale of businesses not subject to tax Utilisation of previously unrecognised tax losses and credits Unutilised tax losses Adjustments in respect of prior years Total tax charge UK Overseas Total tax charge Tax rate reflected in earnings 434 (106) (51) 2 (15) (28) 2 (6) 54 (148) (22) (126) (148) 34.1% 1,047 (277) (27) 9 7 88 1 (3) 40 (162) (10) (152) (162) 15.5% O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 118 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 7. Income tax continued The tax rate reflected in adjusted earnings is calculated as follows: All figures in £ millions Profit before tax Adjustments: Other net losses/(gains) Acquisition costs Amortisation of acquired intangibles Other net finance costs Adjusted profit before tax – continuing operations Adjusted profit before tax – discontinued operations Total adjusted profit before tax Total tax charge Adjustments: Tax charge on other net gains Tax benefit on acquisition costs Tax benefit on amortisation of acquired intangibles Tax benefit on other net finance income Tax amortisation benefit on goodwill and intangibles Adjusted income tax charge – continuing operations Adjusted income tax charge – discontinued operations Total adjusted income tax charge Tax rate reflected in adjusted earnings The tax benefit/(charge) recognised in other comprehensive income is as follows: All figures in £ millions Pension contributions and actuarial gains and losses Net investment hedges and other foreign exchange gains and losses 2012 434 123 20 180 29 786 98 884 2011 1,047 (435) 12 136 19 779 111 890 (148) (162) – (5) (54) (1) 36 (172) (32) (204) 23.1% 19 (4) (43) (5) 34 (161) (38) (199) 22.4% 2012 2011 55 – 55 7 (4) 3 A tax benefit of £6m (2011: tax benefit £3m) relating to share-based payments has been recognised directly in equity. Section 6 Financial statements 119 8. Earnings per share Basic Basic earnings per share is calculated by dividing the profit attributable to equity shareholders of the company by the weighted average number of ordinary shares in issue during the year, excluding ordinary shares purchased by the company and held as treasury shares. Diluted Diluted earnings per share is calculated by adjusting the weighted average number of ordinary shares to take account of all dilutive potential ordinary shares and adjusting the profit attributable, if applicable, to account for any tax consequences that might arise from conversion of those shares. All figures in £ millions Profit for the year from continuing operations Non-controlling interest Earnings from continuing operations Profit for the year from discontinued operations Non-controlling interest Earnings Weighted average number of shares (millions) Effect of dilutive share options (millions) Weighted average number of shares (millions) for diluted earnings Earnings per share from continuing and discontinued operations Basic Diluted Earnings per share from continuing operations Basic Diluted Earnings per share from discontinued operations Basic Diluted Notes 3 2012 286 (3) 283 43 – 326 2011 885 1 886 71 – 957 804.3 1.3 805.6 800.2 1.7 801.9 40.5p 40.5p 119.6p 119.3p 35.2p 35.1p 110.7p 110.5p 5.3p 5.4p 8.9p 8.8p Adjusted In order to show results from operating activities on a consistent basis, an adjusted earnings per share is presented. The company’s definition of adjusted earnings per share may not be comparable to other similarly titled measures reported by other companies. Adjusted earnings includes the results from continuing and discontinued operations. The following items are excluded from adjusted earnings: Other net gains and losses represent profits and losses on the acquisition and disposal of subsidiaries, joint ventures, associates and other financial assets that are included within continuing or discontinued operations but which distort the performance of the Group. Amortisation of acquired intangibles, acquisition costs and movements in contingent acquisition consideration are also excluded from adjusted earnings as these items are not considered to be fully reflective of the underlying performance of the Group. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 120 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 8. Earnings per share continued Other net finance income/costs include the finance costs of put options and deferred consideration that relate to future earn outs and similar payments on acquisition, foreign exchange and other gains and losses that represent short-term fluctuations in market value and foreign exchange movements on transactions and balances that are no longer in a hedge relationship. In the case of acquisition related items these are excluded as they do not reflect cash expended and foreign exchange and other gains and losses are subject to significant volatility and may not be realised in due course as it is normally the intention to hold these instruments to maturity. Other net finance costs of Group companies are included in finance costs or finance income as appropriate. Other net finance costs of joint ventures and associates are included within the share of results of joint ventures and associates within operating profit. Following the adoption of IAS 19 revised in 2013 the Group intends to exclude the pension finance income or expense from adjusted earnings as the calculation under the new standard will not necessarily reflect the underlying economics associated with the relevant pension assets and liabilities. Tax on the above items is excluded from adjusted earnings. Where relevant the Group also excludes the benefit from recognising previously unrecognised pre-acquisition and capital losses. The Group adds the benefit of tax amortisation of goodwill and intangibles as this benefit more accurately aligns the adjusted tax charge with the expected rate of cash tax payments. Non-controlling interest for the above items is excluded from adjusted earnings. The following tables reconcile statutory earnings to adjusted earnings. All figures in £ millions Operating profit Net finance costs Profit before tax Income tax Profit for the year from continuing operations Profit for the year from discontinued operations Profit for the year Non-controlling interest Earnings Weighted average number of shares (millions) Adjusted earnings per share Statutory income statement Discontinued operations Other net gains and losses Acquisition costs Intangible charges 2012 Other net finance income/ costs Tax amortisation benefit Adjusted income statement 98 – 98 (32) 123 – 123 – 66 123 (66) – – – 20 143 – 143 20 – 20 (5) 15 1 16 – 16 180 – 180 (54) 126 2 128 – 128 – 29 29 (1) 28 – 28 – 28 515 (81) 434 (148) 286 43 329 (3) 326 804.3 40.5p – – – 36 36 – 36 – 36 936 (52) 884 (204) 680 – 680 (3) 677 804.3 84.2p 8. Earnings per share continued Statutory income statement 1,118 (71) 1,047 (162) 885 71 956 1 957 800.2 119.6p All figures in £ millions Operating profit Net finance costs Profit before tax Income tax Profit for the year from continuing operations Profit for the year from discontinued operations Profit for the year Non-controlling interest Earnings Weighted average number of shares (millions) Adjusted earnings per share 9. Dividends All figures in £ millions Section 6 Financial statements 121 Discontinued operations Other net gains and losses Acquisition costs Intangible charges 2011 Other net finance income/ costs Tax amortisation benefit Adjusted income statement 111 – 111 (38) (435) – (435) 19 73 (416) (73) – – – – (416) – (416) 12 – 12 (4) 8 – 8 – 8 136 – 136 (43) 93 2 95 – 95 – 19 19 (5) 14 – 14 – 14 – – – 34 942 (52) 890 (199) 34 691 – 34 – 34 2012 225 121 346 – 691 1 692 800.2 86.5p 2011 206 112 318 Final paid in respect of prior year 28.0p (2011: 25.7p) Interim paid in respect of current year 15.0p (2011: 14.0p) The directors are proposing a final dividend in respect of the financial year ended 31 December 2012 of 30.0p per share which will absorb an estimated £245m of shareholders’ funds. It will be paid on 3 May 2013 to shareholders who are on the register of members on 5 April 2013. These financial statements do not reflect this dividend. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 122 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 10. Property, plant and equipment All figures in £ millions Cost At 1 January 2011 Exchange differences Additions Disposals Acquisition through business combination Disposal through business disposal Reclassifications At 31 December 2011 Exchange differences Additions Disposals Acquisition through business combination Disposal through business disposal Reclassifications Transfer from/(to) software Transfer from pre-publication Transfer to assets held for sale At 31 December 2012 Land and buildings Plant and equipment Assets in course of construction 336 2 15 (13) 11 – 12 363 (9) 12 (2) 4 (1) 8 9 – (32) 352 669 (2) 51 (31) 21 (2) – 706 (23) 51 (20) 13 (4) – (27) 3 (102) 597 11 – 13 – – – (12) 12 – 15 – – – (8) – – (1) 18 Total 1,016 – 79 (44) 32 (2) – 1,081 (32) 78 (22) 17 (5) – (18) 3 (135) 967 10. Property, plant and equipment continued All figures in £ millions Depreciation At 1 January 2011 Exchange differences Charge for the year Disposals Acquisition through business combination Disposal through business disposal Reclassifications At 31 December 2011 Exchange differences Charge for the year Disposals Acquisition through business combination Disposal through business disposal Reclassifications Transfer (from)/to software Transfer to assets held for sale At 31 December 2012 Carrying amounts At 1 January 2011 At 31 December 2011 At 31 December 2012 Section 6 Financial statements 123 Land and buildings Plant and equipment Assets in course of construction (166) (1) (16) 2 (1) – (5) (187) 6 (21) 2 (1) – (8) (3) 17 (195) 170 176 157 (484) 1 (54) 29 (10) 2 5 (511) 17 (59) 19 (6) 2 8 7 78 (445) 185 195 152 – – – – – – – – – – – – – – – – – 11 12 18 Total (650) – (70) 31 (11) 2 – (698) 23 (80) 21 (7) 2 – 4 95 (640) 366 383 327 O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 124 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 10. Property, plant and equipment continued Depreciation expense of £19m (2011: £15m) has been included in the income statement in cost of goods sold, £9m (2011: £10m) in distribution expenses and £52m (2011: £45m) in administrative and other expenses. In 2012 £7m (2011: £8m) relates to discontinued operations. The Group leases certain equipment under a number of finance lease agreements. The net carrying amount of leased plant and equipment included within property, plant and equipment was £17m (2011: £18m). 11. Intangible assets All figures in £ millions Goodwill Software Acquired customer lists and relationships Acquired trademarks and brands Acquired publishing rights Other intangibles acquired Cost At 1 January 2011 Exchange differences Additions – internal development Additions – purchased Disposals Acquisition through business combination Disposal through business disposal At 31 December 2011 Exchange differences Additions – internal development Additions – purchased Disposals Acquisition through business combination Disposal through business disposal Transfer from PPE Transfer to assets held for sale At 31 December 2012 4,568 15 – – – 620 (4) 5,199 (213) – – – 505 (50) – (364) 5,077 352 (1) 49 28 (9) 9 – 428 (13) 38 36 (11) 12 – 18 (42) 466 431 1 – – – 200 – 632 (22) – – – 128 (89) – (14) 635 186 (1) – – – 68 – 253 (11) – – – 27 (2) – (9) 258 230 (12) – – – – (5) 213 (9) – – – 10 – – (7) 207 306 (1) – – – 100 – 405 (22) – – – 110 – – (5) 488 Total 6,073 1 49 28 (9) 997 (9) 7,130 (290) 38 36 (11) 792 (141) 18 (441) 7,131 Section 6 Financial statements 125 11. Intangible assets continued All figures in £ millions Goodwill Software Acquired customer lists and relationships Acquired trademarks and brands Acquired publishing rights Other intangibles acquired Amortisation At 1 January 2011 Exchange differences Charge for the year Disposals Acquisition through business combination Disposal through business disposal At 31 December 2011 Exchange differences Charge for the year Disposals Acquisition through business combination Disposal through business disposal Transfer from PPE Transfer to assets held for sale At 31 December 2012 Carrying amounts At 1 January 2011 At 31 December 2011 At 31 December 2012 – – – – – – – – – – – – – – – 4,568 5,199 5,077 (250) (2) (48) 6 (2) – (296) 9 (54) 8 (7) – (4) 32 (312) 102 132 154 (103) 1 (55) – – – (157) 7 (85) – – 45 – 1 (189) 328 475 446 (41) – (22) – – – (63) 3 (27) – – 1 – – (86) 145 190 172 (111) 4 (22) – – 1 (128) 5 (20) – – – – 4 (139) 119 85 68 Total (606) – (187) 6 (2) 1 (788) 32 (237) 8 (7) 46 (4) 37 (913) (101) (3) (40) – – – (144) 8 (51) – – – – – (187) 205 261 301 5,467 6,342 6,218 Goodwill The goodwill carrying value of £5,077m relates to acquisitions completed after 1 January 1998. Prior to 1 January 1998 all goodwill was written off to reserves on the date of acquisition. For acquisitions completed between 1 January 1998 and 31 December 2002 no value was ascribed to intangibles other than goodwill and the goodwill on each acquisition was amortised over a period of up to 20 years. On adoption of IFRS on 1 January 2003, the Group chose not to restate the goodwill balance and at that date the balance was frozen (i.e. amortisation ceased). If goodwill had been restated then a significant value would have been ascribed to other intangible assets, which would be subject to amortisation, and the carrying value of goodwill would be significantly lower. For acquisitions completed after 1 January 2003 value has been ascribed to other intangible assets which are amortised. Other intangible assets Other intangibles acquired include content, technology, contracts and software rights. Intangible assets are valued separately for each acquisition and the primary method of valuation used is the discounted cash flow method. The majority of acquired intangibles are amortised using the unit of production method which is based on the pattern of benefits embodied in the asset. Amortisation of £10m (2011: £10m) is included in the income statement in cost of goods sold and £205m (2011: £177m) in administrative and other expenses. Also included in the amortisation charge for the year in 2012 is an impairment of £21m relating to Pearson in Practice which is included in the income statement in administrative and other expenses. In 2012 £7m (2011: £6m) of amortisation relates to discontinued operations. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 126 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 11. Intangible assets continued The range of useful economic lives for each major class of intangible asset (excluding goodwill and software) is shown below: Class of intangible asset Acquired customer lists and relationships Acquired trademarks and brands Acquired publishing rights Other intangibles acquired The expected amortisation profile of acquired intangible assets is shown below: 2012 Useful economic life 5–20 years 5–20 years 5–20 years 2–20 years All figures in £ millions Class of intangible asset Acquired customer lists and relationships Acquired trademarks and brands Acquired publishing rights Other intangibles acquired One to five years Six to ten years More than ten years 263 89 59 231 132 49 8 63 51 34 1 7 2012 Total 446 172 68 301 Impairment tests for cash-generating units containing goodwill Impairment tests have been carried out where appropriate as described below. The recoverable amount for each unit tested exceeds its carrying value. Goodwill in respect of continuing operations is allocated to, and monitored at the level of, 10 aggregated cash- generating units (CGUs) within the business segments as follows: All figures in £ millions US Education Publishing US School Assessment and Information Canada International – Emerging Markets International – UK International – Rest Of World Professional Publishing Professional Assessment and Training Pearson Education total Financial Times Mergermarket FT Group total Continuing operations Goodwill in respect of discontinued operations is £364m (2011: £315m). 2012 2,384 773 188 463 450 267 15 334 4,874 51 152 203 5,077 2011 2,127 792 192 508 460 228 13 377 4,697 49 138 187 4,884 Section 6 Financial statements 127 11. Intangible assets continued Impairment tests for cash-generating units containing goodwill continued The recoverable amount of each CGU is based on value in use calculations. Goodwill is tested for impairment annually. Other than goodwill there are no intangible assets with indefinite lives. The goodwill is generally denominated in the currency of the relevant cash flows and therefore the impairment review is not materially sensitive to exchange rate fluctuations. In 2011, following a reorganisation within the International Education business the CGUs were re-analysed into Emerging Markets, UK and Rest Of World to align with the management and reporting structure. The goodwill was reallocated accordingly using a relative value approach except where goodwill is directly attributable to one of the new CGUs, in which case the goodwill was specifically allocated to the relevant CGU. Key assumptions The value in use calculations use cash flow projections based on financial budgets approved by management covering a five-year period. The key assumptions used by management in the value in use calculations were: Discount rate The discount rate is based on the risk-free rate for government bonds, adjusted for a risk premium to reflect the increased risk in investing in equities. The risk premium adjustment is assessed for each specific CGU. The average pre-tax discount rates used are in the range of 9.8% to 12.7% for the Pearson Education businesses (2011: 10.7% to 13.3%) and 11.5% to 18.4% for the FT Group businesses (2011: 11.6% to 17.9%). Perpetuity growth rates A perpetuity growth rate of 2.0% was used for cash flows subsequent to the approved budget period for all CGUs in 2012 (2011: 2.0%). This perpetuity growth rate is a conservative rate and is considered to be lower than the long-term historic growth rates of the underlying territories in which the CGU operates and the long-term growth rate prospects of the sectors in which the CGU operates. Cash flow growth rates The cash flow growth rates are derived from management’s latest forecast of sales taking into consideration experience of operating margins achieved in the CGU. Historically, such forecasts have been reasonably accurate. Sensitivities The Group’s impairment review is sensitive to a change in assumptions used, most notably the discount rates, the perpetuity growth rates and expected future cash flows. Based on the Group’s sensitivity analysis, a reasonably possible change in any of these assumptions is unlikely to cause an impairment in any of the CGUs. 12. Investments in joint ventures and associates Joint ventures All figures in £ millions At beginning of year Exchange differences Share of loss after tax Dividends Additions and further investment Goodwill impairment At end of year 2012 18 – (4) (2) 6 (10) 8 2011 18 (3) (2) (2) 7 – 18 The goodwill impairment charge relates to the write down of the Group’s investment in a joint venture in India. Investments in joint ventures are accounted for using the equity method of accounting and are initially recognised at cost. The total goodwill recorded on acquisition of joint ventures at 31 December 2012 was £1m (2011: £11m). O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 128 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 12. Investments in joint ventures and associates continued The aggregate of the Group’s share of its joint ventures’ assets (including goodwill) and liabilities, none of which are individually significant, are as follows: All figures in £ millions Assets Non-current assets Current assets Liabilities Non-current liabilities Current liabilities Net assets Income Expenses Loss after tax Associates All figures in £ millions At beginning of year Exchange differences Share of profit after tax Dividends Additions Disposals Actuarial losses on retirement benefit obligations Transfer to subsidiary Transfer to assets held for sale At end of year 2012 2011 5 19 (2) (14) 8 24 (28) (4) 2012 14 (8) 23 (24) 32 – (3) – (27) 7 15 17 (1) (13) 18 22 (24) (2) 2011 53 (3) 35 (30) 2 (15) (8) (20) – 14 In addition to the amounts disclosed above, FTSE International Ltd paid royalties of £13m to the FT Group during 2011. This royalty payment ceased upon the disposal of FTSE International Ltd. Investments in associates are accounted for using the equity method of accounting and are initially recognised at cost. The total goodwill recorded on acquisition of associates at 31 December 2012 was £20m (2011: £nil). This has been transferred to assets held for sale as it relates to an investment made by Penguin. The Group’s interests in its associates, all of which are unlisted, are as follows: All figures in £ millions The Economist Newspaper Ltd Other continuing operations Discontinued operations Total Country of incorporation % interest held England 50 2012 Assets Liabilities Revenues Profit 140 14 29 183 (140) (7) (2) (149) 174 17 9 200 23 1 (1) 23 Section 6 Financial statements 129 12. Investments in joint ventures and associates continued All figures in £ millions The Economist Newspaper Ltd FTSE International Ltd * Other Total Country of incorporation % interest held England England 50 50 2011 Assets Liabilities Revenues Profit 140 – 16 156 (140) – (2) (142) 179 31 15 225 27 7 1 35 * FTSE International Ltd included to date of disposal The interests held in associates are equivalent to voting rights. On 16 December 2011 the Group sold its 50% interest in FTSE International Ltd. Gain on sale of FTSE International Ltd All figures in £ millions Proceeds Disposal costs Net assets disposed Gain on sale 13. Deferred income tax All figures in £ millions Deferred income tax assets Deferred income tax liabilities Net deferred income tax 2011 428 (1) (15) 412 2011 287 (620) (333) 2012 229 (601) (372) Substantially all of the deferred tax assets are expected to be recovered after more than one year. Deferred income tax assets and liabilities may be offset when there is a legally enforceable right to offset current income tax assets against current income tax liabilities and when the deferred income taxes relate to the same fiscal authority. The Group has unrecognised deferred income tax assets of £13m at 31 December 2012 (2011: £13m) in respect of UK losses, and approximately £30m (2011: £15m) in respect of losses in other territories. None of the unrecognised UK losses have expiry dates associated with them. The recognition of the deferred income tax assets is supported by management’s forecasts of the future profitability of the relevant business units. The movement on the net deferred income tax account is as follows: All figures in £ millions At beginning of year Exchange differences Income statement charge Acquisition through business combination Disposal through business disposal Tax charge to other comprehensive income or equity Transfer to assets held for sale At end of year Notes 7 30 31 2012 (333) 14 (17) (67) 11 38 (18) (372) 2011 (195) (5) (37) (96) 1 (1) – (333) Included in the income statement charge above for 2012 is a £5m charge (2011: £26m charge) relating to discontinued operations. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 130 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 13. Deferred income tax continued The movement in deferred income tax assets and liabilities during the year is as follows: All figures in £ millions Deferred income tax assets At 1 January 2011 Exchange differences Acquisition through business combination Income statement benefit/(charge) Tax (charge)/benefit to other comprehensive income or equity At 31 December 2011 Exchange differences Acquisition through business combination Income statement charge Tax benefit/(charge) to other comprehensive income or equity Transfer to assets held for sale At 31 December 2012 Trading losses Goodwill and intangibles Returns provisions Retirement benefit obligations Other Total 5 – 8 1 – 14 – 19 (13) – (2) 18 4 – – (4) – – – – – – – – 96 1 – (8) – 89 (3) – (16) – (25) 45 6 – – 19 (6) 19 (1) – (5) 43 (9) 47 165 2 1 (6) 3 165 (5) – (33) (6) (2) 119 276 3 9 2 (3) 287 (9) 19 (67) 37 (38) 229 Other deferred income tax assets include temporary differences on share-based payments, inventory and other provisions. All figures in £ millions Deferred income tax liabilities At 1 January 2011 Exchange differences Acquisition through business combination Disposal through business disposal Income statement benefit Tax benefit to other comprehensive income or equity At 31 December 2011 Exchange differences Acquisition through business combination Disposal through business disposal Income statement charge Tax benefit to other comprehensive income or equity Transfer to assets held for sale At 31 December 2012 Goodwill and intangibles Other Total (334) (6) (102) – (22) – (464) 18 (65) 11 15 – 10 (475) (137) (2) (3) 1 (17) 2 (156) 5 (21) – 35 1 10 (126) (471) (8) (105) 1 (39) 2 (620) 23 (86) 11 50 1 20 (601) Other deferred income tax liabilities include temporary differences in respect of depreciation and royalty advances. Section 6 Financial statements 131 14. Classification of financial instruments The accounting classification of each class of the Group’s financial assets and financial liabilities, together with their fair values, is as follows: All figures in £ millions Investments in unlisted securities – continuing operations Investments in unlisted securities classified within assets held for sale Cash and cash equivalents – continuing operations Cash and cash equivalents classified within assets held for sale Marketable securities Derivative financial instruments Trade receivables – continuing operations Trade receivables classified within assets held for sale Total financial assets Trade payables – continuing operations Trade payables classified within liabilities held for sale Other financial liabilities – put options over non-controlling interest Bank loans and overdrafts – continuing operations Bank loans and overdrafts classified within liabilities held for sale Borrowings due within one year Borrowings due after more than one year Total financial liabilities Fair value Amortised cost 2012 Notes Available for sale Derivatives deemed held for trading Derivatives in hedging relationships Other liabilities Loans and receivables Other liabilities Total carrying value Total market value 15 32 17 32 16 22 24 24 18 32 18 18 31 1 – – 6 – – – 38 – – – – – – – – – – – – – 1 – – 1 – – – – – – – – – – – – – 177 – – 177 – – – – – – – – – – – – – – – – – – – (68) – – – – – – – 31 31 1 1 1,062 – 1,062 1,062 115 – – 883 – – – – 115 6 178 115 6 178 883 883 249 2,309 249 249 – – 2,525 2,525 – – – – – – (337) (337) (337) (148) (148) (148) – (68) (68) (55) (55) (55) (7) (229) (7) (229) (7) (228) – (68) – (1,988) (1,988) (2,043) – (2,764) (2,832) (2,886) O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 132 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 14. Classification of financial instruments continued All figures in £ millions Investments in unlisted securities Cash and cash equivalents Marketable securities Derivative financial instruments Trade receivables Total financial assets Derivative financial instruments Trade payables Other financial liabilities – put options over non-controlling interest Bank loans and overdrafts Borrowings due within one year Borrowings due after more than one year Total financial liabilities Fair value Amortised cost 2011 Notes Available for sale Derivatives deemed held for trading Derivatives in hedging relationships Other liabilities Loans and receivables Other liabilities Total carrying value Total market value 15 17 16 22 16 24 24 18 18 18 26 – 9 – – 35 – – – – – – – – – – 3 – 3 (1) – – – – – (1) – – – 174 – 174 (2) – – – – – (2) – – – – – – – – – 1,369 – – 1,061 2,430 – – – 26 26 – 1,369 1,369 9 – 9 – 177 177 – 1,061 1,061 – 2,642 2,642 (3) – (3) (483) (483) (483) (86) – – – (86) – – – – (78) (9) (86) (78) (9) (86) (78) (9) – (1,964) (1,964) (2,000) – (2,534) (2,623) (2,659) Certain of the Group’s derivative financial instruments are classified as held for trading either as they do not meet the hedge accounting criteria specified in IAS 39 ‘Financial Instruments: Recognition and Measurement’ or the Group has chosen not to seek hedge accounting for these instruments. None of these derivatives are held for speculative trading purposes. Transactions in derivative financial instruments are only undertaken to manage risks arising from underlying business activity, in accordance with the Group’s treasury policy as described in note 19. The Group designates certain qualifying derivative financial instruments as hedges of the fair value of its bonds (fair value hedges). Changes in the fair value of these derivative financial instruments are recorded in the income statement, together with any change in the fair value of the hedged liability attributable to the hedged risk. The Group also designates certain of its borrowings and derivative financial instruments as hedges of its investments in foreign operations (net investment hedges). Movements in the fair value of these financial instruments (to the extent they are effective) are recognised in other comprehensive income. None of the Group’s financial assets or liabilities are designated at fair value through the income statement upon initial recognition. More detail on the Group’s accounting for financial instruments is included in the Group’s accounting policies. The Group’s approach to managing risks in relation to financial instruments is described in note 19. Section 6 Financial statements 133 15. Other financial assets All figures in £ millions At beginning of year Exchange differences Acquisition of investments Disposal of investments Transfer to assets held for sale At end of year 2012 26 (2) 10 (2) (1) 31 2011 58 – 12 (44) – 26 Other financial assets comprise non-current unlisted securities. 16. Derivative financial instruments The Group’s approach to the management of financial risks is set out in note 19. The Group’s outstanding derivative financial instruments are as follows: All figures in £ millions Interest rate derivatives – in a fair value hedge relationship Interest rate derivatives – not in a hedge relationship Cross-currency rate derivatives – in a net investment hedge relationship Total Analysed as expiring: In less than one year Later than one year and not later than five years Later than five years Total Gross notional amounts Assets Liabilities Gross notional amounts Assets Liabilities 2012 2011 1,465 143 61 220 1,746 215 701 830 1,746 1 34 178 4 69 105 178 – – – – – – – – 1,208 151 65 220 1,493 – 946 547 1,493 3 23 177 – 81 96 177 – (1) (2) (3) (1) (2) – (3) The carrying value of the above derivative financial instruments equals their fair value. Fair values are determined by using market data and the use of established estimation techniques such as discounted cash flow and option valuation models. At the end of 2012, the currency split of the mark-to-market values of rate derivatives, including the exchange of principal on cross-currency rate derivatives, was US dollar £(59)m, sterling £257m and South African rand £(20)m (2011: US dollar £(66)m, sterling £263m and South African rand £(23)m). The fixed interest rates on outstanding rate derivative contracts at the end of 2012 range from 3.65% to 9.28% (2011: 3.65% to 9.28%) and the floating rates are based on LIBOR in US dollar and sterling. The Group’s portfolio of rate derivatives is diversified by maturity, counterparty and type. Natural offsets between transactions within the portfolio and the designation of certain derivatives as hedges significantly reduce the risk of income statement volatility. The sensitivity of the portfolio to changes in market rates is set out in note 19. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 134 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 16. Derivative financial instruments continued Counterparty exposure from all derivatives is managed, together with that from deposits and bank account balances, within credit limits that reflect published credit ratings and by reference to other market measures (e.g. market prices for credit default swaps) to ensure that there is no significant risk to any one counterparty. No single derivative transaction had a market value (positive or negative) at the balance sheet date that exceeded 3% of the Group’s consolidated total equity. In accordance with IAS 39 ‘Financial Instruments: Recognition and Measurement’ the Group has reviewed all of its material contracts for embedded derivatives that are required to be separately accounted for if they do not meet certain requirements, and has concluded that there are no material embedded derivatives. 17. Cash and cash equivalents (excluding overdrafts) All figures in £ millions Cash at bank and in hand Short-term bank deposits Continuing operations Cash at bank and in hand classified within assets held for sale 2012 372 690 1,062 115 1,177 2011 864 505 1,369 – 1,369 Short-term bank deposits are invested with banks and earn interest at the prevailing short-term deposit rates. At the end of 2012 the currency split of cash and cash equivalents was US dollar 47% (2011: 31%), sterling 25% (2011: 38%), euro 3% (2011: 8%) and other 25% (2011: 23%). Cash and cash equivalents have fair values that approximate to their carrying value due to their short-term nature. Cash and cash equivalents include the following for the purpose of the cash flow statement: All figures in £ millions Cash and cash equivalents – continuing operations Cash at bank and in hand classified within assets held for sale Bank overdrafts – continuing operations Bank overdrafts classified within liabilities held for sale 2012 2011 1,062 115 (33) (7) 1,137 1,369 – (78) – 1,291 Section 6 Financial statements 135 18. Financial liabilities – Borrowings The Group’s current and non-current borrowings are as follows: All figures in £ millions 2012 2011 Non-current 5.5% Global Dollar Bonds 2013 (nominal amount $350m) 5.7% US Dollar Bonds 2014 (nominal amount $400m) 7.0% Sterling Bonds 2014 (nominal amount £250m) 6.0% Sterling Bonds 2015 (nominal amount £300m) 4.0% US Dollar Notes 2016 (nominal amount $350m) 6.25% Global Dollar Bonds 2018 (nominal amount $550m) 4.625% US Dollar Notes 2018 (nominal amount $300m) 3.75% US Dollar Notes 2022 (nominal amount $500m) Bank loans and overdrafts Finance lease liabilities Current Due within one year or on-demand: 5.5% Global Dollar Bonds 2013 (nominal amount $350m) Bank loans and overdrafts Finance lease liabilities Total borrowings – continuing operations Bank overdrafts classified within liabilities held for sale Total borrowings – 264 256 298 229 402 217 315 22 7 2,010 219 33 10 262 233 286 257 298 238 419 224 – – 9 1,964 – 78 9 87 2,272 2,051 7 – 2,279 2,051 Included in the non-current borrowings above is £11m of accrued interest (2011: £12m). Included in the current borrowings above is £2m of accrued interest (2011: £ nil). The maturity of the Group’s non-current borrowing is as follows: All figures in £ millions Between one and two years Between two and five years Over five years 2012 524 552 934 2,010 2011 241 1,080 643 1,964 O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 136 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 18. Financial liabilities – Borrowings continued The carrying amounts and market values of borrowings are as follows: All figures in £ millions Bank loans and overdrafts 5.5% Global Dollar Bonds 2013 5.7% US Dollar Bonds 2014 7.0% Sterling Bonds 2014 6.0% Sterling Bonds 2015 4.0% US Dollar Notes 2016 6.25% Global Dollar Bonds 2018 4.625% US Dollar Notes 2018 3.75% US Dollar Notes 2022 Finance lease liabilities Continuing operations Bank overdrafts classified within liabilities held for sale Effective interest rate Carrying value n/a 5.76% 5.88% 7.20% 6.27% 4.26% 6.46% 4.69% 3.94% n/a n/a 55 219 264 256 298 229 402 217 315 17 2,272 7 2,279 2012 Market value 55 218 260 274 337 233 410 209 313 17 2,326 7 2,333 Carrying value 78 233 286 257 298 238 419 224 – 18 2011 Market value 78 237 280 282 340 237 409 206 – 18 – 2,051 – 2,087 The market values stated above are based on clean market prices at the year end or, where these are not available, on the quoted market prices of comparable debt issued by other companies. The effective interest rates above relate to the underlying debt instruments. The carrying amounts of the Group’s borrowings are denominated in the following currencies: All figures in £ millions US dollar Sterling Other 2012 1,684 573 22 2,279 2011 1,488 563 – 2,051 The Group has the following undrawn capacity on its committed borrowing facilities as at 31 December: All figures in £ millions Floating rate – expiring within one year – expiring beyond one year 2012 2011 – 1,077 1,077 – 1,126 1,126 In addition to the above facilities, there are a number of short-term facilities that are utilised in the normal course of business. All of the Group’s borrowings are unsecured. In respect of finance lease obligations, the rights to the leased asset revert to the lessor in the event of default. Section 6 Financial statements 137 18. Financial liabilities – Borrowings continued The maturity of the Group’s finance lease obligations is as follows: All figures in £ millions Finance lease liabilities – minimum lease payments Not later than one year Later than one year and not later than two years Later than two years and not later than three years Later than three years and not later than four years Later than four years and not later than five years Later than five years Future finance charges on finance leases Present value of finance lease liabilities The present value of finance lease liabilities is as follows: All figures in £ millions Not later than one year Later than one year and not later than five years Later than five years 2012 2011 10 4 3 – – – – 17 9 8 1 – – – – 18 2012 2011 10 7 – 17 9 9 – 18 The carrying amounts of the Group’s lease obligations approximate their fair value. 19. Financial risk management The Group’s approach to the management of financial risks together with sensitivity analyses of its financial instruments is set out below. Treasury policy The Group holds financial instruments for two principal purposes: to finance its operations and to manage the interest rate and currency risks arising from its operations and its sources of finance. The Group finances its operations by a mixture of cash flows from operations, short-term borrowings from banks and commercial paper markets, and longer term loans from banks and capital markets. The Group borrows principally in US dollars and sterling, at both floating and fixed rates of interest, using derivative financial instruments (‘derivatives’), where appropriate, to generate the desired effective currency profile and interest rate basis. The derivatives used for this purpose are principally rate swaps, rate caps and collars, currency rate swaps and forward foreign exchange contracts. The main risks arising from the Group’s financial instruments are interest rate risk, liquidity and refinancing risk, counterparty risk and foreign currency risk. These risks are managed by the chief financial officer under policies approved by the board, which are summarised overleaf. All the treasury policies remained unchanged throughout, except for revisions to the Group’s bank counterparty risk limits and related approval processes and minor amendments to reflect the consolidation of the Group’s treasury operations into one location. The audit committee receives reports on the Group’s treasury activities, policies and procedures. The treasury department is not a profit centre and its activities are subject to regular internal audit. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 138 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 19. Financial risk management continued Interest rate risk management The Group’s exposure to interest rate fluctuations on its borrowings is managed by borrowing on a fixed rate basis and by entering into rate swaps, rate caps and forward rate agreements. The Group’s policy objective has continued to be to set a target proportion of its forecast borrowings (taken at the year end, with cash netted against floating rate debt and before certain adjustments for IAS 39 ‘Financial Instruments: Recognition and Measurement’) to be hedged (i.e. fixed or capped at the year end) over the next four years, subject to a maximum of 65% and a minimum that starts at 40% and falls by 10% at each year end. At the end of 2012 the fixed to floating hedging ratio, on the above basis, was approximately 55%. A simultaneous 1% change on 1 January 2013 in the Group’s variable interest rates in US dollar and sterling, taking into account forecast seasonal debt, would have a £6m effect on profit before tax. Use of interest rate derivatives The policy described in the section above creates a group of derivatives, under which the Group is a payer of fixed rates and a receiver of floating rates. The Group also aims to avoid undue exposure to a single interest rate setting. Reflecting this objective, the Group has predominantly swapped its fixed rate bond issues to floating rate at their launch. This creates a second group of derivatives, under which the Group is a receiver of fixed rates and a payer of floating rates. The Group’s accounting objective in its use of interest rate derivatives is to minimise the impact on the income statement of changes in the mark-to-market value of its derivative portfolio as a whole. It uses duration calculations to estimate the sensitivity of the derivatives to movements in market rates. The Group also identifies which derivatives are eligible for fair value hedge accounting (which reduces sharply the income statement impact of changes in the market value of a derivative). The Group then balances the total portfolio between hedge- accounted and pooled segments, so that the expected movement on the pooled segment is minimal. Liquidity and refinancing risk management The Group’s objective is to secure continuity of funding at a reasonable cost. To do this it seeks to arrange committed funding for a variety of maturities from a diversity of sources. The Group’s policy objective has been that the weighted average maturity of its core gross borrowings (treating short-term advances as having the final maturity of the facilities available to refinance them) should be between three and ten years. At the end of 2012 the average maturity of gross borrowings was 3.9 years (2011: 4.0 years) of which bonds represented 97% (2011: 95%) of these borrowings. The Group believes that ready access to different funding markets also helps to reduce its liquidity risk, and that published credit ratings and published financial policies improve such access. All of the Group’s credit ratings remained unchanged during the year. The long-term ratings are Baa1 from Moody’s and BBB+ from Standard & Poor’s, and the short-term ratings are P2 and A2 respectively. The Group’s policy is to strive to maintain a rating of Baa1/BBB+ over the long term. The Group will also continue to use internally a range of ratios to monitor and manage its finances. These include interest cover, net debt to operating profit and cash flow to debt measures. The Group also maintains undrawn committed borrowing facilities. At the end of 2012 the committed facilities amounted to £1,077m and their weighted average maturity was 2.9 years. Section 6 Financial statements 139 19. Financial risk management continued Analysis of Group debt, including the impact of derivatives The following tables analyse the Group’s sources of funding and the impact of derivatives on the Group’s debt instruments. The Group’s net debt position is set out below: All figures in £ millions Cash and cash equivalents Marketable securities Derivative financial instruments Bank loans, overdrafts and loan notes Bonds Finance lease liabilities Continuing operations Cash & cash equivalents classified within assets held for sale Bank loans, overdrafts and loan notes classified within liabilities held for sale Net debt 2012 2011 1,062 6 178 (55) (2,200) (17) (1,026) 115 (7) (918) 1,369 9 174 (78) (1,955) (18) (499) – – (499) The split of net debt between fixed and floating rate, stated after the impact of rate derivatives, is as follows: All figures in £ millions Fixed rate Floating rate Total 2012 499 419 918 2011 510 (11) 499 Gross borrowings, after the impact of cross-currency rate derivatives, analysed by currency are as follows: All figures in £ millions US dollar Sterling Other Total 2012 1,905 353 21 2,279 As at 31 December 2012 the exposure of the borrowings of the Group to interest rate changes when the borrowings re-price is as follows: All figures in £ millions Re-pricing profile of borrowings Effect of rate derivatives Total Less than one year One to five years More than five years 291 1,311 1,602 1,054 (480) 574 934 (831) 103 2011 1,687 343 21 2,051 Total 2,279 – 2,279 O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 140 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 19. Financial risk management continued The maturity of contracted cash flows associated with the Group’s financial liabilities are as follows: All figures in £ millions Not later than one year Later than one year and not later than five years Later than five years Total Analysed as: Bonds Rate derivatives – inflows Rate derivatives – outflows Trade payables Total All figures in £ millions Not later than one year Later than one year and not later than five years Later than five years Total Analysed as: Bonds Rate derivatives – inflows Rate derivatives – outflows Trade payables Total USD 489 726 863 2,078 1,837 (326) 328 239 2,078 USD 261 984 563 1,808 1,553 (292) 321 226 1,808 GBP 126 357 – 483 639 (264) 3 105 483 GBP 124 378 – 502 675 (281) 5 103 502 2012 Total 757 1,104 863 2,724 2,476 (590) 353 485 2,724 2011 Total 541 1,387 563 2,491 2,228 (573) 353 483 2,491 Other 142 21 – 163 – – 22 141 163 Other 156 25 – 181 – – 27 154 181 All cash flow projections shown above are on an undiscounted basis. Any cash flows based on a floating rate are calculated using interest rates as set at the date of the last rate reset. Where this is not possible, floating rates are based on interest rates prevailing at 31 December in the relevant year. All derivative amounts are shown gross, although the Group net settles these amounts wherever possible. Any amounts drawn under revolving credit facilities and commercial paper are assumed to mature at the maturity date of the relevant facility, with interest calculated as payable in each calendar year up to and including the date of maturity of the facility. Financial counterparty risk management Counterparty credit limits, which take published credit rating and other factors into account, are set to cover our total aggregate exposure to a single financial institution. The limits applicable to published credit ratings bands are approved by the chief financial officer within guidelines approved by the board. Exposures and limits applicable to each financial institution are reviewed on a regular basis. Section 6 Financial statements 141 19. Financial risk management continued Foreign currency risk management Although the Group is based in the UK, it has its most significant investment in overseas operations. The most significant currency for the Group is the US dollar. The Group’s policy on routine transactional conversions between currencies (for example, the collection of receivables, and the settlement of payables or interest) remains that these should be transacted at the relevant spot exchange rate. The majority of the Group’s operations are domestic within their country of operation. No unremitted profits are hedged with foreign exchange contracts, as the company judges it inappropriate to hedge non-cash flow translational exposure with cash flow instruments. However, the Group does seek to create a natural hedge of this exposure through its policy of aligning approximately the currency composition of its core net borrowings (after the impact of cross-currency rate derivatives) with its forecast operating profit before depreciation and amortisation. This policy aims to soften the impact of changes in foreign exchange rates on consolidated interest cover and earnings. The policy above applies only to currencies that account for more than 15% of Group operating profit before depreciation and amortisation, which currently is only the US dollar. The Group still borrows small amounts in other currencies, typically for seasonal working capital needs. Our policy does not require existing currency debt to be terminated to match declines in that currency’s share of Group operating profit before depreciation and amortisation. In addition, currencies that account for less than 15% of Group operating profit before depreciation and amortisation can be included in the above hedging process at the request of the chief financial officer. Included within year end net debt, the net borrowings/(cash) in the hedging currencies above (taking into account the effect of cross-currency swaps) were: US dollar £1,354m, sterling £58m and South African rand £(17)m. Use of currency debt and currency derivatives The Group uses both currency denominated debt and derivative instruments to implement the above policy. Its intention is that gains/losses on the derivatives and debt offset the losses/gains on the foreign currency assets and income. Each quarter the value of hedging instruments is monitored against the assets in the relevant currency and, where practical, a decision is made whether to treat the debt or derivative as a net investment hedge (permitting foreign exchange movements on it to be taken to reserves) for the purposes of IAS 39. Financial instruments – fair value measurement The following table provides an analysis of those financial instruments that are measured subsequent to initial recognition at fair value, grouped into levels 1 to 3, based on the degree to which the fair value is observable: Level 1 fair value measurements are those derived from unadjusted quoted prices in active markets for identical assets or liabilities; Level 2 fair value measurements are those derived from inputs, other than quoted prices included within level 1, that are observable for the asset or liability, either directly (as prices) or indirectly (derived from prices); and Level 3 fair value measurements are those derived from valuation techniques that include inputs for the asset or liability that are not based on observable market data (unobservable inputs). O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 142 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 19. Financial risk management continued Financial instruments – fair value measurement continued All figures in £ millions Level 1 Level 2 Level 3 Financial assets at fair value Derivative financial assets Marketable securities Available for sale financial assets Investments in unlisted securities – continuing operations Investments in unlisted securities classified within assets held for sale Financial liabilities at fair value Derivative financial liabilities Other financial liabilities – put options over non-controlling interest Total – – – – – – – Level 1 Level 2 Level 3 178 6 – – 177 9 – – 2012 Total 178 6 2011 Total 177 9 – – – 30 30 1 – 1 – – 184 (68) (37) (68) 147 – – (3) 26 26 – – – (3) – 183 (86) (60) (86) 123 – – – – – – – The following table analyses the movements in level 3 fair value measurements: All figures in £ millions At beginning of year Exchange differences Additions Fair value movements Transfer to assets classified as held for sale Disposals At end of year 2012 2011 Investments in unlisted securities Other financial liabilities Investments in unlisted securities Other financial liabilities 26 (2) 10 – (1) (2) 31 (86) 5 – (25) – 38 (68) 58 – 13 – – (45) 26 (25) 3 (63) (1) – – (86) The fair value of the investments in unlisted securities is determined by reference to the financial performance of the underlying asset and amounts realised on the sale of similar assets. The fair value of other financial liabilities represents the present value of the estimated future liability. Section 6 Financial statements 143 19. Financial risk management continued Financial instruments – sensitivity analysis As at 31 December 2012 the sensitivity of the carrying value of the Group’s financial instruments to fluctuations in interest rates and exchange rates is as follows: All figures in £ millions Investments in unlisted securities – continuing operations Investments in unlisted securities classified within assets held for sale Cash and cash equivalents – continuing operations Cash and cash equivalents classified within assets held for sale Marketable securities Derivative financial instruments Bonds Other borrowings – continuing operations Other borrowings classified within liabilities held for sale Put options over non-controlling interest Other net financial assets – continuing operations Other net financial assets classified within assets and liabilities held for sale Total financial instruments Carrying value Impact of 1% increase in interest rates Impact of 1% decrease in interest rates Impact of 10% strengthening in sterling Impact of 10% weakening in sterling 31 1 1,062 115 6 178 (2,200) (72) (7) (68) 546 101 (307) – – – – – (66) 64 – – – – – (2) – – – – – 65 (63) – – – – – 2 (3) – (75) (4) – 7 149 5 1 7 (43) (10) 34 4 – 92 4 – (9) (183) (6) (1) (7) 52 12 (42) The table shows the sensitivities of the fair values of each class of financial instruments to an isolated change in either interest rates or foreign exchange rates. The class ‘Other net financial assets’ comprises trade assets less trade liabilities. The sensitivities of derivative instruments are calculated using established estimation techniques such as discounted cash flow and option valuation models. Where modelling an interest rate decrease of 1% led to negative interest rates, these points on the yield curve were adjusted to 0%. A large proportion of the movements shown above would impact equity rather than the income statement, due to the location and functional currency of the entities in which they arise and the availability of net investment hedge treatment. The changes in valuations are estimates of the impact of changes in market variables and are not a prediction of future events or anticipated gains or losses. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 144 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 20. Intangible assets – Pre-publication All figures in £ millions Cost At beginning of year Exchange differences Additions Disposals Acquisition through business combination Transfer to property, plant and equipment Transfer to assets classified as held for sale At end of year Amortisation At beginning of year Exchange differences Charge for the year Disposals Acquisition through business combination Transfer to assets classified as held for sale At end of year Carrying amounts At end of year 2012 2011 1,965 (74) 364 (188) 14 (3) (202) 1,876 (1,315) 55 (316) 188 (8) 186 (1,210) 1,863 6 331 (249) 14 – – 1,965 (1,216) (11) (331) 249 (6) – (1,315) 666 650 Included in the above are pre-publication assets amounting to £431m (2011: £413m) which will be realised in more than one year. Amortisation is included in the income statement in cost of goods sold. In 2012 £33m (2011: £39m) relates to discontinued operations. 21. Inventories All figures in £ millions Raw materials Work in progress Finished goods 2012 13 11 237 261 2011 24 20 363 407 The cost of inventories relating to continuing operations recognised as an expense and included in the income statement in cost of goods sold amounted to £512m (2011: £585m). In 2012 £71m (2011: £63m) of inventory provisions was charged in the income statement. None of the inventory is pledged as security. 22. Trade and other receivables All figures in £ millions Current Trade receivables Royalty advances Prepayments and accrued income Other receivables Non-current Trade receivables Royalty advances Prepayments and accrued income Other receivables Section 6 Financial statements 145 2012 2011 868 16 81 139 1,104 15 13 33 18 79 1,048 107 90 141 1,386 13 88 34 16 151 Trade receivables are stated at fair value, net of provisions for bad and doubtful debts and anticipated future sales returns. The movements on the provision for bad and doubtful debts are as follows: All figures in £ millions At beginning of year Exchange differences Income statement movements Utilised Acquisition through business combination Disposal through business disposal Transfer to assets classified as held for sale At end of year 2012 (102) 4 (21) 53 (1) – 12 (55) 2011 (83) 1 (31) 17 (8) 2 – (102) Concentrations of credit risk with respect to trade receivables are limited due to the Group’s large number of customers, who are internationally dispersed. The ageing of the Group’s trade receivables is as follows: All figures in £ millions Within due date Up to three months past due date Three to six months past due date Six to nine months past due date Nine to 12 months past due date More than 12 months past due date Total trade receivables Less: provision for sales returns Net trade receivables 2012 2011 774 231 43 10 7 5 1,070 (187) 883 1,079 289 37 4 3 – 1,412 (351) 1,061 The Group reviews its bad debt provision at least twice a year following a detailed review of receivable balances and historic payment profiles. Management believe all the remaining receivable balances are fully recoverable. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 146 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 23. Provisions for other liabilities and charges All figures in £ millions At 1 January 2012 Exchange differences Charged to income statement Released to income statement Deferred consideration on acquisition Acquisition through business combination Utilised Transfer to liabilities held for sale At 31 December 2012 Analysis of provisions: All figures in £ millions Current Non-current Current Non-current Deferred consideration Property Legal and other 97 (3) – – 6 (3) (31) (2) 64 17 – 12 (1) – – (1) (1) 26 49 (4) 45 (2) – 4 (8) (26) 58 Deferred consideration Property Legal and other 6 58 64 32 65 97 12 14 26 5 12 17 20 38 58 11 38 49 Total 163 (7) 57 (3) 6 1 (40) (29) 148 2012 Total 38 110 148 2011 48 115 163 Deferred consideration primarily relates to the formation of a venture in the US Professional business in 2011. Legal and other includes provisions in relation to legal claims, contract disputes and potential contract losses. 24. Trade and other liabilities All figures in £ millions Trade payables Social security and other taxes Accruals Deferred income Interest payable Put options over non-controlling interest Other liabilities Less: non-current portion Accruals Deferred income Put options over non-controlling interest Interest payable Other liabilities Current portion The carrying value of the Group’s trade and other liabilities approximates its fair value. 2012 337 30 440 714 21 68 228 1,838 18 147 25 13 79 282 1,556 2011 483 25 544 678 18 86 232 2,066 25 147 62 6 85 325 1,741 Section 6 Financial statements 147 24. Trade and other liabilities continued The deferred income balance comprises principally: multi-year obligations to deliver workbooks to adoption customers in school businesses; advance payments in assessment, testing and teaching businesses; subscription income in school and newspaper businesses; and obligations to deliver digital content in future periods. The put options over non-controlling interest are the fair value of options held by the non-controlling interests in the Group’s Southern African and Indian businesses. 25. Retirement benefit and other post-retirement obligations Background The Group operates a number of defined benefit and defined contribution retirement plans throughout the world. For the defined benefit plans, benefits are based on employees’ length of service and final pensionable pay. Defined contribution benefits are based on the amount of contributions paid in respect of an individual member, the investment returns earned and the amount of pension this money will buy when a member retires. The largest plan is the Pearson Group Pension Plan (‘UK Group plan’) with both defined benefit and defined contribution sections. From 1 November 2006, all sections of the UK Group plan were closed to new members with the exception of a defined contribution section that was opened in 2003. This section is available to all new employees of participating companies. At 31 December 2012 the UK Group plan has approximately 27,000 members, analysed in the following table: % Defined benefit Defined contribution Total Active Deferred Pensioners 3 18 21 26 21 47 32 – 32 Total 61 39 100 The other major defined benefit plans are based in the US. Other defined contribution plans are operated principally overseas with the largest plan being in the US. The specific features of these plans vary in accordance with the regulations of the country in which employees are located. Pearson also has several post-retirement medical benefit plans (PRMBs), principally in the US. PRMBs are unfunded but are accounted for and valued similarly to defined benefit pension plans. Assumptions The principal assumptions used for the UK Group plan and the US PRMB are shown below. Weighted average assumptions have been shown for the other plans, which primarily relate to US pension plans. % Inflation Rate used to discount plan liabilities Expected return on assets Expected rate of increase in salaries Expected rate of increase for pensions in payment and deferred pensions Initial rate of increase in healthcare rate Ultimate rate of increase in healthcare rate UK Group plan Other plans 3.0 4.4 5.8 3.5 2.3 to 5.1 – – 2.5 3.6 5.5 3.9 – – – 2012 PRMB 2.5 3.6 – – – 8.0 5.0 UK Group plan 3.0 4.9 5.7 4.0 2.4 to 4.3 – – Other plans 2.5 4.2 6.4 4.0 – – – 2011 PRMB 2.5 4.2 – – – 7.5 5.0 The UK discount rate is based on the annualised yield on the iBoxx over 15-year AA-rated corporate bond index, adjusted to reflect the duration of liabilities. The US discount rate is set by reference to a US bond portfolio matching model. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 148 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 25. Retirement benefit and other post-retirement obligations continued The inflation rate for the UK Group plan of 3.0% reflects the RPI rate. In line with changes to legislation in 2010, certain benefits have been calculated with reference to CPI as the inflationary measure and in these instances a rate of 2.5% has been used. The expected rates of return on categories of plan assets are determined by reference to relevant indices. The overall expected rate of return is calculated by weighting the individual rates in accordance with the anticipated balance in the plan’s investment portfolio, plus a diversification premium. The expected rate of increase in salaries has been set at 3.5% for 2012 with a short-term assumption of 3.0% for three years. For the UK plan, the mortality base table assumptions have been derived from the SAPS ‘all pensioners’ tables for males and the SAPS ‘normal health pensioners’ tables for females, adjusted to reflect the observed experience of the plan, with medium cohort improvement factors. A 1.5% improvement floor on the medium cohort is applied for males, and 1.25% for females, with tapering. For the US plans, the RP2000 table is used, reflecting the mortality assumption most prevalent in the US. In 2010 a ten-year projection was added. Using the above tables, the remaining average life expectancy in years of a pensioner retiring at age 65 on the balance sheet date for the UK Group plan and US plans is as follows: Male Female 2012 23.0 24.2 UK 2011 22.6 23.5 2012 19.2 21.1 US 2011 19.2 21.1 The remaining average life expectancy in years of a pensioner retiring at age 65, 20 years after the balance sheet date, for the UK and US Group plans is as follows: Male Female Financial statement information The amounts recognised in the income statement are as follows: 2012 25.1 26.1 UK 2011 25.2 25.6 2012 19.2 21.1 All figures in £ millions Current service cost Total operating expense Expected return on plan assets Interest on plan liabilities Net finance (income)/expense Net income statement charge UK Group plan Defined benefit other Sub-total Defined contribution PRMB 23 23 (111) 96 (15) 8 3 3 (8) 7 (1) 2 26 26 (119) 103 (16) 10 78 78 – – – 78 – 4 4 – 3 3 7 – Actual return on plan assets 146 15 161 US 2011 19.2 21.1 2012 Total 108 108 (119) 106 (13) 95 161 Section 6 Financial statements 149 25. Retirement benefit and other post-retirement obligations continued All figures in £ millions Current service cost Total operating expense Expected return on plan assets Interest on plan liabilities Net finance (income)/expense Net income statement charge Actual return on plan assets UK Group plan Defined benefit other Sub-total Defined contribution PRMB 21 21 (107) 100 (7) 14 161 3 3 (7) 8 1 4 5 24 24 (114) 108 (6) 18 166 69 69 – – – 69 – 3 3 – 3 3 6 – 2011 Total 96 96 (114) 111 (3) 93 166 Included within the 2012 results are discontinued operations consisting of a £4m charge (2011: £4m charge) relating to defined benefit schemes and a £7m charge (2011: £7m charge) relating to defined contribution schemes. The amounts recognised in the balance sheet are as follows: All figures in £ millions Fair value of plan assets Present value of defined benefit obligation Net pension asset/(liability) Other post-retirement medical benefit obligation Other pension accruals Net retirement benefit obligations Analysed as: Retirement benefit assets Retirement benefit obligations 2012 UK Group plan 2,162 Other funded plans 165 Other unfunded plans Total UK Group plan – 2,327 2,008 Other funded plans 149 Other unfunded plans 2011 Total – 2,157 (2,181) (19) (196) (31) (24) (24) (2,401) (74) (1,983) 25 (173) (24) (24) (2,180) (23) (24) (89) (35) (198) – (198) (85) (33) (141) 25 (166) Included within the 2012 retirement benefit obligation is a liability of £26m which relates to Penguin and is classified as held for sale. The following losses have been recognised in other comprehensive income: All figures in £ millions Amounts recognised for defined benefit plans Amounts recognised for post-retirement medical benefit plans Total recognised in year Cumulative amounts recognised 2012 (114) (5) (119) (351) 2011 (47) (9) (56) (232) O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 150 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 25. Retirement benefit and other post-retirement obligations continued The fair value of plan assets comprises the following: % Equities Bonds Properties Other UK Group plan Other funded plans 32 38 9 14 2 3 1 1 2012 Total 34 41 10 15 UK Group plan Other funded plans 27 48 3 15 3 3 – 1 2011 Total 30 51 3 16 The plan assets do not include any of the Group’s own financial instruments, or any property occupied by the Group. The table below further disaggregates the UK Group plan assets into additional categories and those assets which have a quoted market price in an active market and those that do not: % UK equities Non-UK equities Fixed-interest securities Index-linked securities Property Other Total The liquidity profile of the UK Group plan assets is as follows: % Liquid – call <1 month Less liquid – call 1– 3 months Illiquid – call > 3 months 2012 2011 Quoted market price No quoted market price Quoted market price No quoted market price 6 25 21 19 – 1 72 1 3 – – 10 14 28 1 23 29 23 – 1 77 1 3 – – 3 16 23 2012 2011 73 2 25 78 6 16 Section 6 Financial statements 151 25. Retirement benefit and other post-retirement obligations continued Changes in the values of plan assets and liabilities of the retirement benefit plans are as follows: All figures in £ millions Fair value of plan assets Opening fair value of plan assets Exchange differences Expected return on plan assets Actuarial gains/(losses) Contributions by employer Contributions by employee Benefits paid Acquisition through business combination Closing fair value of plan assets Present value of defined benefit obligation Opening defined benefit obligation Exchange differences Current service cost Interest cost Actuarial losses Contributions by employee Benefits paid Acquisition through business combination Closing defined benefit obligation UK Group plan Other plans 2,008 – 111 35 72 2 (78) 12 2,162 (1,983) – (23) (96) (144) (2) 78 (11) (2,181) 149 (5) 8 7 2 – (11) 15 165 (197) 7 (3) (7) (12) – 11 (19) (220) Changes in the value of the US PRMB are as follows: 2012 Total 2,157 (5) 119 42 74 2 (89) 27 2,327 (2,180) 7 (26) (103) (156) (2) 89 (30) (2,401) All figures in £ millions Opening defined benefit obligation Exchange differences Current service cost Interest cost Actuarial losses Benefits paid Closing defined benefit obligation UK Group plan Other plans 1,847 – 107 54 71 3 (74) – 2,008 (1,852) – (21) (100) (81) (3) 74 – (1,983) 135 1 7 (2) 18 – (10) – 149 (178) – (3) (8) (18) – 10 – (197) 2012 (85) 4 (4) (3) (5) 4 (89) 2011 Total 1,982 1 114 52 89 3 (84) – 2,157 (2,030) – (24) (108) (99) (3) 84 – (2,180) 2011 (72) (2) (3) (3) (9) 4 (85) O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 152 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 25. Retirement benefit and other post-retirement obligations continued The history of the defined benefit plans is as follows: All figures in £ millions 2012 2011 2010 2009 2008 Fair value of plan assets Present value of defined benefit obligation Net pension (liability)/asset Experience adjustments on plan assets Experience adjustments on plan liabilities 2,327 (2,401) (74) 42 (156) 2,157 (2,180) (23) 52 (99) 1,982 (2,030) (48) 90 (15) 1,727 (1,967) (240) 56 (351) 1,578 (1,594) (16) (268) 194 Funding The UK Group plan is self-administered with the plan’s assets being held independently of the Group. The trustees of the plan are required to act in the best interest of the plan’s beneficiaries. The most recent triennial actuarial valuation for funding purposes was completed as at 1 January 2012 and this valuation revealed a funding shortfall. The Group has agreed that the funding shortfall will be eliminated by June 2017. In 2012 the Group contributed £48m (2011: £48m) towards the funding shortfall. Following the completion of the triennial funding valuation the Group has agreed to contribute £41m per annum until 2017 in excess of regular contributions. In addition, a mechanism has been agreed for the Group to make supplementary payments up to a maximum of £15m per annum. If such payments are made they are expected to accelerate the end date for extinguishing the deficit. Regular contributions to the plan are estimated to be £23m for 2013. The Group expects to contribute $80m in 2013 and $84m in 2014 to its US pension plans. Future benefit payments The following table shows the expected benefit payments from the defined benefit plans over the next ten years. These use actuarial assumptions as at 31 December 2012. These represent payments from the pension funds to pensioners and others entitled to benefits, and are not an indication of payments from the company. For company funding requirements, refer to the prior section. All figures in £ millions Expected future benefit payments: 2013 2014 2015 2016 2017 2018 to 2022 combined UK Group plan Defined benefit other 77 80 85 87 91 503 27 24 22 23 18 76 Total 104 104 107 110 109 579 Section 6 Financial statements 153 25. Retirement benefit and other post-retirement obligations continued Sensitivities The net retirement benefit obligations are calculated using a number of assumptions, the most significant being the discount rate used to calculate the defined benefit obligation. The effect of a one percentage point increase and decrease in the discount rate on the defined benefit obligation and the total pension expense is as follows: All figures in £ millions Effect on: (Decrease)/increase in defined benefit obligation – UK Group plan Decrease of aggregate of service cost and interest cost – UK Group plan (Decrease)/increase in defined benefit obligation – US plan 2012 1% increase 1% decrease (311.7) (0.1) (11.6) 388.1 (1.2) 13.9 The effect of members living one year more or one year less on the defined benefit obligation is as follows: All figures in £ millions Effect on: Increase/(decrease) in defined benefit obligation – UK Group plan Increase/(decrease) in defined benefit obligation – US plan 2012 1 year increase 1 year decrease 76.7 2.1 (73.9) (2.1) The effect of a one percentage point increase and decrease in the assumed medical cost trend rates is as follows: All figures in £ millions Effect on: Increase/(decrease) in post-retirement medical benefit obligation Increase/(decrease) of aggregate of service cost and interest cost 2012 1% increase 1% decrease 2.9 0.1 (2.6) (0.1) O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 154 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 26. Share-based payments The Group recognised the following charges in the income statement in respect of its equity-settled share-based payment plans: All figures in £ millions Pearson plans 2012 28 2011 36 Share-based payment charges included in discontinued operations amounted to £4m (2011: £4m). The Group operates the following equity-settled employee option and share plans: Worldwide Save for Shares Plan Since 1994, the Group has operated a Save-As-You-Earn plan for UK employees. In 1998, the Group introduced a Worldwide Save for Shares Plan. Under these plans, employees can save a portion of their monthly salary over periods of three, five or seven years. At the end of this period, the employee has the option to purchase ordinary shares with the accumulated funds at a purchase price equal to 80% of the market price prevailing at the time of the commencement of the employee’s participation in the plan. Options that are not exercised within six months of the end of the savings period lapse unconditionally. Employee Stock Purchase Plan In 2000, the Group established an Employee Stock Purchase Plan which allows all employees in the US to save a portion of their monthly salary over six-month periods. At the end of the period, the employee has the option to purchase ADRs with their accumulated funds at a purchase price equal to 85% of the lower of the market price prevailing at the beginning or end of the period. Long-Term Incentive Plan This plan was first introduced in 2001, renewed in 2006 and again in 2011. The plan consists of restricted shares. The vesting of restricted shares is normally dependent on continuing service over a three to five-year period, and in the case of senior management upon the satisfaction of corporate performance targets over a three-year period. These targets may be based on market and/or non-market performance criteria. Restricted shares awarded to senior management in May 2011 and May 2012 vest dependent on relative total shareholder return, return on invested capital and earnings per share growth. The award was split equally across all three measures. Other restricted shares awarded in 2011 and 2012 vest depending on continuing service over a three-year period. Annual Bonus Share Matching Plan This plan permits executive directors and senior executives around the Group to invest up to 50% of any after tax annual bonus in Pearson shares. If these shares are held and the Group meets an earnings per share growth target, the company will match them on a gross basis of up to one matching share for every invested share i.e. the maximum number of matching shares is equal to the number of shares that could have been acquired with the amount of the pre-tax annual bonus taken in invested shares. The number and weighted average exercise prices of share options granted under the Group’s plans are as follows: Outstanding at beginning of year Granted during the year Exercised during the year Forfeited during the year Expired during the year Outstanding at end of year Options exercisable at end of year 2012 Weighted average exercise price £ 2011 Weighted average exercise price £ Number of share options 000s Number of share options 000s 3,203 1,321 (840) (294) (17) 3,373 106 7.15 9.09 5.59 7.84 5.60 8.24 5.58 8,878 1,157 (2,323) (457) (4,052) 3,203 64 10.20 8.92 7.27 8.54 14.12 7.15 5.54 Options were exercised regularly throughout the year. The weighted average share price during the year was £12.01 (2011: £11.14). Early exercises arising from redundancy, retirement or death are treated as an acceleration of vesting and the Group therefore recognises in the income statement the amount that otherwise would have been recognised for services received over the remainder of the original vesting period. Section 6 Financial statements 155 26. Share-based payments continued The options outstanding at the end of the year have weighted average remaining contractual lives and exercise prices as follows: Range of exercise prices £ 0 – 5 5 – 10 >10 2012 Weighted average contractual life Years – 2.56 – 2.56 2011 Weighted average contractual life Years – 2.51 – 2.51 Number of share options 000s – 3,203 – 3,203 Number of share options 000s – 3,373 – 3,373 In 2012 and 2011 options were granted under the Worldwide Save for Shares Plan. The weighted average estimated fair value for the options granted was calculated using a Black-Scholes option pricing model. The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows: 2012 Weighted average 2011 Weighted average Fair value Weighted average share price Weighted average exercise price Expected volatility Expected life Risk free rate Expected dividend yield Forfeiture rate £2.38 £11.51 £9.09 23.62% £2.97 £11.47 £8.92 27.50% 3.8 years 4.0 years 1.91% 3.37% 3.5% 0.74% 3.65% 3.3% The expected volatility is based on the historic volatility of the company’s share price over the previous three to seven years depending on the vesting term of the options. The following shares were granted under restricted share arrangements: Long-Term Incentive Plan Annual Bonus Share Matching Plan 2012 Weighted average fair value £ 11.56 11.52 2011 Weighted average fair value £ 10.44 11.29 Number of shares 000s 4,854 285 Number of shares 000s 4,503 237 The fair value of shares granted under the Long-Term Incentive Plan that vest unconditionally is determined using the share price at the date of grant. The number of shares expected to vest is adjusted, based on historical experience, to account for potential forfeitures. Restricted shares granted under the Annual Bonus Share Matching Plan are valued using the share price at the date of grant. Participants under both plans are entitled to dividends during the vesting period and therefore the share price is not discounted. Restricted shares with a market performance condition were valued by an independent actuary using a Monte Carlo model. Restricted shares with a non-market performance condition were fair valued based on the share price at the date of grant. Non-market performance conditions are taken into consideration by adjusting the number of shares expected to vest based on the most likely outcome of the relevant performance criteria. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 156 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 27. Share capital and share premium At 1 January 2011 Issue of ordinary shares – share option schemes At 31 December 2011 Issue of ordinary shares – share option schemes At 31 December 2012 Number of shares 000s Ordinary shares £m 812,677 2,949 815,626 1,417 817,043 203 1 204 – 204 Share premium £m 2,524 20 2,544 11 2,555 The ordinary shares have a par value of 25p per share (2011: 25p per share). All issued shares are fully paid. All shares have the same rights. The Group manages its capital to ensure that entities in the Group will be able to continue as a going concern while maximising the return to shareholders through the optimisation of the debt and equity balance. The capital structure of the Group consists of debt (see note 18), cash and cash equivalents (see note 17) and equity attributable to equity holders of the parent, comprising issued capital, reserves and retained earnings. The Group reviews its capital structure on a regular basis and will balance its overall capital structure through payments of dividends, new share issues as well as the issue of new debt or the redemption of existing debt in line with the financial risk policies outlined in note 19. 28. Treasury shares At 1 January 2011 Purchase of treasury shares Release of treasury shares At 31 December 2011 Purchase of treasury shares Release of treasury shares At 31 December 2012 Number of shares 000s 14,009 5,387 (4,731) 14,665 – (4,563) 10,102 Pearson plc £m 137 60 (48) 149 – (46) 103 The Group holds Pearson plc shares in trust to satisfy its obligations under its restricted share plans (see note 26). These shares, representing 1.2% (2011: 1.8%) of called-up share capital, are treated as treasury shares for accounting purposes and have a par value of 25p per share. The nominal value of Pearson plc treasury shares amounts to £2.5m (2011: £3.7m). At 31 December 2012 the market value of Pearson plc treasury shares was £120.0m (2011: £177.4m). Section 6 Financial statements 157 29. Other comprehensive income All figures in £ millions Net exchange differences on translation of foreign operations Actuarial losses on retirement benefit obligations – Group Actuarial losses on retirement benefit obligations – associate Tax on items recognised in other comprehensive income Total other comprehensive expense for the year All figures in £ millions Net exchange differences on translation of foreign operations Actuarial gains on retirement benefit obligations – Group Actuarial gains on retirement benefit obligations – associate Tax on items recognised in other comprehensive income Total other comprehensive expense for the year 30. Business combinations Attributable to equity holders of the Company Translation reserve Retained earnings (236) – – – (236) – (119) (3) 55 (67) Non- controlling interest (2) – – – (2) Total (236) (119) (3) 55 (303) Attributable to equity holders of the Company Translation reserve Retained earnings (38) – – – (38) – (56) (8) 3 (61) Non- controlling interest (6) – – – (6) Total (38) (56) (8) 3 (99) 2012 Total (238) (119) (3) 55 (305) 2011 Total (44) (56) (8) 3 (105) On 16 May 2012 the Professional business acquired Certiport, Inc. Certiport is based in the US and is a leading provider of certification and assessment programmes in IT and digital literacy. On 5 July 2012 the International Education business completed the purchase of GlobalEnglish Corporation, a leading provider of cloud-based, on-demand business English learning, assessment and performance support software. On 19 July 2012 Penguin announced the acquisition of Author Solutions, Inc., the world’s leading provider of professional self-publishing services and on 21 November 2012 the North American Education business acquired EmbanetCompass, a leading provider of technology enabled online learning solutions. The Group acquired a 100% interest in all of the investments noted above. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 158 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 30. Business combinations continued Provisional values for the assets and liabilities arising from these and other acquisitions completed in the year together with adjustments to prior year acquisitions are as follows: All figures in £ millions Property, plant and equipment Intangible assets Intangible assets – Pre-publication Inventories Trade and other receivables Cash and cash equivalents (excluding overdrafts) Financial liabilities – Borrowings Net deferred income tax liabilities Retirement benefit obligations Provisions for other liabilities and charges Trade and other liabilities Current income tax liabilities Non-controlling interest Net assets acquired at fair value Goodwill Fair value of previously held interest arising on stepped acquisition Total Satisfied by: Cash Deferred consideration Net prior year adjustments Total consideration Notes Certiport fair value Author Solutions fair value Global English fair value Embanet Compass fair value Other fair value Total fair value Total fair value 2012 2011 10 11 20 13 23 11 – 49 5 – 5 2 – (20) – – (11) – – 30 58 – 88 (88) – – (88) 1 35 – – 8 – – (3) – – (28) – – 13 56 – 69 (69) – – (69) – 36 1 – 8 8 – (13) – – (22) (1) – 17 46 – 63 (63) – – (63) 3 74 – – 13 18 – (21) – – (26) – – 61 350 – 411 6 86 – 1 – 6 – (10) (2) (1) (24) – – 62 (5) 10 280 6 1 34 34 – (67) (2) (1) (111) (1) – 183 505 21 375 8 2 58 151 (9) (96) (4) (78) (115) (2) (1) 310 620 – 57 – 688 (15) 915 (411) – – (411) (51) (6) – (57) (682) (6) – (688) (913) – (2) (915) The goodwill arising on these acquisitions results from substantial cost and revenue synergies and from benefits that cannot be separately recognised, such as the assembled workforce. Intangible assets in other acquisitions includes £69m relating to prior year acquisitions. The fair value of trade and other receivables is £34m and includes trade receivables with a fair value of £26m. The gross contractual amount for trade receivables due is £27m of which £1m is expected to be uncollectable. A provisional value of £nil of goodwill arising on 2012 acquisitions is expected to be deductible for tax purposes (2011: £1m). Intangible assets acquired in 2012 have the following useful economic lives: Certiport: customer lists and relationships 3-20 years; Author Solutions: customer lists and relationships 5 years, trademarks and brands 20 years, other intangibles 7-20 years; Global English: other intangibles 10 years. As EmbanetCompass was acquired in late 2012 the useful economic lives of intangible assets acquired are provisional and not yet finalised. Intangible assets acquired with all other acquisitions have useful economic lives of 2-20 years. Section 6 Financial statements 159 30. Business combinations continued All figures in £ millions 2012 2011 Cash flow on acquisitions (682) Cash – Current year acquisitions (31) Deferred payments for prior year acquisitions and other items 34 Cash and cash equivalents acquired (37) Acquisition costs and other acquisition liabilities paid Net cash outflow (716) Acquisitions in 2012 contributed £45m to sales and £5m to operating profit before acquisition costs and amortisation of acquired intangibles from the date of acquisition to the balance sheet date. Of these amounts, Certiport contributed £20m of sales and a profit of £4m, Global English contributed £14m of sales and £2m of profit and EmbanetCompass contributed £7m of sales and £1m of profit. (913) (5) 151 (12) (779) If the acquisitions had completed on 1 January 2012, the Group estimates that sales for the period would have been £5,168m and profit before tax would have been £444m. 31. Disposals including business closures All figures in £ millions Notes 2012 2011 Disposal of subsidiaries Property, plant and equipment Intangible assets Inventories Trade and other receivables Cash and cash equivalents (excluding overdrafts) Net deferred income tax liabilities Retirement benefit obligations Trade and other liabilities Current income tax liabilities Non-controlling interest Attributable goodwill Net assets disposed Costs Loss on disposal All figures in £ millions Cash flow from disposals Cash and cash equivalents disposed Costs paid Net cash outflow 10 11 13 11 (3) (45) – – – 11 – – – – (50) (87) (26) (113) – (4) (7) (5) (6) 1 1 2 1 7 (4) (14) – (14) 2012 2011 – (11) (11) (6) – (6) The disposal in 2012 includes the write down of assets resulting from the closure of Pearson in Practice. The disposal in 2011 relates to Longman Nigeria. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 160 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 32. Held for sale Assets classified as held for sale relate to Penguin as a result of the announcement by Pearson and Bertelsmann to combine Penguin and Random House. All figures in £ m illions Notes 2012 2011 Property, plant and equipment Intangible assets Investments in joint ventures and associates Deferred income tax assets Other financial assets Trade and other receivables Intangible assets – Pre-publication Inventories Cash and cash equivalents (excluding overdrafts) Assets classified as held for sale Financial liabilities – Borrowings Deferred income tax liabilities Retirement benefit obligations Provisions for other liabilities and charges Trade and other liabilities Liabilities directly associated with assets classified as held for sale Net assets classified as held for sale 33. Transactions with non-controlling interest 10 11 12 13 15 20 17 18 13 25 23 40 404 27 38 1 451 16 80 115 1,172 (7) (20) (26) (29) (234) (316) 856 – – – – – – – – – – – – – – – – In 2012 the Group increased its investments in its subsidiaries in China at a cost of £4m. In 2011 the remaining non-controlling interest in Sistema Educacional Brasileiro was acquired for £108m. Section 6 Financial statements 161 34. Cash generated from operations All figures in £ millions Profit Adjustments for: Income tax Depreciation Intangible charges Amortisation of other intangible assets Net finance costs Share of results of joint ventures and associates Loss/(profit) on disposals Acquisition costs Costs on formation of Penguin Random House Net foreign exchange adjustment from transactions Share-based payment costs Pre-publication Inventories Trade and other receivables Trade and other liabilities Retirement benefit obligations Provisions for other liabilities and charges Net cash generated from operations Dividends from joint ventures and associates Purchase of property, plant and equipment Purchase of intangible assets Proceeds from sale of property, plant and equipment Proceeds from sale of intangible assets Finance lease principal payments Operating cash flow Operating tax paid Net operating finance costs paid Free cash flow Dividends paid (including to non-controlling interests) Net movement of funds from operations Acquisitions and disposals (net of tax) Purchase of treasury shares New equity Other movements on financial instruments Net movement of funds Exchange movements on net debt Total movement in net debt Notes 10 11 11 6 12 26 2012 329 167 80 183 54 81 (9) 113 21 32 (21) 32 (55) 49 (94) – (41) (5) 916 27 (78) (73) 1 3 (8) 788 (65) (66) 657 (348) 309 (780) – 11 – (460) 41 (419) 2011 956 199 70 139 48 71 (33) (435) 12 – 24 40 2 15 (9) 31 (65) 28 1,093 30 (67) (77) 9 3 (8) 983 (151) (60) 772 (319) 453 (420) (60) 21 (8) (14) (55) (69) O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 162 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 34. Cash generated from operations continued Net cash generated from operations is translated at an exchange rate approximating to the rate at the date of cash flow. The difference between this rate and the average rate used to translate profit gives rise to a currency adjustment in the reconciliation between net profit and net cash generated from operations. This adjustment reflects the timing difference between recognition of profit and the related cash receipts or payments. Operating cash flow, operating free cash flow and total free cash flow are non-GAAP measures and have been disclosed as they are part of Pearson’s corporate and operating measures. In the cash flow statement, proceeds from sale of property, plant and equipment comprise: All figures in £ millions Net book amount Loss on sale of property, plant and equipment Proceeds from sale of property, plant and equipment 2012 2011 1 – 1 9 – 9 The principal other non-cash transactions are movements in finance lease obligations of £nil (2011: £10m). 35. Contingencies There are contingent Group liabilities that arise in the normal course of business in respect of indemnities, warranties and guarantees in relation to former subsidiaries and in respect of guarantees in relation to subsidiaries, joint ventures and associates. In addition there are contingent liabilities of the Group in respect of legal claims, contract disputes, royalties, copyright fees, permissions and other rights. None of these claims are expected to result in a material gain or loss to the group. 36. Commitments There were no commitments for capital expenditure contracted for at the balance sheet date but not yet incurred. The Group leases various offices and warehouses under non-cancellable operating lease agreements. The leases have varying terms and renewal rights. The Group also leases various plant and equipment under operating lease agreements, also with varying terms. The lease expenditure charged to the income statement during the year is disclosed in note 4. The future aggregate minimum lease payments in respect of operating leases are as follows: All figures in £ millions Not later than one year Later than one year and not later than two years Later than two years and not later than three years Later than three years and not later than four years Later than four years and not later than five years Later than five years 2012 186 174 158 137 124 899 1,678 2011 179 164 149 134 119 980 1,725 Section 6 Financial statements 163 37. Related party transactions Joint ventures and associates Amounts advanced to joint ventures and associates during the year and at the balance sheet date are set out in note 12. There are no material amounts falling due from joint ventures and associates. In December 2011, the Group disposed of its 50% interest in FTSE International Ltd and details of this transaction are also shown in note 12. Key management personnel Key management personnel are deemed to be the members of the board of directors of Pearson plc. It is this board which has responsibility for planning, directing and controlling the activities of the Group. Key management personnel compensation is disclosed in the directors’ remuneration report. There were no other material related party transactions. No guarantees have been provided to related parties. 38. Events after the balance sheet date In January 2013, the Group completed the purchase of a 5% equity investment in NOOK Media, LLC for $89.5m. NOOK Media is a new company consisting of Barnes & Noble’s digital businesses including its NOOK e-reader and tablets, the NOOK digital bookstore and its 674 college bookstores across America. In February 2013 the Group completed the purchase of the remaining minority interest in Tutorvista, the Bangalore based tutoring services company, for £17m. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 164 Pearson plc Annual report and accounts 2012 Notes to the consolidated financial statements continued 39. Accounts and audit exemptions Following a change in legislation in 2012 the Pearson plc subsidiary companies listed below are exempt from the requirements of the Companies Act 2006 relating to the audit of individual accounts by virtue of section 479A. Company number Company number Aldwych Finance Ltd ASET Ltd ASET Group Ltd ASET Management Ltd ASET Solutions Ltd Blue Wharf Ltd Burmedia Investments Ltd Edexcel Ltd Education Development International plc Embankment Finance Ltd eNVQ Ltd EQL Assessment Ltd Financial Times Group Ltd Fronter UK Ltd FT Business Information Ltd FT Labs Ltd FT Personal Finance Ltd Goal Ltd Green Wharf Ltd Hoxton Holdings Ltd Icodeon Ltd Inframation Ltd Joint Examining Board Ltd Longman Group (Overseas Holdings) Ltd MergerID Ltd Midlands Educational Technology Ltd Pearson Amsterdam Finance Ltd Pearson Australia Finance Unltd Pearson BOP Investments Ltd Pearson Canada Finance Unltd Pearson College Ltd 04720439 04231636 03964551 03139404 03849880 04344573 03060487 04496750 03914767 04460625 03985948 05224778 00879531 05737591 00758738 04701650 03855520 03566588 07009228 05052993 05068195 04581107 03278422 00690236 07031999 01448842 03041245 05578463 08038068 05578491 07967446 00872828 Pearson Education Ltd 00210859 Pearson Education Holdings Ltd 03099304 Pearson Heinemann Ltd 07679091 Pearson in Practice ATA Ltd Pearson in Practice Holdings Ltd 06337129 Pearson in Practice Skills Based Learning Ltd 03755464 03786989 Pearson in Practice Technology Ltd 02496206 Pearson International Finance Ltd 05144467 Pearson Loan Finance Unltd 05632021 Pearson Loan Finance No. 2 Unltd 05052661 Pearson Luxembourg Holdings Ltd 02635107 Pearson Luxembourg Holdings No. 2 Ltd 00096263 Pearson Management Services Ltd 00145205 Pearson Overseas Holdings Ltd 00149375 Pearson Professional Holdings Ltd 01341060 Pearson Services Ltd 04623186 Pearson Shared Services Ltd 03754757 Peter Honey Publications Ltd 05342448 Sector Training Ltd 02174119 St Clements Press (1988) Ltd 02496240 Testchange Ltd 05333023 The Coaching Space Ltd 01613899 The Financial Times (Benelux) Ltd 00867316 The Financial Times (France) Ltd 01613900 The Financial Times (Japan) Ltd. 01398449 The Financial Times (M-M UK) Ltd 00519261 The Financial Times (SCP) Ltd 01214411 The Financial Times (Spain) Ltd 07307943 TQ Catalis Ltd 07307925 TQ Clapham Ltd Section 6 Financial statements 165 39. Accounts and audit exemptions continued Following a change in legislation in 2012 the Pearson plc subsidiary companies listed below are exempt from the requirements of the Companies Act 2006 to prepare individual accounts by virtue of section 394A. Exec-Appointments Ltd FDI Intelligence Ltd Financial Times Business Ltd Financial Times Electronic Publishing Ltd Financial Times Investor Ltd Fundex Ltd Company number 04010964 N1040129 00202281 02749250 04005565 00931507 Mandatewire Ltd The Financial News Ltd The Financial Times (Switzerland) Ltd The Financial Times (Zhongwen) Ltd Throgmorton Publications Ltd Company number 03855296 00607228 01613901 01900030 00905696 O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 166 Pearson plc Annual report and accounts 2012 Company balance sheet As at 31 December 2012 All figures in £ millions Notes 2012 2011 Assets Non-current assets Investments in subsidiaries Amounts due from subsidiaries Financial assets – Derivative financial instruments Current assets Amounts due from subsidiaries Prepayments Financial assets – Derivative financial instruments Cash and cash equivalents (excluding overdrafts) Total assets Liabilities Non-current liabilities Amounts due to subsidiaries Financial liabilities – Borrowings Financial liabilities – Derivative financial instruments Current liabilities Amounts due to subsidiaries Current income tax liabilities Financial liabilities – Borrowings Financial liabilities – Derivative financial instruments Total liabilities Net assets Equity Share capital Share premium Treasury shares Special reserve Retained earnings Total equity attributable to equity holders of the company 2 6 6 4 5 6 5 6 7 7 8 9,108 2,021 174 11,303 578 4 4 643 1,229 12,532 (4,227) (473) – (4,700) (1,953) (13) (618) – (2,584) (7,284) 5,248 204 2,555 (27) 447 2,069 5,248 9,056 318 177 9,551 2,944 4 – 469 3,417 12,968 (1,370) (481) (2) (1,853) (5,850) (10) (703) (1) (6,564) (8,417) 4,551 204 2,544 (94) 447 1,450 4,551 These financial statements have been approved for issue by the board of directors on 7 March 2013 and signed on its behalf by Robin Freestone Chief financial officer 7 March 2013 Company statement of changes in equity Year ended 31 December 2012 Section 6 Financial statements 167 All figures in £ millions At 1 January 2012 Profit for the year Issue of ordinary shares under share option schemes* Contributions from subsidiaries for treasury shares Release of treasury shares Dividends At 31 December 2012 All figures in £ millions At 1 January 2011 Profit for the year Issue of ordinary shares under share option schemes* Purchase of treasury shares Release of treasury shares Dividends At 31 December 2011 Share capital 204 – – – – – 204 Share capital 203 – 1 – – – 204 Share premium 2,544 – 11 – – – 2,555 Share premium 2,524 – 20 – – – 2,544 Equity attributable to equity holders of the company Treasury shares (94) – – 21 46 – (27) Special reserve 447 – – – – – 447 Retained earnings 1,450 1,011 Total 4,551 1,011 – 11 – (46) (346) 2,069 21 – (346) 5,248 Equity attributable to equity holders of the company Treasury shares Special reserve (82) – – (60) 48 – (94) 447 – – – – – 447 Retained earnings 727 1,089 – – (48) (318) 1,450 Total 3,819 1,089 21 (60) – (318) 4,551 The special reserve represents the cumulative effect of cancellation of the company’s share premium account. Included within retained earnings is an amount of £131m (2011: £131m) relating to profit on intra-group disposals that is not distributable. * Full details of the share-based payment plans are disclosed in note 26 to the consolidated financial statements. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 168 Pearson plc Annual report and accounts 2012 Company cash flow statement Year ended 31 December 2012 All figures in £ millions Notes 2012 2011 Cash flows from operating activities Net profit Adjustments for: Income tax Net finance costs Amounts due to subsidiaries Net cash generated from operations Interest paid Tax received Net cash generated from operating activities Cash flows from investing activities Acquisition of subsidiaries, net of cash acquired Interest received Net cash received from /(used in) investing activities Cash flows from financing activities Proceeds from issue of ordinary shares Net purchase of treasury shares Repayment of borrowings Dividends paid to company’s shareholders Net cash used in financing activities Effects of exchange rate changes on cash and cash equivalents Net increase/(decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year 1,011 1,089 (39) 103 (427) 648 (93) 43 598 – 1 1 11 – (1) (346) (336) (4) 259 (234) 25 (39) 85 (917) 218 (112) 57 163 (114) – (114) 21 (60) (307) (318) (664) (29) (644) 410 (234) 7 4 Notes to the company financial statements Section 6 Financial statements 169 1. Accounting policies The financial statements on pages 166 to 174 comprise the separate financial statements of Pearson plc. As permitted by section 408 of the Companies Act 2006, only the consolidated income statement and statement of comprehensive income has been presented. The company has no employees. The accounting policies applied in the preparation of these company financial statements are the same as those set out in note 1 to the consolidated financial statements with the addition of the following: Investments Investments in subsidiaries are stated at cost less provision for impairment, with the exception of certain hedged investments that are held in a foreign currency and revalued at each balance sheet date. 2. Investments in subsidiaries All figures in £ millions At beginning of year Subscription for share capital in subsidiaries Disposals/liquidations Currency revaluations At end of year 3. Financial risk management 2012 2011 9,056 110 – (58) 9,108 9,180 279 (413) 10 9,056 The company’s financial instruments comprise amounts due to/from subsidiary undertakings, cash and cash equivalents, derivative financial instruments and current and non-current borrowings. Derivative financial instruments are held at fair value, with all other financial instruments held at amortised cost. The company’s approach to the management of financial risks is consistent with the Group’s treasury policy, as discussed in note 19 to the consolidated financial statements. The company believes the value of its financial assets to be fully recoverable. The company designates certain of its qualifying derivative financial instruments as hedges of the fair value of its bonds (fair value hedges). Changes in the fair value of these derivative financial instruments are recorded in the income statement, together with any change in the fair value of the hedged liability attributable to the hedged risk. The carrying value of the company’s financial instruments is exposed to movements in interest rates and foreign currency exchange rates (primarily US dollars). The company estimates that a 1% increase in interest rates would result in a £55m decrease in the carrying value of its financial instruments, with a 1% decrease in interest rates resulting in a £54m increase in their carrying value. The company also estimates that a 10% strengthening in sterling would decrease the carrying value of its financial instruments by £126m, while a 10% decrease in the value of sterling would increase the carrying value by £154m. These increases and decreases in carrying value would be recorded through the income statement. Sensitivities are calculated using estimation techniques such as discounted cash flow and option valuation models. Where modelling an interest rate decrease of 1% led to negative interest rates, these points on the yield curve were adjusted to 0%. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 170 Pearson plc Annual report and accounts 2012 Notes to the company financial statements continued 3. Financial risk management continued The maturity of contracted cash flows on the company’s borrowings and all of its derivative financial instruments are as follows: All figures in £ millions Not later than one year Later than one year and not later than five years Later than five years Total Analysed as: Bonds Rate derivatives – inflows Rate derivatives – outflows Total All figures in £ millions Not later than one year Later than one year and not later than five years Later than five years Total Analysed as: Bonds Rate derivatives – inflows Rate derivatives – outflows Total USD (26) 105 155 234 232 (326) 328 234 USD (24) 128 176 280 251 (292) 321 280 GBP 3 21 – 24 285 (264) 3 24 GBP 3 24 – 27 303 (281) 5 27 Other 1 21 – 22 – – 22 22 Other 2 25 – 27 – – 27 27 2012 Total (22) 147 155 280 517 (590) 353 280 2011 Total (19) 177 176 334 554 (573) 353 334 All cash flow projections shown above are on an undiscounted basis. Any cash flows based on a floating rate are calculated using interest rates as set at the date of the last rate reset. Where this is not possible, floating rates are based on interest rates prevailing at 31 December in the relevant year. All derivative amounts are shown gross, although the company net settles these amounts wherever possible. Any amounts drawn under revolving credit facilities and commercial paper are assumed to mature at the maturity date of the relevant facility, with interest calculated as payable in each calendar year up to and including the date of maturity of the facility. Section 6 Financial statements 171 4. Cash and cash equivalents (excluding overdrafts) All figures in £ millions Cash at bank and in hand Short-term bank deposits 2012 1 642 643 2011 – 469 469 Short-term bank deposits are invested with banks and earn interest at the prevailing short-term deposit rates. At the end of 2012 the currency split of cash and cash equivalents was US dollar 63% (2011: 2%) and sterling 37% (2011: 98%). Cash and cash equivalents have fair values that approximate to their carrying amounts due to their short-term nature. Cash and cash equivalents include the following for the purpose of the cash flow statement: All figures in £ millions Cash and cash equivalents Bank overdrafts 5. Financial liabilities – Borrowings All figures in £ millions Non-current 7.0% Sterling Bonds 2014 (nominal amount £250m) 4.625% US Dollar Notes 2018 (nominal amount $300m) Current Due within one year or on-demand: Bank loans and overdrafts Total borrowings 2012 643 (618) 25 2011 469 (703) (234) 2012 2011 256 217 473 257 224 481 618 618 1,091 703 703 1,184 Included in non-current borrowings above is £3m of accrued interest (2011: £4m). Included in current borrowings above is £nil of accrued interest (2011: £nil). O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 172 Pearson plc Annual report and accounts 2012 Notes to the company financial statements continued 5. Financial liabilities – Borrowings continued The maturity of the company’s non-current borrowings is as follows: All figures in £ millions Between one and two years Between two and five years Over five years 2012 256 – 217 473 2011 – 257 224 481 As at 31 December 2012 the exposure to interest rate changes of the borrowings and amounts due to subsidiaries when the borrowings re-price is as follows: All figures in £ millions Re-pricing profile of borrowings Amounts due to subsidiaries Effect of rate derivatives The carrying amounts and market values of borrowings are as follows: All figures in £ millions Bank loans and overdrafts 7.0% Sterling Bonds 2014 4.625% US Dollar notes 2018 Effective interest rate n/a 7.20% 4.69% Less than one year One to five years More than five years 618 1,953 1,311 3,882 Carrying amount 618 256 217 1,091 256 3,286 (480) 3,062 2012 Market value 618 274 209 1,101 217 941 (831) 327 Carrying amount 703 257 224 1,184 Total 1,091 6,180 – 7,271 2011 Market value 703 282 206 1,191 The market values are based on clean market prices at the year end or, where these are not available, on the quoted market prices of comparable debt issued by other companies. The effective interest rates above relate to the underlying debt instruments. The carrying amounts of the company’s borrowings are denominated in the following currencies: All figures in £ millions US dollar Sterling Euro 2012 255 826 10 1,091 2011 373 802 9 1,184 Section 6 Financial statements 173 6. Derivative financial instruments The company’s outstanding derivative financial instruments are as follows: All figures in £ millions Interest rate derivatives – in a fair value hedge relationship Interest rate derivatives – not in a hedge relationship Cross-currency derivatives Total Analysed as expiring: In less than one year Later than one year and not later than five years Later than five years Total Gross notional amounts Assets Liabilities Gross notional amounts Assets Liabilities 2012 2011 234 1,292 220 1,746 215 701 830 1,746 35 109 34 178 4 69 105 178 – – – – – – – – 243 1,030 220 1,493 – 946 547 1,493 35 119 23 177 – 81 96 177 – – (3) (3) (1) (2) – (3) The carrying value of the above derivative financial instruments equals their fair value. Fair values are determined by using market data and the use of established estimation techniques such as discounted cash flow and option valuation models. 7. Share capital and share premium At 1 January 2011 Issue of ordinary shares – share option schemes At 31 December 2011 Issue of ordinary shares – share option schemes At 31 December 2012 Number of shares 000s 812,677 2,949 815,626 1,417 817,043 Ordinary shares £m 203 1 204 – 204 Share premium £m 2,524 20 2,544 11 2,555 The ordinary shares have a par value of 25p per share (2011: 25p per share). All issued shares are fully paid. All shares have the same rights. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 174 Pearson plc Annual report and accounts 2012 Notes to the company financial statements continued 8. Treasury shares At 1 January 2011 Purchase of treasury shares Contribution from subsidiaries Release of treasury shares At 31 December 2011 Purchase of treasury shares Contribution from subsidiaries Release of treasury shares At 31 December 2012 Number of shares 000s 14,009 5,387 – (4,731) 14,665 – – (4,563) 10,102 £m 82 60 – (48) 94 – (21) (46) 27 The company holds its own shares in trust to satisfy its obligations under its restricted share plans. These shares are treated as treasury shares for accounting purposes and have a par value of 25p per share. The nominal value of the company’s treasury shares amounts to £2.5m (2011: £3.7m). At 31 December 2012 the market value of the company’s treasury shares was £120.0m (2011: £177.4m). 9. Contingencies There are contingent liabilities that arise in the normal course of business in respect of indemnities, warranties and guarantees in relation to former subsidiaries and in respect of guarantees in relation to subsidiaries. In addition there are contingent liabilities in respect of legal claims. None of these claims are expected to result in a material gain or loss to the company. 10. Audit fees Statutory audit fees relating to the company were £35,000 (2011: £35,000). 11. Related party transactions Subsidiaries The company transacts and has outstanding balances with its subsidiaries. Amounts due from subsidiaries and amounts due to subsidiaries are disclosed on the face of the company balance sheet. These loans are generally unsecured and interest is calculated based on market rates. The company has interest payable to subsidiaries for the year of £171m (2011: £176m) and interest receivable from subsidiaries for the year of £64m (2011: £54m). Management fees payable to subsidiaries in respect of centrally provided services amounted to £47m (2011: £17m). Dividends received from subsidiaries were £1,124m (2011: £1,471m). Key management personnel Key management personnel are deemed to be the members of the board of directors of the company. It is this board which has responsibility for planning, directing and controlling the activities of the company. Key management personnel compensation is disclosed in the report on directors’ remuneration in the consolidated financial statements. There were no other material related party transactions. Principal subsidiaries Section 6 Financial statements 175 The principal operating subsidiaries at 31 December 2012 are listed below. They operate mainly in the countries of incorporation or registration. The investments are in equity share capital and they are all 100% owned. Country of incorporation or registration Pearson Education Pearson Education Inc. Pearson Education Ltd NCS Pearson Inc. FT Group The Financial Times Ltd Mergermarket Ltd The Penguin Group* Penguin Group (USA) Inc. The Penguin Publishing Company Ltd Dorling Kindersley Holdings Ltd** US England US England England US England England * The Penguin Group companies have been included in discontinued operations. ** Direct investment of Pearson plc. The company has taken advantage of the exemption under Section 410(2) of the Companies Act 2006 by providing information only in relation to subsidiary undertakings whose results or financial position, in the opinion of the directors, principally affected the financial statements. A complete list of subsidiary and associated undertakings will be included in the next Pearson plc annual return filed with the Registrar of Companies. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 176 Pearson plc Annual report and accounts 2012 Five year summary All figures in £ millions Sales North American Education International Education Professional Education FT Group Continuing Discontinued Total sales Adjusted operating profit North American Education International Education Professional Education FT Group Continuing Discontinued Total adjusted operating profit 2008 2009 2010 2011 2012 2,002 866 244 3,112 390 3,502 1,317 4,819 303 135 36 474 74 548 214 762 2,470 1,035 275 3,780 358 4,138 1,486 5,624 403 141 43 587 39 626 232 858 2,640 1,234 333 4,207 403 4,610 1,349 5,959 469 171 51 691 60 751 187 938 2,584 1,424 382 4,390 427 4,817 1,045 5,862 493 196 66 755 76 831 111 942 2,658 1,568 390 4,616 443 5,059 1,053 6,112 536 216 37 789 49 838 98 936 Operating margin – continuing 15.6% 15.1% 16.3% 17.3% 16.6% Adjusted earnings Total adjusted operating profit Net finance costs Income tax Non-controlling interest Adjusted earnings Weighted average number of shares (millions) Adjusted earnings per share 762 (88) (178) (36) 460 797.0 57.7p 858 (97) (194) (44) 523 799.3 65.4p 938 (85) (215) (17) 621 801.2 77.5p 942 (52) (199) 1 692 800.2 86.5p 936 (52) (204) (3) 677 804.3 84.2p Section 6 Financial statements 177 All figures in £ millions 2008 2009 2010 2011 2012 Cash flow Operating cash flow Operating cash conversion Operating free cash flow Operating free cash flow per share Total free cash flow Total free cash flow per share Net assets Net debt Return on invested capital (gross basis) Total adjusted operating profit Cash tax paid Return Average invested capital Return on invested capital 796 104% 631 79.2p 631 79.2p 913 106% 723 90.5p 723 90.5p 1,057 113% 904 112.8p 904 112.8p 983 104% 772 96.5p 772 96.5p 788 84% 657 81.7p 657 81.7p 5,024 4,636 5,605 5,962 5,710 1,460 1,092 430 499 918 762 (89) 673 7,337 9.2% 858 (103) 755 8,504 8.9% 938 (85) 853 8,315 10.3% 942 (151) 791 8,731 9.1% 936 (65) 871 9,578 9.1% Dividend per share 33.8p 35.5p 38.7p 42.0p 45.0p O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 178 Pearson plc Annual report and accounts 2012 Corporate and operating measures Pearson’s corporate and operating measures include the results of Penguin throughout 2012 as the business was wholly owned during that period. Sales – underlying and constant exchange rate movement Sales movement for continuing operations excluding the impact of acquisitions and disposals and movements in exchange rates. All figures in £ millions Underlying decrease Portfolio changes Exchange differences Total sales increase Underlying decrease Constant exchange rate increase Adjusted income statement 2012 (41) 318 (27) 250 (1)% 5% Reconciliation of the consolidated income statement to the adjusted numbers presented as non-GAAP measures in the financial statements. All figures in £ millions Operating profit Net finance costs Profit before tax Income tax Profit for the year from continuing operations Profit for the year from discontinued operations Profit for the year Non-controlling interest Earnings Statutory income statement Discontinued operations Other net gains and losses Acquisition costs Intangible charges 2012 Other net finance income/ costs Tax amortisation benefit Adjusted income statement 515 (81) 434 (148) 286 43 329 (3) 326 98 – 98 (32) 123 – 123 – 66 123 (66) – – – 20 143 – 143 20 – 20 (5) 15 1 16 – 16 180 – 180 (54) 126 2 128 – 128 – 29 29 (1) 28 – 28 – 28 – – – 36 36 – 36 – 36 936 (52) 884 (204) 680 – 680 (3) 677 Section 6 Financial statements 179 Discontinued operations Other net gains and losses Acquisition costs Intangible charges Other net finance income/ costs Tax amortisation benefit Adjusted income statement 2011 111 – 111 (38) (435) – (435) 19 73 (416) (73) – – – – (416) – (416) 12 – 12 (4) 8 – 8 – 8 136 – 136 (43) 93 2 95 – 95 – 19 19 (5) 14 – 14 – 14 Adjusted income statement continued All figures in £ millions Operating profit Net finance costs Profit before tax Income tax Profit for the year from continuing operations Profit for the year from discontinued operations Profit for the year Non-controlling interest Earnings Statutory income statement 1,118 (71) 1,047 (162) 885 71 956 1 957 Adjusted operating profit – underlying and constant exchange rate movement Operating profit movement excluding the impact of acquisitions, disposals and movements in exchange rates. All figures in £ millions Underlying decrease Portfolio changes Exchange differences Total adjusted operating profit increase Underlying decrease Constant exchange rate increase – – – 942 (52) 890 34 (199) 34 – 34 – 34 691 – 691 1 692 2012 (14) 19 (11) (6) (2)% 1% O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 180 Pearson plc Annual report and accounts 2012 Corporate and operating measures continued Free cash flow per share Operating cash flow for continuing and discontinued operations before tax and finance charges, divided by the weighted average number of shares in issue. All figures in £ millions 2012 2011 Adjusted operating profit Cash conversion Operating cash flow Operating tax paid Net operating finance costs paid Total operating free cash flow Non operating tax paid Total free cash flow Weighted average number of shares in issue (millions) Operating free cash flow per share Total free cash flow per share Return on invested capital All figures in £ millions Total adjusted operating profit Intangible charges Operating tax paid Return Average goodwill and other intangibles Average net operating assets Average invested capital Return on invested capital 936 84% 788 (65) (66) 657 – 657 804.3 81.7p 81.7p 942 104% 983 (151) (60) 772 – 772 800.2 96.5p 96.5p Net invested capital Gross invested capital 2012 936 (183) (65) 688 6,371 1,028 7,399 9.3% 2011 942 (139) (151) 652 5,680 1,047 6,727 9.7% 2012 2011 936 – (65) 871 8,550 1,028 9,578 9.1% 942 – (151) 791 7,684 1,047 8,731 9.1% Return on invested capital is calculated using two methods: Gross basis – total adjusted operating profit less operating cash tax paid expressed as a percentage of average gross invested capital. Gross invested capital includes the original unamortised goodwill and intangibles. Net basis – total adjusted operating profit less intangible amortisation and operating cash tax paid expressed as a percentage of average net invested capital. Net invested capital includes the carrying value (after amortisation) of goodwill and intangibles. Shareholder information Pearson ordinary shares are listed on the London Stock Exchange and on the New York Stock Exchange in the form of American Depositary Receipts. Corporate website The investors’ section of our corporate website www.pearson.com/investors provides a wealth of information for shareholders. It is also possible to sign up to receive email alerts for reports and press releases relating to Pearson at www.pearson.com/investors/announcements/ email-alerts Shareholder information online Shareholder information can be found on our website www.pearson.com/investors/shareholder- information. Our registrar, Equiniti also provides a range of shareholder information online. You can check your holding and find practical help on transferring shares or updating your details at www.shareview.co.uk. For more information, please contact our registrar, Equiniti, Aspect House, Spencer Road, Lancing, West Sussex BN99 6DA. Telephone 0871 384 2233* or, for those shareholders with hearing difficulties, textphone number 0871 384 2255*. Information about the Pearson share price The company’s share price can be found on our website at www.pearson.com. It also appears in the financial columns of the national press. 2012 Dividends Payment date Amount per share Interim Final 14 September 2012 3 May 2013 15 pence 30 pence Payment of dividends to mandated accounts Should you elect to have your dividends paid through BACS, this can be done directly into a bank or building society account, with the tax voucher sent to the shareholder’s registered address. Equiniti can be contacted for information on 0871 384 2043*. Dividend reinvestment plan (DRIP) The DRIP gives shareholders the right to buy the company’s shares on the London stock market with their cash dividend. For further information, please contact Equiniti on 0871 384 2268*. Section 6 Financial statements 181 Individual Savings Accounts (ISAs) Equiniti offers ISAs in Pearson shares. For more information, please go to www.shareview.co.uk/dealing or call customer services on 0845 300 0430*. Share dealing facilities Equiniti offers telephone and internet services for dealing in Pearson shares. For further information, please contact their telephone dealing helpline on 08456 037 037 (weekdays only) or, for online dealing, log on to www.shareview.co.uk/dealing. You will need your shareholder reference number as shown on your share certificate. A weekly postal dealing service is also available through Equiniti. Please telephone 0871 384 2248* for details or log on to www.shareview.co.uk to download a form. ShareGift Shareholders with small holdings of shares, whose value makes them uneconomic to sell, may wish to donate them to ShareGift, the share donation charity (registered charity number 1052686). Further information about ShareGift and the charities it has supported may be obtained from their website, www.ShareGift.org or by contacting them at 17 Carlton House Terrace, London SW1Y 5AH. American Depositary Receipts (ADRs) Pearson’s ADRs are listed on the New York Stock Exchange and traded under the symbol PSO. Each ADR represents one ordinary share. For enquiries regarding registered ADR holder accounts and dividends, please contact The Bank of New York Mellon, PO Box 43006, Providence, RI 02940-3006, telephone 1 (866) 259 2289 (toll free within the US) or 001 201 680 6825 (outside the US). Alternatively, you may e-mail shrrelations@bnymellon.com, or log on to www.bnymellon.com/shareowner. Voting rights for registered ADR holders can be exercised through The Bank of New York Mellon, and for beneficial ADR holders (and/or nominee accounts) through your US brokerage institution. Pearson will file with the Securities and Exchange Commission a Form 20-F. *Calls to these numbers are charged at 8p per minute plus network extras. Lines open 8.30am to 5.30pm Monday to Friday. O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 182 Pearson plc Annual report and accounts 2012 Shareholder information continued Share register fraud: protecting your investment Pearson does not contact its shareholders directly to provide recommendation advice and neither does it appoint third parties to do so. As required by law, our shareholder register is available for public inspection but we cannot control the use of information obtained by persons inspecting the register. Please treat any approaches purporting to originate from Pearson with caution. For more information, please log on to our website at www.pearson.com/investors/shareholder- information/managing-your-shares and www.pearson.com/shareholderfaqs Tips on protecting your shares ›(cid:3)Keep any documentation that contains your shareholder reference number in a safe place and shred any unwanted documentation ›(cid:3)Inform our registrar, Equiniti promptly when you change address ›(cid:3)Be aware of dividend payment dates and contact the registrar if you do not receive your dividend cheque or better still, make arrangements to have the dividend paid directly into your bank account ›(cid:3)Consider holding your shares electronically in a CREST account via a nominee 2013 Financial calendar Ex-dividend date Record date Last date for dividend reinvestment election Annual General Meeting Payment date for dividend and share purchase date for dividend reinvestment Interim results Payment date for interim dividend 3 April 5 April 12 April 26 April 3 May 26 July 13 September Principal offices worldwide Section 6 Financial statements 183 Pearson plc 80 Strand, London WC2R 0RL, UK T +44 (0)20 7010 2000 F +44 (0)20 7010 6060 firstname.lastname@pearson.com www.pearson.com Pearson Inc. 1330 Avenue of the Americas, New York City, NY 10019, USA T +1 212 641 2400 F +1 212 641 2500 firstname.lastname@pearson.com www.pearson.com Pearson North America One Lake Street, Upper Saddle River, NJ 07458, USA T +1 201 236 7000 F +1 201 236 3222 firstname.lastname@pearson.com www.pearsoned.com Pearson International 190 High Holborn, London WC1V 7BH, UK T +44 (0)20 7190 4190 F +44 (0)20 7190 5700 firstname.lastname@pearson.com www.pearson.com Financial Times Group (UK) Number One Southwark Bridge, London SE1 9HL, UK T +44 (0)20 7873 3000 F +44 (0)20 7873 3922 firstname.lastname@ft.com www.ft.com The Penguin Group (UK) 80 Strand, London WC2R 0RL, UK T +44 (0)20 7010 3000 F +44 (0)20 7010 6060 firstname.lastname@uk.penguingroup.com www.penguin.co.uk The Penguin Group (USA) 375 Hudson Street, New York City, NY 10014, USA T +1 212 366 2000 F +1 212 366 2666 firstname.lastname@us.penguingroup.com us.penguingroup.com Pearson plc Registered number 53723 (England) O V E R V I E W O U R P E R F O R M A N C E O U R I M P A C T O N S O C I E T Y G O V E R N A N C E F I N A N C I A L S T A T E M E N T S 184 Pearson plc Annual report and accounts 2012 Notes Reliance on this document Our Business Review on pages 02 to 43 has been prepared in accordance with the Directors’ Report Business Review Requirements of section 417 of the Companies Act 2006. It also incorporates much of the guidance set out in the Accounting Standards Board’s Reporting Statement on the Operating and Financial Review. The intention of this document is to provide information to shareholders and is not designed to be relied upon by any other party or for any other purpose. Forward-looking statements This document contains forward-looking statements which are made by the directors in good faith based on information available to them at the time of approval of this report. In particular, all statements that express forecasts, expectations and projections with respect to future matters, including trends in results of operations, margins, growth rates, overall market trends, the impact of interest or exchange rates, the availability of financing, anticipated costs savings and synergies and the execution of Pearson’s strategy, are forward-looking statements. By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that will occur in the future. There are a number of factors which could cause actual results and developments to differ materially from those expressed or implied by these forward-looking statements, including a number of factors outside Pearson’s control. Any forward-looking statements speak only as of the date they are made, and Pearson gives no undertaking to update forward- looking statements to reflect any changes in its expectations with regard thereto or any changes to events, conditions or circumstances on which any such statement is based. Design and Production: Radley Yeldar (London) www.ry.com Print: Pureprint Group Pearson has supported the planting of 550 square metres of new native woodland with the Woodland Trust, helping to remove 22 tonnes of carbon dioxide emissions generated by the production of this report. This report has been printed on Edixion Challenger Offset which is FSC® certified and made from 100% Elemental Chlorine Free (ECF) pulp. The mill and the printer are both certified to ISO 14001 environmental management system and registered to EMAS the eco management Audit Scheme. The report was printed using vegetable based inks by a CarbonNeutral® printer. Learn more at www.pearson.com Pearson plc 80 Strand London WC2R 0RL T +44 (0)20 7010 2000 F +44 (0)20 7010 6060