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Hello, and welcome to the Pearson Third Quarter 2018 Trading Update Analyst Call. [Operator Instructions]And just to remind you, this is being recorded.So today I'm pleased to present John Fallon, CEO; and Coram Williams, CFO. Please begin.
Thank you and good morning, everybody. Thanks for joining us for our 9 months trading update. John Fallon here, and as you heard, with me is Coram Williams, our Chief Financial Officer. Headline for today is that with another key selling season behind us, we're in good shape. We're performing in line with our expectations, and we are on track to report underlying profit growth for the full year. Underlying sales are level or flat with last year, with 2 stories to tell. The first is that we're picking the pace across all our structural Growth businesses. So Online Program Management, virtual schools, Pearson Test of English, Pearson VUE, all growing strongly, all doing well. Alongside that, we are running our U.S. higher education courseware business on the basis that the market remains challenging, and it does. We are performing well competitively. We're making good progress on our digital transformation, and that really sets us up well for the future. As you know, as part of our technology transformation, we went live with our new ERP, or enterprise resource planning system in our large business in the U.S. in late May. These big technology implementations are always complex, and we did have some initial supply chain challenges as a result. But we worked very hard to minimize the impact on our customers, ensuring that students have the courseware that they need for the start of term. And as we bed in the new system, we are making sure that we are in much better shape for back-to-school in January, and we are very confident that we are. To put this in context, it does mean that we have now replaced successfully decades-old technology with a new proven platform that reduces risks, accelerates our digital transformation, and is fundamental towards achieving the efficiency gains that we have committed to. And it is running the business more efficiently that enables us to return Pearson to underlying profit growth this year and invest more organically in future digital growth, all sustained by and increasing the strong balance sheet. So let's have Coram take you through the details of current trading, and then I'll say a little more about the progress on our strategic priorities. So, Coram, over to you.
Thanks, John. Good morning, everybody. Let's start by taking a look at our sales performance by region. In North America, revenues were flat in the first 9 months of 2018, in underlying terms. We saw good growth in a number of areas: firstly, OPM due to higher enrollments; secondly, Connections, which is benefiting from a good pipeline of new virtual schools; and thirdly, professional certifications, where we continue to benefit from the recent launch of a contract to administer medical college admissions tests. This was offset by expected declines in higher education courseware, the ongoing retirement of Learning Studio and in U.S. K-12 courseware. In U.S. higher education courseware, revenue declined 3%, in line with our guidance and the expected phasing of sales, where the benefit of lower returns is proportionately smaller in the largest second half of our selling season. We saw lower than anticipated gross sales, partially offset by growth in digital sales and better than expected returns. As John mentioned, we experienced some challenges with the implementation of our new ERP system in the U.S. during the quarter. This led to delays in the delivery of some physical product, which we partly compensated for by extending free temporary digital access. We made good progress in fixing these issues, and whilst we do believe there was a small impact on gross sales in the quarter, we should largely recover this during Q4. Our market share remains within the 40% to 41.5% range that we've discussed previously, and adjusting for the extension of digital access, our digital sales growth was up mid-single digits for the 9 months. In Core, revenues increased 2% in underlying terms due to strong growth in Pearson Test of English, OPM services in Australia and the U.K. and professional certification, partly offset by declines in U.K. school assessment and qualifications and U.K. school and higher education courseware. In Growth, revenues fell 4% in underlying terms, primarily due to the expected decline in sales in South Africa school courseware on the back of a large order in early 2017. This was partially offset by good growth in English courseware in China. Excluding South Africa school courseware, underlying sales in our Growth segment grew by 1%. Overall, our performance is very much within the range we expected and first communicated in January. Our adjusted operating profit guidance remains unchanged. We expect Pearson to deliver underlying growth in operating profit in 2018 in the range of GBP 520 million to GBP 560 million. Our 2018 tax rate is expected to benefit from a couple of one-off factors: Firstly, provision releases following the expiry of the relevant statutes of limitation and the reassessment of historical tax positions; and secondly, significant one-off benefits following a review of the U.S. tax reform, the details of which will become clearer as the year has progressed. This also brings down finance costs due to the one-off reduction in interest cost relating to the tax provision releases. As a result, we now expect our 2018 adjusted effective tax rate to be a credit of between 5% and 7%, our finance costs to be around GBP 30 million, and 2018 adjusted EPS to be in the range of 68p to 72p. Excluding the impact of these one-off tax-driven benefits, we reiterate our prior expectations of EPS to be between 49p to 53p. It's important to note that the majority of the tax benefits are noncash and one-off in nature. So our expectations for our medium-term group effective tax rate remain unchanged at 20% to 22%. Net debt for the 9 months is GBP 620 million, significantly down on this time last year, as outflows from dividends, the share buyback we completed earlier in the year and restructuring were more than offset by operating cash inflows by disposal proceeds. Finally, our U.S. K-12 courseware business continues to be held for sale and is still included in guidance. Moving on to our simplification program. Our cost efficiency program is about making Pearson a leaner and more efficient company. 2018 is an important year, and we have achieved our major delivery milestones. We've implemented the new ERP system in the majority of our U.S. business, as we've described, which is an important step in simplifying our business. We've moved more roles into our shared services in HR, finance and technology. And thirdly, we've continued to reduce the number of applications used across the company as well as rationalizing the number of offices. We're progressing well and are on track to deliver the run rate of GBP 300 million of savings with the full benefits accruing from the end of 2019 onwards. And with that, I'll hand back to John.
Thanks, Coram. Coram has just given you a quick update on the third of our 3 strategic priorities that you can see on the slide, becoming simpler and more efficient. So let me just give you a very, very brief update on the other 2.The digital transformation of our courseware and assessment businesses is progressing well. In U.S. higher education, for example, our focus on affordable choice and better outcomes means that our digital and subscription models now make up the majority of our sales in this part of Pearson. And this shift will continue as more customers see the benefit of our Inclusive Access and e-book rental models as we triple the size of our print rental program, and as we bring that next generation of more personalized digital products that deliver better outcomes to students, to markets and I'm really thrilled to say, that we are now in testing of our new developmental math product. It looks great and we'll have it in the hands of our customers in the spring. As you remember, that's the first product to launch on our new global learning platform. And on the second of our 3 strategic priorities. Across all 4 of our structural growth opportunities, we did very well year-to-date, and more importantly, we have really good strong pipelines and great momentum going into Q4 and through into next year and beyond. So I'm particularly pleased, for example, with the progress we're now making in online program management, and I'm very excited about the opportunity that we can see over the next few years. So all in all, that means we remain firmly on track to meet our full-year expectations and deliver underlying profit growth. We're performing well competitively, we're investing to ensure we emerge as the winner in digital learning, we're helping our customers to develop the skills that learners need to improve their employability prospects and prosper in an ever-changing world. And we're doing all this on the basis of strong foundations, an increasingly efficient company, strong cash generation and prudent management of our balance sheet. So we have a lot still to do, but we continue to make steady progress in building a stronger and more sustainable business. And with that, Coram and I will be very happy to take your questions. So back to you, Hugh.
[Operator Instructions] Today, our first question is from the line of Sami Kassab of Exane.
Three questions to start. The first one, can you give us a bit more color on the future prospects of virtual schools? And I'm struggling with the following that here. You disclosed that Pennsylvania and Louisiana had been 2 states that renewed the contract for and official subjectives show that near 9,000 students enrolled there, which is more than 10% of total enrollment. And yet you are reporting good revenue growth and tone and the outlook remains quite good. So can you help me understand, whether the enrollment pressure may come next year? Or whether there are other factors that are offsetting that enrollment pressure? And which are those factors, please? Secondly, can you comment on your cost inflation outlook? I think, you were talking about 1% to 2% cost inflation in North America. Now in the context of wage inflation picking up and in the context of you moving towards more digital talent, are you still confident in cost inflation remaining below 2% mid-term? And lastly, on the Growth division, I think, John, you were expecting the Growth division to return to growth last year. Perhaps, you by then had the South Africa order already in the books. So where is the division actually underperforming the expectations in the emerging market?
Okay, Sami. I'll pick up the first of those and ask Coram to pick up on the other 2. I think the important thing to think in virtual schools is not all enrollments are of equal economic value. And what you've got rolling off enrollments this year are customers who have been essentially taking more and more services in-house progressively. So the revenue per enrollment for Pearson from those has been declining. And what we are bringing on is new partners, where we got a much fuller partnership and they are sort of looking to Pearson to provide a much fuller range of services, so there's a higher revenue per enrollment. So that's why even though, enrollments will be down somewhat this year, you will actually see healthy revenue growth in the business. I'm actually in Baltimore for 2 days the week after next, with the new management team there. They have done a fantastic job of taking on from the team who was there before, who have been with the business from startup mode and have taken it to a certain size and scale, but we now then needed to sort of rejuvenate and refresh to take it onto the next stage. They're doing a fantastic job of building much closer and more strategic relationships with our virtual school boards and partners, which I think means you'll see retention rates improve over the next few years. We have done a really good job of embedding efficacy in the start [indiscernible] where it's really important that we're able to prove to. Of course, we made this on parents that their children attending the schools, these virtual schools, are going to achieve more than they would in brick-and-mortar or other virtual schools. And you'll see from our efficacy reports early this year that we are exactly able to make that point. And the -- so the Net Promoter scores and all the other measures that you have were really performing very well. So there is a transition as we sort of see some of the older legacy partnerships come off the enrollment role and these new partnerships come on. But actually, I am much more excited and much more confident in the future [indiscernible] because [indiscernible] stage of the business and we're now well [indiscernible] to really [indiscernible] big growth opportunity for us. Coram, can you pick up on the other 2?
Sure. And on cost inflation. I think we've been very clear in the past that this runs at about GBP 50 million per year in our cost base. It's really -- and that's driven by our salaries and very significant chunk of our cost base is our labor bill. So about half of it. And we manage salary inflation in the 2% to 2.5% range, and we effectively use our scale in buying supply chain and other services to mean that we don't really have any inflationary cost pressures in the rest of the cost base. I think, you're right to identify that sort of the current environment is probably putting a bit of upward pressure on the salary bill. But the key thing to remember is our headcount is reducing and has done fairly significantly already and will continue to do so as we deliver the GBP 300 million of cost savings. So I think, the GBP 50 million inflation is a good guide even if there is a little bit of upward pressure on the actual inflation rates. On the Growth segment. So you're right, there was -- as we franked a number of times, there was a significant order that came through in one of the big South African states in our K-12 courseware business in early 2017. That meant that the comparatives has been tough all the way through the year and we've been very explicit on that. If you exclude that effect, as I mentioned, the Growth segment is actually up 1% on an underlying basis. So it's going in the right direction. And the trajectory is good. And the thing to remember is that in a more normal year, like the one that we're seeing in '18, the South African school courseware business is quite heavily weighted towards the fourth quarter, there are a lot of sales that normally go through that. So you should see that growth number improve by the end of the year.
Yes, and I would just answer that as well as -- I mean, we're confident we'll see growth return by the full year, again feeling good about the prospects for this part of the company over the next few years. As Coram and I spent some time last week with the leaders of our businesses in China, Brazil, South Africa, India, and we've got some fantastic exciting growth plans that are starting to come through and build very much on real sort of synergies and scale with different parts of the company. So again, feeling very strong about that for the next few years.[Technical Difficulty]
At Barclays.
I have got 3 questions. So first, maybe just picking up on Sami's points about cost inflation there. I mean, Coram said, as part of answer that headcount is reducing. Isn't there risk of double counting here, because isn't that fully captured in the savings number you're guiding to. Is that what we're thinking about this in terms of step chart that you want to show us, savings are 1 block in that chart and then you have cost inflation separately. So thinking on that basis, could cost inflation now start to be more than GBP 50 million? Second question is just on the ordering issues and the timing there. Can you explain a bit more why that's going to unwind in Q4? I guess thinking about it simply, if people didn't get the books in September, then they didn't sell them. So why do you get some back in Q4 in gross sales? And then, third question. You mentioned the developmental math products can have a pilot next year. That's kind of the first vanguard of your new product, I guess. Is it fair to say it's pretty unlikely that faculty will mandate that product in '19 having just seen a pilot in the spring, one could take several reiterations and therefore possibly several years of showing it to faculty to actually persuade them in scale to change to that product?
Okay. Thanks, Nick. Coram, if you can pick up on the first 2 and then I'll pick up on the third, on chart.
Yes, Nick, on your first point on cost inflation, I get where you're going, but I don't think it's quite right. The savings related to the headcount are what comes out of the cost base. So we take those out at the time and then the point that I'm making is because headcount is lower going forward, your cost base is lower and therefore, the inflationary effect is lower. So I don't believe we're double counting those, they're actually 2 separate effects. One is what happened to the cost base when you turn the heads out. And second is what the ongoing effect of upward pressure on the salary bill might be. So I do believe, we are protected to an extent against that upward effect. And on the ordering issues, let's just spend a moment explaining what happened, because I think that will then help to outline why we think those sales will come back. So there were really 2 effects. The first was early on in the selling season, an interface between a legacy order management platform that some of our customers use to place their orders, and our ERP system didn't work properly. We fixed it. I took us a couple of weeks to do so, but that meant that when the orders then float through, they came later than we would normally have received them. And then our supply chain, and this is the second effect, which we operate in a just in-time basis, which is a little while to catch up. So at the end of September, you have 2 effects in the numbers. One, a slightly higher backlog of physical orders, which were yet to be delivered. And two, to help students deal with that until they got the books, we had extended temporary digital access for a couple of weeks. Now the reason that both of those unwind in October is the books then subsequently get delivered. They still need them because they've only had temporary access on the digital side or 1 or 2 chapters in PDF form. And so they still require the book to complete the course. We make that sale. And then secondary -- secondly, we convert the temporary digital access into a pay for registration. And again, that happens in October. And we are seeing both of those effects in our numbers. Now the key thing here, though, is that all of this is pretty modest in financial terms. So it doesn't have a material effect. We are in the middle of the guidance range even with this. And our market share, as I mentioned in the presentation, is in the 40% to 41.5% range. So that's a fulsome explanation of what happened, but remember, the impact is modest.
And then, Nick...
Is it possible for me to just come back on it. Why wouldn't students having been unable to buy the new book, just taken one of the many other options, which have been affecting [indiscernible] rental or secondhand?
I think at the margins, maybe they did. But the key point here is that you can see from our numbers that the impact was modest. By the time we got to the end of September, the vast majority of the backlog had been cleared. And therefore, actually the students have the books that they needed.
And I think it's also fair to say, Coram, I wouldn't say modest but the biggest weighting in terms of the orders we shipped from September to October was actually in the digital side because, Nick, to be clear -- just to make it absolutely clear, normally we give students 14 days access before they have to pay. What we did on the blanket basis across the whole of the business was extend that to 28 days. So essentially, that meant -- frankly if you started a course between the beginning of September and September the 14th, normally, we would've got those revenues within Q3 because we give them 28 days, we've shifted that into the first 2 weeks of August -- of October rather. And as Coram says, we're already seeing that in our October numbers. And that really didn't make sense. So that means why we're pretty confident; one, the impact was modest; and second, we are going to capture most of it back.
And then on your third point, Nick, developmental. We deliberately started the developmental math because as you rightly said, it's one of the most challenging areas for faculty to teach. And therefore, if we could launch a successful product for that segment of the market on the global leaning platform then we'll be very confident that we have the underlying capabilities that we could then scale for the products on the back of that more quickly, which is what we're doing. So I think, you're right to say that we're not likely to see much material benefit from the developmental math product in financial terms until 2020. And to be clear, we've always been clear that, that was the case. What it does mean, it gives us confidence now as we move rapidly to launch Revel at scale on the global learning platform for back-to-school next year for '19. And as I think you know, Revel is our first mobile, first product, is going incredibly well. Great growth and really great take up. So you are right on the developmental math point, but we've always been clear that, that was the case. And what does give is more confidence that we can ramp up in Revel and other areas through the second half of '19 and into '20 and beyond.
Okay, we are now going to Ian Whittaker at Liberum.
Just 3 questions, please. First for all, just in terms of these one-off tax benefits, can you just exactly explain what reassessment of historic tax provisions means? And what caused that? The second thing is just want to actually sort of ask on the kind of cash flows. If you look at your net cash inflow, the Q3 this year looks like half from what it was last year in Q3, looks like it's gone down from around GBP 320 million to GBP 155 million if you look at the net debt figures. It doesn't look as though there was anything either extraordinary last year or indeed this year in terms of Q3 specifically. So could you just explain what exactly has happened there? And the third point is just looking in terms of U.S. higher education. So you are down 3% in Q3, you grew modestly in the first half, that would imply that -- sorry, you were down 3% for the first 9 months, you're flat in the first half, and finally, Q3 was probably down around 10%. So it looks as though at the moment that you're probably trending towards the bottom end of your 0 to minus 5 sort of range for higher education revenues. Is there anything apart from what you've mentioned in terms of the software sort of issue that we should expect any sort of change in the trends that are coming through?
Okay, Ian. Coram, you're going to pick up on those things?
Sure, yes. On the tax rate, the reassessment of historical tax provisions is effectively us looking at provisions that we have taken and looking at events that have subsequently occurred in determining that they are no longer needed. And very specifically, that means that the statute for certain tax audits in certain countries has passed. This happened last year, this happened this year and it's a positive thing because it means that provisions that we originally [indiscernible] they are no longer to be able to be made. It is a noncash impact but obviously, it does have a technical impact on the P&L rate. Remember, the other point I have made, which is that the long -- the medium-term guidance for tax remains unchanged at 20% to 22%. These are things that happen, but you can't predict them on a go-forward basis. On cash flow, you will remember from the half year that we talked about this, that there are a couple of effects in this year's numbers, which means the cash is slightly lower than it was last year. In particular, we paid higher incentives in the first quarter of 2018 than we did in 2017, reflecting the strong performance in '17. And also in 2017, we had a significant one-off dividend from Penguin Random House as we tidied up the balance sheet before the transaction was complete. So cash flow is doing exactly what I'd expect it to. And as we've said all along this year, we're on track for 90% to 95% cash conversion, which is what you'd expect for business of this kind. On the phasing, I think a couple of points are really important here. Firstly, you can't look at this business on a quarter-by-quarter basis. We've said all along, we have to look at the trends and get a returns benefit early in the year and the sales pressures flow through the second half of the year. But if you were to pick on individual quarters, you would end up misinterpreting the trend. So it's really important that we don't look at it on a quarter by quarter basis. Secondly, we have said all year that there would be the phasing effect that we've seen. So the returns benefit flows through in the first half, the sales pressure flows through in the second. But on an overall basis, we are in the middle of our guidance range. We are in our market share range, and we're pleased with the performance that we're delivering in that business.
Yes, and just to sort of add to that. You look -- everything we be talking about over the last couple of years, we are deliberately trying to shift to a much more digital subscription-led business model. And we are very deliberately trying to reduce our dependence on third-party distributors and go much more direct both to individual students as consumers and director institutions. The cumulative effect of those things is to reduce the level of gross sales but also very significantly reduce the level of returns. And that's a good thing because it creates a healthy and more sustainable business long term. And I think, Coram it's also true to say, if you look -- that's why we would always say, looked at this on a sort of rolling 12-month basis, and if you look at it on a rolling 12-month basis, we're down about sort of 3%, which is where we were, sort of at the end of May, June, which is the natural end to the seasonal cycle of the previous year and is pretty much in line with what the overall market is doing as well. I think, that's the way to be thinking about it.
We are now over to Matt Walker at Crédit Suisse.
Just if I could get a couple of questions in. On the rental side, I think you commented that -- you said it was going to triple the size of the rental program. I think that you in the past said it was going from 130 this year and you're going to add another 150. So could you just explain how many titles are you actually going to have on the rental program in 2019? And also, I think in the first half you commented that rental was up about 24%. Are you still tracking in line with that? Second question is on digital sales. You said mid-single digit up including extensions. So could you just explain what it would be without the extensions? And then finally, on OPM. Could you -- you've given the enrollments number. Could you tell us how OPM is doing in revenue terms, excluding the Learning Studio?
Okay. Coram, you want to pick up on first?
Sure. Matt, so on rental, we are currently just under 150 titles, as you said. And I think the point that John was making, so over the next 12 months, you'd expect us to triple that. So around the sort of 400 mark is where we get to. And that's part of our ongoing commitment to rolling out this program, which -- and then to your question about sales is doing what we expect it to. So we are seeing good growth in rental at the 9-month mark. But also -- and this is a key point because this is one of the reasons why we're doing it. We're getting good visibility into that part of the channel and it helps us protect again for the challenges that we've seen in rental over the last couple of years. On the digital sales basis, I think, because of the impact of the system challenges I think it's right to look at it without the conversion of those temporary access, because as John said, we extended people from 14 to 28 days. And post-September close, we've seen good conversion of those into paid subscriptions. So the underlying position on digital sales is that it's up mid-single digits. And I think, that's the way to think about it. In terms of OPM and enrollments, we're feeling positive about the way in which that business is going. And as John said, we saw some challenges a year or so ago because we're one of the first to go through conversions of the programs, but I think you're starting to see the effect of additional enrollment growth and that's bringing other partner programs on. And the Learning Studio is becoming an ever-smaller drag on the number. It's now a single-digit millions worth of revenue and it will be flushed fully through the system by the middle of next year.
Yes, and I think just then broadening out on your digital sales from higher Ed to Pearson as a whole, you remember that in February, the full-year results, for the first time we broke out our revenues on the basis of sort of pure digital, digital enabled and nondigital. We'll give you -- and obviously, we will report around on a full-year basis in February. But suffice to say that's a smaller key metric that management and the board are tracking on a monthly basis. And we're pleased with the progress that we're making this year.
We now have Katherine Tait at Goldman Sachs.
Two questions from me, please. Firstly on the mid-single-digit growth in digital. I think, before you've broken this out between the number of registrations versus pricing, because I think last year at the full year sort of that flat registrations and high single-digit pricing. Is it possible to give an update on those numbers at the 9-month stage? And then secondly, on OPM, we've seen a few -- some short-seller reports on one of your competitors in the OPM space, talking about new competitive challenges from Coursera and Noodle and pressures on take rates. And clearly, your registrations continue to be very strong. Can you talk about a bit how you feel your OPM offering is positioned versus particularly these newer lower-priced players? And any sort of commentary on pressure or no pressure that you are seeing on take rates?
Thanks, Katherine. I'll take up both of those. On the first one, I think if you remember, what we've been saying is for the '17 and '18, we're expecting digital registrations to be down slightly, 1% or so on -- year-on-year. And that's because whilst we are getting good growth in Revel as we launched a new product, we're under some pressure in our MyMathLab registrations because we have a very heavy weighting to the developmental math market, which is going through very significant sort of restructuring in space across the country, which means just a number of students that have taken developmental math courses is coming down. We expect -- so we should expect registrations to be down slightly, again this year and then start to stabilize and grow in '19 and '20 as we bring new products to bear and the sort of impact of the changes in developmental math starts to sort of dissipate. So on that basis, I think you can assume, therefore, that with that mid-single-digit growth in digital sales, and be clear we're just talking here about 30% Pearson higher ed courseware business, we're seeing registrations down slightly, revenue up mid-single digits because we're adding a lot more value, sort of more early alerts, more personalization, more supporting the student, which means that we can charge more because we're adding more value and basically it is helping them to achieve more in their courses. On the Online Program Management front, I've said, this is a slightly similar story here to in Connections. As you remember, we acquired this business back in 2012. We had a management team that did a good job of taking it through the first phase of growth. We then found life a little more difficult for a year or 2 because we saw some of our original 7-year contracts come to maturity. We strengthened the leadership of the company with Kevin Capitani arriving and some new hires that we've made. We started to build deeper relationships with our partners, with people like Arizona State University and Hawaii. So yes, this is competitive because there's a huge growth opportunity. And we're just, I think, in the foothills of what's going to happen here. Because what's clear is that more and more people are going to need more and more education, training, reskilling, retraining throughout their working lives. And they're not going to want to go and study full time at brick-and-mortar institutions. They're going to want to do so online. So interestingly, that is going to attract a lot of players. We're going to play to what makes us unique. We're the biggest education company in the world for a reason, we have the deepest and best relationships with college leadership, with university faculty, they trust us to really care about the things that they care about. The people actually learn real and important things. So there's a real sort of pedagogy, there's a real focus on outcomes. And so we can both help them to scale better than anybody else, but we can also help them ensure that they deliver high-quality learning experience and better outcomes for their students. And I think, that's what puts us in a very strong competitive position. And that's why we're investing behind it and you've seen that come through in the growth that we're starting to achieve.
Okay, we are now going to Giasone Salati at Macquarie.
Two questions, please. First, on one of the answers by Coram, I think, you said overall, Pearson is still tracking for the middle of the guidance range. Did I get that right? And secondly, can I ask you to a bit more color on the rental-only impact on '19? Improving -- increasing the number of books from 150 to 400 is very long term, but can you tell us more about the phasing of that in 2019?
Coram, can you pick up both?
And -- just to clarify, when I talked about the middle of the guidance range, I meant on higher education. So specifically, the 0 to minus 5 range that we've given. And obviously, we are still firmly on track to deliver our operating profit guidance by GBP 520 million to GBP 560 million, but we are not narrowing that range at this stage because the year is not complete. And in terms of the -- sorry, what's the second?.
Second one was around on the rental-only impact in '19.
So in terms of the impact on rental, you're right, it does have a mildly negative impact in the first year that we move those titles in. That's because you move for monetizing the sale upfront to spreading it over a series of semesters on the rental in terms of the rental receipts that we get. In this case, moving from 150 to 400 titles, it will have a small negative drag next year, but it's nothing that we can't manage within the ranges that we've given. And it's consistent with the strategy that we're using to manage that business.
Okay, we now go to the line of Sarah Simon at Berenberg.
I've got 3 questions, please. First one was just on revenue phasing. Appreciate as you say we shouldn't go quarter-by-quarter, but you've previously said that about 25% of your revenues in higher ed is done in H1. Does that still hold? And can you give us an idea of how much of net revenues you've booked or you would've expect to have booked by the 9-month stage? Second one was on South Africa. Have you got any comments on this antitrust price-fixing investigation? And what kind of cost impact that could have? Or whether it has any impact on your ability to pitch for contracts going forward? And then the final was on the operational issues you had. Are there any -- besides obviously, those sort of having to get it fixed, were there any extra costs that you incurred? We'd heard reports that you are paying for shipping and that you've suspended return fees. So any color on that will be helpful.
Thanks. Coram, you will pick on those, too?
Sure. On the revenue phasing, Sarah, I think we have been very clear about the patterns that we'd expect to see here. So you get the benefit of the returns in the first half. You get the pressure on the sales line in the second half. So these are behaving exactly the way we expect in terms of that shape. And I do think it's important that you look through the quarter-by-quarter. I understand you've taken that point on board. And in terms of how much...
Sorry, Coram. Can you just give us a bigger -- it is very is hard as a sell-side analyst to have a proper view on this business if you have no idea what proportion of the revenues you are recording in the first half versus the second half, or indeed in the quarters. I appreciate, we should be thinking full year, but you know, this is a significant business for you and you've given us very little information to go on.
I think to be fair, Sarah, we've given you a lot of information in terms of the shape of the top line, and the way in which we think about guidance and in fact, we give you a sales number every quarter. So you can really understand what is going. To answer your question, roughly, 75% to 80% of the revenues have been generated by the end of the 9-month period. But there is still a chunk to go. And the trends that we've seen all the way through the year have been very consistent. So I do think that gives you what you need.
And on Q4, Coram, I think it's fair to say, we'll see some benefit of the timing of sales shipping from September into October, but that's also offset by the sort of a secular trend we're seeing, which your sales slip out December into January as we move from a print to a digital model. These are 2 things, Sarah, that you should be thinking about in Q4
Yes.
Absolutely.
And to pick up on this point about extra costs. In a few instances we would have expedited shipping in some cases, we did do free shipping. I mean, a very few cases, we might have compensated retailers. To be really clear, it is an immaterial amount in the context to Pearson. So it's a very small impact, and it will not impact our ability to deliver our operating profit guidance. So we use those tools judiciously, but they haven't had a major impact in terms of cost. And then on the antitrust case in South Africa, I think just to be crystal clear about this, it is an antitrust case against the Publishers Associations in South Africa of which we are a member. But it is against Publishers Association. And I think you'll understand given that investigation is ongoing that we can't comment any further on that.
Okay, we now go to the line of Tom Singlehurst at Citi.
Tom here from Citigroup. I know -- I think you just said that U.S. higher ed is 0 to down mid-single digit. You're guiding to minus 3, I think that's relevant for the full year, I should say. It's relevant, because I think most people are on minus 5 that is one of the double check that, are you ...
I think what we're saying, Tom, is our guidance for the full year would be somewhere between flat and minus 5. And at the end of 9 months, we're minus 3. And that is what we're saying.
Okay, fair enough. Fair enough. Second question, I mean obviously, doing a good job on Inclusive Access. Is Inclusive Access like rental, i.e., when a college moves to an Inclusive Access contract, is this also initially dilutive to growth? That was the second question. And then the third question was going to be on drop-through. Because I think one of the fair points is that it's still very well seeing growth in the non-higher ed pieces of the business, but the drop-through is not as good. Can you give us any sort of color on the relative drop-through as the different part of the business? And especially, if we see growth sustains next year, will that be a step-change in drop-through for non-higher ed pieces?
Coram, can you pick up on the first few points?
Sure. On Inclusive Access, it isn't dilutive to growth in the same way that rental is. Just think about the mechanics. Rental involves you moving away from an upfront monetization of selling a product to a sort of subscription-based rental. Whereas on IA, you typically are doing subscription deals on digital product, which you would have realized anyway. And so there isn't such a big change in the timing of the revenues. The -- in terms of the sort of rest of the business, I think, couple of points here -- remember, we've shown the contribution split of the business, and higher ed is not significantly out of line with the rest of the business. So we know that in the past, it has been a high-margin business, but these days, it is more in line with the rest of the Pearson, which is testimony to the work that we've done in improving the contribution on the margin on the rest of the business. So there isn't a huge margin impact as you -- because of the way that the top line is changing.
And the other thing I would add on Inclusive Access, which is sort of not directly relevant to your question but I think it is an important point to make is this is still a relatively new initiative for us and we learn as we go and as we go, we can improve and shape and iterate the offering. And I think what we're finding is -- in the early years, you can agree the Inclusive Access deal at a headline level with the college leadership, but then it normally takes you 1 to 2 to 3 years to really see that translate into very significant sell-through because you then have to persuade individual faculty to sign up to the sort of headline deal. That's a sort of long winded way of saying, we're really pleased with the progress we're seeing in a number of deals we're signing, but there's a lot more benefit to come from this, because it's really we can improve conversion and sell-through rates from those headline deals over the next couple of years. And that's the key to really making the most of this.
And that makes sense. I suppose just coming back to the drop-through, I mean, growth in area like OPM, and such as [indiscernible], where typically, there is still an upfront -- a lot of upfront investment. I mean, as I say going into next year, even this year, is there any -- because growth is coming from existing programs, does that mean it, inherently more profitable? Is there anything like that?
I think, OPM is a specific case where over the life of the contract, they are profitable, but obviously, in the first couple of years, there is margin investment that you have to make, particularly around marketing and other sort of ramp-up costs. So there is a trade. As you drive that business harder, then in initial phase that puts some pressure on profitability. But actually if you look at other parts of our structural growth opportunities, Connections is a good -- is a strong margin business. Pearson Test of English drops-through very nicely. And our professional certification business, VUE, is also a good margin business. So I agree with your point on OPM, and that's a very particular characteristic of that business. But I don't think you should -- I think you can hear in the way I'm answering this that actually the margin mix of structural growth is also good.
Okay, we have time for one final question. So the ultimate question for today is over the line of Chris Collett at Deutsche Bank.
This is Chris from Deutsche. I just had a couple of questions left. One was, did you -- did I hear you correctly earlier, that you talked about within the college business the gross sales had been lower than your expectations, but then offset by better returns. I'm just wondering if you could give us a little bit more color about that? And if that is a dynamics that you expect to continue sort of this year and into subsequent years? And then, you made the comment about holding your market share within historical ranges. Just wondering, if you had seen anything across the broader market about any market share shift? And then a separate question was just on the professional certification business in the U.S. You're benefiting from the medical college admissions test, but -- coming in this year, but just wondering, excluding that benefit, shouldn't this business been doing really well given the economy, low unemployment and sort of IT certification?
Yes. So on your third point, yes. And it is. And it has been on year-on-year, our most reliably successful business over the last decade. And that's why we continue to invest in and support it and grow and develop it. On the market share point, just to be clear, Chris, there's sort of monthly MPI data we see how we did. And we see how the rest of the industry, excluding [indiscernible]. So we're not a position to share with you -- to give you any color, not that we would anyway because that's for other companies use to do and not for us. And then Coram, you want to pick up on the sort of the gross sales and returns point.
Yes. So you did hear correctly. I mentioned in the presentation that gross sales were slightly lower than we'd expected, but returns were better than we expected. Actually, this is a trend we have seen pretty consistently, and we saw last year as well. I think the -- ultimately, we work towards managing the channel and making sure that we are fulfilling the demand, but not over engineering that. And that's why, net sales is the best measure. We're in the middle of the range of the 9-month mark, which tells you directly we're managing this effectively. Gross sales and returns are 2 sides of the same coin. And all of the actions that we're taking are managing the channel in the right way.
And, Chris, the reasons I explained earlier, if we are getting -- if we are achieving our expectations for this market, and we're getting there with gross sales lower and returns also lower. That's a good thing. That means our strategy is working because none of us want to be back to the world we were a few years ago, where we were seeing high gross sales and then high returns. So to actually squeeze inventory out of the channel says that we are succeeding in moving to more subscription models, moving more digital, moving more direct-to-consumer and institution. So as long as we're achieving that within the range, which we are, this is a positive and healthy thing, both for our business and for the industry.
Final call, we've got time for today. John, can I please pass it back to you for any closing comments.
Just to thank everybody for your continuing interest in the company. [ Jo ], Tom, and [ Angile ] have been with us on the call today. If you have any further questions, to follow up on, please do so. If not, we look forward to catching up in the new year. And in the meantime, obviously, as you can tell, we are very pleased with the progress that we're making. Confident that there is a lot still to do. We're confident that the recovery and return to growth is very, very much on track. Thanks for your time.
This now concludes this course of session. So thank you all very much for attending. And you can now disconnect.