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Hello, and welcome to the Pearson 2018 Fourth Quarter Trading Update. [Operator Instructions] Just to remind you, this is being recorded. So today, I'm pleased to present John Fallon, CEO; and Coram Williams, CFO. Please begin.
Yes, good morning, everybody. Thanks for joining us. As you just heard, John Fallon here, and I have Coram Williams, our CFO, with me. We'll announce our full year results on Friday, February 22. So for today, as usual, we just want to give you a very quick update on the key elements of our 2018 performance and how that shapes our guidance for 2019. The headlines, as you can see here, we returned Pearson to underlying profit growth last year with 208 -- 2018 operating profit expected to be in the range of GBP 540 million to GBP 545 million. That's in line with the guidance we gave on this call a year ago. The 25% of the company that is U.S. Higher Education Courseware was at the bottom of our 0 to minus 5% guidance range. We've now had 8 successive quarters of it performing in line with the market analysis that we set out on this call 2 years ago. We accelerated the digital shift with 55% of our Higher Education Courseware sales now digital, up from 35% 5 years ago, with direct-to-consumer sales up 8% and a 40% increase in Inclusive Access deals. The rest of Pearson grew, in aggregate, with real momentum and growing scale in our structural growth businesses: Online Program Management, up 9%; Virtual Schools, up 8%; Pearson Test of English, up 30%; and Pearson VUE, our Professional Certification Business, up 4%. These are the businesses that are at the heart of the future Pearson. We invested more last year through the P&L in our OPM, our Online Program Management business, which is one of the most exciting of those opportunities and that, in turn, is building a stronger pipeline that will power future growth. We were able to fund that investment but still meet guidance and deliver a healthy increase in profits because we are outperforming on the cost savings that we achieved through simplifying Pearson and making it a leaner, more efficient and more digital business. In 2019, we're going to build on the progress we made last year. We will deliver another year of underlying profit growth. We're running the Higher Education Courseware business, now less than 25% of the company, on the basis that sales will, again, be in the 0 to minus 5% range, with a further shift in revenue mix taking us another year closer to being a truly digital-first business with a more commercially resilient subscription-based model. We're running the rest of Pearson, now more than 75% of the company, to again, grow in aggregate helped by the investments we've been making in our fastest-growing opportunities. And we'll increase organic investment in those businesses again this year, especially in Online Program Management, to drive faster growth in 2020 and beyond. We can fund that extra investment through the P&L whilst delivering profit growth because we now expect to deliver more than the GBP 300 million in annualized cost savings by the end of 2019 that we committed to 2 years ago; all of this underpinned by a strong balance sheet, around GBP 200 million of net debt at the end of last year. This enables us to invest in the digital platforms that create a simpler, more efficient company, capitalizing more quickly on the growing number of possibilities we see to empower people to learn and prosper throughout their working lives. And with that, I will hand over to Coram.
Thank you, John, and good morning, everyone. So let's start by taking a look at our sales performance by region. Revenue for the year was down 1% with a 1% decline in North America, flat performance in Core and revenue up 1% in our Growth segment. In North America, revenues were down 1% with good growth in OPM, Connections and Professional Certification offset by a 5% decline in our U.S. Higher Education Courseware business. The decline of 5% in our U.S. Higher Education Courseware business reflects a continuation of the trends seen all year, with gross sales worse than expected due to continued cautious buy-in from the channel, but returns significantly better, reflecting the actions we've taken to manage channel stock more effectively. We've also seen the same shift of sales out of the fourth quarter and into the following first quarter that we've seen in prior years as our digital penetration increases and the business becomes more direct-to-consumer. In Core, revenues were flat as strong growth continued in the Pearson Test of English, in OPM services in Australia and the U.K. and in Professional Certification. This was offset by weaker performance in the U.K., driven by expected declines in AS levels as a result of policy changes and continued disruption in the U.K. apprenticeship market. And in Growth, sales were up 1% with strong growth in China, good growth in Brazil and other smaller markets, partially offset by declines in South Africa. Turning to operating profit. This slide shows the operating profit bridge from 2017 to 2018. We expect to deliver 2018 adjusted operating profit in the range of GBP 540 million to GBP 545 million. That range reflects a GBP 13 million to GBP 18 million negative impact from trading, driven by our U.S. Higher Education Courseware business being at the bottom of its expected range and a weaker-than-anticipated performance in the U.K. apprenticeship market and in U.S. K-12 courseware. Our restructuring savings of GBP 130 million are ahead of plan due to an increase and acceleration of savings as a result of our recent ERP implementation. Other operating factors were GBP 22 million and included additional investment in our strategic growth priorities, as highlighted in our 2017 full year results. Finally, we've seen roughly GBP 50 million of inflation. So turning to guidance for 2019. This slide summarizes the profit and EPS guidance for the coming year. We expect adjusted operating profit of between GBP 590 million and GBP 640 million, with the midpoint of guidance in line with consensus and representing continued underlying profit growth. In addition to the disposals and FX impact, our guidance reflects the accelerated and increased benefits of our restructuring program, now expected to be incremental GBP 130 million in 2019 and to deliver increased annualized cost savings in excess of GBP 330 million by the end of 2019. We're running the business on the basis that there will be ongoing headwinds in U.S. Higher Education Courseware, where we expect revenue growth to be 0 to down 5% and for the rest of Pearson to continue growing in aggregate. We expect a normalized tax rate of 21% and a finance charge of GBP 30 million. And with that, I'll hand back to you, John.
Thanks, Coram. The logic of the guidance that Coram has just talked you through is that, company-wide, revenues should stabilize this year and grow thereafter. And in summary, we made good progress in 2018 returning Pearson to profit growth. Our strong balance sheet is enabling us to invest in the platforms that will help Pearson to achieve our full digital potential. There's a lot still to do, but we are increasingly confident in our ability to grow and to prosper. And with that, I'll hand back to Hugh and we'll be happy to take your questions.
[Operator Instructions] And we go to the first question, which is from the line of Sami Kassab at Exane BNP Paribas.
May I start with asking on the U.S. Higher Courseware division? John, a year ago, you suggested that, that division could return to growth in 2020. Is that still the view of the business that you have? Secondly, could you quantify the impact included in your '19 guidance from the move towards the consignment model and the 0 to minus 5% in U.S. Higher Ed? How much of that is driven by the impact of the 1 year -- the first year impact of moving to consignment? And secondly, can you say a few words on the K-12 courseware performance? The markets in -12 have been down at around 5%. Is it in line with that performance? Any color on K-12 courseware, please.?
Okay. Coram, do you want to pick up on the consignment points and then give a little color on K-12 and then I'll pick up on Sami's broader point.
Sure. Good morning, Sami. On the consignment, so the rental program increases from 150 to 400 titles. That does have a small drag on our revenues. It is built into our guidance. We will show you the detailed bridge at the prelims time. Remember that there's also a small pickup from the 150 titles that were already in the program. So this isn't a huge negative in the overall bridge for Higher Ed, but we'll show you the detail at prelims. In terms of K-12 courseware, you're absolutely right; the industry has had a difficult year. We have had a good competitive performance, but the challenges have been in Open Territories as a number of other players have been flagging with delayed purchases as people wait to see the impact of the new content that starts to flow through after the adoption cycles. The thing I would say is we're feeling reasonably good about 2019. It is a big year in terms of adoptions and we feel like we're well positioned to do well on those adoptions. But you're right; it's been a difficult year in 2018.
Okay. Thanks, Coram. And on your broader point, Sami, I think as I said in the conclusion there, for Pearson as a whole, so for 100% of the company, we are expecting revenues to stabilize; in other words, not to decline further this year and for the company to start to grow again as a whole in 2020. That happens because the 75% of Pearson that grew last year is getting bigger, is gaining more scale and momentum because of the investment that we're putting into it and so the rate of growth there will improve. The 25% of our revenues that come from Higher Education Courseware are becoming a smaller part of the company. We're running the business on the basis that they could decline by as much as 5% again this year, but that decline is happening on a smaller base. So the pure weight of the math is the 75% is getting bigger and growing more quickly and the 25% that's faced the structural challenges is getting smaller and therefore, has proportionately less impact. That said, 55% digital in Higher Ed courseware now; 8% growth in direct-to-consumer; 40% growth in Inclusive Access deals. All of the things and initiatives that we're putting in place, as that business becomes more resilient because it becomes more digital, it becomes more subscription-based, it is going to stabilize and it will start growing again. But I think you'll understand it will give a better view on the outlook for 2020 in that specific business as we see how the year pans out. But for Pearson as a whole, to be clear, we expect revenues to stabilize this year and we expect the business as a whole to start growing the top line in 2020.
Okay, we now go to Goldman Sachs and Katherine Tait.
A couple of questions for me. Firstly, on the flat to minus 5% market growth, I think previously, you've sort of broken out the various factors driving that. Would it be possible to do the same going into next year? Just interested to see if anything of them are changing or whether we're really sort of seeing very, very similar expectations going forwards? Can you also give us any -- a bit of color around any market share shifts that you've seen? Clearly, another quarter with the Cengage Unlimited product in place, so interested to see if there's been any -- if you've seen any market share shifts. And if you could also remind us on your market share in digital versus print as well, that'd be very helpful. And then, finally, just on OPM, clearly, very strong growth this year and a lot of comments around investment to sort of drive that growth. Can you help us understand how we should be thinking about the sort of longer-term margin outlook for this business? I mean, is this a business that's just going to continue needing more and more investment? I know some of your competitors have been equally investing more and more in this business. So if you can just help us understand how you're thinking about the longer-term margin outlook for that business, it'd be very helpful.
Okay. Okay, Katherine. Well, I'll sort of pick up on the market share and the competitive performance and then Coram can pick up a bit more on the sort of dynamics of the higher ed courseware market and the profitability of our Online Program Management business. So I think, we -- as we talked about previously, each month, we get the data that enables us -- the MPI data that enables us to compare our performance against the rest of the major publishers in higher education, the other 5 major players. Our market share is pretty consistently within a 40% to 41-point-something range. We've got the figures through the end of December and it remains firmly in that range and above 40%. It shifts around a little bit from month-to-month, but it's remarkably consistent. So no, we can say with another quarter that we've not seen any sort of significant change. I think as we talked about before, trying to be precise on digital share is not easy because everybody presents their digital numbers in slightly different ways. But I think I can say without fear of contradiction that our share of the digital market remains significantly more than our 40% share of the overall market. And actually, I think we had -- we've had a few years where, frankly, we've been having to manage what was a relatively mature base of digital products. MyLabs, Mastering, first products in the market a decade ago and it's been sort of modest innovation on those since. We're excited by our first integrated digital product, Revel, that is now getting really critical mass. That will get extra power and on -- as it becomes the first product that we'll launch commercially on the Global Learning platform. This summer, we're looking to launch our first AI-inspired direct-to-consumer product in the summer and the pipeline of investment and innovation that we will have over the next 3 years is going to dwarf what we've been able to do in the last few. So our share remains high in digital and we remain confident that we're going to build and sustain that in the years ahead. I think, Coram, it's fair to say that the dynamics, the moving parts of higher ed courseware market are pretty much as we called them over the last few years, but do you want to just add a little bit of color on that and then talk about the sort of underlying margins in the OPM business?
And I think, John, that's absolutely right. I mean, we've been describing over the last 2 years the dynamics in our business where OER and enrollment are a sort of 1- to 2-point drag and then we have a print decline in the sort of high single to low double digits, digital growth in the mid-single digits and benefits from returns. That's the sort of framework that we've been approaching this market with. And it's not completely precise; there are some movements year-on-year. But I think that is a good way to think about the bridge that we will show you in February when we come out with the preliminary results and we give you the bridge for 2019. A quick word on returns. I sometimes get asked whether the inventory correction is over and therefore, whether there'll be no benefit going forwards. I think it's important to remember that, yes, we had a one-off inventory correction in '17. But actually, we've also been managing the channel very effectively. The actions that we've taken around incentives and returns, restocking charges have had a benefit on returns and that benefit can and will continue into 2019. So returns will be part of that bridge when we finalize it and show it to you in February. In terms of the margins of OPM, I think we've touched on this before in the sense that over -- through the cycle, this is a good margin business, which is in line with Pearson's overall margins. The contracts are long term though, as you know. They can be 7 years, in some cases, a little bit longer than that. And there is a significant investment phase upfront and then you get real profitability in the sort of second half of the contract. So as you grow, you do have to put that P&L investment through. But the returns on that investment are good; we're very satisfied with that. And the reason we're upping investments at the moment is not because others are upping investment, but because we see that there's an opportunity to really capitalize on a growing market and drive that top line in the way that John has described. So I hope that gives a sense of how we're thinking about OPM.
We're going now to see Tom Singlehurst.
Tom here from Citigroup. I thought I would jump in before Patrick with a sort of semantic question in the sense that you talked about another year of underlying profit growth, but, of course, the trading impact from 2018 ended up being negative when you had anticipated slight growth. Can you just give a bit more sort of color on whether that was all just within the U.K. qualification business? Was it a -- was it surprising in nature? Or was it something that you'd anticipated, but you -- stuff that you could sort of make up elsewhere? And then, specifically, you talked about sort of, I suppose, a positive trading impact for 2019. So how confident can we be that there won't be another sort of off-the-ball incident? That was the first question. The second one very quickly, can you quantify the profits from K-12 from 2018 and -- so we have a sense of what the drag will be if and when you do sell it?
Thanks, Tom. Coram, do you want to pick up on those 2?
Yes, sure. Tom, so I think I flagged in my commentary in the script that there were 2 areas, which were a little softer than we'd expected. So the first is the U.K. qualifications business where the pressures that we'd seen in the past had been around BTECs. But BTECs, as we highlighted, have been stabilizing, but there were 2 issues this year, both of which we flagged through the year. These are not new news, but they did have an impact on profitability. The first one was around AS levels where the move to decouple AS levels from A levels has led to a decline in AS level registrations. That was a little worse than we'd anticipated. We saw the impact, but it was -- it's moved a little more quickly. And the second area of pressure has been around U.K. apprenticeships where, as we flagged in previous calls, the introduction of the apprenticeship levy has created quite a lot of disruption in this market in the short term. Longer term, it's probably upside because it means there is more funding available for apprenticeships. But in the short term, the market has struggled to respond and we've been a little caught up in that. And then the second area is actually the one that Sami asked about earlier, which is K-12 learning services where the pressures in Open Territories, I think it's fair to say, have been worse than the industry was expecting as a whole. So those are the 2 areas that meant that the trading was a little bit worse than we had anticipated at the beginning of the year. But to be clear, we compensated for that by driving our cost-saving program and generating more cost savings and these are not short-term savings. These are all about improving the underlying health of Pearson, making it a more efficient and more manageable company, and therefore, we think on that basis, it is right to highlight underlying profit growth because that's exactly what we've got. Why wouldn't that happen this year? Well, I think the -- we are guiding in a similar way this year, so 0 to minus 5% in Higher Ed and growth in the rest of Pearson in aggregate. I think the key point is the one that John made earlier, which is Higher Ed is becoming ever smaller part of the business and the 75% of Pearson that is growing is becoming a larger component and we've been investing in it. So it's really a momentum question and I think you can see from businesses like OPM where revenue growth was 9%, but actually, enrollment growth was 14% and that's a really good leading indicator for what's coming through the pipe in the future. So I think we're feeling good about momentum.
And Tom, I'd just pick up on your off-the-ball comment because the one thing we can guarantee there will be at least one off-the-ball incident this year because that's life, that's what happens. What I'm proud about in these results is I think we're becoming much more resilient when faced with those off-the-ball incidents. And the fact that we did have some things that hadn't been expected, the fact that we did the biggest lift that any of us were ever going to have to do in our lives in terms of implementing the enabling program and ripping out some very deeply rooted systems in our Higher Education business and replacing them with systems that will transform what we're capable to do, but is still unbelievably difficult to do and we have the supply chain challenges that came from that and we still have delivered underlying profit growth and delivered something in the top half of the guidance range, I think that should tell you that we are much better placed to have to deal with what happens off the ball than maybe we were in the past.
And one final comment on K-12 profit, we've quantified it at around GBP 11 million on previous calls and I think that's the right way to think about it still.
We are now over to Ian Whittaker of Liberum.
Three questions, please. First of all, just coming back to that question, sort of a -- I think it was Katherine just talking about returns. You said there'll be a benefit in '19. So there -- but when does this returns benefit actually run out because there's obviously a limit to what you can do? Would it be 2020? Would it be 2021? Or sort of do you think it could be longer? The second question just has to sort of come back just in terms of the cost savings. If you look at the update in the first half, you were talking about GBP 95 million of cost savings. Third quarter, you said you were on track and then the full year, obviously, we've got GBP 130 million. So obviously, there was something done in Q4. Can just tell us if trading is weaker sort of than expected in 2019, what is your capacity to actually implement extra cost savings sort of quickly? Can you do the same again sort of if you had sort of particular issues? And I guess, a third question is it comes back to this point, sort of there's been a debate, sort of the 75% of the businesses is growing in aggregate. Yes, there's obviously in aggregate, that may be the case, but obviously, not -- sort of some of those sort of parts of 75% are also in decline. So could you actually just sort of spell out the benefit of this, sort of the percentage of revenues sort of within your business that are actually declined in 2018? Obviously, we've seen for U.S. Higher Education, sort of U.S. K-12. Any other areas as well, please?
Okay. Well, I'll sort of pick up on the first point maybe and then ask Coram to chip in. I mean, I think, Ian, a ongoing increase -- or decline in returns rather is a ongoing structural change that is happening in our markets. 24%, 1 in 4 students who bought a Pearson product last year bought it direct from us. That's growing at a rate of 8% per year. That means that every year, proportionately fewer students are buying Pearson products from campus bookstores. That's a good thing because the more we drive that up, the more we have a subscription-based resilient business with much greater visibility and a much smaller gap between our gross sales and our net sales. So inevitably, that means that campus bookstores are having to reshape their own business model as a direct consequence of the strategy we're pursuing, and so each year, we should expect that the gross sales through that channel is going to come down. But in turn, the returns are also going to come down significantly as well because they are going to be managing a lower level of capital. And I think we can all agree that that's a much better business model because it gives you much higher levels of visibility and transparency as you work through.
But does that mean -- sorry. So does that mean that 2020 will get a benefit from returns as well?
Yes.
Coram.
Yes. You can….
You are going to see every year gross sales made through campus bookstores decline as sales made through direct-to-consumer and direct on an institutional-wide basis by universities increase. And because they are buying fewer books from us, they are going to return fewer books to us. That's the whole point. That is exactly the strategy that we are pursuing. Okay? Do you want to pick up, Coram, on the other 2 points?
Yes, cost savings and the growth question. Ian, on the cost savings, I think we've highlighted -- I highlighted in my commentary that having moved and done that heavy lift on the ERP in the summer, what we've then been able to do is to use that new system to go more quickly in terms of the way that we're taking costs out of our back office and the lion's share of the additional savings are coming from places like technology, HR and finance and it's really about our confidence that we can take those costs out and, in fact, go further. And that's what's driving the additional savings in this year and it's what's driving the additional savings next year. So I wouldn't want you to think that this was some kind of a knee-jerk response to trading pressures. I think we've been flagging the trading challenges through the year. And we've moved steadily, systematically, but quickly to get the costs out once we've implemented the system. So that's what's happening on the cost-saving program. In terms of the sort of growth of Pearson's top line. I think the best way to think about this, there's 25% of Pearson, which is declining, that is the Higher Ed business. We're very clear in our guidance on that, and as John and I have both said, that will become proportionately less of a drag as the years progress. There's about 1/3 of the business, which is what I would think of the traditional Core, the sort of testing and the other courseware businesses, and there have been some challenges in those in the past, but as we've been describing over the last couple of years, they're stabilizing and they are becoming sort of steady generators of good profits and cash. And then there's 1/3 of the business, which is in the structural growth opportunities where we're seeing real momentum. So the growth rates in OPM of 9%, enrollment growth of 14%, Virtual Schools up 8%, PT up 30% and Professional Certification up 4%, those are gaining momentum. We're investing in them and they are the reason why we're confident in our ability to deliver growth in the future.
Yes. Thanks, Coram. And Ian, I think your -- as Coram just started to unpack, I think that challenge of saying can you give us more -- sort of more sort of color and data around the different moving parts within that 75% I think is absolutely the right question and a fair challenge and we look forward to sharing that in more detail and giving more analytics and data to support the different dynamics that Coram's been talking about. And it's actually something that we're really looking forward to talk about because one of the things I'm very proud of, of what we've achieved over the last few years, is get much better as a company at reallocating our investment to where the biggest growth opportunities in this business are. And the reason why we're really now able to sort of turn up the heat in areas like Online Program Management, Virtual Schools, Professional Certification because as we create a simpler, more efficient business that's run on a fewer number of digital-first platforms, we get much better real-time data and it's much easier to reallocate. And as we know, one of the ways in which you create sustainable growth over time is to get much better at reallocating costs and investment to your biggest growth opportunities and that's what we're doing. So look forward to sharing more data on that with you when we get to the full year results.
We now go to Chris Collett at Deutsche Bank.
I just had a couple. One was just a clarification on the cost savings. So you delivered very impressive GBP 130 million cost savings this year and then did you -- is it then going to be that figure again incremental in 2019, so therefore, an incremental GBP 70 million in 2020? Just wanted to check that. And then the other question was just on Pearson Test of English. You highlighted very impressive 30% growth. I think at the half year stage, it was more like about 60% growth. So just wondering if there were some timing factors or other factors at work there. Yes, I'll leave it there.
Yes. Thanks, Chris. Unless Coram corrects me, I believe your math is completely sort of accurate, but I think the key point there is we also talked about in excess of the GBP 330 million, so that's the sort of the minimum you should expect in 2020. And clearly, I think if you hear the way we're talking, we are -- the more that we do around creating a simpler, more efficient company, the more opportunities we see to do more. And so this is going to be a ongoing program and the more we build the business on these fewer, truly global and digital platforms, the more opportunities there are to run the business ever more efficiently. And so you shouldn't see this as a program that comes to an end in 2020. I think we will be constantly seeing opportunities to further improve efficiencies and save costs. And on the Pearson Test of English, I think we did benefit at the start of last year because we expanded our test center capacity in Australia to meet the demand there. So as you build up the capacity, you get an immediate jump and then obviously, the growth rate is still there, but it's not at quite the same rate. There are still sort of big opportunities to expand the Pearson Test of English as we seek regulatory approval for the test here in the U.K., as we look at opportunities in Canada, as we look to expand our footprint across China. So although the growth in the Pearson Test of English has been very, very strong, we're still in the very early stages and there's a lot more we can do with this.
Okay. Well, before we go to the next question from the phones, John and Coram, there are 2, which we received from the webcast, both are from Mike Totton from Majedie Asset Management. The first one is what was the swing between calling out trading impact of GBP 2 billion -- 10 -- sorry, of between GBP 10 million to 15 -- GBP 50 million, but delivered approximately GBP 15 million less. Is this an OPM investment?
Okay. Coram, do you want to pick up on that?
Sure. I mean, I think I touched on this briefly in the script. The reason why trading was lower than we'd originally expected at the beginning of the year was driven by those 2 challenges in the businesses that I touched on, so the pressure in U.K. apprenticeships and the pressure in K-12 courseware in the U.S. So that -- it's not an investment question; it's simply the drop-through of a 1% decline on our top line. The investment in OPM actually goes through the other operating factors bar on our bridge, which is in our presentation and there are 3 things in there: there's investment in OPM; there is deal running costs as we keep the 2 systems running side by side while we're in the process of transforming the back office; and a small benefit in our incentive schemes normalized for '18 compared to '17. We're showing you the bridge of GBP 22 million. I think that's a decent proxy for the amount of additional investment that we've been putting in, in OPM. So I hope that gives you a sense of how much we've invested and where we've put it.
The next question from Mike is what's the revenue base for the OPM business Pearson is investing behind? It might help with the comparisons with TWOU.
Do you want to pick that up, Coram?
Yes, so I mean we give revenue splits at the full year, but I think if you assume that the revenue base for the Pearson Online solutions business is about $300 million, that will be about right.
Great. So we're now over to Nick Dempsey at Barclays.
Yes, got 3 questions left, please. For the first one, your competitors are looking forward to a very good year in K-12 courseware in 2019 when you talk about adoptions. They're kind of, reading in between the lines, hoping for double-digit growth in that area. So when you're talking about Pearson group being flattish in terms of revenues in 2019 versus 2018, are you including in that this business which you're hoping to sell, which is going to grow double digit and is 8% or 9% of group? In other words, are you expecting the rest of Pearson to decline a bit? Second question, you mentioned that the program of savings is not going to come to an end in 2020. Does that mean we should expect restructuring charges outside of the P&L but in the cash flow beyond 2020? And the third question is other operational factors, you've been helpful there, Coram, in explaining what's in 2018. Is that still going to be part of the profit bridge in 2019 as a drag?
Okay. Let me pick up on the first couple of points and then Coram will pick up on the third. I think, first of all, yes, you're right, Nick, that this is a very strong adoption year in Texas, California and Florida in particular. When we are referencing what competitors are saying, we just need to be clear that we are distinguishing clearly between billings and revenues because a lot of these contracts are sort of 5 to 7 years in duration. So the billings don't necessarily all translate into revenues in year 1. But in any event, to be clear, we are saying that the 75% of Pearson, without the K-12 courseware business, will grow, in underlying terms, the top line this year, and it will grow -- so that basically, the rest of Pearson, excluding Higher Ed Courseware, will grow with or without the K-12 courseware business. And I think the point I was making is as we consolidate from, for example, 50 different finance systems down on to one and we run the business in a much more real-time data way, there will be ongoing opportunities to continue to simplify and run the business much more efficiently. I don't think those are savings that will require significant restructuring to achieve, but they will just be sort of incremental because we're still at the point of just getting the stage 1 benefits as we do the heavy lifting. But every other company I talk to, just once you've got these systems up and running, you just get ongoing benefits year after year as you get better at running and operating them. And that's what we are, that's what we're saying. And Coram, do you want to pick up on the third point?
Sure. So if you think about the 3 factors I described in the -- that were included in other operating factors in 2018, so deal running costs, normalization of the incentive and the investment in OPM, one of the reasons why other operating factors is a bit low -- is a bit less of a drag this year than it was in our original guidance is that those deal running costs are coming down faster than we thought. So they will be less of a drag in 2019. The incentive payout is unlikely to be a major movement. 2017 was a slightly bigger incentive than normal. But you will still see ongoing investment, incremental investment, in our OPM business because we see a significant opportunity to drive the top line there. So I think, Nick, we'll show you the bridge in February as we're putting all of the package together, but you should assume that there will be further investment in OPM and it'll probably be a similar amount or a little bit more than we've quantified this year.
Okay?
Can I just -- all right, thanks.
Sorry, go on, Nick, if you had a follow-up, please go ahead.
Oh yes, sorry, I just want to squeeze another one in. The FX in your bridge in 2018 is a bit higher than I think I was modeling. I mean, against the base of GBP 576 million, minus GBP 52 million, GBP 24 million is 4.5%. The pound-dollar hasn't moved that much. So is it that we're missing Brazil -- I'm missing Brazil, South Africa, something else? Or is there anything funny going on in that GBP 24 million from FX? Sorry to squeeze another one in.
No problem, it's a good question. And you're right, if you were just doing this on the basis of the USD, it would be a little bit lower than that. But because of the political uncertainty in the U.K., there's been a lot of movement on FX. Brazil has been one that's gone against us, so has South Africa. There have been a series of quite significant movements in the basket of other currencies. So GBP 24 million is where it's come out when we've run the numbers.
And I think the -- of those, the movement in the real, particularly in Q4 last year, has been particularly significant. So...
Absolutely.
We're now over to Patrick Wellington at Morgan Stanley.
Three things actually. Just continuing -- because we've done most of the cost bridge now, continuing with inflation. I think, Coram, you've suggested that as the cost base has dropped so rapidly, maybe GBP 50 million is not necessarily the number that we need to be putting in, in here for inflation, so if you could comment around that? Secondly, when push comes to shove, the U.S. Higher Education Courseware business was minus 3% in '17, it was minus 5% in '18. That's arguably a bit disappointing. You've talked about light at the end of the tunnel and maybe getting back to flat in a couple of years. Do you think that's still possible? And in relation to that, if you're flat as a group in organic revenue growth terms in 2019, that will be 10 years that Pearson has failed to produce more than 1% organic revenue growth. How do you feel about that as you look out maybe at the next 5 to 10 years? What do you think this business is capable of producing? And then, finally, GBP 200 million of debt, you've got the K-12 business still to sell, presumably you're just going to sell it. How about a share buyback? The balance sheet, not that efficient? Share buyback when you get to the full year figures at the end of February?
Okay. Three good questions, Patrick. Coram, do you want to pick up on the first 2 and then I'll address the organic growth issue.
Sure. Patrick, so in terms of inflation, I think what I've said is GBP 50 million is a good number and that there's 2 dynamics going on in there. One, the headcount is coming down, so the sort of cost base on which the inflation is being applied is shrinking. But as we know, there is inflationary pressure in the world economy and around wages. So I think assume GBP 50 million, at least this year and next, that's a good number. In terms of the debt, it's around GBP 200 million. That is a -- we are running the balance sheet in a conservative way, but we're doing so because there is still a significant amount of change to deliver this -- in this business and our balance sheet provides a real foundation for us to deliver on that change, to invest in the business, to make the most of the digital opportunity that we've got. So it is the right balance sheet for the company at this point in time.
Okay. And then I think your challenge on organic revenue growth is absolutely the right one. I mean, clearly, the big focus of management team over the last 2 to 3 years has really been to stabilize the business, to start to get underlying profits growing again, to create a much more simpler -- much simpler, much more efficient company, a strong balance sheet that puts us in a good position to manage our way through this analog-to-digital transformation. I recognize given the sort of 10-year track record that there's a healthy degree of skepticism there. But I honestly believe when I see now the sorts of growth rates that we're getting from our Online Program Management business, from Virtual Schools, from Professional Certification, from the Pearson Test of English, from the opportunities that we have really now to accelerate the rate of internal innovation, the ability we have to scale products much more quickly. One of my experiences in Pearson is one of our big challenges is when you've been running the business on such a sort of disparate range of systems and platforms, even when you get a good product, it's very hard to scale it quickly. We're just going to have so much more capacity to not just accelerate the rate of internal innovation, but then to scale successful products quickly. So first challenge is to actually stop the revenues declining and get them growing again at all, which we will do, stabilize this year, start to grow again next year. And then I believe, Patrick, that over the next decade, we're going to surprise you on the positive side with the capacity and capability of this business.
And then just on U.S. Higher Education, I mean, I think you've talked about a bit of light at the end of the tunnel, maybe getting back to 0 on Courseware within a couple of years, slight yield-defined couple years. Is that still the case having seen how the last few months have gone and the continued negative enrollment trends?
Yes, I mean, I think that the opportunity and the challenge there is clear: we want to get that business to be in a truly digital-first, subscription-based model as quickly as we possibly can. We're sort of over the hump of the majority. So it's up to 55% of sales in that business are purely digital. If we can get that up within the next couple of years to 70%-plus, which I believe we will just with the momentum that we already have and, as I mentioned, the new products and innovation that's coming through, then, yes, that is the business that you can start to see stabilize and grow again. But more importantly, I think it also -- and if you think about it, we have, just in the U.S., 14 million students per year do have a direct relationship with Pearson. At the moment, though, students are unknown to us. We know that they are student A taking a course with Professor Smith. The new systems and the way that we're building the business now is we will have a direct and personal relationship with every one of those 14 million students. "You've done well. You've taken this marketing course. Have you considered that whether you do this course next and these career opportunities that are open to you?" And all the research tells us that this generation of learners are much more focused on how they link education to employment, learning-to-earning, than they ever were before. So we're starting to see the Higher Ed Courseware business not just as something we're going to stabilize and turn around in its own right, but becoming a platform with which we can build a relationship of sort of lifelong learning with people as they work through careers, where they're going to be having to constantly reskill, retrain, change careers. This is an incredibly powerful opportunity for us, but we can't capitalize on it unless we get those digital platforms in place first and the great thing is, by the end of this year, we'll pretty much have all those platforms there and then we can up the pace of innovation.
Okay, we now go to the line of Giasone Salati of Macquarie.
Two questions, please. First, John, when you speak about a stable growth in 2019, would that be also the case with minus 5% in North America? Is it built on the mid-case for North American Higher Education or else? Secondly, on rental only. The link you make with the digital sales, that is the transition to rental only; it kind of mixes up with the transition to rental only. Is it true that if all of the books were on rental only, we would have definitely growth in North American Higher Education? And lastly, coming back to the breakdown of North American Higher Ed in Q4, when we look at enrollment to OER at print to digital and inventory, what actually went slightly worse than in the previous 9 months -- or quite significantly worse than in the previous 9 months in Q4, please?
Okay. I'll pick up on the first and the last points and then Coram can perhaps unpack the sort of rental and digital sort of comments there. Yes, we are saying that even if Higher Education Courseware is at the bottom of our range, down 5% again this year, we would expect that our revenues to be stable, i.e., flat on prior year even with a 5% decline in Higher Ed Courseware. That's the first point. And then the -- on your final point, what happened in Q4, I think as Coram mentioned earlier, each year, we are seeing a sort of structural shift of revenues out of Q4 as we sell fewer textbooks into the channel ahead of back-to-school and a proportionate transfer of those sales into January as more of those students are buying a purely digital product and they buy direct from Pearson, which they just do on the day that they start their class. So that's really all that happened in Q4 is a continuation of that shift of sales out of December into January and February. And then, Coram, do you want to sort of unpack the sort of rental-digital point?
Yes, and just to add to that final point that John made, we flagged this very clearly in the Q3 trading call. So I was clear that whilst there's a small supply chain benefit going into the quarter, we would almost certainly see this move from Q4 to Q1. So I do want to just draw attention to the fact that we flagged this, that this would happen. In terms of sort of rental and digital, I mean, I guess, there are sort of a couple of points to make here. Firstly, the growth in digital is there and that reflects the investment that we're putting in, plus a market which is moving that way and students that value the benefits of digital. And on the print side, you're right that the ongoing shift from an ownership to an access model is creating a greater drag on print revenues. And if all physical books were going through a rental model with no timing effect, then that revenue impact would be partially mitigated. But I would not go so far as to say that you would have a print business that's growing because there is still an underlying shift in preference from print to digital. So I hope that gives a sense of what's going on there.
Okay, we now go to Matt Walker at Crédit Suisse.
Just a few questions, please. The first is can you explain the digital growth of 2% in Higher Ed? I think it was significantly higher last year, so if you could just explain that and comment on how much did your Digital Direct Access revenue grow? Second question is on Pearson Test of English, test volumes were up 30%. What was revenue growth for Pearson Test of English? And then could you please also comment on -- with the 2019 bridge, you've basically built in, as far as I can see, for 2019, an additional, probably GBP 80 million of savings. So what actually is -- and you basically put up a number, which is roughly in line with where current consensus is. So what is actually lower to basically explain that movement because the increase in savings is very significant? And do you think that you will basically do the same thing next year in terms of you've guided The Street for one number, but it's going to be massively higher on savings?
Thanks, Matthew. Coram will pick up on the second and third points. Just on digital revenue growth of 2% in the Higher Ed Courseware business, I think there's 3 elements to our digital revenues: first is those direct-to-consumer sales, which I said are up 8%, that means that's now our biggest single channel to students; second is the growth in the sort of Inclusive Access business where we saw a sort of 40% growth in universities, but we're still in the relatively early days of turning those -- of monetizing those agreements and translating them into revenues, they'll start to come through more in 2019 and '20; but then there's a -- the quirk, if you like, is that you also have -- we're still selling through the channel so through sort of campus bookstores a sort of bundled product, which is a textbook, but bundled with a MyLab or Mastering registration. So in a year when you see a big reduction in gross sales through the channel, that sort of reins back the growth in digital because the digital element of that bundle is also sort of down significantly. That's why I think you should sort of read through that headline number and look at what's happening to direct-to-consumer sales, what's happening to institutional sales. That's where the big growth is and that will drive that digital revenue growth back -- number back up over time. So it's a phasing issue really more than anything else. Coram, do you want to pick up on the other 2?
Yes, sure. So test volumes in PTE are a good proxy for revenue growth. Remember, this -- of the 4 structural growth opportunities, this is the smallest, although it is growing rapidly. So there's no major difference between test volume growth and revenue growth. In terms of the savings in 2019, I just want to be clear: we are guiding to GBP 130 million of additional incremental savings in '19. Our previous guidance was for GBP 105 million. So that is GBP 25 million extra, not GBP 80 million. We are using that GBP 25 million...
No, the GBP 80 million was cumulative based on the over-performance in '18 as well.
And remember that we've said that in total cumulative terms, we put up our expectations and we will be in excess of GBP 330 million. So what we're using the additional GBP 25 million for in 2019 is to drive further investment in our OPM business and really capitalize on the opportunity that we see there.
Okay. So I mean, Matthew, just to sort of reinforce that point, when we launched the GBP 300 million cost-saving program 2 years ago, we committed that those GBP 300 million of cost savings would flow through to the bottom line, and they are. We're taking advantage of the fact that actually, we're doing more than we expected, so in excess of GBP 330 million, and we're using that surplus above GBP 300 million to drive faster growth in an OPM business that we become increasingly confident in and where, clearly, because one of our big opportunities and challenges now is to get to the top line growing again, the more we can allocate to our faster-growing businesses, the faster they'll grow and the quicker we get the top line growing again.
All right. So the incremental investment in OPM is around GBP 25 million basically, so that's what you're saying? It was around GBP 20 million -- the investment in OPM was about GBP 20 million in '18 and now you're doing an additional GBP 25 million in '19, is that right?
Those are roughly right, yes.
Okay. So we have time for one final question and that this is a follow-up question. We're going back to Sami Kassab at Exane.
John, it's on Inclusive Access. Can you elaborate a little bit on how this is going? I think you said 7% of your H1 revenues came from Inclusive Access if not mistaken. Would you want to quantify how much of the U.S. Higher Ed Courseware revenues are now from institutional sales? And whether institutional sales are included in the 23% U.S. sales or whether this is something different in your reporting, please?
Coram, do you want to pick up on that?
So we'll give you the revenue number for Inclusive Access in February when we provide all of the details for the top line. But I think you can see, Sami, that we've signed another 192 institutions in the second half of '18 and that will drive growth in our revenues there. And in terms of the direct-to-consumer sales, no, that is a separate channel to the Inclusive Access, the 23%. And what's interesting about that is it is now our biggest channel. The single biggest channel by which we sell product in U.S. higher education is a direct-to-consumer channel and it represents 23% of our U.S. Higher Education sales.
Yes, and then the other point I'd just add is just to reinforce a point I made earlier. What you tend to find is you sign these partnerships, you get the sort of framework agreement in place and then the real work is then translating that framework agreement into widespread adoption across the institution. And I think what we're excited about is sell-through and penetration on those deals is still in the relatively early stages, so there's a lot of opportunity to drive that much more in the years to come. So though we signed the partnerships, we are yet to see the real revenue benefit of those partnerships. That will start to come through this year and into '20 and '21.
Okay. So I think back to you for any closing comments at this stage.
No. Just to say, as ever, thank you for your interest in the company. Jo, Tom and Anjali joined us on the call today. If you've any follow-up questions, I know they'd love to hear from you. And look forward to catching up with you all in February at the preliminary results. Thanks, again.
Thank you.
This now concludes the call. Thank you all very much for attending, and you can now disconnect.