Annual and Transition Report (foreign Private Issuer) (20-f)

PART I

For convenience, the Group has translated the 2018 amounts into US dollars at the rate of £1.00 = $1.28, the noon buying rate in The City of New York for cable transfers and foreign currencies as certified by the Federal Reserve Bank of New York for customs purposes on December 31, 2018.

Notes:

Dividend information

The Group pays dividends to holders of ordinary shares on dates that are fixed in accordance with the guidelines of the London Stock Exchange. The board of directors normally declares an interim dividend in July or August of each year to be paid in September or October. The board of directors normally recommends a final dividend following the end of the fiscal year to which it relates, to be paid in the following May or June, subject to shareholders’ approval at the annual general meeting. At the Group’s annual general meeting on April 26, 2019 shareholders will be asked to approve a final dividend of 13.0p per ordinary share for the year ended December 31, 2018.

6

The table below sets forth the amounts of interim, final and total dividends paid in respect of each fiscal year indicated, and is translated into cents per ordinary share at the noon buying rate in The City of New York on each of the respective payment dates for interim and final dividends. The final dividend for the 2018 fiscal year will be paid on May 10, 2019 (subject to shareholder approval).

Future dividends will be dependent on the Group’s future earnings, financial condition and cash flow, as well as other factors affecting the Group. The dividend was rebased in 2017 to reflect portfolio changes, increased product investment, and the outlook for 2017.

Risk Factors

You should carefully consider the risk factors described below, as well as the other information included in the rest of this document. The Group’s business, financial condition or results from operations could be materially adversely affected by any or all of these risks, or by other risks that it presently cannot identify.

The accelerated pace and scope of our business transformation initiatives increase our risk to execution timelines and to business adoption of change. The risk is that benefits may not be fully realized, costs may increase, or that the Group’s business as usual activities are adversely impacted.

Business transformation and change initiatives in support of the Group’s strategic goals to accelerate its digital transition and to simplify its business will continue throughout 2019. The pace and scope of change increases the risk that not all these changes will deliver within anticipated timeframes, and that the costs of these changes may increase. In addition, as a result of the increased pressure of transformational change, business as usual activities may not perform in line with plans or the level of customer service may not meet expectations. In parallel with the business transformation, as the Group responds to the digital revolution and shift from a product to a services business, it will continue to look at opportunities to develop business models and further refine organization structures. Resistance to change could restrict the organization from making the necessary changes to the business model.

Failure to effectively use the Group’s data to enhance the quality and scope of current products and services in order to improve learning outcomes could adversely affect the Group’s business.

The Group seeks to maximize data to enhance the quality and scope of current products and services in order to improve learning outcomes while managing associated risks. The Group’s ability do so may be subject to factors beyond the Group’s control. In addition, the unavailability of timely, complete and accurate data limits informed decision-making and increases the risk of non-compliance with legal, regulatory and reporting requirements. Business change and transformation success is dependent on migration of a significant number of datasets and our inability to effectively accomplish this could adversely affect the Group’s results.

Global economy and cyclical market factors may adversely impact the Group’s financial performance.

With the continued pressure and uncertainty in the worldwide economies, there remains a risk of a weakening in trading conditions, which could adversely impact future financial performance. The effect of

7

continued deterioration or lack of recovery in the global economy will vary across different businesses and will depend on the depth, length and severity of any economic downturn. The education market can be affected by cyclical factors which, although can have a positive impact for many of the Group’s businesses, could for others lead to a reduction in demand for the Group’s products and services.

Failure to successfully invest in and deliver the right products and services and respond to competitive threats could result in lower than expected revenues and profits.

A common trend facing all the Group’s businesses is the digitization of content and proliferation of distribution channels, either over the internet, or via other electronic means, replacing traditional print formats. The digital migration brings the need for change in product and content distribution, consumers’ perception of value and the publisher’s position between consumers, retailers and authors.

This is a highly competitive market that is subject to rapid change. The Group faces competitive threats both from large media players and from smaller businesses, online and mobile portals and operators in the digital arena that provide alternative sources of content. Alternative distribution channels, e.g. digital format, the internet, online retailers, growing delivery platforms (e.g., e-readers or tablets), pose both threats and opportunities to traditional publishing business models, potentially impacting both sales volumes and pricing.

Students are seeking cheaper sources of content, e.g. second hand and rental copies, online discounters, file sharing and use of pirated copies. This change in behavior puts downward pressure on textbook prices in major markets, and this could adversely impact the Group’s results.

If the Group does not adapt rapidly to these changes, it may lose business to ‘faster’ and more ‘agile’ competitors, who increasingly are non-traditional competitors, making their identification all the more difficult. The Group may be required to invest significant resources to further adapt to the changing competitive environment.

Changes in government policy and/or regulations have the potential to affect the Group’s business model and/or decisions across all markets.

The Group’s educational services and assessment businesses may be adversely affected by changes in government funding resulting from either trends that are beyond the Group’s direct control, such as general economic conditions, changes in government educational funding, programs, policy decisions, legislation and/or changes in the procurement process, or the Group’s failure to successfully deliver previous contracts.

The results and growth of the Group’s US educational services and assessment businesses are dependent on the level of federal and state educational funding, which in turn is dependent on the robustness of state finances and the level of funding allocated to educational programs. State, local and municipal education funding pressures remain, competition from low price and disruptive new business models continues and open source is promoted as a way to keep costs down for customers. The current challenging environment could impact the Group’s ability to collect on education-related debt.

State and local government leadership changes and resultant shifts in education policy can also affect the funding available for educational expenditure, which include the impact of educational reform. Similarly, changes in the government procurement process for textbooks, learning material and student tests, and vocational training programs can also affect the Group’s markets. Political pressure on testing, changes in curricula, delays in the timing of the adoptions and changes in the student testing process can all affect these programs and therefore the size of the market in any given year. There is also a risk of political instability in the UK at the time of publication arising from the potential for Brexit ‘no deal’ plus wider uncertainty and instability in the rest of the world.

There are multiple competing demands for educational funds and there is no guarantee that new courseware or testing or training programs will be funded, or that the Group will win or retain this business.

8

Failure to comply with antitrust and competition legislation could result in costly legal proceedings and/or adversely impact the Group’s reputation.

The Group is subject to global and local antitrust and competition law and although it is committed to conducting business in compliance with local and international laws, there is a risk that management, employees or representatives may act in a way that violates applicable antitrust or competition laws. As a result, there is a risk of litigation and regulatory proceedings in the countries in which the Group operates. These legal proceedings could result in greater scrutiny of the Group’s operations in other countries for anti-competitive behavior and, in the worst case, incur a substantial financial cost. This would also have an adverse impact on the Group’s reputation.

If the Group does not adequately protect its intellectual property and proprietary rights, its competitive position and results may be adversely affected and its ability to grow limited.

The Group’s products and services largely comprise intellectual property delivered through a variety of print and digital media, online software applications and platforms. The Group relies on trademark, patent, copyright and other intellectual property laws to establish and protect its proprietary rights in these products and services. Failure to adequately manage, procure, register or protect intellectual property rights (including trademarks, patents, trade secrets and copyright) in the Group’s brands, content and technology, may (1) prevent the Group from enforcing its rights, and (2) enable bad actors to illegally access and duplicate the Group’s content (print and digital counterfeit, digital piracy), which will reduce sales and/or erode revenues.

The Group’s intellectual property rights (IPR) in brands and content — historically its core assets — are generally well established in key markets. As technology has become an increasingly critical component of the Group’s business strategy, it has also been steadily increasing investment in its patent program to expand its protection of high value inventions in the US.

Online copying and security circumvention have become increasingly sophisticated and resistant to available countermeasures. Notably, 2018 introduced “digital counterfeit” web sites selling unprotected PDF files of many of Pearson’s titles, at scale, using modern and sophisticated ecommerce methods, with a professional and polished look and feel. From an IP perspective, increasing the Group’s digital business exposes it to more trademark, copyright and patent infringement risks.

The Group’s forward-looking IP strategy also includes plans to increase its global patent footprint in key markets outside the US. However, the Group also conducts business in other countries where its protection efforts have been limited or inconsistent and the extent of effective legal protection for intellectual property rights is uncertain, and this uncertainty could affect future growth. Where the Group has registered or otherwise established its IPR, it cannot guarantee that such rights will provide competitive advantages due to: the challenges and costs of monitoring and enforcement in jurisdictions where competition may be intense; the limited and/or ineffective IPR protection and enforcement mechanisms available to it in many countries; the potential that its IPR may lapse, be invalidated, circumvented, challenged, or abandoned, or that it may otherwise lose the ability to assert its intellectual property rights against others. The loss or diminution in value of these proprietary rights or the Group’s intellectual property could have a material adverse effect on the Group’s business and financial performance.

A control breakdown or service failure in the Group’s school assessment and qualification businesses could result in financial loss and reputational damage.

The Group’s professional services and assessment businesses involve complex contractual relationships with both government agencies and commercial customers for the provision of various testing services. The Group’s financial results, growth prospects and/or reputation may be adversely affected if these contracts and relationships are poorly managed or face increased competitive pressures.

9

There are inherent risks associated with the Group’s assessment and qualification businesses, both in the US and the UK. A service failure caused by a breakdown in testing and assessment processes could lead to a mis-grading of student tests and/or late delivery of test results to students and their schools. In either event the Group may be subject to legal claims, penalty charges under contracts, non-renewal of contracts and/or the suspension or withdrawal of its accreditation to conduct tests. A late delivery of qualification results could result in a potentially significant regulatory fine in addition to the contractual penalties. It is also possible that such events would result in adverse publicity, which may affect the Group’s ability to retain existing contracts and/or obtain new customers.

The Group’s investment in inherently riskier emerging markets may deliver returns that are lower than anticipated.

To take advantage of international growth opportunities and to reduce its reliance on the US and UK markets, the Group has invested in a number of emerging markets, some of which are inherently more risky than its traditional markets. Political, regulatory, economic and legal systems in emerging markets may be less predictable than in countries with more developed institutional structures. Political, regulatory, economic, currency, reputational and corporate governance and compliance risks (including fraud, sanctions, bribery and corruption) as well as unmanaged expansion are all factors which could limit returns on investments made in these markets.

Failure to effectively manage risks associated with compliance to global and local anti-bribery and corruption (ABC) legislation could result in costly legal investigations and/or adversely impact the Group’s reputation.

Although the Group is committed to conducting business in a legal and ethical manner in compliance with local and international statutory requirements and standards applicable to its business, there is a risk that the Group’s management, employees or representatives may take actions that violate applicable laws and regulations prohibiting the making of improper payments for the purposes of obtaining or keeping business, including laws such as the US Foreign Corrupt Practices Act or the UK Bribery Act. Responding to investigations is costly and requires a significant amount of management’s time and attention. In addition, investigations may adversely impact the Group’s reputation, or lead to litigation and financial impacts.

Failure to generate anticipated revenue growth, synergies and/or cost savings from acquisitions, mergers and other business combinations, could lead to goodwill and intangible asset impairments.

The Group periodically acquires and disposes of businesses to achieve its strategic objectives and will continue to consider both as means to pursue its strategic priorities, although it does not plan to make any significant acquisitions in the short term.

All the Group’s businesses depend on Information Technology (IT) systems and technological change. Failure to maintain and support customer facing services, systems, and platforms, including addressing quality issues and execution on time of new products and enhancements, could negatively impact the Group’s revenues and reputation.

All the Group’s businesses, to a greater or lesser extent, are dependent on information technology. It either provides software and/or internet services to its customers or uses complex IT systems and products to support its business activities, including customer-facing systems, back-office processing and infrastructure. The Group faces several technological risks associated with software product development and service delivery, information technology security (including viruses and cyber-attacks), e-commerce, enterprise resource planning system implementation and upgrades. Although plans and procedures are in place to reduce such risks, from time to time the Group has experienced verifiable attacks on its systems by unauthorized parties. To date, such attacks have not resulted in any material damage, but the Group’s businesses could be adversely affected if its systems and infrastructure experience a significant failure or interruption.

10

Failure to comply with data privacy regulations, or any unauthorized disclosure of personal information, could result in an incident or other issue potentially causing reputational damage to the Group’s brands and financial loss.

Across its businesses, the Group holds large volumes of personally identifiable information including that of employees, customers, students and citizens. Any perceived or actual unauthorized disclosure of personally identifiable information, whether through breach of the Group’s network by an unauthorized party, employee theft, misuse or error or otherwise, could harm the Group’s reputation, impair its ability to attract and retain its customers, or subject the Group to claims or litigation arising from damages suffered by individuals, and thereby harm its business and operational results. Failure to adequately protect personally identifiable information could potentially lead to penalties, significant remediation costs, reputational damage, cancellation of some existing contracts and difficulty in competing for future business. In addition, the Group could incur significant costs in complying with the relevant laws and regulations regarding the unauthorized disclosure of personal information. Changes to data privacy legislation must also be monitored and acted upon to ensure the Group remains in compliance across different markets.

Failure to prevent or detect a malicious attack on the Group’s systems could result in a breach of confidentiality, integrity and/or availability of sensitive information.

Information security and cyber risk is continually evolving and comprises many complex external drivers: increasing customer demand to demonstrate a strong security posture, external compliance requirements, ongoing digital revolution, increasing use of the cloud and increasingly sophisticated attack strategies. Across its businesses, the Group holds large volumes of personally identifiable information including that of employees, customers, students and citizens, and other highly sensitive business critical data such as financial data, internal sensitive information, and intellectual property. Despite its implementation of security measures, individuals may try to gain unauthorized access to the Group’s data in order to misappropriate such information for potentially fraudulent purposes. A significant breach can result in a devastating impact on the Group’s reputation, customer loyalty, and student experience. Inability to prove due diligence can result in severe penalties and loss of business (existing and future).

The Group’s reported earnings and cash flows may be adversely affected by changes in its pension costs and funding requirements.

The Group operates a number of pension plans throughout the world, the principal ones being in the UK and the US. The major plans are self-administered with the plans’ assets held independently of the Group. Regular valuations, conducted by independent qualified actuaries, are used to determine pension costs and funding requirements. As these assets are invested in the capital markets, which are often volatile, the plans may require additional funding from the Group, which could have an adverse impact on its results.

It is the Group’s policy to ensure that each pension plan is adequately funded, over time, to meet its ongoing and future liabilities. The target for the UK defined benefit plan is a self-sufficient level of funding. The Group’s earnings and cash flows may be adversely affected by the need to provide additional funding to eliminate pension fund deficits in its defined benefit plans. The Group’s greatest exposure relates to the UK defined benefit pension plan, which is valued every three years. Pension fund deficits may arise because of inadequate investment returns, increased member life expectancy, changes in actuarial assumptions and changes in pension regulations, including accounting rules and minimum funding requests.

Although the UK defined benefit plan is significantly derisked (as it is in surplus with effect from 1 January 2018 as per the recent valuation), the ability to achieve and maintain this standard remains subject to market conditions, meaning that additional funding could still be required from the Group in the future.

11

Operational disruption to its business, including those caused by third party providers, a major disaster and/or external threats, could restrict the Group’s ability to supply products and services to its customers.

Across all its businesses, the Group manages complex operational and logistical arrangements including distribution centers, data centers, and educational and office facilities, as well as relationships with third party print sites. It has also outsourced some support functions, including information technology, warehousing and logistics to third party providers. The failure of third parties to whom it has outsourced business functions could adversely affect its reputation or financial condition. Failure to recover from a major disaster, (e.g. fire, flood, etc.) at a key facility or the disruption of supply from a key third party vendor or partner (e.g. due to bankruptcy) could restrict the Group’s ability to service its customers and meet the terms of its contractual relationships with both government agencies and commercial customers. Penalty clauses and/or the failure to retain these contracts at the end of the contract term could adversely impact future revenue growth.

A significant deterioration in the Group’s profitability and/or cash flow caused by prolonged economic instability could reduce its liquidity and/or impair its financial ratios, and trigger a need to raise additional funds from the capital markets and/or renegotiate its banking covenants.

To the extent that worldwide economic conditions materially deteriorate, the Group’s revenues, profitability and cash flows could be significantly reduced as customers would be unable to purchase products and services in the expected quantities and/or pay for them within normal agreed terms.

Disruption in capital markets or potential concerns about the Group’s credit, such as downgrades or negative outlooks by the credit rating agencies, may mean that this capital may not be available on favorable terms or may not be available at all, although the reduced size of debt maturities mean that this risk is reduced.

The Group generates a substantial proportion of its revenue in foreign currencies, particularly the US dollar, and foreign exchange rate fluctuations could adversely affect the Group’s earnings and the strength of its balance sheet.

As with any international business, the Group’s earnings can be materially affected by exchange rate movements. The main exposure is to movements in the US dollar to sterling exchange rate as approximately 60% of the Group’s total revenue is generated in US dollars. The Group also has exposure to a range of other international currencies including emerging market currencies. Operating profit for 2018, translated at 2017 average rates, would have been £17m or 4% higher.

A lack of sufficient capital resources could adversely impact the Group’s ability to operate.

If the global economy weakens further and/or the global financial markets collapse, the Group may not have access to or could lose its bank deposits or suffer a significant increase in customer bad debts. Lack of sufficient capital resources could significantly limit the Group’s ability to take advantage of business and strategic opportunities. If replacement funds are not available, the Group may be required to delay, reduce the scope of, or eliminate material parts of its business strategy, including potential additional acquisitions or development of new products, services and technologies. The Group is working to mitigate this risk by enforcing limits per counterparty, spreading its debt maturities and financing through strong counterparties.

Changes in tax law or perceptions on tax planning strategies may lead to higher effective tax rate or negative reputational impact.

Changes in corporate tax rates and/or other relevant tax laws in the UK, US or other jurisdictions could have a material impact on the Group’s future reported tax rate and/or its future tax payments. The Group has been subject to audit by tax authorities. Although the Group believes its tax provision is reasonable, the final determination of its tax liability could be materially different from its historical income tax provisions, which could have a material effect on the Group’s financial position, results of operations or cash flows.

12

The Group’s tax strategy reflects its business strategy and the locations and financing needs of its operations. In common with many companies, the Group seeks to manage its tax affairs to protect value for its shareholders, in line with its broader fiduciary duties. The Group is committed to complying with all statutory obligations, to undertake full disclosure to tax authorities and to follow agreed policies and procedures with regard to tax planning and strategy.

If the Group fails to attract, retain and develop appropriately skilled employees, it may limit its ability to achieve its strategic and operational goals and its business may be harmed.

The Group’s success depends on the skill, experience and engagement of its employees. If it is unable to attract, retain and develop sufficiently experienced and capable staff, especially in technology, product development, sales and leadership, its business and financial results may suffer. When talented employees leave, the Group may have difficulty replacing those skills, and its business may suffer. There can be no assurance that the Group will be able to successfully retain and attract the skills that it needs.

Failure to adequately protect learners could result in significant harm to one or more learners.

Incidents may occur where learners are abused or harassed. For example, where the Group has direct learner contact via online learning, or in its direct delivery businesses where it is operating, either directly or in a third party partnership. These incidents can cause harm to learners, which is something the Group takes extremely seriously, and could also have a negative financial, legal and reputational impact to the business.

Failure to adequately protect the health, safety and well-being of the Group’s employees, learners and other stakeholders could adversely impact the Group’s reputation, profitability and future growth.

Although the Group has invested in global Health and Safety procedures and controls to safeguard the health, safety and wellbeing of its employees and other stakeholders, accidents or incidents could still occur due to unforeseen risks, causing injury or harm to individuals and impacting the Group’s business operations. This has the potential to lead to criminal and civil litigation, business disruption leading to operational loss, reduction in profitability and impact on the Group’s global reputation.

Failure to ensure security for the Group’s staff, learners, assets and reputation, due to increasing numbers of and variety of local and global threats.

Pearson is a global business with locations in diverse, sometimes high-risk, locations worldwide. Although it has protective measures in place to secure its staff, learners and assets, the Group could still be impacted by external threats, such as localized incidents, terrorist attacks, strikes or extreme weather. Future occurrences could cause harm to individuals and/or disrupt business operations. These have the potential to lead to operational loss, a reduction in profitability and impact on the Group’s global reputation.

Environmental, social and governance risks may also adversely impact the Group’s business.

The Group considers environmental, social and governance (ESG) risks no differently to the way it manages any other business risk. These include ethical business behaviour, compliance with UN Global Compact standards, environmental impact, people and editorial standards. A failure to comply with such standards would adversely affect the Group’s reputation and have a negative impact on its relations with employees, vendors and customers.

The Group’s business depends on a strong brand, and any failure to maintain, protect and enhance its brand would hurt its ability to retain or expand its business.

Protecting the Pearson brand is critical to expanding the Group’s business and will depend largely on its ability to maintain its customers’ trust in its solutions and in the quality and integrity of its products and services.

13

If the Group does not successfully maintain a strong brand, its business could be harmed. Beyond protection, strengthening the Pearson brand will enable the Group to more effectively engage governments, administrators, teachers, learners and influencers more effectively.

In February 2019, the UK Group pension plan purchased a further pensioner buy-in policy valued at approximately £500m with Legal & General. As a result of this latest transaction, 95% of the UK Group plan’s pensioner liabilities are now matched with buy-in policies which significantly reduces longevity risk of the Group. The buy-in will be accounted for in 2019 and is expected to reduce the retirement benefit asset on the balance sheet but is not expected to have a material impact on the income statement.

The Group’s strategy

The Group’s mission is to help people make progress in their lives through learning and its vision is to have a direct relationship with millions of lifelong learners, to link education to the way people aspire to live and work every day and to collaborate with a wide group of partners to help shape the future of learning. To deliver on this, the Group has three key strategic priorities:

The Group strives to leverage its core strengths in combining world-class content and assessment, powered by services and technology, to enable more effective teaching and personalized learning at scale. More detail on the three areas of focus is set out below.

Grow market share through digital transformation of the Group’s courseware and assessment businesses

Digitization enables us to drive improvements in learning outcomes. It allows the Group to build a more sustainable and profitable business with a more visible and predictable revenue profile, based around access not ownership models. The businesses where digital transformation is the key focus are:

Invest in structural growth opportunities

Investment in fast growing areas that will be the long-term growth drivers of Pearson, such as:

15

Become a simpler and more efficient company

This third strategic priority involves further simplification through shared service centres, leaner organizations through reduction in headcount and a reduction in the number of legacy applications, data centres and office locations. This does not just cut costs, it also provides an important platform for future growth because it enables the Group to reallocate investment to its growth areas more quickly, innovate at scale, and build a more direct, longer term relationship with the tens of millions of learners who use Pearson products each year.

Operating divisions

Pearson is one of the leading providers of educational courseware, assessment and digital services. The Group provides test development, processing and scoring services to governments, educational institutions, corporations and professional bodies around the world. The Group publishes across the curriculum and provides a range of education services including teacher development, educational software and system-wide solutions.

The Group’s primary segments for management and reporting are geographical as follows: North America, comprising the courseware, assessment and services businesses in the US and Canada; Core, comprising the courseware, assessment and services businesses in more mature markets outside North America, including the UK, Australia and Italy; and Growth, comprising the courseware, assessment and services businesses in emerging markets, including Brazil, China, India and South Africa. In addition the Group separately reports on an equity basis the results from its 25% interest in Penguin Random House (PRH).

North America Segment

The North American business serves educators and students in the US and Canada from early education through elementary, middle and high schools and into higher education and beyond with a wide range of products and services: courseware including curriculum textbooks and other learning materials; assessments including test development and scoring; and services including the provision of online learning services. The Group has a leading position in each of these areas and a distinctive strategy of connecting those parts to support institutions and personalize learning. Across the US the business works with states, schools and colleges to help make education more effective, accessible and affordable for a diverse community of learners.

The North America Higher Education business offers learning services for students, colleges and universities in the US. It provides learning tools and technologies. Custom content and curriculum solutions offer educators the opportunity to tailor their programs based on the needs of students. The business also offers workforce education products and flexible workforce development solutions to fill the growing skills gap and increased demand for quality certification prep training.

Global digital user registrations of Mylab and related products are more than 13 million. The use of these digital homeworking platforms and integrated digital courseware provides a wealth of data and analytics to improve the performance of individual students. The business’s advanced capabilities in data, analytics and adaptive learning, and its leading efficacy research, enable it to design a smart learning path for every student.

16

The demand for online learning is steadily rising and management see this area as one of the fastest growing parts of the market with demand expected to increase significantly over the next few years both in school and higher education.

In higher education, Pearson Online Services provides Online Program Management (OPM) services to institutions including Arizona State University, Rutgers University and Maryville University, partnering with them to provide fully online undergraduate and graduate degree courses.

The North America school business offers early learning solutions that help educators and families teach fundamental math and literacy skills; elementary and secondary imprints publish school programs in reading, literature, math, science, and social studies; and digital instructional solutions for pre K-12, such as enVisionMATH and Miller-Levine Biology. In order to focus on its digital strategy, on March 29, 2019 the Group completed the sale of its US K12 courseware business.

The Connections Academy business provides school management services and operates virtual and blended schools, serving around 73,000 full time equivalent students.

Testing plays an integral role in determining educator and student success and the business is one of the largest providers of educational assessment services in the US. It marks large-scale school examinations for the US federal government and more than 23 American states, scoring billions of machine-scorable test questions and evaluating approximately 110 million essays, portfolios and open-ended test questions every year. Working with educators and education advocates, the business experts help to lead the development of Next-Generation Assessments that feature technology-enhanced items, performance-based assessments, and adaptive learning to foster problem-solvers and critical thinkers ready to compete in the global economy.

The business’s solutions include learning assessments to help gauge how students learn, talent assessments to help growing companies develop their workforce, and clinical assessments to help psychologists and speech/ language/ hearing/occupational and physical therapists diagnose and monitor patients.

The professional certification business, Pearson VUE (VUE), is a leading provider of electronic testing for regulatory and certification boards, providing a full suite of services from test development to test delivery and data management. Pearson VUE offers exams through an extensive network of over 20,000 test centers across the globe, delivering the NCLEX exam for the National Council of State Boards of Nursing, the GMAT for the Graduate Management Admissions Council and numerous IT exams such as Cisco and CompTIA.

Pearson VUE also includes Certiport, the world-leader in IT performance-based exams delivered through a global network of academic test centers, and GED Testing Service, a joint venture with the American Council on Education to deliver a leading high school equivalency exam.

See “Item 5. Operating and Financial Review and Prospects — Results of Operations — Year ended December 31, 2018 compared to year ended December 31, 2017 — Sales and operating profit by division — North America” for a discussion of developments during 2018 with respect to this segment.

Core Segment

The biggest Core markets are the UK, Europe, APAC and North Africa. These are markets where the business works closely with educators and policy makers to improve learning through creating curriculum, designing assessments and developing digital learning systems. Additionally the business participates in many other markets, where it does not have scale itself, but collaborates with others who share its values and commitment to efficacy to maximize reach and impact.

Pearson is the UK’s largest awarding organization offering academic and vocational qualifications that are globally recognized and benchmarked, with educational excellence rooted in names like Edexcel, BTEC and

17

LCCI. Learners take the business’s qualifications in many countries worldwide. Online marking technology is used to mark the vast majority of examination papers and the ResultsPlus service provides detailed analysis of every learner’s examination results. Innovation is also being driven through digital products such as Bug Club and ActiveLearn, and through supporting skills for employability for progression in study, work and life.

The Higher Education business has seen good growth in OPM in both Australia and the UK, launching degree programs with Monash and Griffith Universities in Australia and Kings College London, University of Leeds and Manchester Metropolitan University in the UK.

In English, the Pearson Test of English is being used to support visa applications to the Australian Department of Immigration and Border Protection resulting in significant growth in volumes.

In the UK, the professional certification business, Pearson VUE, works with professional and government bodies including the Driving and Vehicle Standards Agency (DVSA), Chartered Institute of Management Accountants (CIMA) and the Construction Industry Training Board (CITB).

See “Item 5. Operating and Financial Review and Prospects — Results of Operations — Year ended December 31, 2018 compared to year ended December 31, 2017 — Sales and operating profit by division — Core” for a discussion of developments during 2018 with respect to this segment.

Growth Segment

The business aims to take educational products and services and apply them at scale in countries such as Brazil, India, South Africa, Hispano-America, Hong Kong & China and the Middle East.

English language teaching and learning is one of the biggest opportunities in global education. The Group has refocused its activities in English, with disposals of its Chinese direct delivery businesses, GEDU and Wall Street English, taking place in 2017 and 2018 respectively. The opportunity in English is now addressed in three main ways:

The Brazilian business serves primary and secondary education with its ‘sistemas’ or learning systems which include COC, Dom Bosco and NAME.

In South Africa, the business is one of the largest players in the school textbook market and runs a private university with 8,500 students enrolled in courses ranging from undergraduate degrees in IT and sociology, to business diplomas and Masters courses in psychology.

18

See “Item 5. Operating and Financial Review and Prospects — Results of Operations — Year ended December 31, 2018 compared to year ended December 31, 2017 — Sales and operating profit by division — Growth” for a discussion of developments during 2018 with respect to this segment.

Penguin Random House

On July 1, 2013 Penguin Random House was formed, upon the completion of an agreement between Pearson and Bertelsmann to merge their respective publishing companies, Penguin and Random House, with the parent companies owning 47% and 53% respectively. The Group completed the sale of 22% of Penguin Random House to Bertelsmann on October 5, 2017 and also received recapitalization dividends. The Group used the proceeds from this transaction to maintain a strong balance sheet; invest in its business; and return excess capital to shareholders, whilst retaining an investment grade credit rating. The Group continues to hold a 25% stake in Penguin Random House, the investment is accounted for as an associate under the equity method.

Penguin Random House comprises the adult and children’s fiction and nonfiction print and digital book publishing businesses of Penguin and Random House in the US, UK, Canada, Australia, New Zealand and India, Penguin’s publishing activity in Asia and South Africa, as well as Dorling Kindersley worldwide, and Random House’s companies in Spain, Mexico, Argentina, Uruguay, Columbia and Chile.

Penguin Random House employs more than 10,000 people globally across almost 275 editorially and creatively independent imprints and publishing houses that collectively publish around 15,000 new titles annually. Its publishing list includes more than 70 Nobel Prize laureates and hundreds of the world’s most widely read authors.

Penguin Random House sells directly to bookshops and through wholesalers. Retail bookshops normally maintain relationships with both publishers and wholesalers and use the channel that best serves the specific requirements of an order. It also sells through online retailers such as Amazon.com, as well as its own websites and direct to the customer via digital sales agents.

In 2018, the Group’s share of Penguin Random House profit after tax was £46m.

See “Item 5. Operating and Financial Review and Prospects — Results of Operations — Year ended December 31, 2018 compared to year ended December 31, 2017 — Sales and operating profit by division — Penguin Random House” for a discussion of developments during 2018 with respect to Penguin Random House.

Operating cycles

The Group determines a normal operating cycle separately for each entity/cash generating unit with distinct economic characteristics. The “normal operating cycle” for each of the Group’s education businesses is primarily based on the expected period over which the educational programs and titles will generate cash flows, and also takes account of the time it takes to produce the educational programs. The operating cycles for the courseware markets are typically longer than one year as described below.

Particularly for the North American businesses, there are well established cycles operating in the courseware market:

19

Historically a development phase of typically 12 to 18 months for Higher Education and up to 24 months for School precedes the period during which the Company receives and delivers against orders for the products it has developed for the program.

The Core and Growth courseware markets operate in a similar way although often with less formal ‘adoption’ processes.

The operating cycles in respect of the Group’s professional content are more specialized in nature as they relate to educational or heavy reference products released into smaller markets (e.g. the financial training and IT sectors). Nevertheless, in these markets, there is still a regular cycle of product renewal, in line with demand which management monitor. Typically the life cycle is 5 years for Professional content. Elsewhere in the Group, operating cycles are typically less than one year.

Competition

The Group’s businesses operate in highly competitive environments.

The Group competes with other publishers and creators of educational materials and services. These companies include publishers such as Cengage Learning, McGraw-Hill Education and Houghton Mifflin Harcourt.

In services, the Group competes with companies such as K-12 Inc in virtual schools and 2U Inc. in online program management, alongside smaller niche players that specialize in a particular academic discipline or focus on a learning technology.

In US assessment, the Group competes with other companies offering test development and administration including Educational Testing Service (ETS), American Institute for Research (AIR), Measured Progress Inc, and others. The Professional Certification business competes with Prometric globally and a number of other smaller players in local markets.

In Core student assessment, the UK qualifications business competes with AQA and OCR in general qualifications and a number of smaller players in vocational qualifications.

In English language teaching (ELT) courseware, the Group competes with Oxford University Press, Macmillan and other publishers. In English language testing Pearson Test of English Academic competes with alternative tests including iELTS and TOEFL.

Competition is based on the ability to deliver quality products and services that address the specified curriculum needs and appeal to the student, organizations, school boards, educators and government officials making purchasing decisions.

20

Intellectual property

The Group’s principal intellectual property assets consist of its:

The Group believes it has taken all reasonable legal steps to protect its key brands in its major markets and copyright in its content and has taken appropriate steps to develop a comprehensive patent program to ensure appropriate protection of emerging inventions that are critical to its new business strategies.

Raw materials

Paper remains the principal raw material used by the Group. The Group purchases most of its paper through its global outsourcing partner LSC Communications located in the United States. The Group has not experienced and does not anticipate difficulty in obtaining adequate supplies of paper for its operations, with sourcing available from numerous suppliers. While local prices fluctuate depending upon local market conditions, the Group has not experienced extensive volatility in fulfilling paper requirements. In the event of a sharp increase in paper prices, the Group has a number of alternatives to minimize the impact on its operating margins, including modifying the grades of paper used in production.

Government regulation

The manufacture of certain products in various markets is subject to governmental regulation relating to the discharge of materials into the environment. Operations are also subject to the risks and uncertainties attendant to doing business in numerous countries. Some of the countries in which the Group conducts these operations maintain controls on the repatriation of earnings and capital and restrict the means available for hedging potential currency fluctuation risks. The operations that are affected by these controls, however, are not material. Accordingly, these controls have not significantly affected the Group’s international operations. Regulatory authorities may have enforcement powers that could have an impact. The Group believes, however, that in light of the nature of its business the risk of these sanctions does not represent a material threat.

Licenses, patents and contracts

The Group is not dependent upon any particular licenses, patents or new manufacturing processes that are material to its business or profitability. Likewise, it is not materially dependent upon any particular contracts with suppliers or customers, including contracts of an industrial, commercial or financial nature. Notwithstanding the foregoing, the Group’s education business is dependent upon licensed rights since most textbooks and digital learning tools include content and/or software that is licensed to it by third parties (or assigned subject to royalty arrangements). In addition, some software products in various business lines, particularly those of its Clinical business, rely upon patents licensed from third parties.

Legal proceedings

The Group and its subsidiaries are from time to time the subject of legal proceedings incidental to the nature of its and their operations. These may include private litigation or arbitrations, governmental proceedings and investigations by regulatory bodies. The Group does not currently expect that the outcome of pending proceedings or investigations, either individually or in aggregate, will have a significant effect on its financial position or profitability nor have any such proceedings had such effect in the recent past. The Group is not aware of material proceedings in which any member of senior management or any of its affiliates is a party adverse to it or any of its subsidiaries or in respect of which any of those persons has a material interest adverse to it or any of its subsidiaries.

21

Organizational structure

Pearson plc is a holding company which conducts its business primarily through subsidiaries and other affiliates throughout the world. Below is a list of its significant subsidiaries and associates as at December 31, 2018, including name, country of incorporation or residence, proportion of ownership interest and, if different, proportion of voting power held.

During 2014, the Group disposed of its interest in the Mergermarket group of companies and its North America business disposed of its joint venture interests in Safari Books Online and CourseSmart.

In February 2014, the Group acquired Grupo Multi, Brazil’s leading adult English language training company.

During 2015, the Group disposed of its interest in the FT Group including its 50% share of The Economist. The Financial Times sale was completed in November 2015 and the sale of the 50% share of The Economist Group was substantially completed in October 2015, with the remaining share sold in 2016. Also, in July 2015, the Group disposed of its interest in PowerSchool.

In May 2017, the Group announced that it was undertaking a strategic review of its US K12 courseware business. On March 29, 2019 the Group completed the sale of its US K12 courseware business to Nexus Capital Management LP.

In August 2017, the Group completed the sale of its test preparation in China (GEDU) to Puxin Education.

In October 2017, the Group disposed of 22% of Penguin Random House to Bertelsmann, retaining a 25% interest.

In November 2017, the Group announced that it had agreed the sale of Wall Street English to a consortium consisting of funds affiliated with Baring Private Equity Asia and CITIC Capital. The disposal completed on March 15, 2018.

There were no material acquisitions in 2016, 2017 or 2018.

Property, plant and equipment

The Group’s headquarters are located at leasehold premises in London, England. As at December 31, 2018 it owned or leased approximately 750 properties, including approximately 530 testing/teaching centers in over 55 countries worldwide, the majority of which are located in the United Kingdom and the United States. Approximately 80 properties, primarily testing/teaching centers in China, were disposed in March 2018 as part of the WSE disposal.

The properties owned and leased by the Group consist mainly of offices, distribution centers and computer testing/ teaching centers.

22

In some cases properties leased by the Group are then sublet to third parties. These properties are not included in the list below as they are not considered to be principal properties.

The vast majority of printing is carried out by third party suppliers. The Group operates a small digital print operation as part of its Pearson Assessment & Testing businesses which provides short-run and print-on-demand products, typically custom client applications.

The Group owns the following principal properties at December 31, 2018:

The Group leased the following principal properties at December 31, 2018:

Capital Expenditures

See “Item 5. Operating and Financial Review and Prospects — Liquidity and Capital Resources” for description of the Company’s capital expenditure.

General overview

Introduction

The Group’s primary segments for management and reporting are geographical as follows: North America, comprising the courseware, assessments and services businesses in the US and Canada; Core, comprising the courseware, assessments and services businesses in more mature markets outside North America, including the UK, Europe, Asia Pacific and North Africa, and Growth, comprising the courseware, assessments and services businesses in emerging markets, including Brazil, India, South Africa, Hispano-America Hong Kong and China and the Middle East. In addition the Group separately reports on an equity basis the results from its 25% interest in Penguin Random House (PRH).

On August 16, 2017, the Group completed the sale of its test preparation business in China (GEDU) to Puxin Education, realizing a pre-tax profit on sale of £44m. On October 5, 2017, the Group also completed the sale of a 22% share in Penguin Random House to Bertelsmann, realizing a pre-tax profit on sale of £96m.

On March 15, 2018, the Group completed the sale of Wall Street English (WSE) to a consortium of funds affiliated with Baring Private Equity Asia and CITIC Capital realising a profit before tax of £207m. The business had been classified as held for sale at December 31, 2017.

On March 29, 2019, the Group completed the sale of the US K12 courseware business (K12) to Nexus Capital Management LP for headline consideration of $250m comprising an initial cash payment of $25m and an unconditional vendor note for $225m expected to be repaid in three to seven years. Following the repayment of the vendor note the Group is entitled to 20% of all future cash flows to equity holders and 20% of net proceeds if the business is sold. The K12 business had been held for sale on the balance sheet following a strategic review and discussion with potential buyers regarding a disposal since the end of 2017 and continues to be classified as held for sale on the balance sheet as at December 31, 2018.

None of the disposals referred to above were significant enough to meet the definition of a discontinued business and their results to the date of disposal are included in continuing operations.

The Group’s total sales decreased from £4,513m in 2017 to £4,129m in 2018, a decrease of £384m or 9%. This year on year decrease was exacerbated by currency movements, primarily the comparative weakness of the US dollar relative to sterling during the year. In 2018 currency movements decreased sales by £134m when compared to the equivalent figures at constant 2017 rates. When measured at 2017 constant exchange rates, the Group’s sales declined by 6%. Part of the decrease is due to the absence of sales from businesses sold during 2017 and 2018, partly offset by the impact of the adoption of IFRS 15 ‘Revenue from contracts with customers.’ This new standard was adopted on January 1, 2018 but the comparative figures for 2017 have not been restated (see also note 1 within Item 18–Financial Statements). The impact of adopting IFRS 15 was to increase sales by £9m. The Group estimates that after excluding the impact of disposals and the adoption of IFRS 15, sales declined by 1% at constant exchange rates. This decrease is primarily explained by further declines in North America in higher education and school courseware, largely offset by aggregate growth in the rest of the business.

In 2018, the Group reported an operating profit of £553m compared to an operating profit of £451m in 2017. The increase in profit of £102m mainly reflects an increase in gains on disposal and reduced intangible charges which more than offset increased restructuring, the lost contribution from businesses disposed and the impact of currency movements. After stripping out the effect of gains on the sale of businesses, reduced intangible charges, increased restructuring costs and one-off pension related charges, profits from trading declined by around £30m. This trading decline was primarily due to currency movements and the lost contribution from businesses disposed which offset the increased year on year benefit from restructuring savings. The impact of adopting IFRS 15 on operating profit was similar to the impact on sales described above

24

increasing operating profit by £9m. The Group also adopted IFRS 9 ‘Financial instruments’ on January 1, 2018 but this new standard did not have a material impact on operating profit (see also note 1 within Item 18–Financial Statements).

In May 2017, the Group announced a new restructuring program, the 2017-2019 restructuring program. This program began in the second half of 2017 and costs incurred were £79m in 2017 and £102m in 2018 and relate to delivery of cost efficiencies in the enabling functions and US higher education courseware business together with further rationalization of the property and supplier portfolio. The restructuring costs in 2018 relate predominantly to staff redundancies and the net cost of property rationalization. Included in the property rationalization in 2018 is the impact of the consolidation of the Group’s property footprint in London which resulted in a charge for onerous leases of £91m partially offset by profit from the sale of property of £81m. The onerous lease provisions are the main driver for the overall increase in provisions on the balance sheet at December 31, 2018.

Operating profit in 2018 included a gain of £230m from the sale of businesses that relates to the sale of the Wall Street English language teaching business (WSE), realising a gain of £207m, the disposal of the Group’s equity interest in UTEL, the online University partnership in Mexico, realising a gain of £19m, and various other smaller disposal items realising a net gain of £4m. Operating profit in 2017 included a gain of £128m from the sale of businesses. The sale of the Group’s test preparation business in China resulted in a pre-tax profit on sale of £44m, while the sale of a 22% share in PRH resulted in a pre-tax profit on sale of £96m. These were offset in part by net losses on other smaller disposals.

Currency movements decreased 2018 operating profit by £17m when compared to the equivalent figures translated at constant 2017 exchange rates.

The profit before taxation in 2018 of £498m compares to a profit before taxation of £421m in 2017. The increase in profit of £77m reflects the £102m increase in the reported operating profit identified above offset by an increase in net finance costs of £25m, from £30m in 2017 to £55m in 2018.

The Group’s net interest payable decreased from £79m in 2017 to £24m in 2018. The decrease was primarily due to a reduction in gross debt achieved through the early redemption of bonds in 2017 and in early 2018. Charges relating to early redemptions increased finance charges in 2017 but were not as significant in 2018. Additionally there was a reduction in interest on tax provisions following reassessment of those provisions in 2018. Also included in net finance costs are net finance costs relating to employee benefit plans, foreign exchange and other gains and losses. In 2018 the total of these items was a loss of £31m compared to a gain of £49m 2017. Income relating to employee benefit plans was £8m higher in 2018 than in 2017 reflecting the higher net surplus on pension balances at the beginning of 2018 compared to the beginning of 2017. Other losses in 2018 primarily relate to foreign exchange differences on un-hedged cash and cash equivalents, and other financial instruments that generated gains in 2017.

The reported tax credit in 2018 was £92m (18.5%) compared to a charge of £13m (3.1%) in 2017. The movement in the tax rate reflects several one-off benefits in 2018 including provision releases due to the expiry of relevant statutes of limitation and due to the reassessment of historical positions, as well as a one-off benefit from a reassessment of the tax treatment of certain items of income and expenditure.

Net cash generated from operations increased to £547m in 2018 from £462m in 2017. The main reason for the improvement in cash generated from operations was the absence in 2018 of special pension contributions which in 2017 were £227m and related to the FT Group disposal (£25m) and to agreements relating to the PRH merger in 2013 (£202m). The benefit from the absence of these pension contributions in 2018 was partly offset by higher incentive payments in 2018 relating to 2017 performance and other unfavourable movements in working capital.

Net interest paid at £22m in 2018 compares to £69m in 2017 and reflects the decrease in interest charge for the year referred to above. Tax paid in 2018 was £43m compared to £75m in 2017 with the decrease mainly explained by tax refunds in the US.

25

Capital expenditure on property, plant and equipment was £70m in 2018 compared to £82m in 2017. Proceeds from the sale of property in 2018 of £128m includes proceeds from the sale of the Group’s London property as part of the restructuring program. There were no material property sales in 2017. Capital expenditure on software intangibles reduced from £150m in 2017 to £130m in 2018. The expenditure on both tangible and intangible capital includes the continuing investment in enabling function technology designed to lower administrative costs.

There were no significant acquisitions in either 2018 or 2017 and the net cash outflow in respect of businesses and investments acquired was £15m in 2018 and £14m in 2017. The net cash inflow in respect of businesses and investments disposed was £107m in 2018 compared to £430m in 2017. In 2017 the cash received largely related to the PRH and GEDU disposals and in 2018 includes proceeds from the sale of WSE and UTEL.

Dividends from joint ventures and associates decreased from £458m in 2017 to £117m in 2018. The reduction is primarily due to the PRH sale transaction in 2017 which resulted in a reduced equity share from 47% to 25% and involved recapitalization dividends amounting to £312m in 2017 and £50m in 2018. Dividends paid to company shareholders in 2018 of £136m compares to £318m in 2017 reflecting the rebasing of the dividend in 2017 to reflect portfolio changes, increased investment and to align with profit expectations. Cash returned to shareholders via the share buyback program, announced in October 2017 and completed in February 2018, amounted to £149m in 2017 and £153m in 2018.

Overall the Group’s net borrowings decreased from £432m at the end of 2017 to £143m at the end of 2018. The reduction in net debt was principally due to cash generated from operations and the proceeds from disposal of businesses and property in the year which more than offset interest, tax, share buy-back and dividend payments.

Outlook

In 2019, the Group expects to report adjusted operating profit of between £610m and £660m (including businesses held for sale and after taking account of the adoption of IFRS 16 — see also note 1 within Item 18 — Financial Statements.) Adjusted operating profit is the key financial measure used by management to evaluate the performance of the Group and allocate resources to business segments over time by separating out those items of income and expenditure relating to acquisitions and disposals, major restructuring programs and certain other items that are not representative of underlying performance. Reconciliations of adjusted operating profit to statutory operating profit are included below under ‘Sales and operating profit by segment’ and in note 2 within Item 18 — Financial Statements. Due to the difficulty in making accurate forecasts of some of the information excluded from adjusted operating profit, the Group is unable to quantify expected 2019 statutory operating profit without unreasonable efforts, and consequently, no statement thereof, and no reconciliation of the Group’s expected 2019 adjusted operating profit thereto, is included.

The outlook for 2019 is based on the following factors when comparing to 2018. Guidance is based on exchange rates at 31 December 2018 and these rates would generate approximately £26m more adjusted operating profit than would be the case at constant 2018 average exchange rates. In 2018, the Group generated approximately 64% of its sales in the US, 3% in Greater China, 5% in the Eurozone, 3% in Brazil, 3% in Canada, 3% in Australia, 2% in South Africa and 1% in India. Guidance for 2019 includes the K12 business even though it was sold in March 2019. This business contributed £364m to 2018 sales and around £20m to 2018 adjusted operating profit. In addition, the 2018 results include the WSE business to the point of sale in March 2018 and this business contributed £42m to 2018 sales and £4m to 2018 adjusted operating profit. In 2019, the Group expects cost inflation of around £50m together with increased investment in strategic growth areas of around £33m. Incremental in-year benefits from the 2017-2019 restructuring program are expected to be £130m in 2019. Further restructuring costs of £150m (excluded from adjusted operating profit) are expected in 2019.

In North America, the Group expects US Higher Education Courseware revenue to be flat to down 5% on the continuation of the pressures seen on end demand in 2018 with ongoing declines in enrolment and modest growth in open educational resources (OER) adoptions. For print revenue in this segment, there is scope for

26

further declines in gross sales and improvements in returns. Print continues to be impacted by the ongoing rise of secondary channels, such as rental, but channel inventory has now returned to more normalized levels following the 2016 inventory correction and its after effects. The channel is now optimising the stock it holds, both through reducing purchases and returns, and this is expected to continue in 2019. Growth in digital and direct sales will provide some offset to the continuing pressures on print. In Assessment, good growth is expected in Professional Certification and stable revenue in the Clinical Assessment business in the US. A modest decline in revenue is expected in North America Student Assessment on continued contraction in revenue associated with the Group’s Partnership for Assessment of Readiness for College and Careers (“PARCC”) and ACT Aspire contracts. Good growth is expected in revenue and enrolment in Connections Academy and in North America Online Program Management (OPM).

In Core, the Group is expecting stable revenue across Core, including student qualifications and assessment, with further revenue growth in OPM and Pearson Test of English Academic, offset by continued declines in its courseware businesses.

In Growth, The Group expects revenue to continue to increase in 2019 benefiting from new products and services across all divisions.

The Group anticipates a lower contribution from Penguin Random House from a normalized publishing performance and expects an annual after-tax contribution of around £60m-£65m to adjusted operating profit.

Sales information by segment

The following table shows sales information for each of the past three years by segment:

Sales information by geographic market supplied

The following table shows sales information for each of the past three years by geographic region:

In the table above sales are allocated based on the country in which the customer is located.

Exchange rate fluctuations

The Group earns a significant proportion of its sales and profits in overseas currencies, principally the US dollar. Sales and profits are translated into sterling in the consolidated financial statements using average rates.

27

The average rate used for the US dollar was £1:$1.34 in 2018, £1:$1.30 in 2017 and £1:$1.33 in 2016. Fluctuations in exchange rates can have a significant impact on the Group’s reported sales and profits. In 2018, the Group generated 64% of its continuing sales in the US (2017: 65%; 2016: 65%). In 2018 the Group estimates that a five cent change in the average exchange rate between the US dollar and sterling would have had an impact on its reported earnings per share of approximately 2p. See “Item 11. Quantitative and Qualitative Disclosures about Market Risk” for more information on how foreign exchange risk is managed. The year-end US dollar rate for 2018 was £1:$1.27 compared to £1:$1.35 for 2017 and £1:$1.23 for 2016. The total impact on shareholders’ funds of foreign exchange translation was a gain of £86m in 2018 compared to a loss of £313m in 2017. These net movements are principally driven by movements in the US dollar as a significant portion of the Group’s operations are in the US.

Critical accounting policies

The Group’s consolidated financial statements, included in “Item 18. Financial Statements”, are prepared based on the accounting policies described in note 1 to the consolidated financial statements.

Certain of these accounting policies require the application of management judgment in selecting assumptions when making significant estimates about matters that are inherently uncertain. Management bases its estimates on historical experience and other assumptions that it believes are reasonable. These policies are described in note 1a (3) in “Item 18. Financial Statements”.

Results of operations

Year ended December 31, 2018 compared to year ended December 31, 2017

Consolidated results of operations

Sales

The Group’s total sales decreased from £4,513m in 2017 to £4,129m in 2018, a decrease of £384m or 9%. The year on year movement was impacted by currency movements, primarily the comparative strength of the US dollar relative to sterling during the year. In 2018, currency movements decreased sales by £134m when compared to the equivalent figures at constant 2017 rates. When measured at 2017 constant exchange rates, the Group’s sales declined by 6%. Part of the decrease is due to the absence of sales from businesses sold during the year offset by the £9m additional sales recorded as a result of adopting IFRS 15. The Group estimates that after excluding the impact of disposals and the adoption of IFRS 15, sales declined by 1% at constant exchange rates.

North America sales decreased by £145m or 5% from £2,929m in 2017 to £2,784m in 2018. The Group estimates that after excluding the impact of exchange, the contribution from businesses disposed in 2017 and 2018, and the impact of adopting IFRS 15, North America sales declined by 1% in 2018 compared to 2017. This decline was primarily due to North American Higher Education Courseware which declined 5%, School Courseware which was down 4%, impacted by weak Open Territory sales in the second half of the year, the continued decline in Learning Studio as that product moved towards retirement in 2019 and Student Assessment which declined moderately. Offsetting that, was good growth in Virtual Schools, Online Program Management (OPM) and Professional Certification revenue. North America continued to be the most significant source of the Group’s sales and as a proportion of sales contributed 67% in 2018 and 65% in 2017.

Core sales decreased by £9m or 1% from £815m in 2017 to £806m in 2018. The Group estimates that after excluding the impact of exchange, the contribution from businesses disposed in 2018 and the impact of adoption of IFRS 15, Core sales were flat when comparing 2018 and 2017. Sales growth in Pearson Test of English Academic, OPM in the UK and Australia and Professional Certification were offset by declines in Higher Education and Student Assessment and Qualifications.

Growth sales decreased by £230m from £769m in 2017 to £539m in 2018 principally due to the lost contribution in China following the disposal of GEDU in 2017 and WSE in 2018. The Group estimates that after

28

excluding the impact of exchange, the contribution from businesses disposed and the impact of adoption of IFRS 15, Growth sales increased by 1% when comparing 2018 and 2017. Strong growth in China and modest growth in Brazil and Hispano-America were partially offset by declines in South Africa following a large one-off order in 2017.

Cost of goods sold and operating expenses

The following table summarizes the Group’s cost of sales, net operating expenses and impairment of intangible assets:

Cost of goods sold . Cost of sales consists of costs for raw materials, primarily paper, printing and binding costs, amortization of pre-publication costs, royalty charges, the cost of service provision in the assessment and testing business and the cost of teaching and facilities in direct delivery businesses. The Group’s cost of sales decreased by £123m, or 6%, from £2,066m in 2017, to £1,943m in 2018. The decrease largely reflects the decrease in sales but also includes some continuing benefit from restructuring. Cost of sales as a percentage of sales increased largely as a result of the mix effect caused by the disposal of businesses with generally higher gross margins than Pearson as a whole. Cost of sales was 47.1% of sales in 2018 compared to 45.8% in 2017.

Distribution costs. Distribution costs consist primarily of shipping costs, postage and packing. Distribution costs increased by £4m reflecting some one-off costs in the Core business relating to a change in distribution arrangements in 2018.

Selling, marketing and product development costs. The Group’s selling, marketing and product development costs decreased by £137m or 15% from £896m in 2017 to £759m in 2018. The decrease is partly explained by the absence of costs from businesses disposed and restructuring savings realized in the year. As a percentage of sales, these costs decreased in 2018 from 19.9% in 2017 to 18.4% in 2018.

Administrative and other expenses. The Group’s administrative and other expenses decreased by £168m or 13.9% from £1,207m in 2017 to £1,039m in 2018. This decrease is explained by reductions in intangible amortization relating to past acquisitions, the absence of costs from businesses disposed and the impact of restructuring savings particularly in enabling functions partly offset by continuing investment in technology.

Restructuring costs. Restructuring costs of £90m in 2018 and £79m in 2017 relate to the 2017-2019 restructuring program announced in May 2017. This programme began in the second half of 2017 and costs incurred were £79m in 2017 and £90m (excluding restructuring costs related to associates) in 2018 relating to delivery of cost efficiencies in enabling functions and the US higher education courseware business together with

29

further rationalization of the property and supplier portfolio. The restructuring costs in 2018 relate predominantly to staff redundancies and the net cost of property rationalization. Included in the property rationalization in 2018 is the impact of the consolidation of the Group’s property footprint in London which resulted in a charge for onerous leases of £91m partially offset by profit from the sale of property of £81m.

Other income. Other operating income mainly consists of freight recharges, sub-rights and licensing income, distribution commissions, investment income and gains on minor asset disposals together with the service fee income from Penguin Random House. Other operating income increased to £69m in 2018 compared to £64m in 2017 mainly due to increased rights income and recoveries following legal settlements.

Other net gains and losses . Other net gains and losses relate to the sale of businesses and in 2018 these gains amounted to £230m and result from the sale of the Wall Street English language teaching business (WSE), realising a gain of £207m, the disposal of the equity interest in UTEL, the online University partnership in Mexico, realising a gain of £19m, and various other smaller disposal items realising a net gain of £4m. Other net gains and losses in 2017 include the sale of the Group’s test preparation business in China, which resulted in a pre-tax profit on sale of £44m, the sale of a 22% share in PRH, which resulted in a pre-tax profit on sale of £96m and net losses of £12m relating to other smaller disposals.

Share of results of joint ventures and associates

The contribution from the Group’s joint ventures and associates decreased by £34m to £44m in 2018 from £78m in 2017. The decrease is mainly due to the sale of 22% of PRH in 2017 which resulted in a lower share of profits for the final quarter of 2017 and the whole of 2018. In addition there were restructuring costs incurred at PRH and in respect of the Group’s ACT Aspire joint venture in 2018 that were absent in 2017.

Operating profit

In 2018, the Group reported an operating profit of £553m compared to an operating profit of £451m in 2017. The increase in profit of £102m mainly reflects an increase in gains on disposal and reduced intangible charges which more than offset increased restructuring, the lost contribution from businesses disposed and the impact of currency movements. After stripping out the effect of gains on the sale of businesses, reduced intangible charges, increased restructuring costs and one-off pension related charges, profits from trading declined by around £30m. This trading decline was primarily due to currency movements and the lost contribution from businesses disposed which offset the increased year on year benefit from restructuring savings.

Net finance costs

Net interest payable decreased from £79m in 2017 to £24m in 2018. The decrease was primarily due to a reduction in gross debt achieved through the early redemption of bonds in 2017 and in early 2018. Charges relating to early redemptions increased finance charges in 2017 but were not as significant in 2018. Additionally there was a reduction in interest on tax provisions following reassessment of those provisions in 2018. In February 2018, the Group bought back an aggregate nominal amount of €450,000,000 of 2021 and 2025 notes. There was a charge in respect of these early redemptions however there were partial year savings as a result which have flowed through the income statement in the period since redemption. In March and November 2017 respectively, the Group redeemed the $550m 6.25% Global dollar bonds and $300m 4.625% US dollar notes, both originally due in 2018. In addition, in August 2017, the Group redeemed $383m out of the $500m 3.75% US dollar notes due in 2022 and $406m out of the $500m 3.25% US dollar notes due in 2023. The charge in respect of these early redemptions was booked in 2017 with partial year savings in 2017 and the full annualized savings coming through in 2018.

Other net finance costs are finance income and costs on retirement benefits, foreign exchange, interest costs relating to acquisition consideration and other gains and losses on derivative financial instruments. In 2017 the

30

total of these items was a gain of £49m compared to a loss of £31m in 2018. Income relating to employee benefit plans was £8m higher in 2018 than in 2017 reflecting the higher net surplus on pension balances at the beginning of 2018 compared to the beginning of 2017. Other losses in 2018 primarily relate to foreign exchange differences on un-hedged cash and cash equivalents, and other financial instruments that generated gains in 2017.

For a more detailed discussion of the Group’s borrowings and interest expenses see “— Liquidity and Capital Resources — Capital Resources” and “— Borrowings” below and “Item 11. Quantitative and Qualitative Disclosures about Market Risk”.

Taxation

The reported tax credit in 2018 was £92m (18.5%) compared to a charge of £13m (3.1%) in 2017. The movement in the tax rate mainly reflects several one-off benefits in 2018 including provision releases due to the expiry of relevant statutes of limitation and due to the reassessment of historical positions including those relating to prior year disposals (£111m), as well as a one off benefit from a reassessment of the tax treatment of certain items of income and expenditure (£25m). The provision releases in 2018 were more significant than they had been in 2017 although in 2017 these releases partly explain a lower tax rate than might be expected given the national tax rates that the group is exposed to. As a result of US tax reform, the reported tax charge in 2017 includes a benefit from revaluation of deferred tax balances to the reduced federal rate of £5m and a repatriation tax charge of £6m.

Discontinued operations

There were no discontinued operations in either 2017 or 2018.

Profit for the year

The profit for the financial year in 2018 was £590m compared to a profit in 2017 of £408m. The increased profit reflects increased operating profit and tax credits offset by higher net finance costs as set out above.

Earnings per ordinary share

The basic earnings per ordinary share, which is defined as the profit for the financial year divided by the weighted average number of shares in issue, was 75.6p in 2018 compared to 49.9p in 2017 based on a weighted average number of shares in issue of 778.1m in 2018 and 813.4m in 2017. The increase in earnings per share was due to the increase in profit for 2018 as described above and was also due to the decrease in the number of weighted average number of shares following the share buyback during late 2017 and early 2018.

The diluted earnings per ordinary share was 75.5p in 2018 and 49.9p in 2017, with the dilutive effect of options being minimal.

Exchange rate fluctuations

Currency movements decreased sales by £134m and decreased the operating profit by £17m. See “Item 11. Quantitative and Qualitative Disclosures about Market Risk” for a discussion regarding the Group’s management of exchange rate risks.

Sales and operating profit by segment

The following tables summarize the Group’s sales and adjusted operating profit for each of the Group’s business segments. Adjusted operating profit is included as it is the key financial measure used by management to evaluate the performance of the Group and allocate resources to business segments over time by separating out

31

those items of income and expenditure relating to acquisitions and disposals, major restructuring programs and certain other items that are not representative of underlying performance. Reconciliations of adjusted operating profit to statutory operating profit are included below and in note 2 within Item 18 — Financial Statements.

In the Group’s adjusted operating profit it has excluded other net gains and losses, acquisition related costs, amortization and impairment of acquired intangibles and the cost of major restructuring programs. In 2018, the Group has also excluded the impact of adjustments arising from clarification of guaranteed minimum pension (GMP) equalization legislation in the UK and in 2017, excluded the impact of US tax reform on associate operating profit. The intangible charges relate only to intangible assets acquired through business combinations and acquisition costs are the direct costs of acquiring those businesses. The Group does not believe these charges are relevant to an understanding of the underlying performance. Charges relating to acquired intangible assets are non-cash charges that reflect the historical expenditure of the acquired business. These acquired intangible assets continue to be supported by ongoing expenditure that is reported within adjusted operating profit. Other net gains and losses that represent profits and losses on the sale of subsidiaries, joint ventures, associates and other financial assets are also excluded from adjusted operating profit as it is important to highlight their impact on operating profit, as reported, in the period in which the disposal transaction takes place in order to understand the underlying trend in the performance of the Group. The GMP equalization charge arises from the ruling in the Lloyds Bank High Court case in the UK in October 2018 that provided clarity on how pension plans should equalize GMP between males and females. The case ruling results in an income statement charge, an additional liability and the potential requirement to make back-payments to pensioners who may have been retired for some years. The Group has excluded this charge from adjusted earnings as it relates to historical circumstances. The charge is an estimate based on available data and revisions to these estimates in future years will be treated as assumption changes and recorded in other comprehensive income rather than the income statement. US tax reform in 2017 resulted in the revaluation of deferred tax balances in associates. These revaluations have been excluded from adjusted earnings in 2017 due to their one-off nature.

A reconciliation of operating profit to adjusted operating profit for continuing operations is included in the tables below:

32

North America

Sales in North America decreased by £145m or 5% from £2,929m in 2017 to £2,784m in 2018 and adjusted operating profit decreased by £32m, or 8%, from £394m in 2017 to £362m in 2018. The Group estimates that after excluding the impact of exchange, the contribution from businesses disposed in 2018 and 2017 and the impact of adopting IFRS 15, North America sales declined by 1% in 2018 compared to 2017 and adjusted operating profit increased by 1%. The sales decline was primarily due to North American Higher Education Courseware declining 5%, School Courseware which was down 4%, impacted by weak Open Territory sales in the second half of the year, the continued decline in Learning Studio as the product moved towards the retirement in 2019 and Student Assessment which declined moderately. Offsetting that, was good growth in Virtual Schools, Online Program Management (OPM) and Professional Certification revenue. The adjusted operating profit benefited from restructuring savings which more than offset the impact of lower sales, inflation and other operating factors.

The North America results also include £78m in 2018 and £60m in 2017 in respect of the 2017-2019 restructuring program. Amortization relating to acquired intangibles was £72m in 2018 compared to £89m in 2017 and there were net gains on business disposals of £4m and net losses of £3m in 2017. None of the disposals in either 2018 or 2017 were material. Overall adjusted operating margins in the North America business decreased in 2018 to 13.0% compared to 13.5% in 2017 due to sales mix offset partly by restructuring savings.

On March 29, 2019 the Group completed the sale of the US K12 school courseware business to Nexus Capital Management LP for headline consideration of $250m comprising an initial cash payment of $25m and an unconditional vendor note for $225m expected to be repaid in three to seven years. Following the repayment of the vendor note, the Group is entitled to 20% of all future cash flows to equity holders and 20% of net proceeds if the business is sold.

North America — courseware

In School Courseware, revenue declined primarily due to declines in Open Territory states. This was partially offset by growth in Adoption state revenue on strong performance in Science in Florida, South Carolina and Tennessee, Elementary Math in Oklahoma and Elementary Social Studies in California and South Carolina. The Group’s new adoption participation rate rose to 80% in 2018 from 61% in 2017 and the Group won an estimated 33% share of adoptions competed for (38% in 2017) and 26% of total new adoption expenditure of $509m (29% of $365m in 2017).

In Higher Education Courseware, total US college enrolments, as reported by the National Student Clearinghouse, fell 1.4%, with combined two-year public and four-year for-profit enrolments declining 4.8%.

33

Enrolment weakness was particularly focused on part-time students where enrolment declined 2.9% compared to full-time enrolment which declined 1.1%. Net revenue in the US Higher Education Courseware business declined 5% during the year. The Group estimates that around 2% of this decline was driven by lower enrolment; around 1.5% from the adoption of Open Educational Resources (OER); around 2.5% from the combined impact of shifts in the secondary market, more cautious buying by the channel and lower returns; offset by around a 1% benefit from the shift to digital. In 2018, Pearson’s US Higher Education Courseware market share, as reported by MPI, was within the 40-41.5% range seen over the last five years.

Digital revenue grew 2% benefiting from continued growth in direct sales and favourable mix. Global digital registrations of MyLab and related products were flat. In North America, digital registrations fell 3% with good growth in Science, Business & Economics and Revel offset by lower overall enrolment and continued softness in Developmental Mathematics. Revel registrations grew more than 40%. Including stand-alone eBook registrations, total North American digital registrations rose 1% and global registrations rose 3%.

The actions announced in early 2017 to promote access over ownership met with continued success. Stand-alone eBook volumes grew 34% in the US with revenue up 25% and the partner print rental programme has had a successful start with 130 titles in the programme in 2018. The Group plans to increase the number of titles in the programme to around 400 by fall 2019.

The North America business continued to make good progress with the Inclusive Access (Direct Digital Access) solutions product signing 192 new institutions in 2018, taking the total of not-for-profit and public institutions served to 617. Including 80 longer- standing contracts with for-profit colleges, there are now direct courseware relationships with nearly 700 institutions. Inclusive Access ensures that students have affordable access to the courseware that they need on day one of the course, whilst further shifting the Group’s business model in this segment away from ownership and towards subscription. During the year, the business delivered over 1.4m course enrolments with inclusive access revenues from non-profit and public institutions rising to c.8% of the higher education courseware revenue as more colleges and faculties saw the benefit of this model.

North America — assessment

In Student Assessment, revenue declined moderately in 2018 due to the faster than expected contraction in revenue associated with the PARCC and ACT-Aspire multi-state volume-based contracts and a more disciplined competitive approach. During 2018, Pearson successfully renewed contracts in Arizona and Kentucky through competitive procurements and secured business with the District of Columbia, New Jersey, New Mexico, and Maryland under new contracts with these PARCC states. The business also won new contracts for Utah’s High School Assessments and with the University of Iowa for the delivery of Iowa’s new assessment system.

In 2018, the Group delivered 24m standardized online tests to K12 students, down 5% from 2017. TestNav 8, Pearson’s next-generation online test platform, supported a peak load of 825,000 tests in a single day and provided 99.99% up time. The AI scoring systems scored 36m responses to open-ended test items, around 33% of the total. Paper based standardized test volumes fell 9% to 18.5m.

In Professional Certification, VUE global test volume rose 4% to over 15m. Revenue in North America was up due to growth in medical college admissions testing and certification for professional bodies, offset by continued declines in volumes in the GED High School Equivalency Test and higher-level IT certifications in an environment of low unemployment.

The business signed over 70 new contracts in 2018 and the renewal rate on existing contracts continued to be over 95%. During the year, over 80 contracts were renewed including the National Council of State Boards of Nursing (NCLEX exam), Microsoft and Adobe.

Clinical Assessment sales declined slightly on an absence of new major product introductions. Late in 2018 the Group launched a refresh of the Peabody Picture Vocabulary Test and Expressive Vocabulary Test (PPVT/

34

EVT). Q-interactive, Pearson’s digital solution for Clinical Assessment administration, saw continued strong growth in license sales with sub-test administrations up more than 37% over the same period last year.

North America — services

Connections Academy, the K12 online school business grew revenue 8%. Connections Academy served 73,000 Full Time Equivalent (FTE) students through 37 continuing full-time virtual partner schools in 28 states, up 11% on last year. Total FTE virtual school students declined 3% to 75,400 as expected due to contract exits at Commonwealth Charter Academy in Pennsylvania and Florida Virtual School. Three new full-time online, state-wide partner schools opened in the 2018-19 school year in Florida, Michigan, and Ohio and it is anticipated that between two and five new partner schools will be opened in the 2019-20 school year. The 2018 Connections Academy Parent Satisfaction Survey continued to show solid endorsement for the schools with 93% of families with enrolled students stating they would recommend Connections virtual schools to others and 95% agreeing that the curriculum is of high quality.

In Pearson Online Services, revenue grew 3%, primarily due to growth in OPM, partially offset by a decline in Learning Studio revenue as the product is retired and declines as smaller non-OPM contracts were restructured. In OPM, revenue grew 9% as course registration grew strongly, up 14% to more than 388,000, in programs at key partners including Arizona State University Online, Maryville University, Regis College, Bradley University, Ohio University and the University of Southern California. The overall active program count grew by 33 to 325. The launch of 46 new programs were offset by 13 discontinued programs. During 2018, 27 new multi-year programs were signed including programs at new partners the University of North Dakota and Rider University. The business closed nine out of 15 renewal opportunities and as part of broader efforts around portfolio optimization agreed with partners to terminate 23 programs that were not mutually viable.

Core

Sales in Core markets decreased by £9m, or 1%, from £815m in 2017 to £806m in 2018 while adjusted operating profit increased by £7m, or 14%, from £50m in 2017 to £57m in 2018. At constant exchange and after excluding the contribution from disposals, Core sales were flat year on year and profits increased by 10%. Growth in Pearson Test of English Academic, OPM in the UK and Australia and Professional Certification was offset by declines in Higher Education and Student Assessment and Qualifications.

The increase in adjusted operating profit was mainly due to restructuring savings partly offset by cost inflation. Also included in the Core statutory operating profit were restructuring costs of £16m in 2018 and £11m in 2017 and amortization of acquired intangibles of £8m in 2018 and £12m in 2017. The statutory operating profit in 2018 also includes the one-off £8m charge in respect of guaranteed minimum pension (GMP) equalization in the UK. The GMP equalization charge arises from the ruling in the Lloyds Bank High Court case in the UK in October 2018 that provided clarity on how pension plans should equalize GMP between males and females. The case ruling results in an income statement charge, an additional liability and the potential requirement to make back- payments to pensioners who may have been retired for some years.

Core — courseware

Courseware revenue declined moderately. Slight growth in School Courseware was offset by declines in Higher Education Courseware. In Higher Education Courseware, revenue was down due to market declines in Europe and Asia, partially offset by growth in digital sales to institutional partners in the UK and Australia.

Core — assessments

In Student Assessment and Qualifications, revenue fell as modest growth in BTEC Firsts and GCE A-Level was more than offset by declines in AS levels, international GCSEs in the UK and UK Apprenticeships due to

35

policy changes in the schools qualifications and the apprenticeships market. The business successfully delivered the National Curriculum Test (NCT) for 2018, marking 3.6m scripts, up slightly from 2017 and will deliver the NCT again in 2019 before the test transitions to another provider in 2020.

Clinical Assessment sales declined, primarily in Australia, due to an absence of new major product introductions. Q-Interactive, Pearson’s digital solution for Clinical Assessment administration, saw continued strong growth. Pearson Test of English Academic also saw continued strong growth in test volumes and successfully extended its agreement with the Department of Home Affairs in Australia for another two years. In Professional Certification, revenue was up modestly due to the launch of additional computer-based exams for an existing customer in the UK and the MOI, the French Driving Test.

Core — services

In Higher Education Services, revenue grew strongly. OPM revenue was up 34%. In Australia, there was good growth due to the successful partnership with Monash University, and continued success of the Graduate Diploma in Psychology. There were a total of around 10,200 course registrations across the seven programs in Australia up from around 9,300 in 2017. In the UK, there were 11 new programs launched and course registrations grew, reaching around 3,000 compared to around 1,400 in 2017. During the year, new partnerships with the University of Northumbria in the UK, and ESSEC Business School in France were announced.

Growth

Growth sales decreased by £230m, to £539m in 2018 from £769 in 2017. Adjusted operating profit increased by £21m or 55% to £59m in 2018 from £38m in 2017. The Group estimates that, after excluding the impact of exchange rates and the incremental contribution from businesses disposed in 2018 and 2017, sales were up 1% year on year. Strong growth in China and modest growth in Brazil and Hispano America were partially offset by declines in South Africa following a large one-off order in 2017.

The adjusted operating profit increase reflected the higher revenue and benefits of current and prior year restructuring. The Group’s statutory operating profit included restructuring costs of £8m in 2017. In 2018 restructuring costs were offset by credits to leave a net charge of nil in 2018. Also included in the statutory operating profit was amortization of acquired intangibles of £19m in 2018 and £37m in 2017 and gains on business disposals. In 2018 these gains amounted to £226m and result from the sale of the Wall Street English language teaching business (WSE), realising a gain of £207m and the disposal of the equity interest in UTEL, the online University partnership in Mexico, realising a gain of £19m. Gains in 2017 of £35m include the sale of the Group’s test preparation business in China.

Growth — courseware

Courseware revenue grew slightly, with strong growth in English Language Courseware in China, partially offset by declines in School Courseware in South Africa following a large one-off order in 2017.

Growth — assessments

Professional Certification grew well due to a new ICT infrastructure certification contract. Pearson Test of English Academic saw strong growth in revenue with over 10% growth in the volume of tests taken in India, China and the Middle East and moderate price increases.

Growth — services

In English Services, revenue grew slightly in the English language school franchise, Wizard, due to new product launches. In School Services, revenue was flat, with declines in student enrolment in the public sistemas

36

business in Brazil offset by price increases, improved products and better student retention across the Group’s private sistemas. In India, Pearson MyPedia, an inside service ‘sistema’ solution for schools, expanded to over 700 schools with over 200,000 learners. In Higher Education services revenue declined slightly due to business exits in India and slight revenue decline at Pearson Institute of Higher Education (formerly CTI), the university business in South Africa, due to a change in mix with total enrolment broadly flat and new student enrolment up 18%.

Penguin Random House

The Group owns 25% of Penguin Random House, the first truly global consumer book publishing company. The Group owned 47% until October 5, 2017, when it completed the sale of 22% to Bertelsmann. The Group’s share of Penguin Random House adjusted operating profits were £68m in 2018 compared to £94m in 2017, the decrease is primarily due to the reduced contribution following the sale of part of the Group’s share.

Penguin Random House performed solidly with underlying revenue growth on increased audio sales and stable print sales, whilst the business benefitted from international bestseller “Becoming” by Michelle Obama, the year’s top-selling U.S. title, and bestsellers from Bill Clinton & James Patterson, Jordan Peterson, Jamie Oliver, Dr. Seuss, John Grisham, and Lee Child.

The Penguin Random House Venture Combined Financial Statements are included in this report on pages F-87 to F-160.

Results of operations

Year ended December 31, 2017 compared to year ended December 31, 2016

Consolidated results of operations

Sales

The Group’s total sales decreased from £4,552m in 2016 to £4,513m in 2017, a decrease of £39m or 1%. The year on year movement was impacted by currency movements, primarily the comparative strength of the US dollar relative to sterling during the year. In 2017, currency movements increased sales by £126m when compared to the equivalent figures at constant 2016 rates. When measured at 2016 constant exchange rates, the Group’s sales declined by 4%. Part of the decrease is due to the absence of sales from businesses sold during the year and the Group estimates that after excluding the impact of disposals, sales declined by 2% at constant exchange rates.

North America sales decreased by £52m or 2% from £2,981m in 2016 to £2,929m in 2017. The Group estimates that after excluding the impact of exchange and the contribution from businesses disposed in 2016 and 2017, North America sales declined by 4% in 2017 compared to 2016 due to declines in higher education and school courseware, school assessment and in Learning Studio, a learning management system that is being retired. North America continued to be the most significant source of the Group’s sales and as a proportion of sales contributed 65% in both 2017 and 2016.

Core sales increased by £12m or 1% from £803m in 2016 to £815m in 2017. The Group estimates that after excluding the impact of exchange and the contribution from businesses disposed in 2016, Core sales were flat when comparing 2017 and 2016. Sales growth in OPM in the UK and Australia and growth in the Pearson Test of English Academic were offset by declines in school, higher education, English courseware and student assessment and qualifications.

Growth sales increased by £1m from £768m in 2016 to £769 in 2017. The Group estimates that after excluding the impact of exchange and the contribution from businesses disposed in 2017, Growth sales were flat

37

when comparing 2017 and 2016. Increases in China, school courseware in South Africa and Pearson Test of English Academic, were offset by declines in higher education services primarily due to lower enrolment at CTI, the university business in South Africa and business rationalization in India, and declines in Brazil.

Cost of goods sold and operating expenses

The following table summarizes the Group’s cost of sales, net operating expenses and impairment of intangible assets:

Cost of goods sold. Cost of sales consists of costs for raw materials, primarily paper, printing and binding costs, amortization of pre-publication costs, royalty charges, the cost of service provision in the assessment and testing business and the cost of teaching and facilities in direct delivery businesses. The Group’s cost of sales decreased by £27m, or 1%, from £2,093m in 2016, to £2,066m in 2017. The decrease largely reflects the decrease in sales but also includes some benefit from 2016 restructuring realized in 2017. Cost of sales was 45.8% of sales in 2017 compared to 46.0% in 2016.

Distribution costs. Distribution costs consist primarily of shipping costs, postage and packing. Distribution costs have decreased by £4m reflecting restructuring benefits and the continuing shift to digital and services products.

Selling, marketing and product development costs. The Group’s selling, marketing and product development costs decreased by £12m or 1% from £908m in 2016 to £896m in 2017. As a percentage of sales, these costs were consistent at 19.9% in both 2016 and 2017.

Administrative and other expenses. The Group’s administrative and other expenses decreased by £33m or 3% from £1,240m in 2016 to £1,207m in 2017. This decrease is largely due to the full impact of restructuring savings from the 2016 program flowing through in 2017, partly offset by continuing investment in technology.

Restructuring costs. In 2017, restructuring costs of £79m relate to the 2017-2019 restructuring program announced in May 2017 and include costs incurred in the second half of 2017 relating to this program. Total restructuring in 2016 amounted to £338m and included costs associated with headcount reductions, property rationalization and closure or exit from certain systems, platforms, products and supplier and customer relationships.

Other income. Other operating income mainly consists of freight recharges, sub-rights and licensing income, distribution commissions, investment income and gains on minor asset disposals together with the service fee

38

income from Penguin Random House. Other operating income decreased to £64m in 2017 compared to £85m in 2016 mainly due to a decline in investment income following the disposal of investments and the absence of gains on asset disposals.

Other net gains and losses . Other net gains and losses in 2017 include the sale of the Group’s test preparation business in China, which resulted in a pre-tax profit on sale of £44m, the sale of a 22% share in PRH, which resulted in a pre-tax profit on sale of £96m and net losses of £12m relating to other smaller disposals. Included in other gains and losses in 2016 are losses of £25m associated with the closure of the English language schools in Germany and the sale of the Pearson English Business Solutions business.

Impairment of intangible assets. At the end of 2016, following trading in the final quarter of the year, the Group determined that the underlying issues in the North American higher education courseware market were more severe than anticipated. These issues related to declining student enrolments, changes in buying patterns of students and correction of inventory levels by distributors and bookshops. As a result, in January 2017, the Group revised its strategic plans and estimates for future cash flows and, as a consequence, recognized an impairment to North American goodwill of £2,548m. There were no impairments in 2017.

Share of results of joint ventures and associates

The contribution from the Group’s joint ventures and associates decreased by £19m to £78m in 2017 from £97m in 2016. The decrease was mainly due to the sale of 22% of PRH resulting in a lower share of profits for the final quarter of the year, which is the peak selling season for consumer publishing businesses.

Operating profit/(loss)

In 2017, there was an operating profit of £451m compared to an operating loss on a continuing basis of £2,497m in 2016. The increase in profits primarily reflects the absence of impairment charges in 2017 (£2,548m in 2016), lower restructuring costs (£79m in 2017 compared to £338m in 2016) and gains from the sale of businesses (a gain of £128m in 2017 compared to a loss of £25m in 2016). After stripping out the absence of impairments, lower restructuring costs and gains on the sale of businesses, profits from trading declined by around £58m. This was primarily due to increased amortization charges, higher staff incentives and cost inflation, offset in part by the year on year benefit from restructuring savings.

Net finance costs

Net interest payable in 2017 was £79m, compared to £59m in 2016. The increase was primarily due to higher US interest rates in 2017, additional charges relating to the early redemption of various bonds during the year and some additional interest on tax provisions. In March and November 2017 respectively, the Group redeemed the $550m 6.25% Global dollar bonds and $300m 4.625% US dollar notes, both originally due in 2018. In addition, in August 2017, the Group redeemed $383m out of the $500m 3.75% US dollar notes due in 2022 and $406m out of the $500m 3.25% US dollar notes due in 2023. Although there was a charge in respect of the early redemptions, there were also partial year savings as a result which have flowed through the income statement in the period since redemption, with the full annualized savings coming through in 2018.

Other net finance costs are finance income and costs on retirement benefits, foreign exchange, interest costs relating to acquisition consideration and other gains and losses on derivative financial instruments. The decrease in finance income in respect of employee benefit plans from £11m in 2016 to £3m in 2017 reflects the lower net surplus on pension balances at the beginning of 2017 compared to the beginning of 2016. Both the exchange gain in 2017 of £44m and the exchange loss in 2016 of £20m mainly relate to foreign exchange differences on unhedged cash and cash equivalents and other financial instruments.

For a more detailed discussion of the Group’s borrowings and interest expenses see “— Liquidity and Capital Resources — Capital Resources” and “— Borrowings” below and “Item 11. Quantitative and Qualitative Disclosures about Market Risk”.

39

Taxation

The total tax charge in 2017 of £13m represents 3.1% of pre-tax profit and compares to a benefit of £222m or 8.7% of pre-tax losses in 2016. The tax benefit in 2016 was mainly due to the release of deferred tax liabilities relating to tax deductible goodwill that was impaired. The low tax rate in 2017 is largely attributable to uncertain tax position releases due to the expiry of the relevant statutes of limitation. As a result of US tax reform, the reported tax charge includes a benefit from revaluation of deferred tax balances to the reduced federal rate of £5m and a repatriation tax charge of £6m. In addition to the impact on the reported tax charge, the Group’s share of profit from associates was adversely impacted by £8m.

Discontinued operations

There were no discontinued operations in either 2016 or 2017.

Profit/(loss) for the year

The profit for the financial year in 2017 was £408m compared to a loss in 2016 of £2,335m. The loss in 2016 includes the impairment charge of £2,548m and higher restructuring charges, as noted above.

Earnings/(loss) per ordinary share

The basic earnings per ordinary share, which is defined as the profit for the financial year divided by the weighted average number of shares in issue, was 49.9p in 2017 compared to a loss per share of 286.8p in 2016 based on a weighted average number of shares in issue of 813.4m in 2017 and 814.8m in 2016. The increase in earnings per share was due to the increase in profit for 2017 described above and was not significantly affected by the movement in the weighted average number of shares.

The diluted earnings per ordinary share was also 49.9p in 2017, with the dilutive effect of options being minimal. The diluted earnings per ordinary share in 2016 was the same as the basic earnings per ordinary share due to the loss for the year.

Exchange rate fluctuations

Currency movements increased sales by £126m and increased the operating profit by £13m. See “Item 11. Quantitative and Qualitative Disclosures about Market Risk” for a discussion regarding the Group’s management of exchange rate risks.

Sales and operating profit by segment

The following tables summarize the Group’s sales and adjusted operating profit for each of the Group’s business segments. Adjusted operating profit is included as it is the key financial measure used by management to evaluate the performance of the Group and allocate resources to business segments over time by separating out those items of income and expenditure relating to acquisitions and disposals, major restructuring programs and certain other items that are not representative of underlying performance. Reconciliations of adjusted operating profit to statutory operating profit are included below and in note 2 within Item 18 — Financial Statements.

In the Group’s adjusted operating profit it has excluded other net gains and losses, amortization and impairment of acquired intangibles, the cost of major restructuring programs and the impact of US tax reform. The intangible charges relate only to intangible assets acquired through business combinations and acquisition costs are the direct costs of acquiring those businesses. The Group does not believe these charges are relevant to an understanding of the underlying performance. Charges relating to acquired intangible assets are non-cash charges that reflect the historical expenditure of the acquired business. These acquired intangible assets continue

40

to be supported by ongoing expenditure that is reported within adjusted operating profit. Other net gains and losses that represent profits and losses on the sale of subsidiaries, joint ventures, associates and other financial assets are also excluded from adjusted operating profit as it is important to highlight their impact on operating profit, as reported, in the period in which the disposal transaction takes place in order to understand the underlying trend in the performance of the Group. US tax reform in 2017 resulted in the revaluation of deferred tax balances. These revaluations were excluded from adjusted operating profit in relation to post tax profits of associates in 2017 due to their one-off nature.

A reconciliation of operating profit to adjusted operating profit for continuing operations is included in the tables below:

North America

Sales in North America decreased by £52m or 2% from £2,981m in 2016 to £2,929m in 2017 and adjusted operating profit decreased by £26m, or 6%, from £420m in 2016 to £394m in 2017. The Group estimates that after excluding the impact of exchange and the contribution from businesses disposed in 2017 and 2016, North America sales declined by 4% in 2017 compared to 2016 primarily due to anticipated declines in higher education and school courseware, school assessment, and Learning Studio, a learning management system was retired.

There were no impairment charges in 2017. In 2016, the Group recognized an impairment to its US goodwill. At the end of 2016, following trading in the final quarter of the year, the Group determined that the

41

underlying issues in the North American higher education courseware market were more severe than anticipated. These issues related to declining student enrolments, changes in buying patterns of students and correction of inventory levels by distributors and bookshops. As a result, in January 2017, the Group revised its strategic plans and estimates for future cash flows and, as a consequence, recognized an impairment to North America goodwill of £2,548m. The 2017 North America results also include £60m in respect of the further major restructuring program announced during the year. 2016 results included £172m in respect of the previous major restructuring program and other losses on disposal mainly relating to the sale of the Pearson English Business Solutions business. Overall adjusted operating margins in the North America business declined in 2017 to 13.5% compared to 14.1% in 2016 due primarily to the impact of lower sales and other operating factors, partially offset by restructuring savings.

North America — courseware

In school courseware, revenue declined 6% primarily due to sharp declines across Open Territory states in the second half of the year. This was partially offset by growth in adoption state revenues where strong performance in Texas Grades K-12 Spanish, Indiana Grades K-12 Science and South Carolina Grades 6-8 Science outweighed a lower adoption participation rate resulting from the decision not to compete for the California Grades K-8 English Language Arts (ELA) adoption with a core basal program. The new adoption participation rate fell to 61% in 2017 from 64% in 2016. The Group won an estimated 38% share of adoptions competed for (30% in 2016) and 29% of total new adoption expenditure of $365m (19% of $470m in 2016).

In higher education, total US college enrolments, as reported by the National Student Clearinghouse, fell 1.1%, with combined two-year public and four-year for-profit enrolments declining 2.5%. Enrolment weakness was particularly focused on part-time students where enrolment declined 3.3%, a bigger decline than in any of the last five years. Full-time enrolment grew 0.3%, the first expansion since late 2010. Net revenues at constant exchange rates in the higher education courseware business declined 3% during the year. It is estimated that around 2% of this decline was driven by lower enrolment; just over 1% from the adoption of Open Educational Resources (OER); around 5% from the secondary market, new initiatives and other factors, primarily the growth in print rental; offset by an around 3% benefit from institutional selling and the shift to digital and a 2% benefit in 2017 from lower returns by the channel.

In 2017, the Group’s US higher education courseware market share, as reported by MPI, was in the upper half of the 40-41.5% range seen over the previous five years. During 2017, the Group performed strongly in Statistics and Business Statistics, Biology and Accounting. Statistics benefited from the popularity of “best in class” learning application StatCrunch, Biology from the success of Campbell Biology 11e and MasteringBiology, and Accounting from the success of Miller-Nobles Horngren Accounting 11e and MyAccountingLab. This was offset by weakness in Information Technology, particularly in the for-profit sector, and continued softness in Developmental Mathematics.

Digital revenues grew 9% benefiting from continued growth in direct sales, favourable mix and selected price increases. Global digital registrations of MyLab and related products fell 1%. In North America, digital registrations fell 3% with good growth in Science, Business & Economics and Revel offset by lower overall enrolment and continued softness in Developmental Mathematics. Revel registrations grew more than 50%. Including stand-alone e-book registrations, total North American digital registrations were flat.

The actions announced in early 2017 to promote access over ownership were successfully implemented. The rental price of 2,000 eBook titles was reduced and resulted in eBook revenues increasing by more than 20% in response during 2017. In institutional courseware solutions, 210 institutions were signed up to the Group’s Inclusive Access (Direct Digital Access, DDA) solutions, taking the total to over 500. During the year, over 1m course enrolments were delivered with inclusive access rising to around 5% of higher education revenue in 2017 as more colleges and faculties saw the benefit of this model.

42

North America — assessment

In school assessment (State and National assessments), revenues at constant exchange rates declined by 9% due to contract losses. Colorado announced in June 2017 they would be leaving the PARCC consortium after the 2017/2018 school year. The Group won the subsequent bid to deliver ELA, Math, Science, and Social Studies for at least the next six years and also secured contract extensions in Virginia, Indiana, Arizona, Minnesota, Puerto Rico, Kentucky, New York City and North Carolina and for the National Assessment of Educational Progress.

The Group delivered 25.3m standardized online tests to K-12 students in 2017, up 7% from 2016. TestNav8, the Group’s next-generation online test platform, supported a peak load of 752,000 tests in a single day and provided 99.99% up time. AI scoring systems scored 35m responses to open-ended test items, around 30% of the total. Paper based standardized test volumes fell 7% to 20.4m.

In professional certification, revenues grew 2%. VUE global test volume rose 1% to over 15m. Revenues in North America were flat, with continued growth in certification for professional bodies, offset by modest declines in US teacher certification and the GED (General Educational Development, the high school equivalency test that is part of a joint venture with the American Council on Education), after a strong performance in 2016, and by weakness in higher level IT certifications in the second half of 2017.

The Group signed over 50 new contracts in 2017 including a ten-year contract with the Association of American Medical Colleges (AAMC) to administer the MCAT, and contracts with ExxonMobil for five years and the Project Management Institute for four years. Its renewal rate on existing contracts continues to be over 95%. During 2017, the Group renewed over 50 contracts including the American Board of Internal Medicine (ABIM) for nine years, Florida Teacher Licensure Assessments for five years, Pharmacy Technician Certification Board (PTCB) for five years, and The Institute of Internal Auditors for four years.

Clinical assessment sales increased 2% largely due to the effect of exchange rate movements and, at constant exchange rates, declined slightly on an absence of new major product introductions. Q-Interactive, the Group’s digital solution for Clinical Assessment administration, saw continued strong growth in license sales with sub-test administrations up more than 33% over the same period in 2016.

North America — services

Connections Education the virtual school business, served nearly 78,000 Full Time Equivalent students through full-time virtual and blended school programs, up 6% on 2016. Two new full-time online, state-wide, partner schools opened for the 2017-2018 school year. Enrolment growth from new and existing schools was partially offset by the termination of a school partnership at the end of the 2016-2017 school year. Revenues grew modestly as enrolment growth was partially offset by increased in-sourcing, as some partners took non-core services in-house. The 2017 Connections Academy Parent Satisfaction Survey showed strong results with 92% of families with students enrolled in full-time online partner schools stating they would recommend the schools to others and 95% agreeing that the curriculum is of high quality.

In Pearson Online Services, revenues declined primarily due to a decline in Learning Studio revenues as the product is being retired and the restructuring of smaller non-OPM contracts. Learning Studio declined by just over 50% to a revenue contribution of £11m in 2017. In OPM, revenues grew modestly as course enrolments increased strongly, up 8% to more than 341,000, boosted by good growth and program extensions at key partners including Arizona State University Online, Maryville University, Rutgers University and University of Alabama at Birmingham and from new partners, partially offset by contract exits.

The Group signed 45 multi-year programs in 2017 renewed 19 programs and launched 14 new programs at partners including Maryville University, Duquesne University and Ohio University. During 2017, it also agreed the termination of nine programs that were not mutually viable and did not renew a further six programs.

43

Brinker International, Inc. (NYSE: EAT), one of the world’s leading casual dining restaurant companies and owner of Chili’s ^® Grill & Bar and Maggiano’s Little Italy ^® , with over 1,600 owned, operated and franchised restaurant locations, partnered with the Group to launch a comprehensive employer-education program Best You EDU that provides free educational opportunities to Brinker employees including foundational, GED and Associate Degree programs.

Core

Sales in Core markets increased by £12m, or 1%, from £803m in 2016 to £815m in 2017 while adjusted operating profit decreased by £7m, or 12%, from £57m in 2016 to £50m in 2017. At constant exchange and after excluding the contribution from disposals, Core sales were flat year on year and profits declined by 14%. Growth in OPM sales in the UK and Australia and growth in Pearson Test of English Academic were offset by declines in school, higher education, English courseware and student assessment and qualifications.

The decline in adjusted operating profit was due to revenue mix, investment in new products and services and product line exits, partially offset by restructuring savings. The Group’s statutory results in 2017 included restructuring costs of £11m. The statutory results in 2016 included restructuring costs of £62m and a loss on closure of Wall Street English Germany of £12m.

Core — courseware

Courseware revenues declined 2%. In school, revenues declined in Australia, due to market contraction in the primary sector partly offset by slight growth in secondary, and declines in smaller markets in Europe and Africa. In higher education, revenues were down slightly due to declines in smaller markets, whilst in Australia and the UK an increase in direct to institution sales and a further shift to digital offset declines in traditional textbook sales. In English, there were declines in smaller markets.

Core — assessments

In higher education and School assessment, revenues fell 4% primarily due to lower AS level, iGCSE and Apprenticeship volumes as a result of policy changes. BTEC revenues also declined modestly as revenues recognized in 2017 lagged the greater stability seen in registrations and billed revenue in the year. The Group successfully delivered the National Curriculum Test for 2017, marking 3.5m scripts, up slightly from 2016.

Clinical assessment grew 15% with revenues benefiting from strong growth in the new editions of the Wechsler Intelligence Scale for Children (WISC-V) and the Clinical Evaluation of Language Fundamentals (CELF-5).

Pearson Test of English Academic saw continued growth in test volumes which rose 84% from 2016, driven primarily by its use to support visa applications to the Australian Department of Immigration and Border Protection and good growth in New Zealand.

In Professional certification, revenues were flat as the impact of last year’s renegotiated terms of the UK Driving Theory test for the DVSA was offset by growth from new and existing contracts.

Core — services

In higher education services, revenues grew 17% and OPM revenues grew by 33%. In Australia, there was good growth due to the successful partnership with Monash University, and the continued success of the Graduate Diploma in Psychology. There are a total of around 9,300 course registrations across the seven programs in Australia (up from around 6,900 registrations in 2016). In the UK, five new programs were launched in addition to the two launched in 2016. UK course registrations grew to about 1,400, compared to about 370 in 2016.

44

English services grew, with strong growth in WSE Italy, due to the opening of new centers in 2015 and 2016, partially offset by declines in Japan.

Growth

Growth sales increased by £1m, to £769m in 2017 from £768m in 2016. Adjusted operating profit increased by £9m or 31% to £38m in 2017 from £29m in 2016. The Group estimates that, after excluding the impact of exchange rates and the incremental contribution from businesses disposed in 2017 and 2016, sales were flat year on year. Growth in China, school courseware in South Africa and Pearson Test of English Academic was offset by declines in higher education services, primarily due to lower enrolment at CTI, business rationalization in India and declines in Brazil.

The adjusted operating profit increase reflected the benefits of prior year restructuring and the higher revenues in China, South Africa school courseware and PTEA in India, partially offset by lower revenues in Brazil. The Group’s statutory results included restructuring costs of £8m in 2017 and £95m in 2016.

On November 27, 2017, The Group announced that it had agreed the sale of Wall Street English to a consortium of funds affiliated with Baring Private Equity Asia and CITIC Capital. The sale was completed on March 15, 2018.

Growth — courseware

Courseware revenues grew 7%, due to strong growth in school textbook sales in South Africa and English language courseware in China, partially offset by weakness in Brazil.

Growth — assessments

Professional Certification grew strongly. Pearson Test of English Academic saw over 30% growth in the volume of tests taken in India.

Growth — services

In English services, growth in Wall Street English in China, due to new center openings, was more than offset by declines in Brazil due to macroeconomic pressures.

In school services, revenue fell, with student enrolment in the sistemas business in Brazil falling 14% primarily due to NAME, the public sistema, where the Group took the strategic decision to exit two thirds of its contracts with municipalities due to unattractive economic prospects, together with a reduction in student enrolments in the Dom Bosco private sistema due to challenging economic conditions. In India, Pearson MyPedia, an inside service ‘sistema’ solution for schools, expanded to over 500 schools with approximately 157,000 learners.

In higher education services, revenues declined sharply due to a 14% fall in total student enrolment at CTI, the university business in South Africa, driven by the cumulative impact of economic factors in recent years, partially offset by improved new student enrolments in 2017, together with business exits in India.

Penguin Random House

The Group owns 25% of Penguin Random House, the first truly global consumer book publishing company. The Group owned 47% until October 5, 2017, when it completed the sale of 22% to Bertelsmann. The Group’s share of Penguin Random House adjusted operating profits were £94m in 2017 compared to £129m in 2016, primarily due to the sale of part of the Group’s share.

45

Penguin Random House performed in line with expectations with revenues up slightly year on year on rising audio sales, broadly stable print sales, and modest ongoing declines in demand for e-books, whilst the business benefitted from bestsellers by Dan Brown, R.J. Palacio, John Grisham, Jamie Oliver, and Dr. Seuss.

The Penguin Random House Venture Combined Financial Statements are included in this report on pages F-87 to F-160.

Liquidity and capital resources

Cash flows and financing

Net cash generated from operations increased to £547m in 2018 from £462m in 2017. The main reason for the improvement in cash generated from operations was the absence in 2018 of special pension contributions which in 2017 were £227m and related to the FT Group disposal (£25m) and to agreements relating to the PRH merger in 2013 (£202m). The benefit from the absence of these pension contributions in 2018 was partly offset by higher incentive payments in 2018 relating to 2017 performance and other unfavourable movements in working capital.

Net interest paid at £22m in 2018 compares to £69m in 2017 and reflects the decrease in interest charge for the year referred to above. Tax paid in 2018 was £43m compared to £75m in 2017 with the decrease mainly explained by tax refunds in the US.

Capital expenditure on property, plant and equipment was £70m in 2018 compared to £82m in 2017. Proceeds from the sale of property in 2018 of £128m includes proceeds from the sale of London property as part of the restructuring program. There were no material property sales in 2017. Capital expenditure on software intangibles reduced from £150m in 2017 to £130m in 2018. The expenditure on both tangible and intangible capital includes the continuing investment in enabling function technology designed to lower administrative costs.

There were no significant acquisitions in either 2018 or 2017 and the net cash outflow in respect of businesses and investments acquired was £15m in 2018 and £14m in 2017. The net cash inflow in respect of businesses and investments disposed was £107m in 2018 compared to £430m in 2017. In 2017 the cash received largely related to the PRH and GEDU disposals and in 2018 includes proceeds from the sale of WSE and UTEL.

Dividends from joint ventures and associates decreased from £458m in 2017 to £117m in 2018. The reduction is primarily due to the PRH sale transaction in 2017 which resulted in a reduced equity share from 47% to 25% and involved recapitalization dividends amounting to £312m in 2017 and £50m in 2018.

The cash outflow from financing of £729m in 2018 compares to £1,759m in 2017 and includes the repayment of borrowings of £441m in 2018 and £1,294m in 2017. These repayments include the early redemption of various bonds (and their associated swaps). In January 2018, the Group repurchased €250m of its €500m Euro 1.875% Notes due May 2021 and €200m of its €500m Euro 1.375% Notes due May 2025. In March and November 2017 respectively, the Group redeemed $500m 6.25% Global dollar bonds and $300 4.625% US dollar notes, both originally due in 2018. In addition, in August 2017, the Group redeemed $383m out of the $500m 3.75% US dollar notes due in 2022 and $406m out of the 3.25% US dollar notes due in 2023.

Dividends paid to company shareholders in 2018 of £136m compares to £318m in 2017 reflecting the rebasing of the dividend in 2017 to reflect portfolio changes, increased investment and to align with profit expectations. Cash returned to shareholders via the share buyback program, announced in October 2017 and completed in February 2018, amounted to £149m in 2017 and £153m in 2018.

Overall the Group’s net borrowings decreased from £432m at the end of 2017 to £143m at the end of 2018. The reduction in net debt was principally due to cash generated from operations and the proceeds from disposal of businesses and property in the year which more than offset interest, tax, share buy-back and dividend payments.

46

Capital resources

The Group’s borrowings fluctuate by season due to the effect of the school year on the working capital requirements in the educational materials business. Assuming no acquisitions or disposals, the Group’s maximum level of net debt normally occurs in July, and its minimum level of net debt normally occurs in December. Based on a review of historical trends in working capital requirements and of forecast monthly balance sheets for the next 12 months, the Group believes that it has sufficient funds available for the Group’s present requirements, with an appropriate level of headroom given its portfolio of businesses and current plans. The Group’s ability to expand and grow its business in accordance with current plans and to meet long-term capital requirements beyond this 12-month period will depend on many factors, including the rate, if any, at which its cash flow changes and the availability of public and private debt and equity financing, including its ability to secure bank lines of credit. The Group cannot be certain that additional financing, if required, will be available on favorable terms, if at all.

At December 31, 2018, the Group’s net debt was £143m compared to £432m at December 31, 2017. The reduction in net debt was principally due to cash generated from operations and the proceeds from disposal of businesses and property in the year which more than offset interest, tax, share buy-back and dividend payments. Net debt is defined as all short-term, medium-term and long-term borrowing (including finance leases), less all cash, cash equivalents and liquid resources. Cash equivalents comprise short-term deposits with a maturity of up to 90 days, while liquid resources comprise short-term deposits with maturities of more than 90 days and other marketable instruments which are readily realizable and held on a short-term basis. Total short-term, medium-term and long-term borrowing amounted to £720m at December 31, 2018, compared to £1,085m at December 31, 2017 reflecting the bonds repaid during the year. At December 31, 2018, total cash and liquid resources were £568m, compared to £645m at December 31, 2017. This decrease reflects the utilization of cash to pay down long-term debt and create a more efficient balance sheet.

To ensure efficient use of the cash balances, during March 2019, the Group executed market tenders to repurchase €55m of its €500m 1.875% notes due 2021 of which €250m were outstanding at 31 December 2018.

Contractual obligations

The following table summarizes the maturity of the Group’s borrowings, its obligations under non-cancellable leases, deferred consideration and pension funding obligations, exclusive of anticipated interest payments. Due to the variability of future interest payments, these have been excluded from the table below.

The UK pension plan’s most recent triennial actuarial valuation for funding purposes was completed as at 1 January 2018 and this valuation revealed a technical provisions funding surplus of £163m. The plan expects to be able to provide benefits (in accordance with the plan rules) with a very low level of reliance on future funding from the Group.

47

At December 31, 2018 the Group had no capital commitments for fixed assets, including finance leases already under contract. There are contingent liabilities in respect of indemnities, warranties and guarantees in relation to former subsidiaries and in respect of guarantees in relation to subsidiaries and associates. In addition there are contingent liabilities in respect of legal and royalty claims. None of these claims or guarantees is expected to result in a material gain or loss.

At December 31, 2018, the Group had a $1,750m committed revolving credit facility with a maturity date in August 2021. On March 6, 2019, the Group announced the refinancing of its bank facility, reducing its size to $1.19bn and extending its maturity date to February 2024.

Off-balance sheet arrangements

The Group does not have any off-balance sheet arrangements, as defined by the SEC for the purposes of Form 20-F, that have or are reasonably likely to have a material current or future effect on the Group’s financial position or results of operations.

Borrowings

The Group finances its operations by a mixture of cash flows from operations, short-term borrowings from banks and commercial paper markets, and longer term loans from banks and capital markets.

At December 31, 2018, the full $1.75bn was available under the committed revolving credit facility. The refinanced $1.19bn credit facility, set in place in March 2019, contains two key covenants measured for each 12 month period ending June 30 and December 31:

The Group must maintain the ratio of its profit before interest, tax and amortization to its net interest payable at no less than 3:1; and

The Group must maintain the ratio of its net debt to its EBITDA, explained below, at no more than 4:1.

“EBITDA” refers to earnings before interest, taxes, depreciation and amortization. The Group is currently in compliance with these covenants.

See note 18 of “Item 18. Financial Statements” for information on the Group’s longer term loans from banks and capital markets.

Treasury policy

The Group’s treasury policy is described in note 19 of “Item 18. Financial Statements”. For a more detailed discussion of the Group’s borrowing and use of derivatives, see “Item 11. Quantitative and Qualitative Disclosures about Market Risk”.

Related parties

There were no significant or unusual related party transactions in 2018, 2017 or 2016. Refer to note 36 in “Item 18. Financial Statements”.

Accounting policies

For a description of the Group’s principal accounting policies used refer to note 1 in “Item 18. Financial Statements.

48