Pearson

Net finance costs reported in our adjusted earnings comprise net interest payable and net finance costs relating to retirement benefit plans.

After excluding discontinued businesses, net interest payable in 2010 was £73m, down from £86m in 2009. Although our fixed rate policy reduces the impact of changes in market interest rates, we were still able to benefit from a fall in average US dollar and sterling interest rates during the year. Year-on-year, average three month LIBOR (weighted for the Group’s net borrowings in US dollars and sterling at each year end) fell by 0.3% to 0.4%. This reduction in floating market interest rates drove the Group’s lower interest charge. However, the low rates on deposited funds coupled with the impact on the calculation of significantly lower net debt, created an increase in the Group’s average net interest payable of 5.3% to 7.9%. The Group’s average net debt fell by £681m, reflecting the impact of the Interactive Data disposal.

Finance charges relating to post-retirement plans were £12m in both 2010 and 2009. Also included in the statutory definition of net finance costs are foreign exchange and other gains and losses. These are excluded from adjusted earnings as they represent short-term fluctuations in market value and are subject to significant volatility. These other gains and losses may not be realised in due course as it is normally the intention to hold the related instruments to maturity. In 2010 the total of these items excluded from adjusted earnings was a profit of £12m compared to a profit of £2m in 2009.

The Group finances its operations by a mixture of cash flows from operations, short-term borrowings from banks and commercial paper markets, and longer-term loans from banks and capital markets. Our objective is to secure continuity of funding at a reasonable cost from diverse sources and with varying maturities. The Group does not use off-balance sheet special purpose entities as a source of liquidity or for any other financing purposes.

The net debt position of the Group is set out below.

The main contributor to the change in the Group’s net debt is the increase in cash balances due primarily to the Interactive Data disposal in July 2010 and strong cash collection at the end of 2010. Reflecting the geographical and currency split of our business, a large proportion of our debt is denominated in US dollars (see note 19 for our policy). The weakening of sterling against the US dollar during 2010 (from $1.61 to $1.57:£1) slightly increased our reported net debt.

The Group’s credit ratings remained unchanged during the year. The long-term ratings are Baa1 from Moody’s and BBB+ from Standard & Poor’s, and the short-term ratings are P2 and A2 respectively. The Group’s policy is to strive to maintain a rating of Baa1/BBB+ over the long term.

In May 2010, the Group accessed the capital markets, raising $350m through the sale of notes maturing in 2016 and bearing interest at 4%. Of the $350m issued, $300m was swapped to floating rate to conform with the policy described in note 19. The proceeds were used to fund the Group’s working capital requirements.

In November 2010, the Group negotiated a new $1,750m committed revolving credit facility which matures in November 2015. At 31 December 2010 this facility was undrawn. The facility is intended to be used for short-term drawings and providing refinancing capabilities, including acting as a back-up for our US commercial paper programme. This programme is primarily used to finance our US working capital requirements, in particular our US educational businesses which have a peak borrowing requirement in July. At 31 December 2010, no commercial paper was outstanding.

The Group also maintains other committed and uncommitted facilities to finance short-term working capital requirements in the ordinary course of business.

Further details of the Group’s approach to the management of financial risks are set out in note 19 to the financial statements.

The effective tax rate on adjusted earnings in 2010 was 25.2% which compares to an effective rate of 25.5% for 2009. Our overseas profits, which arise mainly in the US, are largely subject to tax at higher rates than the UK corporation tax rate (which had an effective statutory rate of 28% in 2010 and in 2009). These higher tax rates were offset by amortisation-related tax deductions and the utilisation of previously unrecognised operating tax losses and credits.

The reported tax charge on a statutory basis was £146m (21.8%) compared to a charge of £146m (27.9%) in 2009. The reduction in the statutory rate is largely due to the recognition of tax losses and credits in the year including pre-acquisition and capital losses that were utilised in connection with the Interactive Data sale. The tax charge relating to that sale in July 2010 is included in the loss on discontinued businesses. Tax paid in 2010 was £335m compared to £103m in 2009 and includes £250m relating to the Interactive Data sale.

On 29 July 2010, Pearson’s 61% share in Interactive Data Corporation was sold to Silver Lake and Warburg Pincus for $2bn. The results of Interactive Data have been included as discontinued operations in these financial statements. Interactive Data’s adjusted operating profit for the seven months to the date of sale was £81m compared to a full year contribution in 2009 of £148m. Also included in discontinued operations in 2010 is the gain on sale of Interactive Data of £1,037m and the attributable tax charge of £306m. The total profit from discontinued operations after taking account of the above items, intangible amortisation, interest and related tax was £776m in 2010 compared to £85m in 2009.

During the course of 2010, a number of minor changes to management responsibilities in certain countries were made which have affected reported 2010 segmental numbers in Penguin, North American Education and International Education. The amounts concerned have no impact on the Group as a whole and have been treated as portfolio changes in 2010 for the purposes of calculating growth rates. The 2009 figures have not been restated as the amounts are not considered to be significant. The effect of these changes in the 2010 financial statements has been to reduce the sales and profits at Penguin by £41m and £12m respectively, to increase sales and profits at International Education by £52m and £3m respectively and to reduce sales by £11m and increase profits by £9m in the North American Education segment.

The non-controlling interest in the income statement comprises mainly the publicly-held share of Interactive Data for the period to disposal in July 2010. There are also non-controlling interests in the Group’s businesses in South Africa, Nigeria, China and India although none of these are material to the Group numbers. The non-controlling interest in the Group’s newly acquired Brazilian business, Sistema Educacional Brasileiro (SEB), is expected to be bought out in the first half of 2011.

Included in other comprehensive income are the net exchange differences on translation of foreign operations. The gain on translation of £173m in 2010 compares to a loss in 2009 of £388m and is principally due to movements in the US dollar. A significant proportion of the Group’s operations are based in the US and the US dollar weakened in 2009 from an opening rate of £1:$1.44 to a closing rate at the end of that year of £1:$1.61. At the end of 2010 the US dollar had strengthened slightly in comparison to the opening rate moving from £1:$1.61 to £1:$1.57.

Also included in other comprehensive income in 2010 is an actuarial gain of £71m in relation to post retirement plans. This gain largely arises from improved asset returns for the UK Group pension plan and compares to an actuarial loss in 2009 of £302m. The 2009 loss arose as the assumptions relating to inflation, mortality and the discount rate used in the actuarial valuation all contributed to an increase in the value of liabilities.

The dividend accounted for in our 2010 financial statements totalling £292m represents the final dividend in respect of 2009 (23.3p) and the interim dividend for 2010 (13.0p). We are proposing a final dividend for 2010 of 25.7p, bringing the total paid and payable in respect of 2010 to 38.7p, a 9.0% increase on 2009. This final 2010 dividend was approved by the board in February 2011, is subject to approval at the forthcoming AGM and will be charged against 2011 profits. For 2010 the dividend is covered 2.0 times by adjusted earnings.

We seek to maintain a balance between the requirements of our shareholders for a rising stream of dividend income and the reinvestment opportunities which we identify around the Group and through acquisitions. The board expects to raise the dividend above inflation, more in line with earnings growth, thereby maintaining dividend cover at around two times earnings in the long term.

Pearson operates a variety of pension plans. Our UK Group plan has by far the largest defined benefit section. We have some smaller defined benefit sections in the US and Canada but, outside the UK, most of our companies operate defined contribution plans.

The income statement expense for defined benefit plans is determined using annually derived assumptions as to discount rates, investment returns and salary inflation, based on prevailing conditions at the start of the year. The assumptions for 2010 are disclosed in note 25 to our accounts, along with the year-end surpluses and deficits in our defined benefit plans.

The charge to profit in respect of worldwide pensions and post-retirement benefits for continuing operations amounted to £102m in 2010 (2009: £90m) of which a charge of £90m (2009: £78m) was reported in operating profit and the net finance cost of £12m (2009: £12m) was reported against net finance costs.

The overall deficit on the UK Group plan of £189m at the end of 2009 has become a deficit of £5m at 31 December 2010. This decrease is principally due to an increased level of contributions in the year together with improved asset performance. In total our worldwide deficit in respect of pensions and post retirement benefits fell from a deficit of £339m in 2009 to a deficit of £148m at the end of 2010.

On 17 June 2010 the Group acquired Melorio plc, one of the UK’s leading vocational training groups for £98m.

On 22 July 2010 the Group announced that it had entered into an agreement to purchase the learning systems business of Sistema Educacional Brasileiro (SEB) one of Brazil’s leading education companies for approximately $517m. The agreement provided for the acquisition of the business in two tranches – the first of these tranches representing 69% of the business was acquired on 1 September 2010 for $357m and the remaining tranche is expected to be acquired in the first half of 2011.

On 19 August 2010 the Group completed the acquisition of Wall Street Institute Education S.a.r.l. (WSI) for $101m. WSI provides spoken English training for adults through a combination of web-based content, classroom instruction and digital and printed materials.

The acquisition of America’s Choice, a provider of educational solutions for states and school districts in the US, was completed on 7 September 2010 for $101m.

The Group also completed the acquisition of Medley Global Advisors LLC and various other smaller acquisitions in the year. Although the Group has announced the acquisition of CTI Education Group and the increased stake in TutorVista, these transactions did not complete until 2011.

Net cash consideration for all acquisitions made in the year ended 31 December 2010 was £535m and provisional goodwill recognised was £288m.

In total, acquisitions completed in the year contributed an additional £84m of sales and £6m of operating profit.

Our ROIC is calculated as total adjusted operating profit less cash tax, expressed as a percentage of average gross invested capital. ROIC increased by 1.4 percentage points from 8.9% in 2009 to 10.3% in 2010. Improved profit performance and a reduction in working capital were the main drivers behind the increase. Although cash tax rates were low in 2010 we expect an increase in tax payments in 2011 as US tax losses are now fully utilised.

Net capital expenditure in the year on property, plant equipment and software amounted to £144m. The analysis of capital expenditure and details of capital commitments are shown in notes 10, 11 and 33 of the financial statements.

Transactions with related parties are shown in note 34 of the financial statements.

On 22 November 2010, the Group announced the proposed acquisition of a 75% stake in CTI Education Group, a leading South African education company for £31m. As at the end of December 2010 this acquisition had not been completed but is expected to complete in the first half of 2011.

On 18 January 2011, the Group announced that it had agreed to increase its shareholding in TutorVista, the Bangalore based tutoring services company, to a controlling 76% stake for a consideration of $127m.

On 7 March 2011, the Group and Education Development International plc (EDI) announced that they had reached agreement on the terms of a recommended cash offer to be made by Pearson for the entire issued share capital of EDI. The offer values EDI at approximately £112.7m. EDI is a leading provider of education and training qualifications and assessment services, with a strong reputation for the use of information technology to administer learning programmes and deliver on-screen assessments.

Operating companies are responsible for agreeing the terms and conditions under which business transactions with their suppliers are conducted. These supplier payment terms vary by operating company reflecting the different industries and countries in which they operate. It is company policy that suppliers are aware of such terms of payment and that payments to them are made in accordance with these, provided that the supplier is also complying with all the relevant terms and conditions. Group trade creditors at 31 December 2010 were equivalent to approximately 30 days of purchases during the year ended on that date. The company does not have any significant trade creditors and therefore is unable to disclose average supplier payment terms.