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Edited Transcript of PSON.L earnings conference call or presentation 26-Jul-19 7:30am GMT

Half Year 2019 Pearson PLC Earnings Call

London Jul 31, 2019 (Thomson StreetEvents) -- Edited Transcript of Pearson PLC earnings conference call or presentation Friday, July 26, 2019 at 7:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Coram Williams

Pearson plc - CFO & Executive Director

* John Joseph Fallon

Pearson plc - CEO & Executive Director

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Conference Call Participants

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* Adrien de Saint Hilaire

BofA Merrill Lynch, Research Division - VP & Head of Media Research

* Giasone Ulisse Salati

Macquarie Research - Senior Media Analyst

* Katherine Tait

Goldman Sachs Group Inc., Research Division - Associate

* Matthew John Walker

Crédit Suisse AG, Research Division - Research Analyst

* Nicholas Michael Edward Dempsey

Barclays Bank PLC, Research Division - Research Analyst

* Sami Kassab

Exane BNP Paribas, Research Division - Media Research Director, Co-Head of the European Media Team & Analyst of Media

* Thomas A Singlehurst

Citigroup Inc, Research Division - Director and Head of European Media Research

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Presentation

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Operator [1]

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Hello, and welcome to the Pearson Interim Results Presentation Analyst Call. (Operator Instructions) Just to remind you, this conference is being recorded.

I'll now hand to our hosts, John Fallon, CEO; and Coram Williams, CFO. Gentlemen, please begin.

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John Joseph Fallon, Pearson plc - CEO & Executive Director [2]

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Well, hi, good morning, everybody. Thanks for joining us. As you heard, it's John Fallon here and I've got Coram with me. These, as you can see, are a strong set of half-year figures. Underlying sales are up 2%, profits up 30%, operating cash flow is also stronger with a further reduction in net debt, underpinning our continued investment in building a better more digitally powered business. A 9% increase in the interim dividend is in line with our commitment to a sustainable and progressive dividend policy.

The results reflect the ongoing shift in the dynamics of the business. Through digital transformation, we're seeing the ongoing recovery in our courseware and assessment businesses, down only 1% on prior year, and sales from our structural growth opportunities are up 6% against the strong comparative last year. And with major milestones reached, the simplification program now shifts from recovery and renewal to providing a powerful platform for future growth.

We're on track to at least stabilize revenues this year and return the business to sustainable top line growth from 2020.

So let's have Coram talk you through the numbers, and then I'll be back to talk a little more about the future growth potential of Pearson. Coram?

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Coram Williams, Pearson plc - CFO & Executive Director [3]

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Thank you, John, and good morning, everyone. John has already taken you through the headlines. So I'm going to look at each of the geographies in a little more detail.

Starting with revenue. North America was up 1%. We saw good revenue growth in our structural growth opportunities. Online Program Management and Connections Academy benefited from continued strong enrollment growth. And Professional Certification benefited from strength in key segments and the ramp-up of new contracts. This was partially offset by expected modest declines in U.S. Higher Education Courseware and Student Assessment.

As we explained in Q1, U.S. Higher Education Courseware faced tougher comparison in the first half of 2019 than it did in H1 2018, which was helped by the absence of the additional returns provision that we took in the first half of 2017.

As a result, first half revenues declined at a rate in line with the middle of our guidance range for the year of flat to down minus 5%.

Digital revenues in Higher Education Courseware grew modestly on a like-for-like basis. We benefited from good growth in Revel. This was partially offset by continued declines in developmental mathematics and the planned retirement and deprioritization of a longer tail of older, lower-value titles in advance of our launch of the products on the Global Learning platform. With some help from phasing, Core had a strong first half with growth in School and Higher Education Courseware, U.K. Student Assessment & Qualifications, OPM, PTE Academic and Professional Certification.

In U.K. Student Assessment & Qualifications, we saw good growth in GCSE, A levels, BTEC Firsts and Higher Nationals, and the new digital assessment contract in Egypt, which shows the exciting global opportunities that exist in assessment. This was partially offset by continued declines in U.K. apprenticeships, which will continue to impact the business in the second half of the year.

In growth, revenue increased 2% with good growth in the Pearson Test of English and Professional Certification and timing of orders in School Courseware in the Middle East.

So now let's turn to operating profit. We've had a good performance across the business that is consistent with our expectations and the full year guidance. As you can see from this bridge, improved trading due to higher revenues and restructuring savings have more than offset other operational factors and inflation. As a result, operating profit grew 30% in underlying terms.

Other operational factors, which is predominantly investment in APM was weighted to the first half. All of this is consistent with the full year bridge that we gave you in February.

Our guidance for 2019 operating profit, after adjusting for IFRS 16 and the disposal of U.S. K-12 courseware, remains unchanged. We expect Pearson to do at a underlying profit growth in 2019 and for revenues to stabilize in 2019 and grow in 2020.

Whilst operating profit in H1 was in line with our expectations, you'll have noticed in this morning's release that interest and tax in H1 is a bit better than that implied by the full year guidance that we gave in February. As we benefited from favorable interest outcomes on the settlement of historical tax positions.

As a result, we've updated our guidance and now expect our 2019 finance charge to be around GBP 45 million for the full year. Our tax charge is expected to be in the range 17% to 19%, reflecting that the implementation of new tax rules in the U.S. have been modestly more favorable for us than we anticipated. Taken together, this means we're upgrading our guidance at an EPS level by 4p to a range of 57.5p to 63p based on 31st of December 2018 exchange rates.

Our longer-term expectation remains that our tax rate will be between 20% and 22%, and the finance charge around GBP 55 million per year.

I thought it might also be helpful to give you an update with regards to state aid. As you'll be aware, the European Commission has recently announced its decision that certain parts of the U.K.'s tax code gave raise to state aid. Like many other international companies and the U.K. government, we have launched an appeal against the EC's decision because we believe the merits of our case warrant it. Despite the U.K. government's appeal they are nonetheless obliged under the EU law to recover the tax in line with the commission's decision. Our maximum liability, as we told you before, is GBP 160 million of cash, but we're still awaiting guidance from HMRC on the amount and when it might be due. As a result, this is not included in our net debt guidance, which remains unchanged.

We remain on track to complete our restructuring this year, reducing our 2020 cost base by GBP 330 million or more. In line with this plan, we delivered incremental cost savings of GBP 60 million in the first half and expect to deliver another GBP 70 million of incremental savings in H2.

In H1, we achieved a major milestone in the plan with the successful completion of our ERP implementation in North America. As a result, more than 75% of the company, by revenue, is now operating on our single ERP system, enabling us to progress further in H2 on our cost-reduction plans in areas like finance and HR.

We continue to rationalize costs in other areas too, closing 2 offices and achieving 80% of our headcount reduction. As a result of these actions, Pearson is leaner, more agile and more sustainable than it's ever been before.

As you know, we typically see a cash outflow in the first half. In 2019, this outflow was smaller than the prior year driven by 2 key factors. Firstly, we benefited from the disposal of the K-12 business, which would have seen a seasonal cash outflow in the first half. Secondly, the adoption of IFRS 16 means that we're seeing the benefits in our cash flow of the property rationalization that we've undertaken as a part of our simplification drive. Excluding these 2 factors, our underlying cash performance is in line with last year, and we continue to expect an operating cash conversion rate for the full year in excess of 90%.

Headline net debt is impacted by the adoption of IFRS 16 this year, which, as we told you at prelims, adds just under GBP 700 million of debt to the balance sheet.

On a like-for-like basis, however, H1 net debt is positive compared to prior year and declined by GBP 49 million over the course of the last 12 months. This reflects the inflows from operating cash flow and disposal proceeds, which more than offset the outflows from dividend repayments, treasury share purchases, additional capital invested in PRH and the K-12 disposal.

And with that, I will hand back to John.

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John Joseph Fallon, Pearson plc - CEO & Executive Director [4]

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Thanks, Coram. So as you can see, we're now on the cusp of the next phase in the Pearson transformation, and that's when we transition from a period of renewal and recovery to one of sustainable future growth. And that growth is driven by a clear view of where we want the company to be in 5 years' time and how we're going to get there. You've seen this slide before, you're familiar with the strategies. I won't run through it in detail. But just to summarize, we're the world's learning company, we help over 100 million learners around the world to make progress in their lives through learning. And as we help shape the future of learning, we're all about making quality education more accessible and affordable to far more people. That means it's part of a wider ecosystem, building platforms that make learning highly engaging, effective and relevant to the changing nature of work. We see a world of talent and a world of opportunity. As we help more and more learners prepare for, develop in and change careers through what will be increasingly a lifetime of learning.

This is a strategy for growth based on 3 key strums. First, as our courseware and assessment businesses become even more digital. Revenues will first start to stabilize and then grow again. Second, as we invest more in our businesses in structurally growing markets, these businesses grow both more quickly and from a bigger base. And third, a simple more efficient Pearson built on highly scalable global platforms is able to reallocate investment to growth opportunities more adeptly, we're able to innovate quickly and at scale, and we're able to build a more direct, longer-term relationship with those 100 million learners who use our products every year.

So let's take a quick look on our progress over the last 6 months starting with our first priority, the digital transformation of our courseware and assessment businesses. So our American and British school student assessment businesses are getting back of an even keel after some years of regulatory appeal in the U.K. We're already seeing, as you heard from Coram, the benefits of the investments we've made in the next generation of qualifications. And in the U.S., we'll start to see the benefits in the second half of the year of the success we've had in migrating part customers to new contracts and a couple of new wins, including Tennessee. In both businesses, our customers are seeing the benefits of increased digitization in the enhanced reliability, accuracy and security of the tests with much greater scope for personal feedback. And we benefit from better margins as the cost of process comes down.

Our digital leadership, as you've seen in the press release, is also opening up new international opportunities, such as the 4-year contract we've signed to run high-stage tests for all high school students in Egypt. And our BTEC qualifications, with their focus on applied learning, also have growing international appeal as we're seeing in Thailand and elsewhere.

In Higher Education Courseware, you have seen that we announced last week that we've now done what I signaled we would be doing back in February and that's shifting all 1,500 of our active higher education titles to a digital-first model with frequent releases of content, features and updates no longer tied to an addition cycle. Print will still be available, but increasingly as a rental option. We'll have 410 of our 1,500 titles in a rental or digital access program by the end of this year. And we'll be looking to accelerate the transition of the rest of the titles into that program as quickly as we can. Taken together, this means better customer choice with simple, affordable, convenient access to the courseware that enables students to be successful and all giving better insights for instructors to enable better outcomes. It also simplifies price points, making them much more attractive to students and even more so if they are studying with one of the rapidly growing number of inclusive partners, which currently stands at over 780 universities and colleges.

We're able to go digital first now because we're at the point where we now launch our first products commercially on the global learning platform, our adaptive learning engine that enables both us and our partners to innovate and launch personalized learning experiences much faster, much more efficiently with fantastic user experience and better learning outcomes. All 300 Revel titles will be on the Global Learning platform next year. We will also begin to deliver MyLabs on the platform along with Rio, our new fully adaptive developmental math product, which the market is crying out for. AiDA, spelled A I D A, which is a breakthrough AI-enabled calculus tutor to help students learn with step-by-step feedback will launch in Q4.

As we shift onto the new platform, we are, as you heard from Coram, retiring and deprioritizing legacy digital products of low usage, impact and value. This means total digital registrations are likely to dip slightly, as they did in the first half of this year for the next year or so before starting to grow, again, as we bring our new high-impact and high-value products to market at scale.

We've said that we can stabilize Pearson's overall revenues this year and grow, again, in the future, even if Higher Education Courseware continues to trade in the flat-to-minus 5% range that has been our guidance for this part of Pearson for the last couple of years. And with the ongoing shift in the dynamic of the business, that I described earlier, we will achieve that. But to be clear, in time, we expect to do better than flat to minus 5% in Higher Education Courseware. We're going to get this part of Pearson growing again as well.

We'll do that through our digital first model with a great user experience and learning outcomes, which means that over time, we can gain a share of our spend back from the secondary market and gain share of adoption from our competitors.

Our average revenue per unit, ARPU, will continue to decline. But the average revenue per enrollment, RP, which is the more crucial driver of the business will start to increase again. It will increase because we'll be able to deliver the most engaging, effective, affordable learning experiences and in doing so, build a direct, ongoing relationship with millions of students who will increasingly look to Pearson to guide them from what will increasingly be a lifetime of learning.

Let's shift gears now and talk briefly about our structural growth opportunities. Virtual Schools is an underserved market in several states, nearly 1 in 50 school students, which is about 10 -- 2%, attend a virtual schools but participation is considerably lower than that in most states, including some of the most populous where virtual schools should have big appeal, such as Florida, Texas, California. It is a real and growing unmet need, which we will meet with new schools and expansion of existing schools.

Revenues in our Virtual Schools business grew at a high single-digit rate in the first half, reflecting the ramp up of the newer school enrollments and growth in existing schools. We've announced 6 new schools for the next academic year starting in August, ahead of our target, and this will bring the total number of schools to 42. We expect good growth in Virtual Schools for the foreseeable future.

Now one of our biggest structural growth opportunities is in Online Program Management. This is where we partner with universities to provide fully online courses. This market is expected to grow to over $5 billion in the U.S. alone over the next 5 years. We're the only provider, as you know, to partner with universities in the undergraduate market where there are some 40 million adults in America who have some college credits but have not yet completed a degree. That provides us with a very large opportunity to help those learners with more affordable and flexible access.

Revenue in this business increased net double-digit rate globally, reflecting good growth across our U.S. and international businesses. Registrations up 13%, which is reflecting new program launches. And as we partner with companies like Manpower, announcement we've made recently, we also see a big opportunity to help employers with the vital rescaling of their workforce and help individuals to gain the skills and credentials to prosper in their career.

You can see the size of this employability opportunity from the success of our Professional Certification business, which has nearly doubled in size over the last decade and continues to grow strongly and profitably. Cash volumes are up 8%. We signed 17 new agreements. We now provide the Professional Certification for 450 credential owners. These are professional bodies, regulated organizations, major technology companies. And with the pace of change only increasing across all types of jobs, we see plenty of further growth in this market.

Our Professional Certification network is also fundamental to our fourth big growth opportunity, the success of the Pearson Test of English. PTE has grown very quickly in the last 5 years as it should. We believe it is by far the best test on the market, but there is still a lot of room for further growth. For example, for all our success in the study and visa market, we still have less than 10% share. And we see a similar-sized opportunity for the Pearson Test of English in the employment and skill-proficiency markets as well, and linked to that, there's also significant opportunity in English Courseware, particularly, as we exploit our digital capabilities and get better aligned with the assessment goals of learners.

So in summary, I think these are a good set of results in their own right, but they also signal that Pearson, as I say, is now shifting from that phase of renewal and recovery to a new age of sustainable growth. We're at a point in the digital transformation of our courseware and assessment businesses, where the rate of decline first slows and then reverses as these businesses collectively start to grow again. Our structural growth businesses are gaining both scale and momentum. And Pearson is now a global, scalable platform, a learning outcome engine that can power our growth and that of our partners by playing a vital role in society, and that role is to see a world of talent and working with partners, give that talent the very best chance of prospering through a life of learning.

And with that, Coram and I will be very happy to take your questions. So back to you for questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Sami Kassab of Exane BNP Paribas.

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Sami Kassab, Exane BNP Paribas, Research Division - Media Research Director, Co-Head of the European Media Team & Analyst of Media [2]

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I have three questions to begin with, please. First, can you put a revenue number on the Egyptian assessment contract? Secondly, where are you with accreditation of the PTE in Canada? And lastly, can you come back on the decline in the online registration in Higher Ed Courseware? I understand the move to the Global Learning platform, but you're also referring to market pressure in math. Can you elaborate on that market pressure, please?

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John Joseph Fallon, Pearson plc - CEO & Executive Director [3]

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Coram, do you want to pick up on the Egyptian contracts and I'll pick up on the other 2?

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Coram Williams, Pearson plc - CFO & Executive Director [4]

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Yes. Thanks, John. Look, it's a very exciting contract for us as we say in the press release because it involves a significant number of tests over 4 years. And I think it demonstrates the opportunity that we've got for our assessment businesses outside of our traditional strengths of the U.S. and the U.K., but it is in ramp-up phase. So you should work on the basis that it's mid-single-digit millions of pounds of revenue in the first half numbers.

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John Joseph Fallon, Pearson plc - CEO & Executive Director [5]

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Okay. Thanks, Coram. On your second question, Sami, in both Canada and the U.K. there's an ongoing process with the authorities, when there's some news we'll share it with you, but that's an ongoing process at this point. And then just on digital registrations, really just to sort of repeat and maybe expand a little bit on what Coram and I both said in the presentation. There's sort of 2 headwinds we've got going on here. One is college enrollments, particularly in the community college sector, as you know are continuing to decline. And the impact of that, in our case, is compounded by ongoing very significant changes in the way developmental education courses are taught, particularly around math where historically we have a market share or something in the 70% range. In addition to that, we've identified a long tail of digital products, which as I said, have low value and low use, where frankly, the cost of transferring them onto the Global Learning platform would cost us more than the revenue they generate for us on an annual basis.

If we were just sort of seeing those 2 things flush through the numbers and nothing else would -- was happening, our digital registrations would be down about 5%. The fact that they're only down 1% tells you that actually in underlying terms, we're continuing to see the analog to digital conversion continue. So good growth in Revel, as you heard, and good growth in BTECs. I think we should expect that sort of trend to sort of continue. We're going to see continued impact in developmental education. We've got another sort of 18 months of work to do in retiring that long tail. And then as we start to launch new products on the Global Learning platform at scale, which is really sort of from this time next year through into 2021, then you'll start to see digital registrations grow. So I think you should assume sort of flat down minus 1% sort of range for the next year or so in headline terms, but the underlying growth is still there and that will then feed into top line growth and registrations thereafter. And in the meantime, of course, we will continue to see revenues from digital grow as they did in the first half.

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Sami Kassab, Exane BNP Paribas, Research Division - Media Research Director, Co-Head of the European Media Team & Analyst of Media [6]

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This is very, very helpful. Can I come back on the PTE? You gave market share for study and visa is at 10%. Can you elaborate a little bit on the competitive landscape, I'm not so familiar with that side of market segment? Is ETS the main player you're facing here, where they have a 90% of the market, or who are the other players in the...

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John Joseph Fallon, Pearson plc - CEO & Executive Director [7]

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There's 2 major incumbents in this play. One is a joint venture between the British Council Cambridge Assessment and an Australian company called IDP, which runs something called IELTS. And then, as you correctly said, there's a product called TOEFL which is run by ETS. We are the fast growing third player in the market, and then if you -- I think in Canada there's a local player as well, and you have -- and there's 1 or 2 local players here in the U.K., but that's broadly the competitive landscape.

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Sami Kassab, Exane BNP Paribas, Research Division - Media Research Director, Co-Head of the European Media Team & Analyst of Media [8]

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And the 10% was just for Australia or for the markets where you compete in?

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John Joseph Fallon, Pearson plc - CEO & Executive Director [9]

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That's -- we -- our share in Australia is significantly higher. That would be our overall share of the study and visa market. So that would really be looking across the major country -- major English-speaking countries. So really, it's the U.S., Canada, Australia and the U.K.

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Operator [10]

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Our next question comes from the line of Katherine Tait of Goldman Sachs.

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Katherine Tait, Goldman Sachs Group Inc., Research Division - Associate [11]

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Three questions for me, please. Firstly, on OPM, you talked about 13% enrollment growth. Can you help us understand how that translates into revenue profit growth to? And I suppose linked to that, I know you talked about strong pipeline going forward. But I'm aware that some of your peers have been seeing slowing growth more in-housing from their customers and higher student acquisition costs. Is this something you're also seeing, or perhaps you can just make a couple of comments on those points?

Second question on U.S. Higher Ed Courseware, so I see this went from declining slightly in the first quarter to declining at the midpoint of the 0% to minus 5% range for the first half. Can you perhaps talk about whether or not you're losing share within this part of the market? I also remember you talking about the phasing -- shifting more to the first half from the second half as you, obviously, become more digital. So perhaps an update in terms of what you're seeing there? And then finally, you talked quite a bit in the release about the employer education partnership with Manpower opportunity. Can you talk a bit about how big this is today as part of your business, and perhaps what makes you the best partner for the players in this market?

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John Joseph Fallon, Pearson plc - CEO & Executive Director [12]

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Okay. Thank you very much, Katherine. Coram, you wanted to pick up on how OPM, sort of, the enrollment growth swings into -- turns into revenue and profit, and also around phasing of Higher Ed sales, and then I'll pick up on the pipeline and market share performance and then I'll pick up on the Manpower point as well.

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Coram Williams, Pearson plc - CFO & Executive Director [13]

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Absolutely. Hi, Katherine. I think we said in the past when we were talking about OPM that the enrollment growth is a really good leading indicator of revenue growth, but there is a lag to that revenue growth because you bring those students onboard and then the fees start to come through, but obviously, they are deferred over a period of time. So a good way to think about it is that you've see the revenue growth come through sort of 12 to 18 months after you get the enrollment. In terms of profitability, I think we've also run you through the characteristics of these contracts, which is that for the first couple of years. Typically the investment in the marketing spend means that we run them at a loss, and then you back turns and we pick up and make good profitability in the back end. So I think you should assume that the profits relating to the enrollments come through a year or 2 after you see the revenue. So enrollment growth then revenue growth then profit growth. And just to remind you the IRR on these contracts is very strong. So we're talking 35%-plus, is a very good return on the investment that we're making.

In terms of the timing of the revenue in Higher Ed, it's really important to remember the phasing effect that we have. So in terms of the first half of 2018, it was really helped in comparative terms by the returns top up that we took in H1 and in H2. So you can't infer anything from the comparison because the 2018 comp was an easy one in '17, it's much tougher now for '19. And so on that basis, the middle of the range that we're in feels like the right place to be and isn't distorted by the returns in 2017.

And there's one other point I want to pick up on, which is I think you mentioned in your question that digital bring sales forward, it's actually the other way around. Digital moves sales closer to the point at which the student requires them and consumes the content, and therefore, you would, all other things being equal, except to see a move later in the sales periods.

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John Joseph Fallon, Pearson plc - CEO & Executive Director [14]

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Yes. Thanks, Coram. And then just coming back on the Online Program Management, the broader question you asked for a minute. The other way I think about it, is there's really 4 big roles that we play with our university partners. The first is that we are constantly, actively managing our portfolio of university partners and program. So have we got the right regional mix and balance, have we got the courses aligned with where the biggest gaps in the jobs market. Is it aligned for some of the biggest growth trends around digital and the like. So we are actively managing the portfolio all the time. And you can see that in the number of new programs that we're launching and the programs that we retire, and we've referred to that in the press release.

Secondly, then, we're trying to market those programs as effectively as we can to generate a pool of appropriate people for whom this would present the right career opportunity. And then the third element is then to translate those leads or convert those leads into enrolled students. And fourth, most critically and more importantly, ensure that we deliver on the promise to those students by helping them to complete their courses and be successful and help to place them into a better job or career.

We are investing not just in the marketing but improving each of that 4 steps in the process. And there's a lot of work that we can do around how we are using AI, for example, to get much better at getting a better return on investments. So we'll actively work in each of those 4 elements of the process all the time, and you'll start to see the benefits of that work over the next couple of years.

So in the first point, I think you then were asking about our competitive performance in Higher Education Courseware. Just to remind you our sales and the other 5 major players in Higher Education Courseware, we all submit our data on a monthly basis to a third party and what we get back is we're able then to track our performance against the industry as a whole. As you've heard me say previously, it bumps around a little bit from month-to-month, but it's always in that 40% to 41% range. We'll continue to trade in the range. I think on the June 12-month figures we're probably towards the bottom of that range. I was at the national sales meeting last week, the team feeling very good about our competitive performance, as I think you probably expect to see that bump back up towards the middle or top of that range as we work our way through the year. So we continue to perform strongly competitively. As we've been through, obviously, a period of very significant change, when you think of all the cost savings we made, the supply chain challenges we had, the way we've completely restructured and reengineered our sales force. I think there is a real opportunity to break out the top of that range, but that will come later next year as we start to bring the new digital products of scale to market.

And then on your third point, the Manpower at moment is a relatively small contract. But this is a big opportunity, but one that will play out over the next 3 to 5 years. There is, as you can see, I think it's partly driven at the moment by the strength of the U.S. economy, but I think every major employer in the world is increasingly focused on how technology is disrupting its own business and the impact that it will have on their employees. Every major American company runs a major tuition assistance program, and we have a real opportunity to build a business by helping them to spend those tuition dollars more wisely and get a better return on investment, both for themselves as an employer and as importantly for their employees as well. So relative small business as today, but a very big growth opportunity for us over the next 3 to 5 years.

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Operator [15]

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Our next question comes from the line of Tom Singlehurst at Citi.

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Thomas A Singlehurst, Citigroup Inc, Research Division - Director and Head of European Media Research [16]

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It's Tom here from Citi. Actually, three quick ones. I think you just alluded to it John, but just to pin you down on that. Hopeful, I think the adoption sort of part of the year on the Higher Ed Courseware side that's come to an end. When you talk about strong competitive position, are you explicitly talking about confidence that you haven't lost any share in that adoption process? That was the first question.

Second question, actually on the English language side, I noticed you've got the slide on English language assessment. I was just wondering whether you could just talk about English language learning, is there any sort of particular trends there that we should be aware of? And -- actually I think that's it. I just -- I think I've only got 2 questions.

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John Joseph Fallon, Pearson plc - CEO & Executive Director [17]

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Okay. Just (inaudible) for a little bit, Tom, on the second question, what -- just what are the big trends we see in English language learning?

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Thomas A Singlehurst, Citigroup Inc, Research Division - Director and Head of European Media Research [18]

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Yes, yes. It's notable it is absence in the presentation. I mean it's -- obviously it's very skewed to Latin America now but is there anything you would call out particularly in those trends?

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John Joseph Fallon, Pearson plc - CEO & Executive Director [19]

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Well, I think I did say that as well as seeing a big opportunity in the Pearson Test of English and associated high stakes assessment, we did see a big opportunity in English Courseware, particularly as we go more digital and it's particularly realigning to assessment. And actually one of the things that we have done over the last year is on the back of making a strategic decision to exit the direct delivery of the English language teaching with the sale to Wall Street English in GEDU, that has actually given us the opportunity to sort of reinvest in our courseware businesses, building on our competitive advantages, which are in digital and assessment. And we actually got some good products coming to market this year that we are excited about. And one of the next generation of products, one of the sort of first big use cases, if you like, for the Global Learning platform is also going to be one of our new big blockbuster English courseware program. So we continue to be committed to it and excited by the opportunity. And just -- I don't think I can say much more than what I said in answer to the question from Katherine, which is you're right, we are through the major adoption season. I was with the team last week. As in any year, you win some and you lose some, but overall we're feeling good and strong about our competitive performance that we've held our own, and as I said, we'll see our market share held pretty much steady in the range it's been over the last few years.

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Thomas A Singlehurst, Citigroup Inc, Research Division - Director and Head of European Media Research [20]

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And then one quick follow-up on that topic. I mean obviously, with Cengage McGraw-Hill sort of, obviously, considering combining, how does that impact the sort of sales price that will cost the back half of the year? Does that create any temporary opportunities or disruption one way or the other?

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John Joseph Fallon, Pearson plc - CEO & Executive Director [21]

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I think you'll understand, Tom, that I'd rather focus on what we're doing, and making sure that we are doing a brilliant job of meeting the needs of our customers. I mean clearly, I think you probably got a sense from the presentation, one of the things we do feel very good about is the process of completely reengineering the technology platforms of this company. The process have taken over GBP 300 million of costs out of the business, have the potential to be highly disruptive and very distracting. So the fact that we sustained our competitive performance through all that disruption is great. And what's exciting that's now behind us. And so now it was really good, it was really focused on the future, and we're very focused on making the most of the great opportunity that we see ahead of this. So that's what I think is good about the future for us.

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Operator [22]

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Our next question comes from the line of Nick Dempsey at Barclays.

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Nicholas Michael Edward Dempsey, Barclays Bank PLC, Research Division - Research Analyst [23]

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So first question, when you talk about 300 additional titles for Revel in 2020. Are we talking about those being available? So how confident are you that high numbers of faculty members will adopt those in the spring of 2020? And therefore, you'll be able to fill them in September, or is it going to be a slow process to get those products into the market through those adoptions? So that's the first question.

And then, second question on -- in terms of digital registration. So as I understand that you're saying that digital registrations will be down, digital revenues will be up a bit. And we're talking about through 2020. You still got drags from enrollments. You still got drags from the print side of things. So are we saying that we're looking at another decline for sure in 2020 based on those dynamics in U.S. Higher Ed Courseware?

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John Joseph Fallon, Pearson plc - CEO & Executive Director [24]

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Okay, Nick. I'll pick up on the first question and then Coram, might want to pick up on the second around revenues and just remind you with the guidance we've given you on our -- on the role of digital revenues play. The 300 Revel titles that we're talking about are titles that are already in the market today, but they are on a legacy platform. That one is much more expensive for us to serve and to support the growth in those registrations, and secondly, limit the new features and functionality that we can offer. So what we're saying is that all our Revel titles will be on the Global Learning platform for back to school next year. That will make for an enhanced user experience. Learners already love, if you look at the NPS scores, it always -- already gets a very strong response from students, but we'll be further able to improve the student experience. But crucially, the platform that Revel is currently on does inhibit our ability to enhance features and functionality for faculty, particularly, for example, in areas like authentic assessment, where we want to provide faculty with the ability to set, for example, their own assessment rubric, the machine can then assess and mark on their behalf. So what this means is all Revel titles are on the new platform as it continues to grow in scale. It costs us less to serve and support those Revel products, and it enables to continue to enhance and improve the student experience and provide teachers or faculty with much greater functionality, which is going to make them more likely to want to use and adopt Revel as a product. So that's on the first point. Secondly, Coram, can you just remind them with our guidance on the contribution from digital revenues in higher education?

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Coram Williams, Pearson plc - CFO & Executive Director [25]

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Yes. Let me just touch a bit on the sort of framework that we've laid out for higher education. I mean there are pressures on enrollments, but as we know, it is linked to the economic cycle. And so that can vary in line with the economy. OER, as we know, is having a limited impact on our revenues in higher education. It's an area that we track very closely. And then clearly, there are ongoing print declines and digital revenue growth, and we've seen it in the first half, and you'd expect us to see digital revenue growth in the second half. So I think despite the registration pressure that John has walked you through, we are seeing revenue growth in digital and we would expect that to continue. We're not going to guide to 2020 at this stage for obvious reasons, but I think we are excited about the prospects that we see in higher education as a result thrown at the GLP and the products that will come on the back of that.

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Operator [26]

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And our next question comes from the line of Matthew Walker at Crédit Suisse.

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Matthew John Walker, Crédit Suisse AG, Research Division - Research Analyst [27]

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A few questions please. The first is, can you just expand on your recent announcement about the printed books? So my understanding is, obviously you're cutting the number of printed books, they're going to be new additions but the print books for old editions will still be available, if people like Amazon or whatever order them or anyone wants to order them. Can you just give us a feel for, let's say, for 2021, in terms of the actual number of books that are going to be produced as a range? How does it move from, say, '19 to '20 to '21 under this system? Just to get an idea of scale because we don't really know how much is -- how many old editions will be ordered versus new additions, et cetera. So just to get a feel for that would be helpful.

Second thing, on the guidance, on Core, I think in end of 2018 you guided for this year, the Core to be stable. Clearly, you've done 6% in the first half. Looking at what you're saying about Egypt, you said mid-single-digit revenues for Egypt. So that, I guess, implies about GBP 10 million for the full year, that's at least the percentage points of growth. Can you update your guidance for Core from stable to something else because otherwise it doesn't really look very realistic?

And then last question is on tax. It seems like every year we start at 21% then we edge down a bit in the first half then we edge down a little bit in the 9 months. By the time we get to the full year the tax rate is gone from 21% to 11%. So how much extra tax savings, et cetera, are there -- is there to go? And like should we just stop putting our tax rates for 21%, 22%, 23% at 11% to 15% to save ourselves the trouble of having to reduce it constantly later on?

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John Joseph Fallon, Pearson plc - CEO & Executive Director [28]

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Yes. A couple of very good questions there, Matthew. So I'll ask Coram to pick up on tax and guidance on Core geographies. And then I'll sort of talk a little bit more about the digital first strategy.

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Coram Williams, Pearson plc - CFO & Executive Director [29]

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On Core, and it's clear, we've had a good start to the year in Core. It's not just Egypt though, there are 3 phasing effects that I think I've mentioned. The first is the Egyptian contract, which is new and which we've quantified. The second is that courseware in both the U.K. and Europe has benefited from some early order patterns. So there are different reasons by country, but that's come together and given us a bit of a phasing benefit there. And I think the second -- the third thing to remember is that various ongoing pressure in our apprenticeships business and where is the benefits in A levels in BTECs and GCSEs have disproportionately felt in the first half, and the drag on apprenticeships is a bit more spread between first and second half. So if we've had a good start we're half way through the year, I think it's looking promising for Core but you must remember there are some phasing effects in those numbers.

In terms of tax, I think a couple of points here. Firstly, it is unprecedented tax environment right now. There is a lot going on. U.S. tax reform is a once in a generation experience in terms of the changes to the rules and the rates. And you also have a series of other changes going on in the way in which countries think about international transfer pricing and the such like. So it is a more difficult tax environment to forecast. Last year, we benefited from not just U.S. tax reform, which became clearer as the year progressed because the other aspect that it was introduced very quickly with minimal detail, but there were a couple of other one-offs, which were driven by things that we had done in the past and by improving our relationships with tax authorities. So last year was absolutely exceptional. This year, it's been a small adjustment, which has really come from us getting clearer, again, on some of the aspects of U.S. tax reform, and that's why we're now guiding to the 17% to 19%. I don't believe that fundamentally changes our long-term guidance in tax of 20% to 22%. I think if you were to pitch it towards the bottom of that range, you would be modeling in the right way.

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John Joseph Fallon, Pearson plc - CEO & Executive Director [30]

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Okay. Thanks, Coram. And then Matthew, just to pick up on your -- answer your first question. Maybe I can sort of break it down into a couple of separate but related themes. First -- the first thing is really most fundamentally, which is around how do we create and make new products and new revisions as we become a digital first courseware company. So although we've been on a extended analog-to-digital transition in this business over the last 15 years, 55% of the revenues last year were now digital. But the product development cycle has still been an analog like one. So in other words, it was all driven by the 3-year revision cycle, but new physical textbooks, which have been driven the economics of the industry since at least the 1970s. It's time to break that. So from now onwards, product updates are done in a digital first way. And the types of reasons why you've get data product is changes in the body of knowledge, a new scientific breakthrough, a new compelling business case study, a major development in world history or contemporary politics or whatever it would be. And in there you don't wait 3 years. You can now do it from 1 semester to another.

Secondly, as we really up our investment in efficacy and research, we're learning a lot more about the user experience, about learning design, about cognition and how people learn. We're making big breakthroughs around artificial intelligence in how we do authentic assessment and the like. Rather than having to wait the 3 years title by title and do that as the sort of follow-up supplemental to the print, it clearly makes sense to completely flip that. And so as those big developments and insights come through, we have the capacity to make those changes in real time across all 1,500 titles. So think of it as updates to your mobile phone or the way your Netflix or your Spotify account or anything else. So it's just a real time user update as and when it is appropriate to do so. That's the first one. I mean it's obviously -- it's much more aligned with the strategy. It's cheaper and much more efficient way of doing it and it works for a better user experience and better outcomes for teachers and for students.

So that's the first point. That's how we create and make products. Related to that is then how over time we shift all of those 1,500 products from an ownership to an access model. And as you heard me say in the presentation, we're now at a point where just over 400 of our titles are in access model. Either they are in print rental or some Revel products are pure, there is no print version of the Revel, it's just -- you just subscribe to Revel. I think we've announced today, or signaling very clearly today that we will put at least another 110 products in -- of the 1,500 into the Access model next year. So that gets us over to 500. And our intention will be to get all 1,500 into that Access model as quickly as we can over the next few years. But you'll understand we'll just sort of update on that as we go because it's a sort of iterative process.

The third benefit of doing this, what that means for prices for students. And the prices that we announced next week are not new. There wasn't any change in the guidance, it's what we're already doing. But it's really enabling us to simplifying the message. So really we now have 3 products. So a full-on digital product, that eText with all the scope and sequence and all the chapters and table of contents that you traditionally expected from the physical textbook in an online environment wrapped around a highly adaptive personalized assessment, submitting all your homework online, getting lots of feedback. The average price for that, there is a little bit from Revel to MyLabs and Mastering, but the average price is about $80 -- $79. If you just want the eText, so if you just want the textbook in a digital format, the average price there is $40 and if you still really want a physical textbook because we have to assume that for the foreseeable future people will, the average price of that rent will be $60. So $80, $60, $40. That's a much simpler model for people to understand. It's much more aligned with the economics of the business. If you all want one of those Inclusive Access partners that works with Pearson then the price actually per student could be between 10% and 25% lower than that.

And this just reinforces the point that I was making earlier. That's fantastic value. It's highly competitive with the secondary market. It's highly competitive with OER, and it means that we can achieve a lower average revenue per unit with a higher average revenue per enrollment, and we start to close the gap, if you see there's a slide in the appendix to the presentation that talks about the fact that we have over 30% of use, but we have less than 20% of value. And this strategy will enables us, I think, over time both to increase our share reviews, but most importantly, close that gap between the value and use. So this is genuinely a win-win.

Lower prices to students, more revenue for Pearson. That's how we get this business going again, but we'll only do it by having fantastic content, brilliant adaptive learning capability, great user experience and that's why we've invested so much in the Global Learning platform and the transformation of the company. And that's what make this exciting. It's all hard work and grassroot that we've done over the last 5 years that now has enabled us to really get on with the next and most exciting phase in the company.

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Operator [31]

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Our next question comes from the line of Adrien de Saint Hilaire of Bank of America.

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Adrien de Saint Hilaire, BofA Merrill Lynch, Research Division - VP & Head of Media Research [32]

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So three of them, please. John and Coram, you gave us, in 2018, a split of U.S. higher ed by product model between digital -- print digital and print. Just wondering if you could update perhaps that revenue split, it would be incredibly helpful.

Secondly, given the announcement that you've made a couple of weeks ago about decommissioning or stopping to edit new print textbooks. Should we assume that print decline should accelerate in the coming years?

And then thirdly, as a follow-up question to what was asked about revenue growth in Core, what were the drivers of the underlying improvement in profitability in the Core business because I think you've converted 100% of your incremental revenues into profits?

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John Joseph Fallon, Pearson plc - CEO & Executive Director [33]

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Okay. Coram, do you want to pick up on those?

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Coram Williams, Pearson plc - CFO & Executive Director [34]

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Yes, sure. Let me take each in turn. And in terms of the split of the business. I think it's best to do that at the full year because, obviously, you do have distortions at the half year because of some of the phasing effects that I've talked about between physical and when physical and when digital sales are made. But just to remind you, this at the full year for 2018 we were 55% digital and 45% print. I think in terms of the dynamics between print and digital, I think you'd expect to continue to see similar dynamics as we work through this transition I think. Obviously print will continue to decline. And as John has described, we are very much focusing on the digital side of the content, but it's going to become an even smaller part of the base. And then in terms of Core, the thing you have to remember is it's not just the revenue drop through, but it's also the restructuring savings that we have seen come through in the first half of this year, and which was spread across each of the geographies. So that's why you're getting good drop-through on that revenue in Core, but there also a restructuring benefit in there.

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Operator [35]

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And our next question comes from Giasone Salati of Macquarie.

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Giasone Ulisse Salati, Macquarie Research - Senior Media Analyst [36]

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First question for Coram, please. Can you help us with -- what is your view on H1, H2 balance? We've gone through a couple of years of changing models, the different comps and stuff. It looks to me like 2019 should be much more balanced between H1 and H2, but interesting to hear more color on that.

Second question, and third for John, please. Last year, we had those ERP glitches in the summer, but we understand now most of the technology transition has been completed. Do you see any more technology risk with any of the new products or else into the summer we should be wary of? And lastly, on Inclusive Access, very strong increase, again, on the number of institutions. They're probably becoming smaller in size. I guess we're getting into the long tail. Can you give us a feeling for how much of the market is now covered by these Inclusive Access deals? And maybe if you have any indication on the share, clearly we're now seeing you've been claiming market share for the last few years and that is something that is very, very interesting to monitor because the selling model is exactly the same between you and Cengage.

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John Joseph Fallon, Pearson plc - CEO & Executive Director [37]

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Okay. Coram, do you want to pick up on phasing and then I'll pick up on the other 2?

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Coram Williams, Pearson plc - CFO & Executive Director [38]

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Yes, sure. So I mean, obviously we've had a good start to the year. I think you're right that there will be more balance in the phasing, particularly if you think about some of the descriptions I've given earlier on in answer to specific questions. The 2 things to remember about second half: one, they're are those phasing effects in Core; and two, higher ed continues its trends, it would still have slightly more weight in the second half than it does in the first half. But nevertheless, a good start to the year.

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John Joseph Fallon, Pearson plc - CEO & Executive Director [39]

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And Coram, do you actually -- do you want to pick up on where we are in the ERP process as well?

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Coram Williams, Pearson plc - CFO & Executive Director [40]

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Yes. So in terms of the ERP process, we are -- we have it fully implemented in the U.S. and the U.K. That's a big milestone for us. Because, as you know, we started this process with 63 different ERP platforms across Pearson, and we now have our 2 biggest markets and more than 75% of revenue running of a single technology backbone. That in turn allows us to standardize processes, drive work into shared service centers and really reduce our headcount. So I mean there's a bit more to go. And so far as the remaining 20% of smaller countries, we have a system which we know can deliver work within all of the business models of Pearson, so you'd expect us to complete that over the next 12 or so months.

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John Joseph Fallon, Pearson plc - CEO & Executive Director [41]

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Yes. And I would say on your third question, on Inclusive Access, we're still in the early stages of adoption here. And actually you've got a probably reasonable cross section of universities that have adopted it, but if by far -- by no means the biggest ones and actually, probably the earlier adopters have been sort of community colleges, some smaller universities. And it's actually only really now I think that people can see the real benefits of it, that many of the bigger institutions are coming onboard. So there's lots of opportunity and lots of further growth to continue to ramp up Inclusive Access takeup by universities. And then secondly, quiet often where we sign up an Inclusive Access partner, we often start with 1 faculty and then the other faculty see the benefits that bringing both to the students and to the department in terms of the extra, so the data analytics and capabilities and service that it provides, and then you build out. So Inclusive Access will grow in 2 ways: one, more institutions, and two, greater takeup within institutions. And there's a lot of growth from ways on still there.

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Giasone Ulisse Salati, Macquarie Research - Senior Media Analyst [42]

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And so you have -- can you help us with the sizing that in terms of the market value rather than a number of institutions?

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John Joseph Fallon, Pearson plc - CEO & Executive Director [43]

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Well I think, we've said, it's sort of -- it's a -- it's somewhere around sort of 15% of our revenues or whereabout at the moment. And so there's lots of opportunity for further growth. So that's probably good proxy for the level of adoption takeup there is so far. So to say, there's a lot more opportunity. Coram, anything you want to add anything on that?

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Coram Williams, Pearson plc - CFO & Executive Director [44]

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So only point that I'd add is, John is absolutely spot on with the revenue number. We've got more than that in terms of institutions because you tend to sign up the institutions and then the revenues lag. I think if you are looking for an assumption so just north of 20% of the institution base would be about right. And that's a good leading indicator of the revenue shifting into the model.

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John Joseph Fallon, Pearson plc - CEO & Executive Director [45]

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And the difference -- the reason there's a difference between the 2 is just because we've got the institution signed up it doesn't yet mean we've got full takeup within the institution. And that's why the growth comes in 2 waves.

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Operator [46]

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And as we come to the end of our final, I'll hand back to our speakers for the closing comments.

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John Joseph Fallon, Pearson plc - CEO & Executive Director [47]

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Okay. Hi, everybody. Thanks, then, again, for joining us today. Thanks for your interest in the company. Joe, Anjali and Tom are all on the call. If you have any follow-up questions in the course of today please let us know. If not, look forward to catching up with you in due course. Thanks, again, for joining us.

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Operator [48]

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This now concludes the conference. Thank you all very much for attending. You may now disconnect your lines.