In May 2017, we announced a restructuring programme, to run between 2017 and 2019, to drive significant cost savings. This programme began in the second half of 2017 and costs incurred relate to delivery of cost efficiencies in our enabling functions and US higher education courseware business together with further rationalisation of the property and supplier portfolio. The restructuring costs in 2019 relate predominantly to staff redundancies whilst the restructuring costs in 2018 relate predominantly to staff redundancies and the net cost of property rationalisation including the net impact of the consolidation of our property footprint in London.
Intangible amortisation charges to the end of June 2019 were £49m compared to a charge of £57m in the equivalent period in 2018 as acquisition activity has reduced in recent years. Other net gains (before tax) of £6m in 2019 is the profit on sale of the K12 business. Other net gains (before tax) of £207m in 2018 relate to the sale of the Wall Street English language teaching business (WSE), a gain of £184m, the disposal of our equity interest in UTEL, the online University partnership in Mexico, a gain of £19m, and various other smaller disposal items for a net gain of £4m.
The statutory operating profit from continuing operations of £37m in the first half of 2019 compares to a profit of £233m in the first half of 2018. The decrease in 2019 is largely due to the lower profit on disposal of businesses and higher restructuring charges in 2019, partly offset by improved trading, additional restructuring savings and reduced intangible amortisation charges.
Net finance costs
Net interest payable to 30 June 2019 was £18m, compared to £26m in the first half of 2018. The decrease is primarily due to lower levels of net debt together with favourable movements in interest on tax and the absence of one-off costs relating to the redemption of bonds in the first half of 2018 which were more than enough to offset the impact of net interest payable on leases. The increase in interest on leases is due to the adoption of IFRS 16 which resulted in an additional £16m of net interest payable in the first half of 2019.
Finance income relating to retirement benefits has been excluded from our adjusted earnings as we believe the income statement presentation does not reflect the economic substance of the underlying assets and liabilities. Also included in the statutory definition of net finance costs (but not in our adjusted measure) are interest costs relating to acquisition consideration, foreign exchange and other gains and losses on derivatives. Interest relating to acquisition consideration is excluded from adjusted earnings as it is considered to be part of the acquisition cost rather than being reflective of the underlying financing costs of the Group. Foreign exchange and other gains and losses are excluded from adjusted earnings as they represent short-term fluctuations in market value and are subject to significant volatility. Other gains and losses may not be realised in due course as it is normally the intention to hold the related instruments to maturity (for more information see note 3 to the condensed consolidated financial statements).
In the period to 30 June 2019, the total of these items excluded from adjusted earnings was a charge of £6m compared to a charge of £5m in the first half of 2018. Finance income relating to retirement benefits increased from £5m in the first half of 2018 to £7m in 2019 reflecting the comparative funding position of the plans at the beginning of each year. This increase was offset by increased losses on derivatives although foreign exchange losses on unhedged cash and cash equivalents reduced in the first half of 2019 compared to the first half of 2018. For a reconciliation of the adjusted measure see note 3 to the condensed consolidated financial statements.
Taxes on income in the period are accrued using the expected tax rates that would be applicable to forecast annual earnings. The reported tax on statutory earnings for the six months to 30 June 2019 was a benefit of £35m compared to a charge of £13m in the period to 30 June 2018. The benefit in 2019 includes a £37m credit relating to the sale of the K12 business with the remaining charge reflecting the overall mix of profits projected for the full year and the tax rates expected to apply to those statutory profits.
The effective tax rate on adjusted earnings for the period to June 2019 was 18% compared to an effective rate of 20% in the first half of 2018. This rate is lower than the average statutory rate applicable to the countries we operate in as it includes the benefit of tax deductions attributable to amortisation of goodwill and other intangibles. This benefit more accurately aligns the adjusted tax charge with the expected rate of cash tax payment. For a reconciliation of the adjusted measure see notes 4 and 5 to the condensed consolidated financial statements.
Tax paid of £8m in the six months to 30 June 2019 was consistent with the amounts paid in the same period in 2018. In the first half of both 2018 and 2019, there were refunds in respect of prior years.
The Group adopted IFRIC 23 ‘Uncertainty over Income Tax Treatments’ on 1 January 2019 resulting in a reduction of £5m in provisions for uncertain tax positions. The cumulative effect of applying this adjustment has been applied to retained earnings at 1 January 2019 (see also note 1c to the condensed consolidated financial statements). The impact of adopting IFRIC 23 on the income statement for the first half of 2019 was not material.
Other comprehensive income
Included in other comprehensive income are the net exchange differences on translation of foreign operations. The gain on translation of £25m at 30 June 2019 compares to a loss at 30 June 2018 of £15m. The gain in 2019 arises from an overall strengthening of the currencies to which the Group is exposed even though the Sterling to US dollar exchange rate remained fairly constant through the period. A significant proportion of the Group’s operations are based in the US and the US dollar closing rate at 30 June 2019 was the same as the opening rate of £1:$1.27 At the end of June 2018, the US dollar had strengthened slightly from an opening rate of £1:$1.35 to a closing rate of £1:$1.32 and this movement was offset by the weakness in other currencies to which the Group is exposed causing the small loss in the first half of 2018.
Also included in other comprehensive income at 30 June 2019 is an actuarial loss of £141m in relation to retirement benefit obligations. The loss arises from the unfavourable impact of changes in the assumptions used to value the liabilities in the plans and in particular movements in the discount rate. The value of assets was also impacted following the UK plan’s purchase of insurance buy-in policies in the first half of 2019. The loss in 2019 compares to an actuarial gain at 30 June 2018 of £122m.
Our operating cash flow measure is used to align cash flows with our adjusted profit measures (see note 17 to the condensed consolidated financial statements). Operating cash outflow decreased on a headline basis by £73m from £202m in the first half of 2018 to £129m in the first half of 2019. The decrease includes the impact of the adoption of IFRS 16 in conjunction with the property rationalisation programme as part of the Group’s transformation and the absence of the K12 business which would have seen a seasonal cash outflow in the first half.
The equivalent statutory measure, net cash used in operations, was £117m in 2019 compared to £131m in 2018. Compared to operating cash flow, this measure includes restructuring costs but does not include regular dividends from associates or capital expenditure on property, plant, equipment and software. Restructuring costs paid increased from £27m in the first half of 2018 to £60m in the first half of 2019. The adoption of IFRS 16 has resulted in a change in the classification of lease related cash flows in the cash flow statement although there is no impact on the total movement in cash and cash equivalents.
The Group’s net debt increased from £143m at the end of 2018 to £1,376m at the end of June 2019. The adoption of IFRS 16 added £688m of debt on transition with the remainder of the increase principally due to the seasonal operating cash outflow, interest, tax and dividend payments, treasury share purchases, additional capital invested in PRH and outflows from the K12 disposal transaction.
Pearson operates a variety of pension and post-retirement plans. Our UK Group pension 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 charge to profit in respect of worldwide pensions and retirement benefits amounted to £27m in the period to 30 June 2019 (30 June 2018: £25m) of which a charge of £34m (30 June 2018: £30m) was reported in adjusted operating profit and income of £7m (30 June 2018: £5m) was reported against other net finance costs. The increase in the charge in 2019 is largely explained by the absence of past service credits which in the first half of 2018 amounted to £11m and related to changes in the US post-retirement medical plan.
The overall surplus on UK Group pension plans of £571m at the end of 2018 has decreased to a surplus of £433m at the end of June 2019. The decrease has arisen principally due to the actuarial loss noted above in the other comprehensive income section. In total, our worldwide net position in respect of pensions and other post-retirement benefits decreased from a net asset of £471m at the end of 2018 to a net asset of £337m at the end of June 2019.
Adoption of new accounting standards and interpretations in 2019
The adoption of IFRS 16 ‘Leases’ has impacted both the income statement as described above and has had an impact on certain lines in the balance sheet. The lease liability (classified as financial liabilities - borrowings) brought onto the balance sheet at transition was £904m with the corresponding right-of-use asset (classified within property, plant and equipment) valued at £435m. In addition, certain subleases have been reclassified as finance leases resulting in an additional lease receivable (classified as other receivables) of £216m being brought on balance sheet. The net impact on the balance sheet is a reduction of net assets of £86m after taking into account existing liabilities relating to onerous lease provisions (reducing provisions for other liabilities and charges by £101m), lease incentives, adjustments to tax and the net impact on associates. The full impact of the adoption of this standard is outlined in note 1b to the condensed consolidated financial statements.
The impact of adopting IFRIC 23 ‘Uncertainty over Income Tax Treatments’ had a small impact on the current tax balance but has not materially impacted the income statement (see note 1c to the condensed consolidated financial statements).
The dividend accounted for in the six months to 30 June 2019 is the final dividend in respect of 2018 of 13.0p. An interim dividend for 2019 of 6.0p was approved by the Board in July 2019 and will be accounted for in the second half of 2019.
Following the decision in 2017 to sell the K12 school courseware business in the US, the assets and liabilities of that business were classified as held for sale on the balance sheet at 30 June 2018 and at 31 December 2018. In March 2019, the Group completed the sale of its K12 business resulting in a pre-tax profit on sale of £6m. Total gross proceeds were £192m including £172m of deferred proceeds which include the fair value of an unconditional vendor note for $225m and an entitlement to 20% of future cash flows to equity holders and 20% of net proceeds in the event of a subsequent sale. The cash outflow in the period relating to the disposal was £100m mainly reflecting this deferral of proceeds and the seasonal level of cash held in the business at the disposal date.
Tax on the disposal is estimated to be a benefit of £37m. The benefit arises as the transaction gives rise to a loss for tax purposes mainly due to the differing treatment of deferred revenue disposed in the tax computation.
Further details relating to this transaction can be found in notes 10, 14 and 16 to the condensed consolidated financial statements.
Principal risks and uncertainties
The principal risks and uncertainties have not changed materially from those detailed in the 2018 Annual Report and are summarised below.
Business transformation and change
The accelerated pace and scope of our transformation initiatives increase our risk to execution timelines and to business adoption of change. The risk is that benefits may not be fully realised, costs may increase or that our business as usual activities are adversely impacted.
Products and services
Failure to successfully invest in, develop and deliver (to time and quality) innovative, market leading global products and services that will have the biggest impact on learners and drive growth, ensuring Pearson: Responds to market needs, as well as threats from both traditional competitors as well as disruptive innovation; Offers products to market in line with our strategy, at the right price and with a deal structure that remains competitive.
Failure to maximise our talent – Risk that we are unable to attract the talent we need and to create the conditions in which our people can perform to the best of their ability.
Political and regulatory risk
Changes in policy and/or regulations have the potential to impact business models and/or decisions across all markets.
Failure to deliver tests and assessments and other related contractual requirements because of operational or technology issues, resulting in negative publicity impacting our brand and reputation.
Safety and security
Risk to the safety and security of our people and learners arising from either the risk of injury and illness; our failure to adequately protect children and learners; or due to increasing local and global threats.
Failure of either our current operations, supply chain or customer support to deliver an acceptable service level at any point in the end-to-end journey; or to accelerate Pearson’s lifelong learner strategy and transformation.
Failure to plan for, recover, test or prevent incidents at any of our businesses or locations. Incident management and technology disaster recovery (DR) plans may not be comprehensive across the enterprise.
Harnessing the power of our data
Failure to: 1) Maximise our use of data to enhance the quality and scope of current products and services in order to improve learning outcomes while managing associated risks. 2) Maintain data quality, accuracy and integrity to enable informed decision-making and reduce the risk of non-compliance with legal and regulatory requirements.
Legislative change caused by the OECD Base Erosion and Profit Shifting (BEPS) initiative, the UK exit from the EU or other domestic government initiatives, including in response to the European Commission State Aid decision regarding the UK CFC exemption, results in a significant change to the effective tax rate, cash tax payments, double taxation and/or negative reputational impact.
Information security and data privacy
Risk of a data privacy incident or other failure to comply with data privacy regulations and standards and/or a weakness in information security, including a failure to prevent or detect a malicious attack on our systems, could result in a major data privacy or confidentiality breach causing damage to the customer experience and our reputational damage, a breach of regulations and financial loss.
Intellectual property (including piracy)
Failure to adequately manage, procure, register or protect intellectual property rights (including trademarks, patents, trade secrets and copyright) in our brands, content and technology may (1) prevent us from enforcing our rights and (2) enable bad actors to illegally access and duplicate our content (print and digital counterfeit, digital piracy), which will reduce our sales and/or erode our revenues.
Compliance including anti-bribery and corruption (ABC) and sanctions
Failure to effectively manage risks associated with compliance (global and local legislation), including failure to vet third-parties, resulting in reputational harm, ABC liability or sanctions violations.
Failure to comply with anti-trust and competition legislation could result in costly legal proceedings and/or adversely impact our reputation.