: financial review :
: 2000 Highlights :
The year 2000 was a period of intense activity for Pearson financially as well as operationally. We issued nearly £2bn in new equity, the bulk of it through the largest rights issue on the UK record books. And we transformed several subsidiary organisations into publicly quoted companies over which we exert either voting control or significant influence.
The balance sheet that we present to shareholders this year has been considerably strengthened by financial initiatives which have supported our public commitment to a minimum credit rating of BBB+ during a period of heavy investment in both acquisitions and organically grown enterprises.
Portfolio changes We have managed the development of the Pearson portfolio over the past five years with the twin objectives of achieving greater focus on a limited range of media activities and of securing a higher rate of sustainable growth for the whole company. Both these objectives were achieved during 2000. The sale of our shareholdings in the Lazard banking houses completed our withdrawal from non-media businesses, while all of our acquisitions strengthened our core media franchises and created growth opportunities for the future.
This portfolio strategy was executed at some short-term cost to earnings. The interest receipts from the cash proceeds of Lazard did not match the historical profit contribution of that investment, while the interest cost of acquiring Dorling Kindersley, for example, was not mitigated by any offsetting contribution of profits during the year of acquisition. We expect Dorling Kindersley to move into profit this year and to achieve margins comparable with those of Penguin as a whole by 2003, but it is a tribute to the underlying growth characteristics of our established businesses that we were able to deliver double digit growth in earnings per share last year despite these short-term portfolio effects.
Pearson Television/rtl group Pearson TVís merger with CLT-Ufa to create RTL Group was completed on 25 July 2000. Pearson now holds a 22% interest in the merged business, which is listed on the London Stock Exchange.Up until 25 July, Pearson Television made sales of £185m and contributed £32m in profits. Our share of RTL Groupís unaudited profit for the remainder of the year was £36m.
Financing We concluded early in 2000 that our accelerating investment in internet enterprises should be funded at least in part by new equity. These new initiatives offered greater growth opportunities, but also carried greater risks, than more traditional media investments, and we therefore considered it appropriate to finance their development with new equity. We successfully completed an equity placing of £250m in January of last year and earmarked the proceeds for the internet.
We returned to the equity market in August in order to finance the acquisition of NCS for £1.7bn ($2.5bn) in cash. Until the NCS transaction, Pearsonís acquisition programme had successfully been funded through a combination of disposals and additional debt. NCS gave us the opportunity to strengthen Pearsonís capital base in support of a large strategic acquisition, and we raised all the funds required through a 3-for-11 rights issue to existing shareholders at a deep discount. The deep discount allowed us to reduce the transaction costs associated with the fund raising and the rights issue was well received. The acquisition of NCS had a neutral effect on earnings per share last year and should be positive from 2001 onwards.
Earnings and dividends for 1999 and previous years have been restated to reflect the bonus element of the rights issue.
Capital structure We also recognised last year that the growth opportunities of some of our businesses might best be realised through a partnership with public markets. Three of our companies finished the year with public company status:
Pearson TV The merger between Pearson TV (PTV) and CLT-Ufa gave Pearson a 22% interest in RTL, a new public company with its primary listing in London. This transaction secured the future of PTV within Europeís largest free-to-air broadcasting company and provided a significant uplift in value to Pearson shareholders.
FT Interactive Data In February of last year we completed the merger between FT Interactive Data, our information business serving the asset management industry, and Data Broadcasting Company (DBC), a NASDAQ-quoted company with complementary interests in financial information. Pearson now owns 60% of this successfully combined company.
Recoletos Our Spanish media company floated on the Madrid Stock Exchange in October of last year. Pearson sold 20% of its interest at that time in order to provide Recoletos with the financial means to develop its strategy in new media markets and in Latin America.
While we do not expect any change in the status of our three principal operating divisions Ė FT Group, Penguin and Pearson Education Ė we see advantages in a more flexible approach to our capital structure so long as we can address the administrative and governance issues which arise.
NYSE listing We took the decision last year to list the companyís shares on the New York Stock Exchange. This has increased the compliance burden on the company, as we are now registered with the US Securities & Exchange Commission and required to file our results in accordance with US GAAP, but it does allow us greater headroom in the development of share-based incentives for our 13,000 US employees. Our US colleagues and shareholders are also now able to follow the fortunes of the Pearson share price in a currency and format with which they are familiar.
Dividend Policy The company seeks to maintain a balance between the requirement of our shareholders, including our many private shareholders, for a rising stream of dividend income and the reinvestment opportunities that we see across the Group. This balance has been expressed in recent years as a commitment to increase our annual dividend faster than the prevailing rate of inflation while progressively re-investing a higher proportion of our distributable earnings in the business. We have also pegged the growth in our dividend to earnings before internet enterprises in order to reassure shareholders that their dividend will be protected during a period of exceptional investment. The 21.4p dividend that we are recommending in respect of 2000 is consistent with that policy. It represents an increase of 6.5% on the adjusted 1999 dividend and is covered 2.6 times by adjusted before internet earnings per share, although only 1.5 times by earnings after internet investment. We expect to maintain this balance between dividend growth and investment in 2001 and beyond.
Accounting disclosures and policies We have expanded the description of our accounting policies this year in order to clarify the presentation of certain costs and balance sheet values specific to the publishing industry. These include our treatment of pre-publication costs, royalty advances and newspaper development costs. The notes to the accounts have also been expanded to provide separate identification of these items. The significant accounting policies of the group are shown on pages 62 and 63.
During the year we have adopted FRS 16, a standard relating to current tax. The main impact of this standard is to reflect UK dividend income net of UK tax credits. The new standard on tangible fixed assets, FRS 15, has also been adopted, although its impact on results and disclosures is not material.
: Interpreting the financial statements :
This section is designed to provide shareholders with background narrative on key elements of Pearsonís financial statements.
Integration costs and fair value adjustments Integration costs represent the cost of integrating our significant acquisitions into our existing businesses. These costs are separately identified and are excluded from our calculation of adjusted earnings. In 2000 £40m of integration costs were incurred, of which £27m related to the integration of Dorling Kindersley into the Penguin Group. In addition a further £9m was charged in respect of the Simon & Schuster acquisition, representing the final part of the integration process, and £4m was charged in respect of the NCS acquisition. Provisional fair value adjustments amounting to £70m have been made to the net assets of the businesses acquired in the year. The most significant adjustments have been to harmonise certain Dorling Kindersley accounting policies with those of Penguin, together with the increase to market value of the carrying value of CBSMarketwatch, following the combining of the FT Interactive Data business with DBC.
Goodwill amortisation The amortisation charge for goodwill, the difference between the price paid and the fair value of the net assets acquired, amounted to £239m in the year compared with £131m in 1999. This increase reflects the significant acquisitions made in the year, particularly Dorling Kindersley and NCS, and the combining of FT Interactive Data with DBC and our television business with CLT-Ufa to form the RTL Group.
Non-operating items Non-operating items remained significant in 2000 reflecting the sale of Lazard, which resulted in a non-operating profit of £231m, and the initial public offering of 20% of Recoletos, which resulted in a non-operating profit of £86m.
Interest Net interest rose by £10m to £157m, with average net debt remaining largely constant. This increase in interest cost followed a general rise in interest rates during the year. A weighted three month LIBOR rate, reflecting the Groupís borrowings in US dollars, euros, and sterling, rose by 110 basis points, or 1.1%. The effect of these rises on the Group was mitigated by its existing portfolio of interest rate swaps, which converted over half of its variable rate commercial paper and bank debt to a fixed rate basis. As a result, the Groupís net interest rate payable averaged approximately 6.9%, rising 0.5% from the previous year.
Taxation The tax charge of £106m represents 37% of profit before taxation of £284m. Although the absolute amount of the tax charge was lower than in 1999, reflecting the reduced profit before taxation, the effective rate was little changed. There is limited tax relief available on goodwill amortisation, and this is the main reason why the effective tax rate is higher than the UK statutory rate of 30%. Profit before taxation was, of course, materially affected in 2000 by the increased losses from internet enterprises. To the extent that losses arose in the US we have generally not recognised tax relief given the existing tax losses available there. This factor was more than offset by the fact that the tax charge on non-operating profits was rather lower than the UK rate. This in turn largely reflected the fact that there was a relatively low effective rate of tax on the profit on disposal of our Lazard interests. In addition, integration costs, on which limited tax relief has been taken, were significantly lower in 2000 than in 1999.
Turning to the tax rate on adjusted earnings, this fell from 25% to 23%. As in 1999, the availability of tax losses in the consolidated tax group in the US meant that only a very limited tax provision was required on the Groupís profits there, and this factor was again the largest single item accounting for the difference between the UK statutory rate and the effective rate on adjusted earnings. The effect was, however, diluted this year by the fact that DBC and its subsidiaries, including FT Interactive Data, are outside the consolidated tax group and as such their profits are not covered by the Groupís US losses. As indicated in the analysis in note 8 on page 68, other factors, which had an adverse effect last year, were favourable to us this year. This largely reflected progress during the year in agreement of the companyís affairs with the tax authorities.
Minorities Minorities reflect the 20% interest in Recoletos following the initial public offering in September 2000 and the 40% interest in DBC following the combining of our asset valuation business with DBC in February 2000.
: Managing our financial risks :
This section explains the Groupís approach to the management of financial risk.
Treasury policy The Group holds financial instruments for two principal purposes: to finance its operations and to manage the interest rate and currency risks arising from its operations and its sources of finance. 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. The Group borrows principally in US dollars, euros and sterling, at both floating and fixed rates of interest, using derivatives, where appropriate, to generate the desired effective currency profile and interest rate basis. The derivatives used for this purpose are principally interest rate swaps, interest rate caps and collars, currency swaps and forward foreign exchange contracts.
The main risks arising from the Groupís financial instruments are interest rate risk, liquidity and refinancing risk, counterparty risk and foreign currency risk. These risks are managed by the group finance director under policies approved by the board which are summarised below. These policies have remained unchanged, except as disclosed, since the beginning of 2000. A treasury committee of the board receives reports on the Groupís treasury activities, policies and procedures, which are reviewed periodically by a group of external professional advisers. The treasury department is not a profit centre, and its activities are subject to audit.
Interest rate risk The Groupís exposure to interest rate fluctuations on its borrowings is managed by borrowing on a fixed rate basis and by entering into interest rate swaps, interest rate caps and forward rate agreements. In December 2000 the Group amended its policy objective to set a target pro-portion of its forecast borrowings (taken at the year end, with cash netted against floating rate debt) to be hedged (i.e. fixed or capped) over the next four years of 50% to 65% for the first two years, and 40% to 60% for the next two years. At the end of 2000 that ratio was 54%. On that basis, a 1% change in the Groupís variable rate US dollar, euro and sterling interest rates would have a £10m effect on profit before tax.
Liquidity and refinancing risk The Groupís objective is to procure continuity of funding at a reasonable cost. To do this it seeks to arrange committed funding for a variety of maturities from a diversity of sources. In May 2000 the Group amended its policy objectives so that the weighted average maturity of its core gross borrowings (treating short-term advances as having the final maturity of the facilities available to refinance them) should be between three and ten years, and that bank and non-bank sources should each provide at least £250m of such core gross borrowings.
In February 2000 the Group issued §650m of bonds due 2007. In July 2000 it put in place a $2,500m syndicated bank facility maturing in 2005, which replaced a similar facility maturing in 2003. As a result, at the end of 2000 the average maturity of gross borrowings was 5.6 years and non-banks provided £1,565m (56%) of them (up from 5.1 years and 46% respectively at the beginning of the year). The proceeds of the bond issue were used to repay part of the groupís syndicated bank facility.
The Group believes that ready access to different funding markets also helps to reduce its liquidity risk, and that published credit ratings and published financial policies improve such access. The Group manages the amount of its net debt, and the level of its net interest cover, principally by the use of a target range for net interest cover. All of the Groupís credit ratings remained unchanged during the year. The long-term ratings are Baa1 from Moodyís and BBB+ from Standard & Poorís, and the short-term ratings are P2 and A2 respectively. The Group continues to operate on the basis that the board will take such action as is necessary to support and protect its current credit ratings. The Group also maintains undrawn committed borrowing facilities. At the end of 2000 these amounted to £609m, and their weighted average maturity was 4.5 years.
Counterparty risk The Groupís risk of loss on deposits or derivative contracts with individual banks is managed in part through the use of counterparty limits. These limits, which take published credit limits (among other things) into account, are approved by the group finance director. In addition, for certain longer dated higher value derivative contracts the Group has entered into mark to market agreements whose effect is to reduce significantly the counterparty risk of the relevant transactions.
Currency risk Although the Group is based in the UK, it has a significant investment in overseas operations. The most significant currency for the Group is the US dollar, followed by the euro and sterling.
The Groupís policy during the year on routine transactional conversions between currencies (for example, the collection of receivables, and the settlement of payables or interest) remained that these should be effected at the relevant spot exchange rate. As in previous years, no unremitted profits were hedged with foreign exchange contracts.
The Groupís policy is to align approximately the currency composition of its core borrowings in US dollars, euros and sterling with the split between those currencies of its forecast operating profit. This policy aims to dampen the impact of changes in foreign exchange rates on consolidated interest cover and earnings. Long-term core borrowing is now limited to these three major currencies. However, the Group still borrows small amounts in other currencies, typically for seasonal working capital needs.
At the year end the split of aggregate net borrow-ings in its three core currencies was US dollar 63%, euro 14% and sterling 23%. These figures differed from the split of forecast operating profit, primarily because of temporary balances relating to the Pearson Television/RTL Group transaction and the Recoletos initial public offering.