Hello, and welcome to today's Pearson Interim Results. Participants will be in listen only mode and afterwards there will be a question and answer session. And just to remind you, this is being recorded. Today, I'm pleased to present John Fountain, CEO and Sally Johnson, CFO. Please begin.
Good morning, everybody. Thanks for joining us. As you just heard, I'm John Fallon, and I'm here in London with Sally Johnson, our CFO. We're joined virtually by members of our executive team, Tim Bozic, Rob Bristow, Gio Giovanelli, Albert Hitchcock, and Bob Whelan. Tim, Rod, Gio, and Bob lead our North America Courseware, Global Online Learning, International and Global Assessment businesses respectively, and Albert is, of course, our CTO.
As you'll have seen from the press release, there are a lot of great things happening across the company, so I'm keen for you to hear directly from the colleagues who are making them happen when we get to the Q and A. Before Sally takes you through the financial results for the first half of the year in more detail, let me share with you what I think are the key headlines. First, the impact of COVID-nineteen has had a major impact, especially in our global assessment and international businesses. The worldwide closure of schools and professional testing centers and their subsequent reopening to limited capacity has hit first half sales and profits by around £260,000,000 and £140,000,000 respectively. Things are improving.
June was better than May, but we will, of course, all be living with considerable uncertainty for some time yet, and we are running the business on that basis. Second, the lead indicators of digital take up are encouraging. For example, in the last three months, applications to online university programs are up significantly year on year. Virtual school applications were up 61% in the first half of the year, with retention rates also trending favorably. In U.
S. Higher Education Courseware, digital registrations, including e books, are up 5% year to date and up 10% since March. And in July, new digital course creations by faculty using Pearson platforms are also up. Internationally, my EnglishLab users have increased by over 40% year on year. In these unusual times, translating these leading indicators into future enrollments and revenues is more difficult to predict, but colleagues across Pearson are confident that we're seeing an accelerated shift to digital that will outlast the pandemic.
And third, the purpose, speed, grit and ingenuity with which thousands of Pearson colleagues around the world are stepping up through the pandemic will ensure that all parts of the company are well placed to emerge from it in a stronger competitive position. For example, in recent weeks, we've won two new school assessment contracts in The U. S. And are building a stronger pipeline of new opportunities. We've delivered a more than eightfold increase in online proctored tests at Pearson VUE to 580,000 in the six months to June and a 33% increase in the use of our digital platform by psychologists using our clinical assessments.
This will continue to enhance the competitive offerings of both businesses well beyond the pandemic. In international, we've hit the ground running in the Pearson Test of English in China far faster than our competitors, doubling test bookings on the same month last year. Our track record in Egypt online testing volumes, excuse me, rising from around 5,900,000 in the whole of last year to around 19,800,000 in the first half of this is attracting attention from other countries looking to follow their lead. In North American courseware, we've been scrapping for adoption deep into July when normally the season would be well over by now, and we have now taken back most of the points or so of adoption share that we gave up last year. The support we're offering to colleges as they move to hybrid learning at scale, building services from our courseware or bundling services from our courseware and OPM businesses puts us ahead of the field, and the pandemic has not distracted us for a moment from delivering on time and plan both a new fully digital experience for enrolling OPM students and on the Pearson Learning platform road map that we shared with you in February.
Both will bring major competitive advantages and plenty of new opportunities to grow. As Sally will explain, as well as making the discretionary cost savings vital to mitigate the impact of COVID-nineteen, we're continuing to simplify Pearson and make the company more efficient so we ensure that the cost of running the company benchmark favorably against a wide range of peers. The actions we've taken have enabled us to emerge with our strong balance sheet intact and with enduring competitive strength. With ample liquidity and signs of a trading recovery, we are declaring an interim dividend in line with last year. And with that, I will hand over to Sally.
Good morning. John has already taken you through the headlines, so let me walk you through each of the segments, starting with sales. Global Online Learning was up 5% with strong growth in virtual schools and slight growth in OPM as expected. Assessment was down 27%. That's due to the closure of test centers and schools, which are now reopening.
North America Courseware was down 14% due to the expected performance of U. S. Higher education courseware, but also the impact of COVID, particularly in Canada, where schools were closed. International was down 23%, given global test center and school closures, which lasted longer than originally anticipated. Turning to profit.
Assessment and International profits were both down, which reflects the drop through of COVID related trading pressures, including moderate write off for stock obsolescence and bad debt. These trading pressures were partially mitigated by cost savings. In Global Online Learning, the profit impact of sales growth was more than offset by the investments we've made as we target growing markets. In virtual schools, we've invested in our teaching platform and curriculum development as well as enrollment and customer care support. In OPM, we're continuing to invest in the early stages of new programs.
We implemented a new digitized enrollments platform, which would enable us to reorganize part of the business, which incurred severance costs. And we saw the margin impact as discontinued programs came to an end. North America courseware profit was impacted by the sales decline drop through, partially offset by restructuring savings. Enabling functions costs continued to reduce through restructuring as well as discretionary cost reductions given the current circumstances, and our share in PRH was sold at the April. There's a small profit impact relating to Q1 given the business has held for sale at year end.
Here, you can see the usual profit bridge for the group as a whole. The profit impact from COVID trading pressures, offset by cost mitigation, was £140,000,000 There were expected profit impacts from trading and inflation. Our other operation factors are predominantly the online learning investments I mentioned earlier, and we saw reorganization savings of £35,000,000 Disposals relate to PRH and U. S. K12.
So what can we expect in H2? Obviously, there are still a lot of uncertainties, both in terms of lockdown and how recent impacts might impact future behaviour, particularly in terms of university enrolments. But in many parts of our businesses, things are starting to return to a new normal. Test centres have largely reopened in a socially distant fashion, but with extended opening hours. Children are starting to return to school and universities are planning returns to campus or hybrid models.
As you can see from this slide, whilst April and May were very difficult, June starts to see improvement. We are also continuing to see strong interest in online and digital learning. In our virtual schools, applications are up year on year by 61%. This should translate into enrollments and revenues for the 2021 school year. And although the reaction in OPM was a little slower, we're now seeing applications in ongoing programs right there too.
In US higher education courseware, we're seeing growth in digital registration and inclusive access deals as well as lead indicators such as course creation. This will partially offset the expected declines in print sales. Now turning to each division. In H1, global online learning saw 5% growth. In virtual schools, we've worked hard to increase capacity in anticipation of good enrolment for the 2021 school year, given the application data I just mentioned.
We're also seeing improved retention rates, all of which will benefit from the investments we've made in platform, curriculum and enrolment and customer care support. Looking further ahead, we also see potential for new school districts and states to accept virtual schooling for the first time, opening up the chance for more parents to choose this form of education for their child. We also see potential and are starting to pursue international opportunities. In OPM, we had always planned to slow revenue growth this year to pivot the model towards programs and partnerships with the best potential. We've started to combine OPM partnerships with digital courseware relationships, and we're also investing in platforms that help students to find the right pathway for them.
A short course, a longer course, an online degree or certification, or a mixture of a few Combining in this way supports lifelong learning and enables us to make the most of our spend and improve profitability. Over the longer term, we expect global online learning to grow mid to high single digits with improved margins. This will be driven by three things: increased awareness and demand for virtual schools growth in undergraduate enrollments and employability linked offerings as well as a sustainable operating model in OPM. Global assessment had a difficult first half. Physical locations had to close, but we shifted operating wherever we could to online assessments and proctoring.
And in clinical, we moved to our telepractice digital service. Many test centers across the world have now reopened with social distancing in place and longer opening hours to start to meet pent up demand. We expect to see recovery for Pearson VUE in the second half of the year, presuming any second waves are not expensive. Schools are also starting to reopen but more slowly, so we anticipate student assessments and clinical will likely have a further modest impact in H2 in comparison with last year. And looking further forward, as testing resumes in 2021, we have retained and won key new contracts.
Over the long term, we expect low to mid single digit growth in Global Assessment with stable margin as View continues to benefit from the desire to demonstrate employability and as our strong track record in winning share in student assessment continues. John is going to discuss North American courseware further, so I'll touch on the key points. First of all, the H1 USHE courseware decline was as expected, with the main COVID impact in Canada due to closed schools. We continue to expect further declines in print revenues and unbundling of packages partly offset by growth in digital with the associated year in phasing impact of deferred revenue. But as this becomes an immaterial part of the business, our digital growth will recapture the secondary market.
Digital KPIs, as I outlined earlier, are trending well, and we will use the shift to digital amongst other things to improve profitability. In international, the closure of test centers and schools, including language schools, affected courseware sales and Pearson Test of English. International qualification were canceled, and our Brazilian English franchise business was impacted as premises closed, though they quickly switched to virtual services. In H2, we expect the international business to recover, presuming any further COVID lockdowns are not extensive. And looking further ahead, we see opportunities employ in employability as well as Pearson Test of English, where we've now been approved to deliver testing for UK visas and immigration.
Longer term, we expect this business to grow low to mid single digits at current or moderately improved margins. Enabling functions costs have reduced by 19% in H1 through the impact of our restructuring programs as well as discretionary savings. Our enabling function costs are those that support our entire business and each of our divisions in proportion to their size. They include enterprise technology, applications such as our ERP and CRM, finance, services from collecting cash through to forecasting, HR, everything from payroll to learning and development, and legal as well as corporate functions. We have an ongoing focus on cost competitiveness.
And with the further £50,000,000 of savings in 2021, we'll reach top quartile when benchmarked externally for every cost category with the exception of technology, which will be in line with the median. Obviously, there continues to be much uncertainty. But for the business overall, based on our current assessment of the trends experienced over the last few months, we are on track to deliver adjusted operating profit broadly consistent with market expectations, presuming any further COVID lockdowns are not expensive. Cash flow was as expected given reduced profit. The higher operating cash outflow in H1 twenty twenty compared to 2019 was lower due to lower profit, partially offset by reduced bonus payments.
Working capital has been successfully controlled but will obviously continue to be an area of focus given recent circumstances. Net debt was GBP 400,000,000.0 lower than the same time last year, mostly due to operating cash flow and the net proceeds from the PRH disposal. We continue to have a strong balance sheet and significant liquidity, which we enhanced with the very successful launch of our £350,000,000 education bond in May. Today, I am exactly three months into my role as CFO of Pearson. So now feels like a good time to share some of my initial thoughts and key areas of focus.
Firstly, as we transition further to a digital model, we need to hone our key KPIs, particularly lead indicators. We have shared today some KPIs such as applications for the first time, and we'll look to enhance and refine these over time. Secondly, we will focus on improving divisional profitability, in particular, in North America courseware and OPM, which is where the biggest opportunities lie, as these models business models transition. And alongside this, I will ensure that we remain cost conscious and competitive, particularly in our enabling functions. Finally, I'm also focused on our return on investment metrics.
My ambition is to report externally what we track internally in time. And with that, I will hand over to Tom.
Thanks, Sally. Couple of key themes emerged from what Sally just took you through. Two of our biggest growth opportunities, professional certification and English assessment and services, were, as you heard, temporarily diminished by the global lockdown. But as the lockdown eases, they are now recovering and they will continue to grow into the future. At the same time, our other big growth opportunities, virtual schools and online universities, services that enable blended or hybrid learning, online proctoring and digital assessment, pathways to employment, pearson.com as a learner centric gateway just got bigger and more immediate.
And that's because COVID nineteen is accelerating three big trends that are at the heart of our strategy. Learners are taking more direct control of their own learning, the growth of hybrid education models, which combine the best of face to face and online learning and the urgent need for people to continuously reskill and upskill to succeed and make progress in the changing way of a world of work. The Pearson Learning platform is a key enabler of this digital transformation. It brings to market consumer grade products great user experience that drive clear learning outcomes. In February, we identified a specific road map of missions that accelerate our ambition in higher education as well as lifelong learning and employability.
You can see them on the slide here. In the fall, we launched as planned a direct to learner storefront offering on pearson.com that will enable learners to easily find, subscribe to and access their digital text directly from us, and that actually went live yesterday. We are launching feature improvements and additional titles to our Revel product that will enable educators to organize their classes and get insights about student progress with an improved learning experience. And we're also launching the new Pearson eText, a platform based product with enhanced features and functionality, taking the traditional ebook to a new level. So we're making good progress on our current road map, and we're working on new missions specifically targeted at skill development and employability and are transforming our OPM business from a white label managed services provider to an online learning pathways business.
The Pearson Learning platform, you remember we talked in February, drives digital growth in four ways: share gains with differentiated experiences that improve learning outcomes expanding the platform segment with innovative new products, establishing direct relationships with an evergreen supply of learners who we engage with over a lifetime of learning and recapturing share from the secondary market. Let me expand briefly on this last point. The biggest immediate opportunity for us in U. S. Higher Education Courseware is recapturing share from our biggest competitor, which is the sale or rental of our own products in the secondary market.
Last year, adoption of Pearson courses by faculty generated demand for learners to consume around 33,000,000 units of Pearson product. We only got paid for 12,000,000 of those units with the rest of the demand being filled primarily by the secondary market with some, as you can see, non consumption. As we scale our digital and access models, providing better value to learners by focusing on outcomes, affordability and the experience, we will recapture a growing share of this lost value. We can see that this strategy is already gaining traction. Digital volumes are up 5% with a 26% increase in e book rentals, which is an early indication of secondary recapture.
As you can see on this slide, inclusive access revenues are up 28% year to date. As importantly, more new institutions are signing up all the time, which will help us in the years ahead. The first year of our digital first product strategy, with frequent releases of content, features and updates no longer tied to an addition cycle with print only available through our own rental program is working. In the first half of this year, we increased total unit sales whilst shipping 700,000 fewer print products into the channel, diminishing future secondary supply. This print to digital shift will continue to hurt revenues in the second half of this year as we unbundle premium priced print and digital products for digital only and as campus bookstores carry less and less physical inventory.
But the quicker we complete this transition to an overwhelmingly digital and subscription based business, the sooner our higher ed courseware revenues will first stabilize and then start to grow again as we take back the share of those 14,000,000 units per year that we currently lose to the secondary market. That is a very big and interesting opportunity for Pearson that will play out over the next few years. And that's just one example for all the short term challenges of the longer term value we are creating by focusing everything on ensuring that Pearson emerges as the winner in digital learning. So to recap, as anticipated back in April, we have seen significant disruption as a result of COVID-nineteen, but we are encouraged by the improving trends and pickup of sales in June. Of course, uncertainty remains, but we've taken swift action with all major parts of the company moving quickly to respond to the pandemic.
This is enabling our business to recover as lockdown measures ease. Longer term, the pandemic is accelerating a key trend. The future of learning will be digital, and learners will care most about three things, experience, outcomes, and affordability. Those are the three things that drive everything that Pearson, the world's digital learning company, does each day. And to repeat what I said earlier, speed, grit, ingenuity, and purpose with which thousands of Pearson colleagues around the world are stepping up through the pandemic will ensure that all parts of the company are well placed to emerge from it in a stronger competitive position and with more opportunities to grow in a sustainable and profitable way.
And with that, we will be very happy to take your questions. I mentioned that we've got colleagues joining us us for the Q and A. They are all in different locations around the world. So we'll be as slick as we can be in handling the questions, but I hope you'll bear with us if there's an odd delay as we patch different colleagues in. But Hugh, over to you for to take questions from our colleagues.
Thank you.
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Okay. Our first question is over the line of Catherine Tate at Goldman Sachs. Please go ahead. Your line is now open.
Good morning, everyone. Thank you for taking the questions. My first question is on the growth in inclusive access, the sort of additional 94 institutions that you signed, over the course of the first half. Can you give us a sense of how much, these institutions were using Pearson Materials before? And sort of how you think about the shape of the revenue through?
Do we see a negative mix impact from the lower pricing? How does that translate ultimately into higher revenue? If you could just give us a bit of a sense of the moving parts for those specifically, that would be helpful. Secondly, on the online proctoring, can you help us understand the cost structure of online proctoring? How does it differ to, I guess, the sort of physical test centers in your business?
And how could we think about the evolution of that going forward? And then finally, Sally, you talked about focus on ROI. Can you talk about how you think about this with relation to organic versus organic investment versus acquisitions like SmartSparrow? What are the sort of, yes, key considerations there?
Thanks, Catherine, and good morning to you as well. Let's go to Tim first. Tim, do you want to pick up on the sort of inclusive access? So 94 institutions, new institutions, what was their mix and use of Pearson products? And how do we think about the impact on revenue over time?
Sure. Thanks for the question, Catherine. We're very encouraged by the IA results year to date as well as our pipeline. In terms of the product mix between current customers and new, it's a combination. John mentioned that we had a strong competitive adoption performance this spring, so some of the uptake in Inclusive Access volume as a result of new customers as well as conversion of current customers.
From a product mix standpoint, we're also happy with an increasing proportion of the product mix in e books as well as our platform products because the more that e books are fulfilled through the inclusive access channel, not only do we have the customer benefits, but it's a big driver of secondary recapture.
Okay. Thanks, Tim. Bob, do you want to pick up on obviously significant growth in online proctoring still in its relatively early stages, but how does the cost structure compare to our physical test centers? And how are we thinking about scaling it over time?
Thanks, John. I appreciate the question. Online proctoring hit us really hard and fast, and we were to adapt quickly. The cost structure early on is very similar to brick and mortar because you do have the remote proctors. You still have the human headcount cost, but you obviously don't have the rent and facilities cost.
We have a major investment going on to get our cost down, have more automation in that area to keep the cost down. The the take up for online proctoring has surprised us. We're very happy with the success we've had, and we are going to continue to best to be the best in class in that emerging area.
Thanks, Bob. And Sally, do you want to how are we thinking about return on investment between sort of organic and inorganic spend?
Yes. So one of the things I've been looking at in the early months is the return on investment, particularly looking across each of our businesses and divisions to make sure that we have clear metrics in place. We're focused on the return on the cash investment that we're making. So whether it's an OPM business where the investment tends to be more from a P and L perspective or whether it's one of our more traditional businesses where you capitalize that investment, making sure that we're balancing both risk and reward. Obviously, over recent times, that's an organic focus that we've had.
You're quite right. We've had some small investments, more recently, Smart Sparrow, that enhances organic investment that we're making internally with things like the Pearson learning platform and as well as the Lumeric business we have. So basically, a return on cash flow, which is equal whether we're looking at something from an external acquisition point of view or whether it's from an internal organic point of view.
The
next question is over the line of Matthew Walker at Credit Suisse. First
of all, obviously, it's nice to hear that you're recapturing recapturing some share. I think you said you recaptured most of the points of share that you lost. Can you just go into more detail about how you've done that and what incentives you may have given in order to do that? We noticed on the Cengage call, they said people have been less focused on unlimited because of
the
pandemic. The second question is really, I don't know if Sydney is on the line. It's really about the new CEO. And the question is really how much freedom is the new CEO going to be given on digital pricing? And if they decide that they want to rebase digital pricing, are they going to be allowed to do that?
Or is the Board going to basically appoint someone who agrees with them and doesn't want to rebase digital pricing?
Okay. On the first question, Tim, do you want to pick up? I mean, I think the I think as I signaled, Matthew, the I think the adoption season paused in March, late March, early April because of the pandemic, but then it picked up again with vigor. And I think we are very pleased with the way we've performed competitively. Tim has done a great job of leading that.
So Tim, do you want to talk a little bit more about the work we've been doing?
Sure. Thanks, Matt. You sort of pick that up. The Salesforce the incentives for the adoption recapture were largely around the quality of the relationships that our Salesforce has with customers as well as product market fit. They got off, as John mentioned, to a strong start in January.
They supported customers significantly in the sudden shift to digital and online learning and they resumed their sales activity more quickly than we had anticipated and extended into the summer as John indicated, all of which added up to the strong competitive performance we mentioned. It's also a sales force that entered particularly the spring stable from a relationship standpoint. We had we were through the changes we had made and making greater utilization of our OneCRM tool, which provides the kind of visibility and confidence about our adoption performance.
Okay. Thanks, Tim. On your second question, Matthew, obviously, this is our interims call. So as you would expect, you have the CEO, the CFO and all of the senior management team. You'll have seen in the press release this morning that Sydney has reported the CEO succession is in an advanced stage.
That's obviously a matter for the Chairman and the nominations committee. That's not a matter for me. My job and the job of everybody on this call is to ensure that we do the best possible job we can of meeting the needs of educators and learners through the pandemic. We are rising to the challenge. I'm confident we're going to emerge from it as a stronger, better business.
Our job is to my job is to transition to the new CEO with as much wind in our sails as we possibly can, and that's what we're doing. And then I would expect that the the CEO will pursue the strategy that he or she thinks is right for the future of the company. And my job is to make sure that they're in the best possible position to do that.
Okay. So
we now go to the line of Adam Berlin at UBS. The
first thing I just wanted to get clarity on was compared to the original kind of EBIT bridge that you gave for the full year results and now updated for the first half, how should we think about the second half? Is there anything that's changed in terms of any of the specific drivers that may have changed since you gave the guidance in February? And specifically on the trading, are we still thinking of the GBP 20,000,000 impact as you first described? And then what are the other COVID impacts we could see? And if you could help us think through the size of those based on your best of ever.
I know you've mentioned there's bit more to come in student assessment, where else could we see negative trading in the second half? To get to what your guidance is today, would you still think consensus numbers are achievable? And just to understand the thinking there. And specifically on that, when you talk about Global Assessment improving in the second half, are you saying that you expect Global Assessment, particularly Pearson VUE, to grow year on year in the second half or just decline by less in the second half? And the third kind of point is within online learning, you said there was about GBP 15,000,000 of investment in the first half.
Is there going to be more investment in the second half as well in online learning? It's kind of all on the same theme, but just if you can answer those two supplementary questions specifically, that would be very helpful.
So Sally, could you sort of pick up on the bridge and sort of how we're thinking about the second half of the year. And then, Bob, maybe you could then just give a little bit of color about how sort of how we're adjusting to use the phrase of the day, the new normal in how we're running our global assessment businesses. So, Sallie, maybe you could pick up on the bridge. And then Bob, you could just talk a little bit more operationally about how we're adjusting to the world.
Yes. So first of all, picking up on the bridge in the first half, you'll see that putting the COVID impact of GBP 140,000,000 to one side, all the other elements are pretty much what we would all have expected. Turning to H2, the key elements are picking apart assessments, first of all. You've got review recovery in the second So half of the I think you can expect to see view exiting the year back on the trajectory that we would all have expected at the beginning of the year into 2021. Then for school assessments and clinical, which are more tied to schools, which are going back more slowly, a moderate impact as you picked up compared to H2.
Then for our international businesses, we expect to see recovery in a similar manner to that that I described for view. And then our online business. So we've shared with you the applications data for our Virtual Schools business, so that 60% increase in the first part of that the year. That should turn into enrollments in Q3, which will drive revenues in the second half of the year and then also into 2021. And then for North American courseware, we expect the similar trends that we had flagged at the beginning of the year.
So decline in print, unbundling offset by digital growth with an impact from enrollments given the current circumstances. And then from an online investment point of view, the nature of these businesses means that, that investment tends to be in the first half of the year, so you see more of an impact in the first half.
Okay. Thanks, Sally. Bob, do you just want to give a bit of color to sort of as we got our network going again around the world, sort of how things are operating, how we're adjusting to the new world?
Sure. Thanks for the question. We are open in most places now. We have limited capacity for social distancing, but we are compensating that by staying open longer hours. Most of our testing centers in The US are open from, 6AM till midnight in The UK from nine or eight eight in the morning till about eight at night, and, we are back on track.
We are excited that the online proctoring has taken a good bit of volume out of the PPCs, our Pearson Professional Centers, which reduces some of the stress on those. So we think that we will emerge in the third and fourth quarter with the trajectory of getting back to the growth that we expected at the beginning of the year.
Okay. Thanks, Bob, and thanks, Adam. Hugh, back to you.
Thank you. So we now go to the line of Tom Singlehurst at Citi. Please go ahead. Your line is now open.
Hi. It's Tom here from Citigroup. Thanks for taking the questions. First one actually on U. Education Courseware.
I've noticed there are some complaints from libraries that you, Cengage and McGraw Hill, are not making physical versions of your books available for them to loan out to students, which is obviously an encouraging sign that you're focused on sort of clamping down on the secondary market. I just wondered, one, whether you'll be able to hold the line on that, whether there's any prisoner's dilemma type impact that we should worry about. And then secondly, whether there's any sort of extraordinary provisions the libraries could could pull to try and sort of argue that they're justified in sort of breaching copyright and lending them out under extraordinary measures anyway? So that was the first question. And then the second one on virtual schools.
Obviously, applications are up, which is great. You talked a bit more about sort of more schools coming online. I'm just wondered whether you could sort of contextualize that. Three new schools in the fall, what increase in total available spaces does that give you? And then just more broadly, as we run into next year, I mean, this process that you can accelerate?
Or is it just a sort of slow burn in terms of expanding available places? Okay.
Thanks, Tom. We'll come to Rod in a minute to talk about how we're building capacity in our virtual schools. But first of all, Tim, do you want to pick up on the question around rental or loaning our e books through libraries and pick up on that point?
Sure. So libraries play an important role in the educational access system primarily for research purposes. So specifically in terms of product availability from a print perspective. As a reminder, while our print products in our rental program are available in print only, it's a print to own model where at the end of the rental period the consumer can decide if they want to retain ownership. From a library perspective I'm sure we can evolve a policy that could enable libraries to participate in print availability.
But again, primarily students access their content in a number of different models that in addition to libraries.
Yes. And just to add on that, Tom, I mean I think the fact that we've seen a 25% increase in volume of e book rentals in the first half of the year basically says to you that we've put together a compelling model. It's priced very competitively against the secondary market. So I think we are providing very good value to students in the e book market. And I think we expect that growth to continue in the second half.
Rod, do you want to pick up on the virtual schools point? I mean I know in addition to opening new schools, we're also working hard and have been for some months now to expand capacity in our existing schools so we can meet as much of the huge increase in demand that we're seeing as we possibly can. So do you want to say a little more about that?
Yes. Thanks, John, and thanks, Tom, for the question. And absolutely, we are seeing one of the biggest constraints to growth in the virtual school sector until now has been about capacity and more about category awareness. So one of the things that the COVID-nineteen crisis has done is, of course, significantly increased the awareness of virtual schooling as an available option, which is driving very strong accelerating demand. In terms of the capacity itself, there are currently 32 states, in The United States where it is possible to operate virtual schools.
We and Pearson are already in 29 of them, and we are reasonably confident in the next year or so of getting into at least another two of them. As far as capacity is concerned within each of the schools, we're actually feeling pretty good about our capacity right now to take the level of growth that we're seeing, very significant growth, but we are confident today in the capacity that we've So yes, so feeling good on the capacity front.
Yes. And it's probably just worth saying, I mean, we are not expecting the 60% increase in applications, I don't think you should assume, is going to translate into a 60% growth in enrollments, but I think you should expect it to translate into very significant growth in enrollments and much higher than we would have seen in recent years. Hugh, where should we go next?
Okay. So we now go to the line of Sami Kassab at Exane BNP Paribas. Please go ahead, Sami. Your line is now open.
Thank you very much, Hugh, and good morning, everyone. I have three questions, please. The first one is just to follow on what Tom asked. How many of your Connections Academies have enrollment caps? And how far are you from reaching these enrollment caps, please?
Secondly, how do you assess the impact of the regulatory changes on developmental education? Are you through with the headwind there? Or do you think that changes in developmental math and reading will remain a drag into H2 next year? And lastly, historically, your Higher Ed courseware revenue forecast implied 1% to 2% decline in enrollment. Is that still your view for fall twenty twenty?
Thank you.
Okay. Thanks, Sami. Rod, do you want to pick up on the first point, what enrollment caps exist and what sort of headroom does that give us in terms of meeting increased demand for virtual schools? And then we'll then I'll come on to Tim for the next two questions.
Yes. So about half
about 21 of the Connections Academies have got enrollment caps. But even within those, we're very confident about the caps that are in place give us capacity to grow with the exception of a small number, which we are currently in conversation with. So there are small number that have caps that could limit growth. But for the most part, we are we feel that we're in a good place.
Okay. Thanks, Rod. And then, Tim, do want to pick up on Sami's other points? Are we is there still more room to go in terms of the impact of regulatory changes in developmental education? Or are we there now?
And we were working on the basis of a 1% to 2% decline in college enrollments at the start of the year. What's our best sense of now where it's likely to end up and why?
Sure. Thanks, Sami. So we think we're considerably through the impact on developmental education, but not completely. And as a reminder, developmental education demand is driven by the number of students who need it and how it served. And how it served has continued to integrate developmental education in other college courses.
So it eliminated in some states dedicated courses. So majority through, not entirely through that, Sami. On the enrollment outlook, as John said, we started the year with an outlook of low single digit enrollment declines consistent with recent years. We now have a view of high single digit declines. And that's a function let me step back first, acknowledge no one knows.
So we have a working hypothesis on this. But we think it will be high single digit because we'll see some pressures from expected lower first year starts. Some students will choose to defer. We expect lower international enrollments for policy reasons. But as a reminder, international enrollments are 5% of the total U.
S. Student enrollment and 2.5% of undergraduate. We think that's factored into the high single digits. We also expect some redistribution. Some students will choose to stay closer to home and we may see a possible increase in adult learners seeking up skilling or re skilling.
And how they acquire those skills may change and they involve more short courses. Those are areas we're also investing in and offering through our online learning and higher ed business.
Okay. Thanks, Tim. And I think the other point, just to I mean, I think Tim talked about earlier, Sami, is whatever level enrollments end up being, we are certainly going to see an accelerated shift from analog to digital within it, partly as a direct result of the actions that we're taking. But I think also with the accelerated shift to hybrid learning, we're seeing greater and deeper use of our digital products, both in terms of platform based products and e books as well. Okay.
Thanks, Tim. Thanks, Sami. Hugh, where are we going next?
Okay. We now go to Patrick Wellington at Morgan Stanley.
Yes. Good morning. Questions. First one for Sally. You talked about the enabling costs and how they are pitched at pretty optimum levels in most areas.
So can you give us a likely absolute number run rate for those that level of cost? Because you've clearly, you know, pitched it at the at the optimum rate. And then secondly, just going back to virtual schools, can you give us an idea or talk a little bit about operational gearing in this business? So if we get a substantial increase in enrollment, obviously, you have the capacity, as you're saying, in place. So what's the drop through like of incremental revenue to the bottom line in the virtual schools business?
Okay. Thanks, Patrick. I think Sally will pick up both of those, and I'm sure she'll make the point on enabling cost. We'd we'd never say we're optimum because there's always learning, always improving, always scope to do better. But, Saj, you want pick up both on enabling cost and what the sort of, gearing and sort of margin characteristics of our virtual schools businesses are.
Sure. So on enabling functions costs, you know we've had a period of reorganization that's got us to a really good place in these costs. And we do benchmark well. But I want to remain cost competitive, and the benchmarks will move on and so will we. So we'll make sure that all of the systems that we've put in, all the processes we've put in continue to keep those costs on a downward trajectory.
Also that we make the most out of those investments. So things like the CRM system that we've put in, that's not just about making our sales teams benchmark well from a cost perspective. It's also about driving revenues with the data that we see as well. So I'm very, very focused on cost competitiveness and enabling functions. In terms of virtual schools, that business, from a profitability perspective, it has decent profitability already compared to the rest of the group.
Operational gearing of that group would be in line with most online businesses. So you're looking at a sort of 40% type
margin. Okay.
Well, hang on a second. I didn't actually get an answer to either of those questions. I mean, if you're can you talk about the enabling functions as an absolute number? I mean, either you have reached an optimum level in terms of the absolute cost because a lot of the things you talk about don't have a relationship with sales, you know, the ERP platform, the corporate functions. So do you look at those enabling costs in proportion to the sales of the group?
Or is that an absolute number, which last year was €449,000,000 which you can make marginal adjustments to? You've got your €50,000,000 next year. But I'm just trying to see what drives those costs because they don't it doesn't seem to me that they move around with the level of sales, and you did talk about having already largely optimized the level of costs. And then on your 40% margin in virtual schools, so are you is that a 40% total margin, or is that 40% drop through of incremental revenue? Because, actually, that drop through should surely be much higher.
You've got basically a fixed cost in virtual schools, and you're getting more student revenue across it. So what does that what you've sent me?
So so on the enabling functions cost, you're you're right. £450,000,000 last year, which is about 11.6%. I'm wanting to drive percentage down. The £50,000,000 will help with that next year, but that's not the end of it. I want to continue to drive it down.
In terms of variable to sales, you're right, the type of costs that are in there aren't variable to sales. There's an element of discretionary costs that I can continue to drive down and make the most of, but it's not I wouldn't call them cost of sales type costs. And in terms of the schools margin, profile is not simple. If you've got an early day school, you're recruiting teachers, you've got to maximize class sizes. And so that 40% that I'm giving you is kind of a broad brush over a period of time with a small level of central cost given the type of business it's in.
And just to build on that last point, Patrick, just I mean if you think in the virtual schools, there's really the costs come in three buckets. You've got your sort of enrollment marketing, so the cost of actually sort of generating leads and converting those leads into enrollments. Clearly, a time like this, your cost of acquisition goes down because you've got a lot more level of interest. Secondly, you've got your technology platform costs, which we are sort of investing in, which obviously do have leverage and scale the more you go through them. But to Sally's point, this is virtual schooling.
So this is still schooling that involves teachers but teaching virtually rather than face to face. So by definition, if you've got more students, you need more teachers. So it's a bit of a hybrid model rather than thinking of it as a pure sort of online platform play. Thank you, Patrick.
Should we go next?
Okay. Well, before going to Nick Dempsey at Barclays, if anyone has any further questions at this stage, please Nick, over to you.
Yes. I've got Efthor, just to pick up on the point of adults perhaps choosing short courses for upskilling rather than perhaps a two year community college. Now to what extent do those shorter courses typically use textbooks? Or do the companies offering them create their own content, some kind of notebook that goes alongside it? Second question, you're talking about operating profit being broadly consistent with the $330 odd million of boomer consensus.
To what extent either side of that should we be thinking? And and what what are the major variables? You know? Is that $3.30 gonna link to your high single digit assumption on enrollment? So but, yeah, how do we define broadly consistent?
And last question, you know, as you work to take share back from the secondary market, how do you expect the secondary market to fight back? You know, there's a hell of a lot of print textbooks out there in the secondary market. Won't the rental players just start to lower their prices to make sure that they're clearly the cheapest option out there? Otherwise, they're stuck with a lot of books. And then won't students just opt for the cheapest option again?
Okay. Thanks, Nick. Well, I'll pick up on the third point in a minute. But, Rod, do you wanna pick up on the first point? Because, clearly, the shift to sort of short courses and offering it as part of a of a sort of a a broader blended offering is important.
And I know that you and, Tim have been working very closely together, as I mentioned in the in the opening remarks, in terms of sort of bundling. And I know we also got some interesting initiatives where we're actually combining our courseware with our services with some of our biggest enterprise partners. So do you want to talk a little bit about that? And then, Sally, do you want to talk a little more about some of the underlying assumptions between how we're expecting things to turn out in the second half of the year? So Rod, do you want to pick up on the short courses point?
Absolutely, yes, Jon. Thanks for the question, Nick. Actually, as Jon was saying earlier, as learners take more control of their own learning, we are seeing a clearer and growing demand, for shorter courses connected to employment, and this, of course, has been accelerated by what's happened with COVID-nineteen. In fact, in The UK, in response to a government request, we created something called UK Learns, which is, populated with about 500 or so, short accredited, short courses that we, made available to to the millions of of furloughed workers. UK Learns is really the precursor to something we've been working on now for a while, Pearson Pathways, which contains a sophisticated engine which matches consumer need to the right path when ultimately to the right course, that actually is going to help us not just drive growth, but it will also help drive efficiency in the enrollment processes that we have within our core OPM business.
And indeed, we're inviting our OPM partners to participate in the platform. To your question about the degree to which content that we may have produced is relevant to those courses, it certainly is. You know, there are a number of things we're doing. In fact, might pick up a little bit on some of the IT, IT professional courses that we're producing. We're producing shorter courses of our own.
In fact, we have, based on our own courseware, a range of courses that, give students credit for, part of their degree program that are based on Pearson textbooks. And these also are short courses that we're making available, to to students. There is there is a synergy between the two, but this is a a a growing opportunity.
Okay. Thanks, Sally, do you want to pick up on the point around what are our broad assumptions for the second half of the year, acknowledging the high degree of uncertainty that there is?
Yes, sure. Our current assessment, as I said, is that we'll be broadly in line with those market expectations, which you've pointed out are on VUMER. In terms of a range around that, obviously, we give a range around guidance and did so at the beginning of the year. So that would be a decent range to use, maybe given the uncertain circumstances, a little wider than that. And to your question about the enrollments and whether those are in line with that, then that's one of the assumptions that we've used in giving that feedback.
Okay. And then on your third point around the secondary market, I'll ask Tim to in a minute just to talk a little bit more about some of the new features and functionality that we're bringing to bear with the next generation of eText and how that will further enhance the eText offering. But just to sort of pick up on your point, Nick, first of all, I mean, you think even three years ago, we still had something like 7,000,000 print units units going into the secondary market. It's now dramatically lower than that. So over time, we are starving the secondary unit.
And whilst you're right to say that there's a lot of secondary units out there, each year they get older and they get less out of date, and we are starving it of new up to date products. So that is having an impact. And secondly, for the first time last year, the student survey showed that given a choice, a majority of students, if the price was right, preferred an eText to a print rental offer. So the sort of the consumer demand is going our way, and then we're playing a very active role in shaving the dynamic of the market. But then third, Tim, we're actually making the eTech a very different and much more attractive proposition.
I don't if you want to talk a little bit more about that.
Sure, John. So Nick, thanks for the question. And agree, consumer choices are based on utility and price. And as John mentioned, we're seeing this students demonstrate digital preferences as sort of a rise of a secular digital preference we're seeing. On the utility side, as we shift more of our product not digital but through our Pearson eText, we're able to add features that students value, be that search, omni channel, offline, online, integrated study tools within them and regular updates to content and functionality.
So we think those consumer preferences and our ability to meet them rapidly through the Pearson Learning platform put us in a strong position for secondary recapture.
Can I just quickly go
back to the sorry, go ahead?
Well, was just going say, Nick, just another example. Audio. You know, this generation of students love being able to listen while they're commuting or traveling or working out at the gym or in the coffee shop or whatever. You can't listen to a physical textbook. You can listen to, eText.
So that's just another example of how as we increase features and functionality, we make our offerings much more attractive compared to secondary. Sorry, Nick. I I
interrupted Sorry.
No. So just
to get back to
the first question. I mean, I heard some interesting stuff you're doing with short courses. I guess my question was really, if there's a mix shift away from two year community colleges or adult learners coming back if they're out of a job, to short courses, is that a negative effect on your ability to sell content because those short courses don't use your content, whereas back the last recession, two year community colleges absolutely do?
Yes. So I think I mean, Tim, you may want to pick up on this, but I think a lot of the short courses provision we're seeing has been offered by four year public universities. It's been offered by the for profit sector. Short courses have been offered by sort of community colleges. So I don't think you should assume that just because there's a shift to short courses, we're not seeing some of established partners and providers meet that demand.
But Tim, do you want to add to that?
Sure. Thanks, Nick. So community colleges in The U. S. Serve two purposes.
One is that the first two years of a general education for students who want to transfer. The second is really they've all been in the provided the role of employment based job driven education. Short courses to some extent are just an alternative increasingly a digital form of that. And to Rod's point, as more teaching turns to online and digital, they still have content. And the trends of integrated content and drawing on course digital courseware content as part of short courses is part of what exists now and we believe will continue.
Okay.
Great.
Thanks, Nick. Hugh, back to you.
Okay. Well, I'm afraid we've only got time for one more question. So the final question for today is over the line of Sarah Simon at Berenberg. So please go ahead.
Yes. Hi. I've just got a couple of small questions. Firstly, can you give us an idea of how much discretionary saving you managed to get out in the first half to offset some of the COVID impact? And secondly, within can you give us an idea within Higher Education Courseware, what the split is in the first half between analog and digital?
And within digital, what is inclusive access and what is e books? Okay.
Sally, do you want to pick up on the discretionary savings point? And then maybe between you and Tim, you can help answer that. They'll give a bit of a color and a bit of flavor around the sort digital analog mix.
Yes. So for discretionary savings, once COVID locked us down, we have about £10,000,000 worth of savings each month coming through. And then also, there's obviously an impact in terms of performance bonuses in the first half as well.
Okay. And then, Tim, do you want to how is the sort of digital analog mix shaping up? And how has that been sort of influenced by the growth in inclusive access? Jim, are you there?
Sorry, I was on mute. Thanks, Sarah. The in terms of the analog digital mix, as John and Tali have mentioned, we're seeing both digital volumes and digital revenue increases and we're seeing accelerated print declines. The first half of the year is circa 40% of the full year, but we expect those trends to continue into the second half. It's too early to tell how that might completely turn out.
In terms of the how IA factors into that, the as we mentioned, we're seeing a 28% increase year to date. We're seeing a strong pipeline for fall. And to the question Catherine posed earlier, we're seeing the product mix within that support an increasing portion of e books as well as platform products and both retained and new customers. So while we don't know how the second year will turn out, we do expect growth in digital and growth in direct channels, all of which set us up for a long term more digital and more sustainable business poised for both the kind of secondary growth that John's described as well as the adoption share growth fueled by the Pearson Learning platform.
Thanks, Sorry, Tim.
Sarah, go on.
Yes. I was just going to say, can you give
us any idea of how what proportion of total revenue total courseware revenue in H1 was from inclusive access? Not the growth, just the percent in total.
Tim, can you help with that?
I'd have to do a quick look up so that maybe something we have to get back on.
Maybe we'll. Sarah, we'll follow-up offline because, I mean, clearly, remember that there's a sort of, obviously, a weighting to the second half, but we'll pick up and follow-up on that offline.
Thanks,
Thanks, Tim. Thanks, everybody, for joining us this morning. I think that we I don't know what your experience of the lockdown has been, but the fact that we went sixty five minutes before somebody said, Sorry, I was on mute, I think was pretty good going. Thanks as ever for your interest in the company. Joe, Angelie and Teddy are all with us here.
And if you have any follow-up questions that you want to ask, please let us know. And as I say, thanks for your interest and look forward catching up again soon. Cheers now. Bye.
This now concludes today's call. So thank you all very much for attending, and you can now disconnect.