Report of the Directors

The directors are pleased to present their report to shareholders, together with the financial statements for the year to 31 December 1998. Details of the businesses, the development of the Group and its subsidiaries and likely future developments are given in this annual report. Use the related links on the right, to go to specific sections of the annual report.

Results and Dividend

The profit for the financial year to 31 December 1998 was £437m (1997: £38m). The profit retained for the year was £311m (1997: loss £74m) and has been transferred to reserves. A final dividend of 13p per share is recommended for the year ended 31 December 1998. This, together with the interim dividend already paid, makes a total for the year of 21p (1997: 19.5p). The final dividend will be paid on 4 June 1999 to shareholders on the register at the close of business on 26 March 1999, the record date.

Dividend Reinvestment Plan (DRIP)

The Company has, in common with many other FT-SE 100 companies, decided to terminate the current share dividend plan and to replace it with a dividend reinvestment plan with effect from and including the final dividend for the year to 31 December 1998. The new plan will provide similar benefits by giving shareholders the right to buy the Company's shares on the London stock market with the cash dividend. Full details of the new plan will be sent to shareholders on 26 April 1999.

Significant Acquisitions and Disposals

Details of these transactions can be found in note 25 and note 26 and on pages 12 to 35 of the annual report (use the related links on the right).

Transaction with Related Parties

Details of transactions with related parties, which are reportable under FRS8, are given in note 30 to the accounts.

Capital Expenditure

The analysis of capital expenditure and details of capital commitments are shown in note 12 to the accounts.

Directors

Biographical details of the directors who served throughout the year are shown here. Details of their remuneration and interests in ordinary shares and options of the Company are contained in the personnel committee report. Three directors, Greg Dyke, Dennis Stevenson and David Verey, will retire by rotation at the forthcoming annual general meeting (AGM) on 30 April 1999. All three, being eligible, will offer themselves for re-election. Details of directors' service contracts can be found here. No director was materially interested in any contract of significance to the Company's business.

Corporate Governance

The board supports the principles of good governance and code of best practice expressed in the Combined Code (the Code) published in June 1998. The directors' report, including the personnel committee report which has been considered and adopted by the board, describes how the Company has applied such principles and, apart from the two following exceptions, has complied with the provisions of the Code. Given the small size of the board and the calibre and experience of the non-executive directors, the board does not believe the identification of a senior independent director is appropriate. Also, the board does not have a nomination committee for non-executive directors as it considers that the most formal and transparent procedure for the appointment of a new non-executive director is for this to be a matter for the whole board.

The Company also complies with the best practice provisions on remuneration committees prescribed in Section A of the annexure to the Listing Rules of the London Stock Exchange, and has done so throughout the year ended 31 December 1998.

The Board

The board currently comprises five executive directors, including the chairman, who is part-time, and five non-executive directors. The majority of the non-executive directors are independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgement. Michel David-Weill and David Verey are not considered to be independent under the terms of the Code due to their connection with the Company through Lazard Frères and Lazard Brothers, respectively, but excuse themselves from discussions of all matters related to the Company's holdings in these businesses. A selection process is currently being undertaken by the board with a view to appointing an additional non-executive member.

The board schedules six meetings each year and arranges to meet at other times as appropriate. There is a formal schedule of matters specifically reserved to the board for decision and approval, and the board is supplied in a timely manner with the necessary information to discharge its duties. A procedure exists for directors to seek independent professional advice in the furtherance of their duties, and all directors have access to the advice and services of the company secretary.

Board Committees

The board of directors has established the following committees all of which have written terms of reference setting out their authority and duties:

Audit Committee

This committee is chaired by Vernon Sankey and its other members are Reuben Mark and David Verey. All are non-executive directors. The committee provides the board with the means to appraise Pearson's financial management and reporting, and to assess the integrity of the Group's accounting procedures and financial controls. The Group's internal and external auditors have direct access to the committee to raise any matter of concern and to report the results of work directed by the committee. The committee reports to the full board of Pearson.

Personnel Committee

This committee is chaired by Gill Lewis and its other member is Reuben Mark. Both are non-executive directors. The committee meets regularly to decide the remuneration and benefits packages of the executive directors and the chief executives of the main operating companies, as well as recommending the chairman's remuneration to the board for its decision and reviewing the Group's management development and succession plans. The board considers three members to be the ideal number in line with the recommendations of the Greenbury Report and intends to appoint an additional non-executive member following the completion of the selection process currently being undertaken by the board. The committee reports to the full board and its report, which has been considered and adopted by the board, is set out here.

Treasury Committee

This committee comprises the finance director, one other executive director and one non-executive director namely, John Makinson, Dennis Stevenson and David Verey. The committee sets the policies for the Company's treasury department and reviews its procedures on a regular basis.

Internal Financial Control

The board of directors has overall responsibility for the Group's system of internal financial controls, which it exercises through an organisational structure with clearly defined levels of responsibility and authority, and appropriate reporting procedures. This structure includes the audit committee which, with the finance director, has reviewed the effectiveness of the internal financial control environment of the Group. The audit committee meets regularly and considers, inter alia, reports from internal and external auditors covering such matters.

The directors consider that the Group's system of internal financial controls is appropriately designed to provide reasonable but not absolute assurance against material misstatement or loss. The main elements of these internal financial controls are as follows:

Operating Company Control

The identification and mitigation of major business risks is the responsibility of operating management. Each operating company maintains controls and procedures appropriate to its own business environment but conforming to Group standards and guidelines. These include procedures to identify and then mitigate financial, operating and compliance risks.

Self Assessment

Each year, chief executives of the main operating companies are required to certify that they had in place, throughout the year, a comprehensive system of controls and that they have conducted a review of the effectiveness of those internal controls. The Group control department reviews the chief executives' submissions and reports its conclusions to the audit committee.

Financial Reporting

There is a comprehensive budgeting system with an annual budget approved by the board of directors. Monthly financial information, including balance sheets, cash flow statements, trading results and indebtedness, are reported against the corresponding figures for the budget and the previous year, with corrective action taken by the directors as appropriate.

Treasury Management

The treasury department operates within policies approved by the board, and its procedures are reviewed regularly by the treasury committee. Major transactions are authorised outside the department at the requisite level, and there is an appropriate segregation of duties. Frequent reports are made to the finance director and regular reports are prepared for the treasury committee.

Group Control

The Group control department has the central responsibility for risk control and internal audit which it exercises through teams located both in the UK and the US. The department reviews risks, systems and procedures in all main operating companies, agrees with operating companies their plans to mitigate risks and improve controls and systems, and reports regularly to the audit committee. Group control ensures that operating companies take steps to eliminate or mitigate these risks where possible. For further details on Group control see the financial review.

Insurance

Insurance cover is provided either through Pearson's captive insurance subsidiary or externally, depending on the scale of the risk in question and the availability of cover in the external market.

During 1999, the directors will undertake a review of the internal control system in the light of the Code provision D2.1 and will report on the results of the review next year, after guidance from the Turnbull Committee has been issued. In the meantime, as allowed by the London Stock Exchange, the directors continue to report on their review of internal financial control.

Going Concern

Having reviewed the Group's liquid resources and borrowing facilities, and the 1999 and 2000 cash flow forecasts contained in the Group budget for 1999, the directors believe that the Group and the Company have adequate resources to continue as a going concern for the foreseeable future. For this reason, the financial statements have, as usual, been prepared on a going concern basis.

Year 2000

Like all other companies, the Year 2000 issue presents a significant risk to the Group. Pearson is very aware of the need for all its products, services and computer systems, as well as those of its suppliers and customers, to be Year 2000 compliant. To achieve this end it established an overall Year 2000 programme in 1997 led by John Makinson, the finance director, with the full support of the board. Progress on the overall project is reported to the board on a regular basis.

An overall Group timetable was established to which all Pearson operating companies were required to work. By the end of January 1999, remedial work and thorough testing of all systems had been completed such that all operating companies within the Pearson organisation, apart from the Simon & Schuster businesses, had achieved material internal Year 2000 compliance. Activities being undertaken in the overall project include understanding legal implications, dealing with the embedded system issue as it relates to all equipment and facilities, and co-ordinating with key suppliers and customers.

At the end of November 1998, Pearson acquired the Simon & Schuster businesses which now form part of Pearson Education. These businesses have similarly been working towards the achievement of Year 2000 compliance, but to varying timescales. A co-ordinated worldwide programme has been reaffirmed for this new part of the organisation and is being overseen by the Pearson Year 2000 programme office. Plans are now fully established to accomplish the significant work yet to be done. This work is progressing to schedule with the aim of achieving material compliance by the end of August 1999.

Pearson is highly sensitive to the risks associated with its key suppliers and customers. The continuity of supply of services from the providers of telecommunications and power represents a particular risk to the Group. All operating companies are in correspondence and discussion with their key suppliers and customers to ensure that the state of Year 2000 readiness of each is fully understood.

The Group will work throughout 1999 to ensure that, in so far as possible, compliance is maintained, to plan for the move into the new millennium and to prepare contingency plans to deal with any business disruption which may arise.

As at January 1999, the estimated cost to resolve the Year 2000 problem for the whole of Pearson is £19m of which £5m remains to be spent. These figures include all remedial work, upgrades, hardware replace-ment and additional external resources. However, they do not include the cost of internal resources, nor the introduction of new IT systems where there are significant functional enhancements, over and above simply resolving the Year 2000 issue. Where new systems are required to support the ever-changing business needs and also resolve any Year 2000 problems, these replacement systems are being accounted for in the normal way.

Shareholder Communications

Management continues to develop, increase and improve communications with shareholders, large and small, institutional and private. This year's AGM will again include information about the Group's businesses, as well as the 1998 results and general AGM business. In addition, Pearson has developed a comprehensive institutional investor communications programme, as well as communicating with employees.

Employment

The average number of Group employees in 1998 was 18,400, of whom some 7,903 were employed in the UK. The employment policies of the Group embody the principles of equal opportunity and are designed to meet the needs of operating companies and comply with local regulations in their areas of operation. The sole criterion for selection, training, development and promotion is the individual's suitability for the position of employment offered and his or her aptitudes and abilities. The Company takes seriously its statutory obligations relating to disabled persons (i.e. the Disability Discrimination Act 1995 in the UK) and seeks not to discriminate against current or prospective employees with disabilities because of a reason relating to their disability. Consideration is given to making reasonable adjustments to premises, or employment arrangements, if these substantially disadvantage a disabled employee, or prospective employee, compared to a non-disabled person.

Training and Development

The Group is committed to the improvement of performance through training and development of its employees. In addition to development opportunities offered by the Group, operating companies have their own programmes and courses to meet the needs of their employees and their business. Pearson also encourages employees to develop their careers by taking up opportunities in other parts of the Group.

Employee Participation

The directors believe that the key to the success of the Company lies in a motivated workforce. In 1998, Pearson completed the implementation of the incentive and reward programmes first announced under the heading 'Changegear' the previous year. This included a Group profit sharing plan and the Worldwide Save for Shares plan. For success in 1998, eligible employees will receive a cash bonus and an award of Pearson shares under the Group profit sharing plan. Under the Save for Shares plan, employees worldwide have been given the opportunity to save from their pay and acquire Pearson shares. About one-third of eligible employees took up this offer in 1998 and the Company plans to make a similar offer in 1999. In 1998, shareholders approved a reduction in the qualifying period to take part in the plan to six months, thereby making the plan accessible to more employees.

European Employee Forum

Pearson has established a European Employee Forum with elected representatives from each of the Group's main operating companies and from countries in Europe where the Group's operations are of significant scale. The forum is intended to provide an arena for the exchange of relevant and appropriate information and to establish a constructive dialogue between management and employees on transnational issues which affect them. Two meetings of the forum were held in 1998.

Employee Communications

Employee communications continue to be developed through regular Group-wide communication from the chief executive, Marjorie Scardino; wide-ranging presentations to staff around the world in connection with the publication of Pearson's results or other important events; the distribution of PearsonNow, the employee magazine; the introduction of Pearsonville, the Group-wide intranet; and reports to participants in the various benefit plans. The various operating companies also have their own channels of communication such as briefing groups, videos, magazines and newsletters.

Supplier Payment Policy

Operating companies are responsible for agreeing the terms and conditions, including terms of payment, under which business transactions with their suppliers are conducted. It is Group policy that suppliers are made aware of such terms of payment and that payments to suppliers are made in accordance with these terms, provided that the supplier is also complying with all relevant terms and conditions. Group trade creditors at 31 December 1998 were equivalent to 25 days of purchases during the year ended on that date. The Company does not have any significant trade creditors enabling it to produce creditor information for this purpose.

External Giving

In 1998, charitable donations in the UK amounted to £1,031,000 (1997: £809,000) and overseas to £308,000 (1997: £458,000). Approximately half of this was given by the Company to charities working on educational, literacy and youth projects, including the Pearson sponsored Gallery of Living Words at the British Library, which opened in 1998. The other half was given by Pearson's operating companies which take active roles in supporting their local communities and industries. Many of the operating companies already match the funds raised by their employees for charities which amounted to £30,000 in 1998. Pearson does not make party political donations but it does support a number of independent research institutes across the political spectrum.

The Environment

Pearson does not operate in industries where there is potential for serious industrial pollution. However, the Company recognises its responsibility to be aware of, and take steps to control and minimise, any damage its operating companies may cause to the environment.

Share Capital

On 4 August 1998 Pearson announced the placing for cash of 28.88 million new ordinary shares representing approximately 5% of its then existing issued ordinary share capital. The shares were subscribed for by institutional investors at a price of £11.35 per share. The purpose of the placing was to refinance part of the debt incurred as a result of the acquisition of the Simon & Schuster businesses. At the AGM held on 1 May 1998, the Company was authorised, subject to certain conditions, to acquire up to 57.7 million of its ordinary shares by market purchase. This authority expires on the date of the forthcoming AGM. Although circumstances have not merited using this authority and there are no plans at present to do so, shareholders will be asked to renew this authority at the AGM on 30 April 1999.

At 10 March 1999, beneficial interests amounting to 3% or more of the issued ordinary share capital of the Company notified to the Company comprised:

Annual General Meeting

The notice convening the AGM to be held at 12 noon on Friday, 30 April 1999 at The Queen Elizabeth II Conference Centre, Broad Sanctuary, Westminster, London SW1P 3EE, is contained in the circular to shareholders dated 30 March 1999.

Registered Auditors

On 1 July 1998, the Group's auditors, Price Waterhouse, merged with Coopers & Lybrand following which Price Waterhouse resigned and the directors appointed the new firm, PricewaterhouseCoopers, as auditors. In accordance with sections 384 and 390A of the Companies Act 1985 (the Act) resolutions proposing the reappointment of PricewaterhouseCoopers as auditors to the Company, at a level of remuneration to be agreed by the directors, will be put to the shareholders at the AGM, special notice having been given pursuant to sections 379 and 388(3) of the Act.

Statement of Directors' Responsibilities

Company law requires the directors to prepare financial statements for each financial year which give a true and fair view of the state of affairs of the Company and Group as at the end of the year and of the profit or loss of the Group for that period. The directors are also responsible for the maintenance of adequate accounting records in compliance with the Act, for safeguarding the assets of the Group, and for preventing and detecting fraud and other irregularities. In preparing the financial statements, the directors consider that appropriate accounting policies have been used and applied in a consistent manner, supported by reasonable and prudent judgements and estimates, and that all relevant accounting standards have been followed.

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