In this Annual Report on Form 20-F (the “Annual Report”) references to “Pearson”, the “Company” or the “Group” are references to Pearson plc, its predecessors and its consolidated subsidiaries, except as the context otherwise requires. “Ordinary Shares” refer to the ordinary share capital of Pearson of par value 25p each. “ADSs” refer to American Depositary Shares which are Ordinary Shares deposited pursuant to the Deposit Agreement dated March 21, 1995, amended and restated as of August 8, 2000 among Pearson, The Bank of New York as depositary (the “Depositary”) and owners and holders of ADSs (the “Deposit Agreement”). ADSs are represented by American Depositary Receipts (“ADRs”) delivered by the Depositary under the terms of the Deposit Agreement.

      We have prepared the financial information contained in this Annual Report in accordance with European Union(“EU”)-adopted International Financial Reporting Standards (“IFRS”), which differ in certain significant respects from generally accepted accounting principles in the United States, or US GAAP. We describe these differences in “Item 5. Operating and Financial Review and Prospects — Accounting Principles”, and in note 3536 to our consolidated financial statements included in “Item 17. Financial Statements” of this Annual Report. Unless we indicate otherwise, any reference in this Annual Report to our consolidated financial statements is to the consolidated financial statements and the related notes, included elsewhere in this Annual Report.

      We publish our consolidated financial statements in sterling. We have included, however, references to other currencies. In this Annual Report:

      For convenience and except where we specify otherwise, we have translated some Sterlingsterling figures into US dollars at the rate of £1.00 = $1.72,$1.96, the noon buying rate in The City of New York for cable transfers and foreign currencies as certified by the Federal Reserve Bank of New York for customs purposes on December 30, 2005,29, 2006, the last business day of 2005.2006. We do not make any representation that the amounts of sterling have been, could have been or could be converted into dollars at the rates indicated. On April 28, 2006March 30, 2007 the noon buying rate for sterling was £1.00 = $1.82.$1.97.

      You should not rely unduly on forward-looking statements in this Annual Report. This Annual Report, including the sections entitled “Item 3. Key Information — Risk Factors”, “Item 4. Information on the Company” and “Item 5. Operating and Financial Review and Prospects”, contains forward-looking statements that relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terms such as “may”, “will”, “should”, “expect”, “intend”, “plan”, “anticipate”, “believe”, “estimate”, “predict”, “potential”, “continue” or the negative of these terms or other comparable terminology. Examples of these forward-looking statements include, but are not limited to, statements regarding the following:

      These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by the forward-looking statements. In evaluating them, you should consider various factors, including the risks outlined under “Item 3. Key Information — Risk Factors”, which may cause actual events or our industry’s results to differ materially from those expressed or implied by any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

      Not applicable.

      Not applicable.

      The tabletables below showsshow selected consolidated financial data under IFRS and US GAAP. Under US GAAP, the consolidated financial data has been presented for each of the years in the five-year period ended December 31, 2005.2006. The Company adopted IFRS on January 1, 2003. As a result, in accordance with the instructions of Form 20-F, selected consolidated financial data under IFRS is only presented for each of the years in the four-year period ended December 31, 2006. The selected consolidated profit and loss account data for the years ended December 31, 2006, 2005 2004 and 20032004 and the selected consolidated balance sheet data as at December 31, 2005, 20042006 and 20032005 have been derived from our audited consolidated financial statements included in “Item 17. Financial Statements” in this Annual Report and have been prepared in accordance with IFRS.Report.

      Our consolidated financial statements for the year ended December 31, 2005 have been prepared in accordance with IFRS, which differs from US GAAP in certain significant respects. See “Item 5. Operating and Financial Review and Prospects — Accounting Principles” and note 3536 to the consolidated financial statements. The consolidated financial statements contain a reconciliation to US GAAP of profit/lossprofit for the financial year, shareholders’ funds and certain other financial data.

      The selected consolidated financial information should be read in conjunction with “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements and the related notes appearing elsewhere in this Annual Report. The information provided below is not necessarily indicative of the results that may be expected from future operations.

      For convenience, we have translated the 20052006 amounts into US dollars at the rate of £1.00 = $1.72,$1.96, the noon buying rate in The City of New York on December 30, 2005.

      We payThe Group pays dividends to holders of ordinary shares on dates that are fixed in accordance with the guidelines of the London Stock Exchange. OurThe board of directors normally declares an interim dividend in July or August of each year to be paid in September or October. OurThe board of directors normally recommends a final dividend following the end of the fiscal year to which it relates, to be paid in the following May or June, subject to shareholders’ approval at our annual general meeting. At ourthe annual general meeting on April 21, 200627, 2007 our shareholders approved a final dividend of 17.0p18.8p per ordinary share for the year ended December 31, 2005.2006.

      The table below sets forth the amounts of interim, final and total dividends paid in respect of each fiscal year indicated, and is translated into cents per ordinary share at the noon buying rate in the city of New York on each of the respective payment dates for interim and final dividends. The final dividend for the 20052006 fiscal year will be paid on 5 May 2006.11, 2007.

      Future dividends will be dependent on our future earnings, financial condition and cash flow, as well as other factors affecting the Group.

      The following table sets forth, for the periods indicated, information concerning the noon buying rate for sterling, expressed in dollars per pound sterling. The average rate is calculated by using the average of the noon buying rates in the city of New York on each day during a monthly period and on the last day of each month

     You should carefully consider the risk factors described below, as well as the other information included in this Annual Report. Our business, financial condition or results from operations could be materially adversely affected by any or all of these risks, or by other risks that we presently cannot identify.

      Our products largely comprise intellectual property delivered through a variety of media, including newspapers, books and the internet. We rely on trademark, copyright and other intellectual property laws to establish and protect our proprietary rights in these products.

      We cannot be sure that our proprietary rights will not be challenged, invalidated or circumvented. Our intellectual property rights in countries such as the United StatesUS and the United Kingdom, which are theUK, jurisdictions withcovering the largest proportionsproportion of

      These unauthorized activities may be more easily facilitated by the internet. The lack of internet-specific legislation relating to trademark and copyright protection creates an additional challenge for us in protecting our proprietary rights relating to our online business processes and other digital technology rights. The loss or diminution in value of these proprietary rights or our intellectual property could have a material adverse effect on our business and financial performance. In that regard, Penguin Group (USA) Inc. and Pearson Education have joined three other major US publishers in a suit brought under the auspices of the Association of American Publishers to challenge Google’s plans to copy the full text of all books ever published without permission from the publishers or the authors. This lawsuit seeks to demarcate the extent to which search engines, and other internet operators and libraries may rely on the fair-use doctrine to copy content without authorization from the copyright proprietors, and may give publishers and authors more control overon-line online users of their intellectual property. If the lawsuit is unsuccessful, publishers and authors may not be ableunable to control copying of their content for purposes of on-lineonline searching, which could have an adverse impact on our business and financial performance.

      Our Professional division provides services ranging from call center operationsThe results and growth of our US educational textbook and testing business is dependent on the level of US and state educational funding, which in turn is dependent on the robustness of state finances and the level of funding allocated to complete outsourcing of administrative functions. Customers are government agencies and professional organizations, mainlyeducational programs. Federal and/or state legislative changes can also affect the funding available for educational expenditure, e.g. the No Child Left Behind Act.

      Similarly changes in the USAstate procurement process for textbooks, learning material and student tests, particularly in the UK, and commercial businesses. These services are provided under contracts with values that vary significantly, from a few million to several hundred million pounds overadoptions market can also affect our markets. For example, changes in curricula, delays in the termtiming of the contract, whichadoptions and changes in the student testing process can run from one to ten years in length. The resultsall affect these programs and therefore the size of our Professional division can be significantlymarket in any given year.

      Our newspaper businesses are highly geared and remain dependent on advertising revenue; relatively small changes in revenue, positive or negative, have a small number of large contracts.

      There are inherent risks associated with our school testing businesses, both in the USA and the UK. A breakdown in our testing and assessment products and processes could lead to a mis-grading of student tests and/or late delivery of test results to students and their schools. In either event we may be subject to legal claims, penalty charges under our contracts, non-renewal of contracts andand/or in the case of our UK testing business, the suspension or withdrawal of our accreditation.accreditation to conduct tests. It is also possible that such events would result in adverse publicity, which may affect our ability to retain existing contracts and/or obtain new customers.

      New distribution channels, e.g. digital format, the internet, used books, combinedThese businesses are characterized by multi-million pound contracts spread over several years. As in any contracting business, there are inherent risks associated with the concentration of retailer power pose multiple threats tobidding process, start-up, operational performance and contract compliance (including penalty clauses) which could adversely affect our traditional consumer publishing models. Penguin’s financial performance can also be negatively affected if book return rates increase.and/or reputation.

      Our education, business information and book publishing businesses operate in highly competitive markets. These markets constantly change in response to competition, technological innovations and other factors. To remain competitive we continue to invest in our authors, products, services and services.people. There is no guarantee that these investments will generate the anticipated returns or protect us from being placed at a competitive disadvantage with respect to scale, resources and our ability to develop and exploit opportunities.

      Specific competitive threats we face at present include:

      All our businesses, to a greater or lesser extent, are dependent on technology. We either provide software and/or internet services to our customers or we use complex information technology systems and products to support our business activities, particularly in business information publishing, back-office processing and infrastructure.

      We face several technological risks associated with software product development and service delivery in our educational businesses, information technology security (including virus and hacker attacks), e-commerce, enterprise resource planning system implementations and upgradesupgrades. The failure to recruit and retain staff with relevant skills may constrain our ability to grow as we combine traditional publishing products with online and service offerings.

      We have developed business continuity arrangements, including IT disaster recovery plans, to minimize any business disruption in the event of a major disaster. However, despite regular updates and testing of these plans there is no guarantee that our financial performance will not be adversely affected in the event of a major disaster at a key data center.and/or external threat to our business. Insurance coverage may minimize any losses in certain circumstances.

      We operate a number of pension schemesplans throughout the world, the principal ones being in the UK and US. The major schemesplans are self-administered with the schemes’plans’ assets held independently of the Group. Regular valuations, conducted by independent qualified actuaries, are used to determine pension costs and funding requirements.

      It is our policy to ensure that each pension schemeplan is adequately funded, over time, to meet its ongoing and future liabilities. Our earnings and cash flows may be adversely affected by lowerthe need to provide additional funding to eliminate pension fund deficits in our defined benefit plans. Our greatest exposure relates to our UK defined benefit pension plan. Pension fund deficits have/may arise because of inadequate investment returns, due to a general deteriorationincreased member life expectancy, changes in equity or bond markets, requiring increased company funding of these schemes to eliminate any deficits over time. Similarly,actuarial assumptions and changes in pension regulations, including accounting rules may affectand minimum funding requirements.

      The latest valuation of our UK defined benefit pension costsplan has been completed and future funding status.arrangements have been agreed between the Company and the pension fund Trustee. Additional payments

      Beginning withThere are several factors which may affect our 2006 fiscal year, we will be required to comply with section 404reported tax rate and/or level of SOX relating to internal control over financial reporting. Our SOX 404 implementation project commencedtax payments in 2003 and we believe wethe future. The most important are on track to be compliant. However, the cost of complying with SOX 404 may reduce our earnings.as follows:

      As with any international business, our earnings can be materially affected by exchange rate movements. We are particularly exposed to movements in the US dollar to sterling exchange rate as approximately 65% of our revenue is generated in US dollars. We estimate that if 20042005 average rates had prevailed in 2005,2006, sales for 20052006 would have been £46 million£44m or 1% lower.higher. This is predominantly a currency translation risk (i.e., non-cash flow item), and not a trading risk (i.e., cash flow item), as our currency trading flows are relatively limited. Pearson generates about two-thirds of its sales in the US and each five cent change in the average £:$ exchange rate for the full year (which in 2006 was £1:$1.84 and in 2005 was £1:$1.81) would have an impact of 1p on earnings per share. We estimate that a five cent change in the averageclosing exchange rate between the US dollar and sterling in any year could affect our reported earnings per shareshareholders’ funds by approximately 1 pence.£85m.

      Pearson is a global publishing company with its principal operations in the education, business information and consumer publishing markets. We have significant operations in the United States, where we generate over 65% of our revenues, and in the United Kingdom and continental Europe. We create and manage intellectual property, which we promote and sell to our customers under well-known brand names, to inform, educate and entertain. We deliver our content in a variety of forms and through a variety of channels,

      Pearson was incorporated and registered in 1897 under the laws of England and Wales as a limited company and re-registered under the UK Companies Act as a public limited company in 1981. We conduct our operations primarily through our subsidiaries and other affiliates. Our principal executive offices are located at 80 Strand, London WC2R 0RL, United Kingdom (telephone: +44 (0) 20 7010 2000).

      Although our businesses increasingly share markets, brands, processes and facilities, they consist of three core operations:

     Pearson Educationis a global leader in educational publishing and services.the world’s leading education company. We are a leading international publisher of textbooks, supplementary materials and electronic education programs for elementaryteachers and secondary school, higher educationstudents of all ages, and business and professional markets worldwide. We alsowe play a major role in the testing and certification of school students and professionals, mainly in the US but increasingly in the UK.professionals. Pearson Education consists of the following three operating segments:

     The FT Group consistsis a leading provider of our international newspaper,business and financial news, data, comment and analysis, in print and online financial information, business magazine and professional publishing interests. Our flagship product is theFinancial Times, published internationally and known for its premium editorial content and international scope both in newspaper and internet formats.online. The FT Group comprises the following operating segments:

     The Penguin Groupis one of the premierworld’s foremost English language publishers in the world, with brand imprints such as Penguin, Putnam, Berkley, Viking and Dorling Kindersley (“DK”).publishers. We publish the works of many authors in an extensive portfolio of fiction, non-fiction, reference and illustrated works.works under imprints including Penguin, Hamish Hamilton, Putnam, Berkley, Viking and Dorling Kindersley.

      Since 1997,Over the past decade we have reshapedtransformed Pearson by divestingfocusing on companies which provide ‘education’ in the broadest sense of the word; companies that educate, inform and entertain. Through a rangecombination of non-core interestsorganic investment and investing over $7 billion in education, consumer publishing and business information companies. Eachacquisitions, we have built each one of our businesses into a leader in its market, and we have integrated our operations where appropriate so that our businesses can share assets, brands, processes, facilities, technology and central services.

aims      Our goal is to benefit from educating, informingproduce sustainable growth on our three key financial measures — adjusted earnings per share, cash flow and entertaining peoplereturn on invested capital — which we believe are, together, good indicators that we are building the long-term value of Pearson.

      We do this by investing consistently in an increasingly knowledge-based economy. Our strategy is:four areas, which are common to all our businesses:

      Pearson Education is one of the world’s largest publishers of textbooks and online teaching materials based on published sales figures and independent estimates of sales. Pearson Educationmaterials. It serves the growing demands of teachers, students, parents and professionals throughout the world for stimulating and effective education programs. With federalprograms in print and state governments increasingly required to measure academic progress against clear objective standards, the market for educational testing services in the United States has grown significantly, as have markets around the world. Our integrated approach to education has helped us grow faster because of our breadth.online.

      We report Pearson Education’s performance by the three market segments it serves: School, Higher Education and Professional. In 2005,2006, Pearson Education had sales of £2,663 million£2,591m or 65%63% of Pearson’s total sales (63% in 2004).(2005: 62%) and contributed 68% (2005: 63%) to Pearson’s total operating profit.

      In the United States, ourOur School business includescontains a unique mix of publishing, testing and software operations.technology products, which are increasingly integrated. It generates around two-thirds of its sales in the US.

      Outside of the United States,US, we have a growing English Language Teaching business and we also publish school and college materials in local languages in a number of countries. In the United States, we publish for pre-kindergarten through 12th grade, with a comprehensive range of textbooks, supplementary materials and electronic education programs. Pearson Education’s elementary school imprint, Pearson Scott Foresman, and secondary school imprint, Pearson Prentice Hall School, publish high quality programs covering subjects such as reading, literature, math, science and social studies. We also publish supplementary teaching aids for both elementary and secondary schools and teacher-written activity books. We are a leading publisher in online assessment and digital courseware through Pearson Digital Learning, whose offerings include SuccessMaker, NovaNet and the Waterford Early Reading Program. Through Pearson Achievement Solutions, we provide professional development for teachers in kindergarten through 12th grade with the use of the latest technologies and software tools to improve classroom teaching.

      Pearson Education is the United States’ largest publisher, by sales, of textbooks and related course materials for colleges and universities. We publish across all of the main fields of study with imprints such as Pearson Prentice Hall, Pearson Addison Wesley, Pearson Allyn & Bacon and Pearson Benjamin Cummings. Our sales forces call on college educators, who chooseTypically, professors or other instructors select or ‘adopt’ the textbooks and online resources to be purchasedthey recommend for their students, which students then purchase either in a bookstore or online. Today the majority of our textbooks are accompanied by their students. In 2005, 1.8 million college students registered for our online offerings,services which include homework and assessment products, onlinetools, study guides and textbook companion websites. Many of our online offerings are integrated with course management systems that provide easy-to-use tools that enable professors to create online courses. We have also introduced new

      WeOur Professional education businesses publish text, reference,educational materials and interactive productsprovide testing and qualifications services for IT industry professionals, graphics and design users of all types, and consumers interested in software applications and certification, professional business books, and strategy guides for those who use PC and console games. Publishingadults. Our publishing imprints in this area include Addison Wesley Professional, Prentice Hall PTR, and Cisco Press (IT professional imprints)(for IT professionals), Peachpit Press and New Riders Press (graphics and design imprints)professionals), Que/Sams (consumer and professional imprint) and Prentice Hall Financial Times (business imprint)(for the business education market). We also generate revenues through our own website — InformIT, and through Safari Books Online (a joint venture with O’Reilly Media). We also provide services to professional markets, managing several commercialhave a fast-growing Professional Testing business, Pearson VUE, which manages major long-term contracts to implement and executeprovide qualification and assessment systems for individual professions, including IT professionalsservices through its network of test centers around the world. Key customers include major technology companies, the Graduate Management Admissions Council, the National Association of Securities Dealers and nurses.

      The FT Group one of the world’s leading business information sources, aims to provideprovides a broad range of data, analysis and services to an audience of internationally-minded business people.people and financial institutions. In 2005,2006, the FT Group had sales of £629 million,£698m, or 15%17% of Pearson’s total sales (16% in 2004)(2005: 17%), and contributed 21% of Pearson’s operating profit (2005: 25%). The

      It has two major parts: FT Group’sPublishing, our network of international and national business is global,

      TheFinancial Timesis athe world’s leading international daily business newspaper. Its average daily circulation of 439,563430,469 copies in December 2005,2006, as reported by the Audit Bureau of Circulation, gives theFinancial Times the second largest circulation of any English language business daily in the world. TheFinancial Times derived approximately 67% of its revenue in 2005 from advertising and approximately 33% from print and online content sales. The geographic distribution of theFinancial Times average daily circulation in 2005 was:is split as follows:

      TheFinancial Times is printed on contract in 23 cities around the world and our sales mix is increasingly international. The newspaper draws upon an extensive local network of correspondents to produce unique, informative and timely business information. For production and distribution, theFinancial Times uses computer-driven communications and printing technology for timely deliveryIn 2006, approximately 70% of the various editions of the newspaper to the appropriate geographic markets. TheFinancial Times is distributedFT’s revenues were generated through independent newsagents and direct delivery to homes and institutions.

      FT Publishing also includes: FT Business, produceswhich publishes specialist information on the retail, personal and institutional finance industries and publishes the UK’s premier personal finance magazine,through titles includingInvestors Chronicle together with,Money Management,Financial AdvisorAdviserandThe Banker for professional advisers; Les Echos, France’s leading business newspaper, and a number of joint ventures and associates in business publishing.

      In August 2006, the Financial Times acquired Mergermarket, an online financial sector professionals.data and intelligence provider. The acquisition strengthens the FT Group, adding proprietary content, a premium customer base, reliable growth from new revenue sources and attractive financial characteristics to the organization.

      Through our 62% interest in Interactive Data Corporation (“Interactive Data”), we are one of the world’sis a leading global providersprovider of financial market data, analytics and related services to financial institutions, active traders and individual investors. Interactive Data suppliesThe company’s businesses supply time-sensitive pricing, dividend, corporate action,evaluations and descriptive informationreference data for more than 3.5 million securities traded around the world, including hard-to-value instruments. Customers subscribe toinstruments such as illiquid bonds. We own 62% of Interactive Data’s services and useData Corporation; the company’s analytical tools in support of their trading, analysis, portfolio management, and valuation activities.remaining 38% is publicly traded.

      On December 14, 2004,April 8, 2005, the Group announced that we had accepted an offer fromcompleted the sale to Retos Catera S.A. to sellof our 79% stake in Recoletos, a publicly quoted Spanish media group that we built with its Spanish founding shareholders over a number of years,Group, for gross proceeds of€743 million. The consortium of investors behind Retos Cartera included members of the Recoletos management team, individual Spanish investors and the Banesto banking group. We decided to accept the offer as Recoletos’ strategy in sport, lifestyle and general publications had taken it further away from Pearson’s core focus on financial and business news and information. The sale became unconditional in February, 2005 and net743m. Net cash proceeds of £371 million£371m were received on April 8, 2005 resulting in a profit on disposal of £306 million.£306m.

      As at 2005 year end,2006 year-end, the FT Group also had a number of other associates and joint ventures, including:

      Penguin is one of the world’s premier English language book publishers in the world.publishers. We publish an extensive backlist and frontlist of titles, including some of the very best new fiction and non-fiction, literary prize winners, commercial bestsellers, classics and commercial bestsellers. Our titles range from history and science to essential reference. We are also one of the pre-eminent classics publishers and publish some of the most highly prized and enduring brands in children’s publishing, featuring popular characters such as Spot, Peter Rabbit and Madeline, as well as the books of Roald Dahl.titles. We rank in the top three consumer publishers, based upon sales, in all major English speaking and related markets — the United States,US, the United Kingdom,UK, Australia, New Zealand, Canada, India and South Africa.

      Penguin publishes under many imprints including, in the adult market, Allen Lane, Avery, Berkley Books, Dorling Kindersley, Dutton, Hamish Hamilton, Michael Joseph, Plume, Putnam, Riverhead and Viking. Our leading children’s imprints include Puffin, Ladybird, Warne and Grosset & Dunlap. In 2005, Penguin’s US imprints placed 129 titles onThe New York Times bestseller list. In the United Kingdom, 54 Penguin titles featured on the Nielsen Bookscan top ten bestseller list. Our illustrated reference business, Dorling Kindersley, or DK, is the leading global publisher of high quality illustrated reference books. DK has built a unique graphic style that is now recognized around the world. It produces books for children and adults covering a huge variety of subjects including childcare, health, gardening, food and wine, travel, business and sports. Not only does DK’s “lexigraphic” design approach make its books easily translatable across cultures, but it has also formed the basis of a library of 2.5 million wholly-owned images which have many applications — in print and online.

      We sell directly to bookshops and through wholesalers. Retail bookshops normally maintain relationships with both publishers and wholesalers and use the channel that best serves the specific requirements of an order. We also sell online through third parties such as Amazon.com.

      The operating cycles in respect of the Professional and Penguin Group’s gateway internet site, Penguin.com, provides accesssegments are more specialized in nature as they relate to its focused websiteseducational or heavy reference products released into smaller markets (e.g. the financial training, IT and travel sectors). Nevertheless, in these markets, there is still a regular cycle of product renewal, in line with demand which management monitor. Typically the United States, Canada, United Kingdomlife cycle is 5 years for Professional content and Australia. Websites have also been developed to target certain niche audiences. For example, Penguinclassics.com has an entire online service4 years for the classics, with anthologies, original essays, interviews and discussions and links to other classics sites.Penguin content.

      All of Pearson’s businesses operate in highly competitive environments.

      Pearson Education competes with other publishers and creators of educational materials and services. These companies include some small niche players and some large international companies, such asMcGraw-Hill, Reed Elsevier, Houghton Mifflin Riverdeep Group and Thomson.Thomson alongside smaller niche players that specialize in a particular academic discipline or focus on a learning technology. Competition is based on the ability to deliver quality products and services that address the specified curriculum needs and appeal to the school boards, educators and government officials making purchasing decisions.

      The FT Group’s newspapers, magazines and magazineswebsites compete with newspapers and other information sources, such asThe Wall Street Journal, by offering timely and expert journalism.analysis and insight. It competes for advertisers with

      The Penguin Group competes with other publishers of fiction and non-fiction books. Principal competitors include Random House, HarperCollins, and Hachette Livre. Publishers compete by developing a portfolio of books by established authors and by seeking out and promoting talented new writers.

      Our principal intellectual property assets consist of our trademarks and other rights in our brand names, particularly theFinancial Timesand the various imprints of Penguin and Pearson Education, as well as all copyrights in our content and our patents held in the testing business in the name of Pearson NCS. We believe we have taken all appropriate available legal steps to protect our intellectual property in all relevant jurisdictions.

      Paper is the principal raw material used by each of Pearson Education, the FT Group and the Penguin Group. We purchase most of our paper through our central purchasing department located in the United States. We have not experienced and do not anticipate difficulty in obtaining adequate supplies of paper for our operations, with sourcing available from numerous suppliers. While local prices fluctuate depending upon local market conditions, we have not experienced extensive volatility in fulfilling paper requirements. In the event of a sharp increase in paper prices, we have a number of alternatives to minimize the impact on our operating margins, including modifying the grades of paper used in production.

      The manufacture of certain of our products in various markets is subject to governmental regulation relating to the discharge of materials into the environment. Our operations are also subject to the risks and uncertainties attendant to doing business in numerous countries. Some of the countries in which we conduct these operations maintain controls on the repatriation of earnings and capital and restrict the means available to us for hedging potential currency fluctuation risks. The operations that are affected by these controls, however, are not material to us. Accordingly, these controls have not significantly affected our international operations. Regulatory authorities may have enforcement powers that could have an impact on us. We believe, however, that we have taken and continue to take measures to comply with all applicable laws and governmental regulations in the jurisdictions where we operate so that the risk of these sanctions does not represent a material threat to us.

      We are not dependent upon any particular licenses, patents or new manufacturing processes that are material to our business or profitability. Likewise, we are not materially dependent upon any contracts with suppliers or customers, including contracts of an industrial, commercial or financial nature.

      On January 9, 2006February 15, 2007 the Group completed the disposal of Pearson announcedGovernment Solutions, its Government services business, to Veritas Capital. Sale proceeds consist of $560m in cash, $40m in preferred stock and 10% of the purchaseequity of 1,130,739 shares in Interactive Data from an individual shareholderthe business. The Group expects to report a post tax loss on the disposal, as the capital gain for $21.67 per share in cash. This purchase brings Pearson’s total holding in Interactive Data to almost 62%.tax purposes will exceed any book gain.

      On January 23,September 30, 2006, Pearson announced the acquisitionGroup acquired 100% of the voting rights of Mergermarket, a financial information company providing information to financial institutions, corporations and their advisers. In addition, several other businesses were acquired in 2006 including Promissor, a leading professional testing business from Houghton Mifflin Company for $42m in cash.

      On May 5, 2006July 22, 2005, Pearson announcedacquired 100% of the acquisitionvoting rights of AGS Publishing, an 80% stakeeducational assessments and curriculum materials publisher.

      In addition, several other businesses were acquired in Paravia Bruno Mondadori, onethe current and prior years, none of Italy’s leading educational publishing companies.which were individually material to the Group.

      Pearson plc is a holding company which conducts its business primarily through subsidiaries and other affiliates throughout the world. Below is a list of our significant subsidiaries as at December 31, 2005,2006, including name, country of incorporation or residence, proportion of ownership interest and, if different, proportion of voting power held.

      Our headquarters isare located at leasehold premises in London, England. We own or lease approximately 650 properties in more than 50 countries worldwide, the majority of which are located in the United Kingdom and the United States.

      All of the properties owned and leased by us are suitable for their respective purposes and are in good operating condition. These properties consist mainly of offices, distribution centers and computer centers.

      We own the following principal properties:

      We lease the following principal properties:

      There are no unresolved staff comments.

      The following discussion and analysis is based on and should be read in conjunction with the consolidated financial statements, including the related notes, appearing elsewhere in this Annual Report. The financial statements have been prepared in accordance with IFRS, which differs in certain significant respects from US GAAP. Note 3536 to our consolidated financial statements, included in “Item 17. Financial Statements”, provides a description of the significant differences between IFRS and US GAAP as they relate to our business and provides a reconciliation to US GAAP. These consolidated financial statements are the Group’s first financial statements to be prepared in accordance with IFRS, as adopted by the EU. Consolidated financial statements of Pearson up to and including December 31, 2004 had been prepared in accordance with UK GAAP. UK GAAP differs in certain respects from IFRS. When preparing the Group’s 2005 consolidated financial statements, management has amended certain accounting, valuation and consolidation methods applied in the UK GAAP financial statements to comply with IFRS. The comparative figures in respect of 2004 and 2003 were restated to reflect these adjustments. Note 34 included in “Item 17. Financial Statements”, describes how, in preparing the consolidated financial statements, the Group has applied accounting standards as adopted for use in the EU under the first-time adoption provisions as set out in IFRS 1.

      Sales from continuing operations increased from £3,696 million£3,808m in 20042005 to £4,096 million£4,137m in 2005,2006, an increase of 11%9%. The increase reflected growth across all the businesses together with a particularly strong performance at Pearson Education.additional contributions from acquisitions made in both 2005 and 2006. The year on year growth was impacted by exchange rates, but less so than in previous years.particular the US dollar. The average US dollar exchange rate strengthened slightlyweakened in 2005,2006, which had the effect of increasingreducing reported sales

      Profit before taxation in 20052006 of £466 million£466m compares to a profit before taxation of £325 million£446m in 2004.2005. The increase of £141 million£20m reflects the improved operating performance andoffset by a reductionsmall increase in net finance costs. Net finance costs reducedincreased from £79 million£70m in 20042005 to £70 million£74m in 2005. Net2006. The Group’s net interest payable benefited from the reductionincreased by £17m in average net debt following receipt of the proceeds from the sale of Recoletos and MarketWatch and good cash generation from the businesses. Partially offsetting this effect was an increase in the group’s average net interest rate payable driven principally by2006 due to the strong rise in US dollar floating interest rates and an increase in the year. As at January 1, 2005 we adoptedGroup’s average net debt largely reflecting the cost of acquisitions made in 2006. Partially offsetting this effect was finance income relating to post retirement plans of £4m in 2006 compared to a cost of £7m in 2005. The adoption of IAS 39‘Financial Instruments: Recognition and Measurement’in our financial statements. Thisstatements as at January 1, 2005 has had the effect of introducingpotential to introduce increased volatility into the net finance cost andalthough the effect in 2005 the adoption of2006 was not significantly different from that in 2005. IAS 39 related items and foreign exchange gains and losses together reduced net finance costs by £14 million. There was no equivalent benefit£16m in 20052006 compared to the one-off credita reduction of £9 million for interest on a repayment of tax that occurred£14m in 2004.2005.

      In AprilDecember 2006 the Group announced the sale of its Government contracting business, Pearson Government Solutions. The sale was completed in February 2007 and the results of this business have been shown in discontinued operations in the consolidated income statement for 2006, 2005 Pearsonand 2004. In 2005 the Group sold its 79% interest in Recoletos Grupo de Comunicacion S.A. to Retos Cartera, a consortium of investors, as part of a tender offer for all of Recoletos. The transaction became unconditional on approval from the Spanish regulatory authorities in February 2005. The results of Recoletos have been consolidated for the period to February 28, 2005 and have been shown as discontinued operations in the consolidated income statement for 2005 2004 and 2003.2004.

      Net cash generated from operating activities increaseddecreased to £709 million£456m in 2006 from £487m in 2005. Cash generation in 2006 would have shown an improvement on 2005 from £562 million in 2004 with very strong cash generation across allbut for the businesses. Cash flow in 2004 benefited from collection of the $151 million receivable in respect of the Transportation Security Administration (“TSA”) contract, a contract to create a qualification, assessment, staffing and placement system for security screeners at airports in the US. The relative strengthweakness of the US dollar also increasedwhich reduced the value of our cash flows in Sterling. Capital expenditure was down from 2004 following the up-front expenditure on professional testing contracts in that year but investment in pre-publication increased.sterling. On an average basis, the use of working capital continued to improve. Capital expenditure in 2006 was in line with 2005 levels at constant exchange rates. The net cash inflowoutflow in respect of businesses acquired increased from £246m in 2005 to £363m in 2006. There were no significant disposals in 2006 to match the proceeds received from the sale of Recoletos and Marketwatch in 2005 resulting in a decrease in cash proceeds from disposals net of acquisitions was £175 million in 2005 compared£420m. Dividends from joint ventures and associates increased by £31m largely due to a net cash outflow of £4 million in 2004.special dividends received from the Economist. Dividends paid of £222 million£235m in 20052006 (including £17 million£15m paid to minority interests) compares to £197 million£222m in 2004 and, after an adverse2005. After a favorable currency movement of £121 million,£126m, overall net borrowings fell 18%increased by 6% from £1,221 million£996m at the end of 20042005 to £996 million£1,059m at the end of 2005.2006.

      Pearson reported record results in 2006 and our strong trading has continued in the early part of 2007. We have made a good start in the major school textbook adoptions; continued to roll out our groundbreaking online learning and assessment platforms in Higher Education; published a string of bestsellers in Penguin; and achieved steady growth in both advertising and circulation at FT Publishing.

      We are trading in line with expectations for 2007 and expect 2006 to be anotherachieve good year for Pearson as we anticipate increasing margins andunderlying earnings growth, cash conversion ahead of our markets. We expect to achieve strong earnings growth, good cash generation80% threshold, and a further significant improvementincrease in return on invested capital. As always, our sales and profits will be concentrated in the second half of the year.

      We expect Pearson EducationSchool to achieve underlying sales growth in the 3-5%4-6% range with similar rates of growth in each of its three worldwide businesses (School,margins improving; Higher Education and Professional). We expect margins to improve in School and Professional and remain stable in the Higher Education business. School testing is strengthened by 2005 contract wins with a lifetime value of $700 million (including Texas, Virginia, Michigan and Minnesota) and the US School new adoption market is expectedsales to grow strongly overin the period 2007 to 2009.

      We expect furtherFinancial Times Group profit improvementto grow strongly with our cost measures, integration actions and revenue diversification pushing margins into double digits at the FT Group. TheFinancial Times continuesPublishing. IDC revenues to show good momentumgrow in the6-9% range with circulation up 4% and advertising revenues continue to show double digitnet income growth in the early part of 2006. IDC expects another good year, benefiting from similar business conditionshigh single-digits to 2005, strong organiclow double-digits (headline growth and the contribution of recent acquisitions.under US GAAP);

      Penguin is expected to grow at a similar rate in 2006 to 2005 with continued investment in new markets and international talent and with a strong list of new titles from best selling authors. Margins are expectedmargins to improve steadilyfurther, as we benefit fromits publishing investment and efficiency gains.

      The following table shows sales information for each of the past three years by operating division:

      The following table shows sales information for each of the past three years by geographic region:

      We earn a significant proportion of our sales and profits in overseas currencies, principally the US dollar. Sales and profits are translated into sterling in the consolidated financial statements using average rates. The average rate used for the US dollar was $1.84 in 2006, $1.81 in 2005, and $1.83 in 2004 and $1.63 in 2003.2004. Fluctuations in exchange rates can have a significant impact on our reported sales and profits. The GroupPearson generates approximately 65% of its sales in US dollars andthe US. We estimate that a five cent change in the averageclosing exchange rate forbetween the fullUS dollar and sterling in any year has an impact of approximately 1 pence oncould affect our reported earnings per share.share by 1p and shareholders’ funds by approximately £85m. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk” for more information. Theyear-end US dollar rate for 2006 was £1:$1.96 compared to £1:$1.72 for 2005. The weakening in the US dollar reduced our shareholders’ funds by £417m (see note 27 of “Item 17. Financial