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Rating Action:

MOODY'S CONFIRMS READER'S DIGEST Ba1 SR IMPLIED, UPGRADES SR UNSEC NOTES TO Ba2 FROM Ba3; OUTLOOK IS STABLE

06 May 2005
MOODY'S CONFIRMS READER'S DIGEST Ba1 SR IMPLIED, UPGRADES SR UNSEC NOTES TO Ba2 FROM Ba3; OUTLOOK IS STABLE

Approximately $750 Million of Debt Affected

New York, May 06, 2005 -- Moody's Investors Service confirmed the corporate ratings for The Reader's Digest Association, Inc. ("Reader's Digest") in connection with the company's closing of a new $400 million senior secured revolving credit facility and announcement that the Board of Directors approved a $100 million share repurchase authorization. The outlook was changed to stable from negative due to Moody's expectation for greater revenue stability and our belief that the company will continue to generate free cash flow and reduce debt.

Moody's undertook the following rating actions:

- Upgraded to Ba2 from Ba3 the rating on the $300 million 6.5% senior unsecured unguarateed notes due March 2011

- Confirmed the Ba1 senior implied rating

- Confirmed the Ba3 senior unsecured issuer rating

The following specific ratings were withdrawn:

- Ba1 rating on the $458.5 million guaranteed senior secured bank credit facility, consisting of:

- $192.5 million revolving credit facility due July 2006

- $128 million remaining outstanding Tranche A term loan due November 2007;

- $138 million remaining outstanding Tranche B term loan due May 2008

Moody's does not rate the new $400 million guaranteed senior secured revolving credit facility due April 2010. Proceeds from an initial drawdown made upon closing of the new revolver were utilized to retire the remaining balances on the previous credit facility, the commitments of which were then terminated.

The change in outlook to stable from negative reflects the company's aggressive debt reduction and greater potential for new product introductions to stabilize the revenue base now that the bulk of the portfolio rationalization has been completed. Since the negative outlook was assigned in June 2003, lease-adjusted debt has declined to 3.6x EBITDAR in the 12 months ended March 31, 2005 from 4.9x in the fiscal year ended June 30, 2003. Reader's Digest has reduced debt by approximately $375 million since the May 2002 acquisition of Reiman Holding Company, LLC largely through free cash flow from operations. The company also utilized the $48.5 million proceeds from the sale and partial leaseback of its Pleasantville, NY headquarters in December 2004 to reduce debt. Net annual operating lease rental commitments will increase by approximately $3 million, but the transaction results in a net reduction in lease-adjusted debt-to-EBITDAR as the company only occupies a portion of the facility and will also benefit from a reduction in facility maintenance costs. The stable outlook also reflects our expectation that future share repurchases will be sized relative to and funded only from free cash flow and that the company will not complete and significant debt-financed acquisitions.

The ratings reflect the company's high leverage, weakening revenue base, high sales return and bad debt experience, and adequate liquidity. Reader's Digest's retained cash flow generation remains vulnerable to further erosion of the revenue base, which has decreased due to a managed decline in flagship Reader's Digest magazine circulation, membership contraction and rationalization of product offerings at U.S. Books and Home Entertainment, lower renewal rates and series book sales at Reiman, and operating difficulties at Books are Fun and QSP. Management believes it has strategies in place to stabilize and renew growth. However, BAF and QSP will remain a particular challenge. These businesses are subject to low entry barriers, a limited amount of unique product offerings, and reliance on a sales force that at times exhibits high turnover.

A doubling of the annual dividend to $40 million from $20 million announced in January 2005 and recent $100 million share repurchase authorization could also reduce cash flow available for debt repayment. These actions represent a notable move toward more shareholder-oriented cash uses from the last three years. Moody's believes management remains committed to further debt reduction. However, the pace of debt reduction will likely slow considerably.

Liquidity remains only adequate. An effective reduction in the bank credit facility commitment to $400 million from the $458 million that was remaining under the previous facility is balanced by looser covenants and the elimination of the $40+ million annual term loan amortization on the old facility. A sizable portion of the $400 million revolver will be utilized with intra-period borrowings and the seasonal working capital build in advance of the peak Holiday sales season further diminishing unused capacity.

The ratings more favorably reflect Reader's Digest's strong brands, significant global circulation of the company's various magazines that collectively exceeds 30 million and consistent free cash flow. In addition to the Reader's Digest magazine, the company generates a significant portion of its revenue from other products including special interest magazines (topics include food, gardening, and crafts), books, recorded music collections and home videos. Reader's Digest is geographically diversified with 41% of revenues generated outside North America and further expansion planned into developing countries. The company is near the completion of a two year restructuring program that focused on reducing fixed costs, stabilizing the customer base and renewing revenue growth. Reduction in the U.S. rate base for the Reader's Digest magazine to 10 million has relieved pressure on the company to sustain circulation at levels where subscriber acquisition and retention costs exceeded marginal revenue. These actions stabilized margins in the last few years notwithstanding ongoing contraction of the revenue base.

Failure to exhibit greater revenue stability, an erosion of EBIT operating margins below 7.5%, lease-adjusted debt in excess of 4.0x EBITDAR and/or debt approaching 8.0x free cash flow could put negative pressure on the ratings.

We view the likelihood of upward movement in the ratings as limited until the company can demonstrate sustainable organic revenue growth and reduce lease-adjusted debt-to-EBITDAR closer to the 2.0x range with operating margins in excess of 10%.

Reader's Digest and subsidiaries Books are Fun, Ltd., QSP, Inc. and Reiman Media Group, Inc. are borrowers under the new $400 million guaranteed senior secured revolving credit facility. As with the previous facility, obligations under the revolver are cross guaranteed by each of the borrowers. The facility is secured by a first lien on the stock of material domestic subsidiaries of the borrowers and by a pledge of 65% of the stock of material first tier foreign subsidiaries. Moody's estimates approximately 70% of revenues are generated at legal entities whose stock is pledged under the credit facility. The facility does not contain limits on equity buybacks or dividends.

Moody's narrowed the notching and upgraded the senior unsecured unguaranteed notes to Ba2 from Ba3 because the bonds are no longer effectively subordinate to the credit facility with respect to the tangible and intangible assets (except the subsidiary stock holdings discussed above) of the parent company The Reader's Digest Association, Inc. Accordingly, the bonds and the new credit facility have the same priority of claim with respect to such parent company assets, which include the customer lists and brands. The parent's tangible and intangible assets had been pledged as security under the previous credit facility. The bonds do not benefit from subsidiary guarantees and are now placed one notch below the senior implied due to their structural subordination to subsidiary obligations.

The Reader's Digest Association, Inc, headquartered in Pleasantville, New York, is a global publisher and direct marketer of products including magazines, books, recorded music collections and home videos. Products include Readers Digest magazine, which is published in 48 editions and 19 languages. Annual revenues approximate $2.3 billion.

New York
John E. Puchalla
Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Andris G. Kalnins
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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