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Rating Action:

MOODY'S DOWNGRADES READER'S DIGEST ASSOCIATION, INC'S SR. SECURED RATINGS TO Ba1 FROM Baa3; OUTLOOK IS NEGATIVE

20 Jun 2003
MOODY'S DOWNGRADES READER'S DIGEST ASSOCIATION, INC'S SR. SECURED RATINGS TO Ba1 FROM Baa3; OUTLOOK IS NEGATIVE

$917 million in debt affected

New York, June 20, 2003 -- Moody's Investors Service has downgraded Reader's Digest Association, Inc.'s senior secured ratings to Ba1 from Baa3 and senior unsecured shelf registration rating to (P)Ba3 from (P)Ba1. Moody's also assigned Ba1 senior implied and Ba3 issuer ratings to the company. The outlook is negative.

The downgrade reflects: 1) declining revenues and profitability, 2) weakened debt-to-EBITDA metrics, 3) limited success to date in rebuilding profitability at its flagship magazine and integrating and expanding new business offerings, like Reiman, QSP and BAF, to drive revenue growth, 4) the need to take restructuring actions to rationalize its cost structure to reflect the challenging operating environment, which will take time to gain any traction; and 5) the need to amend the leverage covenant for existing secured bank facilities in order to provide intermediate-term covenant relief which could be offset by a marginal increase in interest costs and future covenant step downs.

The negative outlook reflects Moody's expectations that: 1) revenues and profitability will remain under pressure, particularly in the international businesses, which account for over 40% of total revenues, and 2) credit metrics will not improve significantly, and could even deteriorate further over the next 12-18 months.

Moody's expects that the company will successfully amend the financial leverage covenant for its existing secured bank facilities in order to avoid a potential breach at the end of this quarter when it will step down from 3.75x debt-to-EBITDA to 3.25x. Despite the performance declines, the company generates free cash flow and should be able to pay down debt, given it is not buying back shares and Moody's does not expect it to make any acquisitions. This should provide some comfort to the bank group. Should the amendment encounter difficulties, further rating actions will be necessary.

Moody's believes that management's attempts to rationalize the company's cost structure will not keep pace with the pressure on revenue growth in virtually all of its business segments. This could result in additional deterioration in already weak EBITDA margins of 10% and high financial leverage of 3.65x debt-to-EBITDA and more than 6.0x debt-to-free cash flow (as of 3rd quarter 2003).

Over the last year, Reader's has experienced operating pressure due to the economic and geopolitical climate and increasing competition. This has had an adverse impact on the company's plans for rebuilding profitability around its flagship magazine, driving revenue growth from QSP and Books Are Fun, successfully integrating the new Reiman properties, and stabilizing operating performance in the international businesses. On a trailing 12 months basis for the 3rd quarter 2003, the business segments with the weakest operating performance were the international businesses and U.S. Books and Home Entertainment (B&HE), which experienced revenue declines of 5% and 24%, respectively, over fiscal 2002. Over this same time period, the international businesses saw operating profit decline by nearly 54%, and while U.S. B&HE improved the bottom line operating profit was still negative. The business segments performing relatively better, but still underperforming, include Books Are Fun and QSP, which saw revenue increases of 4% and 1%, respectively, with flat growth in operating profit overall. In order to keep up with revenue declines of 6.6% (excluding the Reiman revenues) over the last 12 months, the company has taken some restructuring initiatives that will take some time before operating margins will improve.

Due to Reader's acquisition of Reiman Holding Company for $760 million, and its purchase of the Wallace Funds stake for $100 million, which together gave rise to the bulk of the debt on its balance sheet, Moody's believes financial leverage ratios will not improve significantly until the middle of fiscal 2005.

On the one hand, Moody's expects the amended terms of the credit facility will provide sufficient liquidity for Reader's to cover its working capital needs. However, on the other hand, Moody's believes the new financial covenants could prevent the company from fully drawing on its revolver, thereby limiting its ability to address unexpected contingencies. Historically, in its 1st fiscal quarter (3rd calendar quarter), the company requires between $90 million - $100 million in working capital as it builds inventories at a number of its businesses. In order to meet these working capital needs, the company borrows from its $192.5 million 5-year revolver, which the company begins to repay in the 2nd fiscal quarter when it generates approximately two-thirds of its total EBITDA for the year, with a substantial portion of this being generated at QSP, Books are Fun, and Reiman. In addition, due to low capital expenditure requirements and some working capital gains, the company generates approximately $115 million to $130 million in free cash flow (after dividends), which represents a high 45% to 50% conversion of EBITDA to free cash flow, and only has $32 million in required amortization in fiscal 2004 and $57 million in fiscal 2005.

Reader's Digest continues to be one of the best-known brands in the world with more than 100 million people using the company's products. The company has moved away from sweepstakes as a primary channel for generating revenue with increasing reliance on retail, direct mail, school fundraising, book fairs, and joint promotion and marketing ventures. The company is increasingly diversified, both in its geographic operations and in its line of products, with international businesses accounting for 45% of revenues and 20% of its revenues from new non-traditional core products, such as QSP and BAF.

The Reader's Digest Association, Inc. is a global publisher and direct marketer of products that inform, enrich, entertain and inspire people of all ages and cultures around the world. Products include Readers Digest magazine, the most widely read magazine in the world, published in 19 languages, 48 editions and more than 60 countries. Global headquarters are located at Pleasantville, New York.

The Reader's Digest Association, Inc. is a global publisher and direct marketer of products that inform, enrich, entertain and inspire people of all ages and cultures around the world. Products include Readers Digest magazine, the most widely read magazine in the world, published in 19 languages, 48 editions and more than 60 countries. Global headquarters are located at Pleasantville, New York.

New York
David Hamburger
Associate Analyst
Media & Telecom Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Glenn B. Eckert
VP - Senior Credit Officer
Media & Telecom Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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