Readers Digest touts debt paydown progress, seeks covenant flexibility

By Paul Deckelman

New York, Jan. 26 - Readers Digest Association Inc. said Wednesday that it had paid down $203 million of debt in the 2005 fiscal second quarter ended Dec. 31 and indicated that it had been in preliminary talks with its bank lenders on giving the Pleasantville, N.Y.-based publisher more covenant flexibility in the use of its cash.

The company - which since 1922 has published the famed little magazine from which it takes its corporate name, in addition to marketing books, book collections, recorded music collections and home video products and providing fundraising services to schools and other institutions - generated $230 million in cash in the quarter, behind what chief financial officer Michael S. Geltzeiler termed "solid" cash flow from operations and the sale of some non-strategic assets.

He told analysts on a morning conference call following the release of the quarterly and fiscal first half results that free cash flow for the quarter was $181 million, $15 million more than a year earlier. The company additionally realized an incremental $47 million from the first installment of proceeds from the sale and partial leaseback of its Pleasantville headquarters facility, and $2 million from magazine divestitures in the United States and Britain.

Most of that cash was used to pay down the $203 million of debt, disburse the company's quarterly dividend - which last week was increased to 40 cents a share annually from 20 cents - and to increase existing cash balances.

Cash on hand increased by $26 million in the quarter to $56 million. The CFO noted that the fiscal second quarter historically is the strongest quarter for cash generation for each of the company's three business sectors - its venerable flagship magazine, a U.S. division that sells books and other products and services, and an international division.

Following the debt paydown during the quarter, total debt as of Dec. 31 was $596 million, consisting of $300 million of long-term fixed-rate debt - its 6½% senior notes due 2011, which were issued last February - and $296 million of variable-rate term loans. Last May, the company took out $385 million in a two-part term loan deal, a portion of which has now been paid down.

The company's revolving credit facility has been fully paid down.

Aiming for net debt under $500 million

Gertzeiler said that free cash flow for the first six months of the '05 fiscal year totaled $94 million, about the same as a year ago. The company confirmed its previously announced expectations that fiscal 2005 free cash flow will exceed fiscal 2004's $172 million - a projection which does not include the proceeds from the Pleasantville sale/leaseback transaction.

He said that Reader's Digest "continue[s] to expect that net debt will be below $500 million" by the end of the fiscal year on June 30.

The company's net debt leverage ratio improved to 2.7 times EBITDA as of Dec. 31 and the executive said that he expects that ratio to "drop comfortably" below 2.5 times EBITDA by the end of June, as Reader's Digest further pays down debt and reports higher second-half EBITDA.

Geltzeiler said that while the company "remains focused on repaying debt at an accelerated rate," the lower leverage also enables it "to explore opportunities to return excess capital to its shareholders," such as the recent doubling of its dividend.

He noted that the company's credit covenants allow for discretionary payments of dividends and share repurchases, up to $50 million per year.

Looking for more flexibility

As the company's credit profile continues to improve, he said, it will be "pursuing additional flexibility" with its lenders. He anticipates something happening on that front some time in the fiscal second half.

In answer to a question from an analyst who wanted to know what kind of response Reader's Digest was getting from its lenders on the notion of giving it a little more covenant flexibility in the matter of spending its cash, Geltzeiler said that the company had already had some "preliminary dialogues" on the matter with its lead bank, although he declined to be any more specific, other than to say the lenders "are pleased, certainly" with the level of the company's debt repayments, since "we're ahead of schedule," and are also pleased with the current state of its leverage ratio.

"The banking market is very favorable now, and we will be exploring these opportunities," and keeping the financial community abreast of its progress, he said.

When another analyst asked for clarification on just how much under $500 million the company expects net debt to be by the end of the fiscal year, the CFO acknowledged that the $500 million figure might be "a little conservative" - but he stuck with it.

"It think that the missing link there is we've already raised our dividend by $10 million - now what else are we going to do with our cash, besides pay down debt?"

He said that the company had "factored in those potential uses" of cash in coming up with its projections that it would be below $500 million.

Geltzeiler said "both elements of our debt are trading considerably above par, which I think is an indication that our lenders are happy."

Selling assets

Meanwhile he said, Reader's Digest continues to make progress in its efforts to divest and monetize non-productive assets. During the second quarter, besides closing on the Pleasantville sale/leaseback, it closed on a real estate sale in Australia, sold magazines in the United Kingdom and the United States, and sold the gifts.com URL. Those transactions generated a $7 million earnings gain in the quarter.

For the quarter, the company earned $57.8 million (or 58 cents a share), down about 13% from year-earlier earnings of $66.5 million (67 cents a share). Wall Street had been looking for 72 cents a share of profit. Earnings in the latest period were impacted by a 17 cent per share non-cash charge for amortization of previously deferred magazine promotion expenses, and the company also said results would have been an additional six cents a share higher, had magazine promotion expense in fiscal 2004 been accounted for the same way.

Revenues in the latest quarter were $798 million, up slightly from $796.4 million a year earlier.

The company's chairman and chief executive officer, Thomas O. Ryder, declared on the conference call that he was "pleased with the overall condition of our business."

While he noted that he wished "we were further along with QSP [its school fundraising services operation] and Books Are Fun [which organizes book fairs and other sales venues], I do think that we are doing the right things with them and I know that we have tremendous growth potential in each of those businesses."

Ryder said he was "increasingly confident" that the company would meet its guidance of 77 cents to 87 cents of per-share earnings for the fiscal year, excluding special items, "because I think the positive momentum in our core business will more than offset any residual downside in consumer business services."

"Strong producer of cash"

Ryder said that one of the notable features of the company is that "it's a very strong producer of cash. Even during transition years - even during the most difficult times in our turnaround, with the exception of only one year, Reader's Digest has produced strong cash flow."

He noted that since the company's last significant acquisition several years ago and its share re-capitalization at that time, "we have used almost all of our cash to repay debt. We are now at the point where we have more choices how to improve shareholder value.

"Based on our current ratios," he said, "we believe we have a further opportunity to reduce our cost of financing and to achieve greater flexibility in our covenants."

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