*The
      Reader’s Digest Association, Inc. and Subsidiaries*





**Management’s
      Discussion and Analysis**


*Dollars
      in millions, except per share data*




Unless
        otherwise indicated, references in Management’s Discussion and Analysis to “we,”
“our” and “us” are to The Reader’s Digest Association, Inc. and its
        subsidiaries. All references to 2006, 2005 and 2004, unless otherwise indicated,
        are to fiscal 2006, fiscal 2005 and fiscal 2004, respectively. Our fiscal
        year
        represents the period from July 1 through June 30.





The
      following discussion and analysis provides information that we believe is
      relevant to an assessment and understanding of our consolidated results of
      operations and financial condition and
      has
      been written excluding the effect of foreign currency translation, except as
      specifically noted otherwise .
      This
      discussion should be read in conjunction with our Consolidated Financial
      Statements and related Notes. Certain amounts and percentages do not recalculate
      due to rounding.








**Results
      of Operations: Company-Wide**




**Our
      Reportable Segments**





Our
      businesses are structured into the same three reportable segments (Reader’s
      Digest North America, Reader’s Digest International and Consumer Business
      Services) that our chief operating decision maker uses to assess business
      performance. In addition to the reportable segments, we separately report
      Corporate Unallocated expenses, which are expenses not directly attributable
      to
      business unit performance. Similarly, we separately report the effects of
      previously deferred magazine promotion expense, goodwill charges and other
      operating items, net, because our chief operating decision maker does not factor
      in these items when assessing business unit performance. Here is a brief
      description of the activities included within our reportable
      segments.





**Reader’s
      Digest North America**





This
      segment comprises our operations in the United States and Canada that publish
      and market *Reader’s
      Digest* magazine, Reiman magazines and several special interest magazines. It also
      includes our operations in the United States and Canada that publish and market
      Books and Home Entertainment products (including Select Editions, Reader’s
      Digest Young Families, music and video products, and series and general books
      related to the following affinities: reading, home and health, and
      entertainment) as well as two new businesses, *Allrecipes.com* and
      Taste
      of Home Entertaining. Growth initiatives in this segment include developing
      and
      launching new products and leveraging our existing products and
      brands.





These
      businesses have a common focus on the direct marketing aspect of new customer
      acquisition at a minimal cost. The performance of *Reader’s
      Digest* magazine
      and our special interest magazines is driven primarily by circulation revenues
      and secondarily by advertising sales. Circulation is also the principal driver
      of performance for Reiman magazines, which have limited advertising revenues.
      The results of our Books and Home Entertainment business are driven by the
      size
      of our active customer base, new customer acquisition programs, response rates
      to promotional mailings, customer payment rates and membership in our continuity
      series business.




-1-


**Reader’s
      Digest International**





This
      segment comprises our operations outside of the United States and Canada, with
      our most significant markets in the United Kingdom, Germany, Central Europe
      and
      France. The businesses in this segment publish and market *Reader’s
      Digest* magazine
      (in numerous editions and languages) and books and home entertainment products
      (described above). Growth initiatives in this segment include entering new
      geographic markets, developing and launching new products, acquiring customers
      through new channels and expanding U.S. business models into markets outside
      of
      North America.





The
      performance of these businesses is driven by factors similar to those in the
      Reader’s Digest North America segment, except that overall results are less
      sensitive to changes in individual geographic market conditions due to the
      number of markets in which we operate. The results for *Reader’s
      Digest* magazine
      in international markets are driven primarily by circulation and secondarily
      by
      advertising revenues. The results of our books and home entertainment products
      in these markets are driven by the size of our active customer base, new
      customer acquisition programs, response rates to promotional mailings, customer
      payment rates and membership in our continuity series business.





**Consumer
      Business Services**





This
      segment comprises Books Are Fun, our display marketing business, and QSP, our
      youth fundraising businesses, in the United States and Canada. These businesses
      focus on increasing market penetration and expanding efficiency with existing
      accounts by leveraging our sales force.





Books
      Are
      Fun and QSP principally sell products through non-direct marketing channels,
      primarily through their sales forces. The performance of these businesses is
      driven by product selection, the number of accounts or events, the average
      sales
      per account or event, and the number of participants in fundraising
      programs.





**Intercompany
      Eliminations and Corporate Unallocated Expenses**





We
      present our segment revenues and operating (losses) profits consistently with
      how we manage our operations and how our chief operating decision maker reviews
      our results. Revenues and expenses attributable to intercompany transactions
      are
      included in the results of our reportable segments. Such amounts are eliminated
      (under the intercompany eliminations caption below) to reconcile our reportable
      segment amounts to consolidated amounts, as reported in the statements of
      operations. In addition to intercompany revenues and expenses, we separately
      report Corporate Unallocated expenses, which cover expenses that are not
      directly attributable to business unit performance. Corporate
      Unallocated expenses include the cost of governance and other corporate-related
      expenses, as well as income and expenses associated with our U.S. pension plans
      and retiree healthcare benefits, and stock and executive compensation programs
      that are not allocated to the reportable segments.




-2-


**Summary
      of Reportable Segment Results**





**Years
                ended June 30,****2006**
            
            2005
            
            2004***Revenues***Reader’s
                Digest North America
            
            **$**
            **939**
            
            $
            917
            
            $
            919Reader’s
                Digest International
            
            
            **1,031**
            
            
            1,012
            
            
            970Consumer
                Business Services
            
            
            **446**
            
            
            485
            
            
            525Intercompany
                eliminations
            
            
            **(30**
            **)**
            
            (24
            )
            
            (26
            )**Total
                revenues**
            
            **$**
            **2,386**
            
            **$**
            **2,390**
            
            **$**
            **2,388*****Operating
                (loss) profit***Reader’s
                Digest North America
            
            **$**
            **115**
            
            $
            91
            
            $
            76Reader’s
                Digest International
            
            
            **78**
            
            
            76
            
            
            57Consumer
                Business Services
            
            
            **(3**
            **)**
            
            29
            
            
            59Previously
                deferred magazine promotionexpense(1)
            
            
            **---**
            
            
            (77
            )
            
            (27
            )Goodwill
                charge(2)
            
            
            **(188**
            **)**
            
            (129
            )
            
            ---Corporate
                Unallocated
            
            
            **(40**
            **)**
            
            (38
            )
            
            (44
            )Other
                operating items, net(3)
            
            
            **(7**
            **)**
            
            14
            
            
            (9
            )**Operating
                (loss) profit**
            
            **$**
            **(45**
            **)**
            **$**
            **(34**
            **)**
            **$**
            **112*****Intercompany
                eliminations***Reader’s
                Digest North America
            
            **$**
            **(11**
            **)**
            $
            (9
            )
            $
            (11
            )Reader’s
                Digest International
            
            
            **(6**
            **)**
            
            (4
            )
            
            (4
            )Consumer
                Business Services
            
            
            **(13**
            **)**
            
            (11
            )
            
            (11
            )**Total
                intercompany eliminations**
            
            **$**
            **(30**
            **)**
            **$**
            **(24**
            **)**
            **$**
            **(26**
            **)**





(1)
            In
                connection with our change to expensing magazine deferred promotion
                costs
                when the promotion is mailed to prospective customers, our reportable
                segment operating (loss) profit in 2005 includes such expenses as
                incurred. Amortization of previously deferred promotion costs in
                2005 and
                our deferred promotion charge recorded in the fourth quarter of 2004
                are
                not included in segment results reviewed by our chief operating decision
                maker. For the year ended June 30, 2005, 81% of amortization of previously
                capitalized magazine promotion costs was related to Reader’s Digest North
                America and 19% to Reader’s Digest International. For the year ended June
                30, 2004, 45% of our magazine deferred promotion charge was related
                to
                Reader’s Digest North America and 55% to Reader’s Digest
                International.





(2)
            The
                goodwill charge related to Books Are Fun, part of the Consumer Business
                Services reportable segment, is not included in segment results reviewed
                by our chief operating decision maker. See Note 6, Goodwill and Other
                Intangible Assets, Net, in our Notes to Consolidated Financial Statements
                for additional information.





(3)
            Other
                operating items, net consists of gains on sales of certain non-strategic
                assets and restructuring charges. Such items are not included in
                segment
                results reviewed by our chief operating decision maker. See Note
                3, Other
                Operating Items, Net, in our Notes to Consolidated Financial Statements
                for additional information. In previous periods, gains on sales of
                certain
                non-strategic assets were classified as other (expense) income, net,
                and
                have been reclassified to other operating items, net to conform to
                the
                current year presentation.





-3-


**Overview**





During
      2005 we made many changes to right-size our businesses and invest in new market
      expansion. In 2006 we shifted our focus from stabilization to growth. As such,
      in 2006, we continued to invest in the future, while realizing some of the
      benefits from our investments. During the year, we launched *Every Day with
      Rachael Ray, Daheim in Deutschland* and three new editions of *Reader’s
      Digest* magazine, and we started selling books and home entertainment products in six
      new international markets. These investments expanded both our product portfolio
      in key affinity groups and our global scale. Also, in the fourth quarter we
      launched Taste of Home Entertaining, and we acquired *Allrecipes.com* .
      Taste
      of Home Entertaining is a home party plan business that extends our Taste
      of Home brand, while *Allrecipes.com*  provides
      us a platform to leverage our content in the food affinity to digital media. Each
      of
      these investments made positive contributions to revenues in either Reader’s
      Digest North America or Reader’s Digest International.





While
      revenues and profits in these segments improved, Consumer Business Services
      continued to experience challenges in 2006. Competitive pressures at Books
      Are
      Fun and turnover in our sales force adversely affected revenues and profits.
      As
      a result, Books Are Fun recorded a charge in the second quarter to write off
      its
      remaining goodwill. At QSP, the benefits of cost reduction measures were
      partially offset by a charge related to our calendar year 2006 World’s Finest
      Chocolate minimum tonnage purchase commitment.





During
      the fourth quarter of 2006 we also recorded restructuring and inventory charges
      primarily related to the Books Are Fun turnaround plan and, to a lesser extent,
      to strategic downsizing activities at other business units.




**Revenues
      and Operating (Loss) Profit**





***2006
      v. 2005***





**Revenues**





Revenues
      decreased to $2,386 in 2006, compared with $2,390 in 2005. The effect of foreign
      currency fluctuations reduced revenues in 2006 by $7. While revenues improved
      in
      Reader’s Digest North America and Reader’s Digest International, revenues
      declined at Consumer Business Services.





Revenues
      for Reader’s Digest International increased principally because we began to
      realize the benefits of previous investments to expand our business in new
      markets, including Romania and Ukraine. Also, growth in our active customer
      base
      translated into increased promotional activity and, consequently, higher
      revenues in certain established markets, including Russia, Brazil and Australia.
      These increases were partially offset by lower revenues in the United Kingdom,
      Poland, the Nordic region and Portugal, where our active customer base
      contracted.





Revenues
      also increased for Reader’s Digest North America in part because we realized the
      benefits of previous investments in the business. Increased circulation revenues
      were driven by new magazine titles, while the additions of our home party plan
      business and *Allrecipes.com* made
      positive contributions. These increases were partially offset by continued
      weakness in certain established Reiman-inspired book annual products, lower
      promotion activity in Reader’s Digest Young Families and lower circulation
      revenues for *Reader’s
      Digest* magazine.


-4-





Lower
      revenues for Consumer Business Services were driven by fewer corporate events
      held by Books Are Fun because of turnover in our independent sales force and
      competitive pressures in certain regions. In addition, lower average sales
      per
      school event at Books Are Fun contributed to the decline. Revenues were also
      lower at QSP, where lower magazine volumes were partially offset by higher
      food
      and gift sales.




**Operating
      (Loss) Profit**





In
      2006,
      our operating loss was $(45), compared with a loss of $(34) in 2005. The
      comparability of results was affected by two significant items: a $(59) higher
      goodwill charge recorded in 2006 when compared with the charge recorded in
      2005,
      offset by the absence of $(77) of expense recorded in 2005 related to the
      amortization of previously deferred magazine promotion costs (see *Previously
      Deferred Magazine Promotion Expense* below).
      Also, lower profitability for Consumer Business Services and higher Corporate
      Unallocated expenses were partially offset by higher profits for Reader’s Digest
      North America and Reader’s Digest International.





Product,
      distribution and editorial expenses increased 3% to $(997) in 2006, compared
      with $(971) in 2005. Increased costs were principally driven by the addition
      of
      printing and paper expenses for new magazine titles, including *Every
      Day with Rachael Ray* and *Cooking
      for 2* ,
      higher
      postage costs in Reader’s Digest North America, and a charge related to our
      calendar year 2006 World’s Finest Chocolate minimum tonnage purchase commitment.
      Also, product costs were higher in certain international markets, commensurate
      with the increase in revenues and due to an inventory charge at Books Are Fun
      to
      lower the value of old and discontinued items. These increases were partially
      offset by supply chain savings in certain international markets.





Promotion,
      marketing and administrative expenses decreased 7% to $(1,240) in 2006, compared
      with $(1,337) in 2005. The comparability of these amounts was affected by the
      inclusion of amortization of previously deferred magazine promotion costs of
      $(77) in 2005 (see *Previously
      Deferred Magazine Promotion Expense* below).
      Also, promotion, marketing and administrative expenses declined because certain
      intangible assets established when we acquired Reiman reached the end of their
      useful lives in 2005, and thus we recorded $21 of lower amortization; we also
      had lower promotion costs in Reader’s Digest North America. The effects of cost
      reduction measures at QSP, and lower commission expense at Books Are Fun because
      of lower sales, further lowered costs. These decreases were partially offset
      by
      increased costs in certain international markets, commensurate with the increase
      in revenues.





*Reportable
      Segments*


The
      loss
      for Consumer Business Services was driven by the effects of competitive
      pressures, costs associated with recruiting and retaining members of the
      independent sales force, and a charge to lower the value of old and discontinued
      inventory. Also, in the fourth quarter of 2006, we recorded a charge of $(6)
      associated with the calendar year 2006 minimum tonnage purchase commitment
      in
      our World’s Finest Chocolate licensing agreement. These factors were partially
      offset by the effects of cost reduction measures at QSP.





The
      improvement in profits for Reader’s Digest North America was principally driven
      by $21
      of
      lower amortization of intangible assets at Reiman and lower promotion costs.
      This improvement was partially offset by costs associated with new initiatives.





Higher
      profits for Reader’s Digest International were driven by increased revenues,
      partially offset by investments in the business.




-5-


*Corporate
      Unallocated*


Corporate
      Unallocated expenses reflect the cost of governance and centrally managed
      expenses, as well as the accounting for U.S. pension plans, postretirement
      healthcare costs, and stock and executive compensation programs that are not
      allocated to the reportable segments. These expenses were $(40) in 2006,
      compared with $(38) in 2005. Increased costs were driven by stock
      option expense and lower net pension income, partially offset by the reversal
      of
      $4 from a litigation-related accrual recorded in previous periods that is no
      longer necessary and by lower incentive compensation expenses.





*Other
      Operating Items, Net*


Other
      operating items, net decreased to an expense of $(7) in 2006, compared with
      income of $14 in 2005. In 2006, restructuring charges comprised $(6) related
      to
      the Books Are Fun turnaround plan and $(5) related to various businesses, mostly
      in international markets. These charges were partially offset by gains of $3
      from the sale of non-strategic assets and restructuring reversals of $1,
      principally related to severance accruals recorded in previous periods that
      are
      no longer necessary.





To
      implement our turnaround strategy at Books Are Fun, we recorded severance of
      $(3) to lower our cost base, streamline processes and restructure the management
      team. Actions associated with these restructuring initiatives are expected
      to be
      completed by the end of fiscal 2007. In addition, we recorded $(3) to write
      off
      capitalized software costs for abandoned assets.





We
      also
      recorded restructuring charges of $(5), principally severance, to lower our
      cost
      base and streamline operations across various businesses, mostly in
      international markets. Actions associated with these initiatives are expected
      to
      be completed by the end of fiscal 2007.





In
      2005,
      we recorded income of $14 in other operating items, net. This amount comprises
      gains on the sales of non-strategic assets, including the sale of properties
      in
      various international markets and the sale of certain magazines, and
      restructuring reversals of $4 related to severance and other charges recorded
      in
      previous periods that are no longer necessary, partially offset by severance
      charges of $(4).





*Goodwill
      Charge*


We
      are
      required to assess the recoverability of goodwill and our indefinite-lived
      intangible assets at least annually. Due to a shortfall in Books Are Fun’s
      operating performance relative to our expectations during its peak selling
      season, we recorded a charge of $(188) in 2006 to write off its remaining
      goodwill. Similarly, in 2005 we recorded a goodwill charge of $(129). The fair
      value of Books Are Fun was determined by a third-party appraiser using a
      combination of discounted future net cash flows and an assessment of comparable
      companies in the marketplace. For further information, see Note 6, Goodwill
      and
      Other Intangible Assets, Net, in our Notes to Consolidated Financial
      Statements.




***2005
      v. 2004***





**Revenues**





Revenues
      were relatively flat in 2005 when compared with 2004. The effect of foreign
      currency fluctuations increased revenues in 2005 by 3%. While revenues were
      lower for all three of our reportable segments, the declining trend that
      Reader’s Digest North America and Reader’s Digest International have reported in
      recent years appears to have stabilized.




-6-


Lower
      revenues for Consumer Business Services were driven by both Books Are Fun and
      QSP. Books Are Fun continues to be adversely affected by lower average sales
      per
      event and fewer events. QSP
      reve nues
      were
      lower principally because of magazine and gift volume declines driven by lower
      participation in fundraising programs. Both Books Are Fun and QSP continued
      to
      experience competitive pressure for accounts, which adversely affected profit
      margins.





Revenues
      for Reader’s Digest International decreased slightly in 2005, compared with
      double-digit declines in 2004 and 2003, due to lower membership in series
      products and a decline in our active customer base. Planned reductions in
      circulation for *Reader’s
      Digest* magazine
      in certain markets to improve profitability, and the elimination of *Moneywise* magazine
      in the United Kingdom contributed to the decline. The largest declines were
      in
      Germany, Brazil, Mexico and the United Kingdom. Partially offsetting these
      declines were strength in single sales products and increased mail quantities
      in
      Australia as well as positive results from new markets and new
      products.





The
      slight revenue decline in Reader’s Digest North America was principally driven
      by the planned elimination of marginally profitable and unprofitable activity
      in
      Reader’s Digest Young Families and lower membership in series products. In
      addition, lower circulation revenues for *Reader’s
      Digest* magazine, due in part to the January 2004 reduction in the rate base,
      contributed to the decline. Partially offsetting these declines were improved
      revenues in Canada and our special interest magazines, and new revenues from
      products launched within the last two years. Reiman revenues in 2005 were flat
      compared with 2004.





**Operating
      (Loss) Profit**





Operating
      profit decreased significantly to a loss of $(34) in 2005, compared with a
      profit of $112 in 2004. The operating loss was principally driven by the
      goodwill charge of $(129) related to Books Are Fun and $(77) related to
      amortization of previously deferred magazine promotion costs (described in
      further detail below). The effect of foreign currency fluctuations reduced
      our
      operating loss in 2005 by $9. Lower profits for Consumer Business Services
      and
      investments in new products and geographic markets contributed to the decline.
      Despite lower revenues, profits at Reader’s Digest North America and Reader’s
      Digest International improved because of lower costs. Combined with lower
      Corporate Unallocated expenses and gains on sales of certain non-strategic
      assets of $14, these factors partially offset profit declines
      elsewhere.





Product,
      distribution and editorial expenses decreased to $(971) in 2005, compared with
      $(973) in 2004. The effect of foreign currency fluctuations increased these
      costs in 2005 by 3%. Lower overall sales volumes, and lower
      manufacturing and delivery costs for *Reader’s
      Digest* magazine
      due to reductions in the rate bases in various markets, including the January
      2004 rate base reduction in the United States, principally drove the decline.
      These decreases were partially offset by costs incurred to enter new
      markets.





Promotion,
      marketing and administrative expenses increased 3% to $(1,337) for 2005,
      compared with $(1,294) in 2004. The effect of foreign currency fluctuations
      increased these costs in 2005 by 3%. In 2005, these expenses included
      amortization of previously deferred magazine promotion costs of $(77), while
      in
      2004 these expenses included a charge of $(27) related to magazine deferred
      promotion costs (described below). In addition to this increase in magazine
      promotion costs, promotion, marketing and administrative expenses increased
      slightly because of costs
      incurred to enter new markets. These increases were partially offset by lower
      costs due to a
      reduced
      rate base for *Reader’s
      Digest* magazine, lower mail quantities for books and home entertainment products in
      various markets and for certain Reiman products, and the effects of cost
      reduction measures initiated in previous periods, including staff
      reductions.


-7-


*Reportable
      Segments*


Profits
      for Consumer Business Services declined principally because of lower sales
      activity and increased incentives at both QSP and Books Are Fun.





Improved
      profits for Reader’s Digest North America were driven by effective management of
      overhead costs, and by lower promotion and production costs because of lower
      overall promotion activity and the January 2004 reduction in the rate base
      for *Reader’s
      Digest* magazine.
      Partially offsetting this improvement were costs incurred to launch two new
      Reiman-inspired magazines, *Cooking
      for 2* and *Birds
      & Blooms Extra* .





Profits
      for Reader’s Digest International improved because of increased response rates
      to promotional mailings for single sales products, more efficient mailings
      and
      the results of cost reduction measures initiated in previous periods. These
      improvements were partially offset by costs incurred to develop new products
      and
      enter new geographic markets, a critical component of the growth initiatives
      for
      this reportable segment.





*Corporate
      Unallocated*


Corporate
      Unallocated expenses reflect the cost of governance and centrally managed
      expenses, as well as the accounting for U.S. pension plans, postretirement
      healthcare costs, and stock and executive compensation programs that are not
      allocated to the reportable segments. These expenses were $(38) in 2005,
      compared with $(44) in 2004. Lower expenses were driven by an $8 increase in
      net
      pension income (from our over-funded U.S. pension plan) and a $2 decrease in
      postretirement healthcare costs (due to changes in our healthcare plans and
      recognition of a government Medicare subsidy announced in January 2004). We
      also
      had lower costs of $2 due to the favorable settlement of prior property taxes
      and due to the sale and partial leaseback of our Westchester, New York
      headquarters facility. These items were partially offset by a $(4) increase
      in
      employee compensation expenses.





*Other
      Operating Items, Net*


Other
      operating items, net was $14 in 2005, compared with $(9) in 2004. This includes
      gains from the sales of certain non-strategic assets totaling $14 and $6,
      respectively. The
      primary factors affecting comparability related to these gains
      were:




·
            a
                gain of $7 from the sale of buildings in Portugal and Australia in
                2005,
                compared with a gain of $6 from the sale of a building in Hong Kong
                in
                2004


·
            gains
                of $3 from the sale of*Moneywise*magazine in the United Kingdom and*Crafting
                Traditions*magazine in the United States, both of which occurred in the second
                quarter of 2005


·
            a
                gain of $4 from the sale of other non-strategic assets in 2005,
                principally fine art





In
      addition, restructuring charges of $(4) (principally related to severance
      actions in the United States) in 2005 were offset by reversals of $4 related
      to
      severance and other charges recorded in previous periods that were no longer
      necessary. We
      review
      our restructuring plans periodically to determine the appropriateness of
      existing accruals in light of current circumstances. Accordingly, these charges
      were reversed because of the occurrence of events that affected our original
      plans.





Restructuring
      charges recorded in the second, third and fourth quarters of 2004 comprised
      $(14) for severance and $(3) for contract terminations, asset impairments and
      pension curtailments. Reversals of $2, principally related to severance,
      partially offset these charges.





Charges
      of $(14) for severance related to streamlining operations in certain
      international markets, domestic businesses and corporate departments. Charges
      of
      $(3) for contract terminations, asset impairments and pension curtailments
      principally represented costs associated with closing our Norway location and
      a
      lease termination at Books Are Fun.


-8-


These
      charges were partially offset by reversals of $2, principally severance,
      recorded in the third quarter of 2004 related to charges recorded in previous
      periods that were no longer necessary.





*Previously
      Deferred Magazine Promotion Expense*


After
      reassessing our accounting for magazine promotion costs in the fourth quarter
      of
      2004, we began expensing magazine promotion costs when the promotion is mailed
      to prospective customers instead of deferring and amortizing such costs. In
      the
      fourth quarter of 2004 we recorded a $(27) charge related to this change.
      Similarly, in 2005 we expensed $(77) related to promotion costs capitalized
      as
      of June 30, 2004. Such amount is included as a component of promotion, marketing
      and administrative expenses on the statements of operations. As of June 30,
      2005, there are no deferred magazine promotion costs for promotions that were
      capitalized as of June 30, 2004.





*Goodwill
      Charge*


The
      third
      quarter of the fiscal year is our designated annual period to assess the
      recoverability of goodwill and our indefinite-lived intangible assets. Based
      on
      our assessment, Books Are Fun recorded a goodwill charge of $(129) in the third
      quarter of 2005 because the performance of our product portfolio and competitive
      pressures on margin resulted in revenue and operating profits falling short
      of
      our expectations. The fair value of Books Are Fun was determined independently
      using a combination of discounted future net cash flows and an assessment of
      comparable companies in the marketplace.




**Other
      (Expense) Income, Net**





***2006
      v. 2005***





Other
      (expense) income, net was $(41) in 2006, compared with $(46) in 2005. The most
      significant component of other (expense) income, net was interest expense of
      $(48) and $(54) in 2006 and 2005, respectively. Interest expense in 2005
      included $(7), principally related to the write-off of deferred financing fees
      because of refinancing activities consummated in the fourth
      quarter.





***2005
      v. 2004***





Other
      (expense) income, net remained flat at $(46) in 2005, compared with 2004. The
      most significant component of other (expense) income, net was interest expense
      of $(54) and $(55) in 2005 and 2004, respectively. Interest expense in both
      periods included $(7), principally related to the write-off of deferred
      financing fees because of refinancing activities (see Liquidity and Capital
      Resources for additional information).




**Income
      Taxes**





***2006
      v. 2005***





Since
      pre-tax losses in 2006 and 2005 were the result of non-deductible goodwill
      charges at Books Are Fun, we recorded income tax expense of $(31) and $(12),
      respectively. Tax expense in these years was also affected by certain discrete
      tax benefits. In 2006, we recorded discrete tax benefits of $6 due to the
      settlement of tax audits in foreign countries, and $2 due to changes in our
      estimates of permanent book-to-tax differences, as a result of filing our tax
      return for fiscal 2005. Tax expense in 2005 included benefits of $6 due to
      the
      reversal of tax liabilities resulting from various settlements of U.S. federal
      and state tax audits, partially offset by a reduction in the value of certain
      deferred tax assets as a result of a change to the tax law of a foreign
      jurisdiction.


-9-


***2005
      v. 2004***





Since
      the
      pre-tax loss in 2005 was a result of non-deductible goodwill charges at Books
      Are Fun, we recorded an income tax expense of $(12), compared with a tax expense
      of $(17) in 2004. Income tax expense in both 2005 and 2004 were favorably
      affected by a reduction in tax liabilities resulting from various settlements
      of
      U.S. federal, state and foreign audits.




**Net
      (Loss) Income**





***2006
      v. 2005***





As
      a
      result of the items discussed above, net loss in 2006 was $(117) or $(1.24)
      per
      share for both basic and diluted loss per share. In 2005, net loss was $(91)
      or
      $(0.95) per share for both basic and diluted loss per share. For both 2006
      and
      2005, the effect of potentially dilutive shares was not considered in the
      calculation of loss per share because such shares would have been
      anti-dilutive.





***2005
      v. 2004***





As
      a
      result of the items discussed above, net loss in 2005 was $(91) or $(0.95)
      per
      share for both basic and diluted loss per share. For 2005, the effect of
      potentially dilutive shares was not considered in the calculation of loss per
      share because such shares would have been anti-dilutive. In 2004, net income
      was
      $49 or $0.49 per share on a diluted-earnings basis ($0.50 per share for basic
      earnings per share).






**Results
      of Operations: Reportable Segments**





**Reader’s
      Digest North America**





**2006
      v. 2005**





Revenues
      for Reader’s Digest North America increased 2% to $939 in 2006, compared with
      $917 in 2005. The effect of foreign currency fluctuations increased revenues
      in
      2006 by $8. Revenues increased principally because we have started to realize
      the benefits of previous investments to grow our business, including new
      magazine titles and the addition of our home party plan business. Also,
      advertising revenues were slightly higher. These increases were partially offset
      by lower books and home entertainment revenues.





Circulation
      revenue growth was driven by new magazine titles, including Every
      Day
      with Rachael Ray (launched in the second quarter of 2006), Cooking for 2
      (launched in the third quarter of 2005) and Birds & Blooms Extra (launched
      in the fourth quarter of 2005), and by expansion of our themed newsstand
      specials. These improvements were partially offset by lower circulation revenue
      for certain Reiman-inspired cooking titles and for Reader’s Digest magazine due
      to a change in the mix of the renewal pool to newer subscribers and less
      reliance on agents.





Higher
      advertising revenues, due to the addition of Every Day with Rachael Ray and
      increased advertising pages in Reader’s Digest magazine, were partially offset
      by fewer advertising pages in our special interest magazines.




-10-


Lower
      books and home entertainment revenues were driven by lower sales of certain
      established Reiman-inspired book annual products, planned reductions in
      promotional activity in Reader’s Digest Young Families to improve profitability
      and lower membership in Select Editions. These declines were partially offset
      by
      increased sales of products in our home & health affinity, due to stronger
      products, and higher retail sales.





Operating
      profit increased 26% to $115 in 2006, compared with $91 in 2005. The increase
      in
      profitability was principally driven by $21 of lower amortization of certain
      intangible assets that were established when we acquired Reiman, because the
      assets reached the end of their useful lives in 2005, and lower promotion costs.
      Although investments in growth initiatives positively affected revenues in
      2006,
      costs incurred to launch these businesses lowered profits. Higher postage costs
      also adversely affected profits.





***2005
      v. 2004***





Revenues
      for Reader’s Digest North America were relatively flat in 2005 when compared
      with 2004. The effect of foreign currency fluctuations increased revenues in
      2005 by $9. Lower revenues for U.S. Books and Home Entertainment and *Reader’s
      Digest* magazine
      were partially offset by increased revenues in Canada and for our special
      interest magazines.





Lower
      revenues for U.S. Books and Home Entertainment were driven by the planned
      elimination of marginally profitable and unprofitable activity in Reader’s
      Digest Young Families and a continued decline in Select Editions membership.
      Strong performance of certain single sales products, due in part to increased
      mail quantities, and increased Trade Publishing revenues partially offset these
      declines.





Circulation
      revenues for *Reader’s
      Digest* magazine
      were lower principally due to the January 2004 reduction in the rate base and
      a
      continued decline in renewal pools. However, the circulation decline shows
      signs
      of stabilizing following the reduction in the rate base and a decreased reliance
      on subscriptions generated by agents. Also, newsstand volume declined 9% because
      of industry-wide softness in this market, while fewer prescription drug and
      automotive pages drove a slight decline in advertising revenues.





Lower
      revenues at Reiman were attributable to lower renewal rates for certain cooking
      titles and the absence of revenues from *Crafting
      Traditions* magazine
      (sold in the second quarter of 2005). In addition, sales of annual book products
      declined slightly because weaker performance of established titles was partially
      offset by the performance of newer titles. These declines were offset by
      increased revenues from *Backyard
      Living* (a
      magazine launched in the third quarter of 2004) and increased catalog and
      ancillary sales.





Partially
      offsetting the declines described above were increased revenues in Canada,
      the
      addition of revenues from new products and stronger performance from certain
      special interest magazines.





Increased
      revenues in Canada were driven by *Our
      Canada* ,
      a new
      magazine launched in the third quarter of 2004, and strong performance of single
      sales products, due to increased mail quantities and response rates to
      promotional mailings. Advertising
      revenues from our special interest magazines increased, particularly *The
      Family Handyman* and *Selecciones* .





As
      part
      of our program to invest in the business, in 2005 we launched two new
      Reiman-inspired magazines: *Cooking
      for 2* and *Birds
      & Blooms Extra* .
      Both of
      these titles made positive contributions to revenues during the
      year.




-11-


Operating
      profit increased 19% to $91 in 2005, compared with $76 in 2004. The increase
      in
      profit was principally driven by effective management of overhead costs and
      lower promotion costs. Lower production costs for *Reader’s
      Digest* magazine, due to the January 2004 reduction in the rate base, contributed to
      the
      improvement. These increases were partially offset by investments in new
      products.




**Reader’s
      Digest International**





***2006
      v. 2005***





Revenues
      for Reader’s Digest International increased 2% to $1,031 in 2006, compared with
      $1,012 in 2005. The effect of foreign currency fluctuations lowered revenues
      in
      2006 by $17. The increase in revenues was driven by previous investments to
      extend our global scale and by investments in n ew
      customer acquisition. Growth in new markets, including Romania, Ukraine,
      Bulgaria and certain southeastern European markets, significantly contributed
      to
      the increase in revenues. Similarly, growth in our active customer base resulted
      in increased promotional mailings. Coupled with improved products or promotions,
      these factors translated into increased revenues in
      certain markets, including Russia, Brazil and Australia.





Revenues
      also benefited from the introduction of Reiman-inspired magazines in certain
      European markets as well as the introduction of new products in
      Asia.





While
      in
      the aggregate our active customer base increased, the number of active customers
      in certain markets decreased. This resulted in lower revenues in the United
      Kingdom, Poland, the Nordic region and Portugal. Also, revenues in Norway were
      lower because we licensed publication of *Reader’s
      Digest* magazine
      to a third party in 2005.





Operating
      profit increased 3% to $78 in 2006, compared with $76 in 2005. The improvement
      in profits was principally driven by an increase in our active customer base
      in
      certain markets. The most significant profit improvements were in Russia,
      Australia and France. These
      increases were partially offset by investments in the business.




***2005
      v. 2004***





Revenues
      for Reader’s Digest International increased 4% to $1,012 in 2005, compared with
      $970 in 2004. The effect of foreign currency fluctuations increased revenues
      in
      2005 by $66. Although revenues declined, the declining trend experienced in
      recent years appears to have become stable. Our active customer base has
      stabilized, after substantial declines in recent years. Other key indicators
      also showed progress, including improved response rates, strong performance
      of
      single sales products and stabilizing magazine circulation and series
      membership. Collectively, these trends indicate that actions taken to restore
      the business are positively affecting this segment.





The
      decrease in revenues was driven by Germany, Brazil, Mexico and the United
      Kingdom as a result of lower sales of books and home entertainment products
      due
      to declining continuity series membership, lower response rates to promotional
      mailings and a decline in our active customer base. In addition, revenues for *Reader’s
      Digest* magazine
      were lower because of planned reductions in circulation to better manage
      customer acquisition costs, improve profitability and achieve a sustainable
      circulation level.


-12-


Also,
      revenues were $(9) lower because we sold *Moneywise* magazine
      in the United Kingdom (in the second quarter of 2005) and because we licensed
      publication of *Reader’s
      Digest* magazine
      to a third party in Norway.





Increased
      revenues from single sales books and home entertainment products in Australia,
      Asia, and from new markets, including Romania and Ukraine, partially offset
      revenue declines elsewhere. The increase in revenues in Australia was driven
      by
      increased mail quantities due to an increased active customer base and improved
      response rates to promotional mailings, while revenues in Asia improved because
      of the introduction of new products.





Operating
      profit increased 34% to $76 in 2005, compared with $57 in 2004. The effect
      of
      foreign currency fluctuations improved profits in 2005 by $8. Improved profits
      were driven by the United Kingdom, Germany, Australia and the addition of new
      markets. The increase in profits was attributable to increased response rates
      to
      promotional mailings for single sales products, more efficient mailings, lower
      customer acquisition costs, the benefits of continuing cost reduction measures
      and lower product and distribution costs.




**Consumer
      Business Services**





***2006
      v. 2005***





Revenues
      for Consumer Business Services decreased 8% to $446 in 2006, compared with
      $485
      in 2005. The decline was principally driven by Books Are Fun and, to a much
      lesser extent, by QSP.





Revenues
      at Books Are Fun decreased 15% principally due to fewer corporate events held
      because of turnover of independent sales representatives and the resulting
      vacancies in certain territories. Also, because of softer performance of our
      product portfolio in the fourth quarter of 2006, average sales per school event
      were lower.





QSP
      revenues declined 2%, primarily due to an 8% decline in magazine volumes because
      of lower renewal rates. This decline was mitigated by an improvement in same
      school sales in 2006 when compared with 2005. Also, a 5% increase in World’s
      Finest Chocolate vo lumes
      despite the after-effects of Hurricanes Katrina and Rita, and increased gift
      revenues, because of a higher-priced mix of products sold, partially
      offset the decline.





In
      2006,
      we incurred a loss of $(3), compared with a profit of $29 in 2005. The revenue
      changes described above, the effects of competitive pressures, and costs
      associated with recruiting and retaining members of the independent sales force
      at Books Are Fun principally drove the loss. We also recorded a charge at Books
      Are Fun to lower the value of old and discontinued items. While certain products
      were reserved to position them for sale through alternate channels, other
      products were written-off as we terminated certain non-core lines of business.
      At QSP, the benefits of cost reduction measures were partially offset by a
      charge of $(6) associated with the calendar year 2006 minimum tonnage purchase
      commitment in our World’s Finest Chocolate licensing agreement, despite
      increased sales volumes.




***2005
      v. 2004***





Revenues
      for Consumer Business Services decreased 8% to $485 in 2005, compared with
      $525
      in 2004. Both QSP and Books Are Fun contributed to the decline.




-13-


Revenues
      at Books Are Fun decreased 8% due to lower average sales per school event and
      fewer business display and corporate events held. Average sales per school
      event
      were lower because of weaker performance of our product portfolio and a shift
      in
      the mix of products sold to lower-priced products. Although we experienced
      significant sales force turnover in the school market early in the year, in
      the
      second half of the year we recovered lost events through intensive recruiting
      efforts. The decline in business events was driven by turnover in the
      independent sales force, due to increased competition, while turnover in
      accounts resulted in fewer corporate
      events. In
      contrast to the school market, our recruiting efforts were not as successful
      in
      recovering lost events. Also, because new representatives generally require
      a
      certain amount of time to build their territories, these representatives did
      not
      significantly affect revenues. During the year, the number of sales
      representatives in our primary lines of business, the school and corporate
      markets, decreased 1%.





Double-digit
      declines in magazine and gift sales volumes due to lower participation in
      fundraising programs drove the 8% decline in revenues at QSP. These declines
      were partially offset by increased sales of music and food products. Sales
      of
      World’s Finest Chocolate products increased 9% due to efforts to convert more of
      our food business to these products.





Operating
      profit for 2005 decreased 50% to $29, compared with $59 in 2004. The revenue
      changes described above along with increased incentives at Books Are Fun drove
      most of the decline in profits. Investments at QSP, including additional
      incentives, enhanced promotional materials and costs to integrate new products,
      contributed to the decline.





These
      declines were partially offset by the effect of cost reduction measures at
      QSP
      that were initiated during the second half of 2005.








**Liquidity
      and Capital Resources**


***(includes
      forward-looking information)***





The
      consolidated statement of cash flows for the year ended June 30, 2006 is
      summarized below:





**Cash
                and cash equivalents at June 30, 2005**
            
            **$**
            **38*****Net
                change in cash due to:***Operating
                activities
            
            
            48Investing
                activities
            
            
            (82
            )Financing
                activities
            
            
            29Effect
                of exchange rate fluctuations on cash and cash equivalents
            
            
            2**Net
                change in cash and cash equivalents**
            
            
            **(3**
            **)****Cash
                and cash equivalents at June 30, 2006**
            
            **$**
            **35**




-14-


Cash
      and
      cash equivalents decreased 8% to $35 as of June 30, 2006, compared with $38
      as
      of June 30, 2005. Cash flow from operations decreased to $48 in 2006, compared
      with $139 in 2005, principally driven by lower operating profits in Consumer
      Business Services and changes in working capital as we shifted our focus from
      stabilization to growth. Also, spending related to restructuring actions and
      programs to retain members of our independent sales force at Books Are Fun
      further lowered operating cash flow. Aside from these items, significant sources
      (uses) of cash were:





·
            net
                proceeds from borrowings of $136


·
            acquisition
                of*Allrecipes.com*for $(66)


·
            dividend
                payments of $(40)


·
            share
                repurchases of $(65)





**Borrowings**


Our
      primary debt obligations as of June 30, 2006 are our borrowings under our $500
      Five-Year Revolving Credit Agreement (2005 Credit Agreement) and $300 in senior
      unsecured notes.





On
      April
      14, 2005, we entered into a $400 Five-Year Revolving Credit Agreement to retire
      all outstanding borrowings under our Five-Year Revolving Credit and Competitive
      Advance Facility Agreement and $950 Term Loan Agreement (collectively
      referred to as the 2002 Credit Agreements) and for general corporate purposes.
      Financing fees of $(2) related to the 2005 Credit Agreement were deferred and
      are amortized on a straight-line basis over the life of the 2005 Credit
      Agreement. In connection with the termination of the 2002 Credit Agreements,
      we
      recorded a write-off of $(7) in the fourth quarter of 2005 related to the
      associated capitalized financing fees and the discontinuance of the related
      interest rate protection agreements.





On
      April
      19, 2006, we entered into an amendment to our 2005 Credit Agreement, which
      increased the aggregate principal amount available to $500, increased the
      maximum leverage ratio (as defined in the amendment) and increased pricing
      when
      the leverage ratio is at higher levels. The interest rate on the 2005 Credit
      Agreement is currently at LIBOR plus 125 basis points and is subject to change
      based on our leverage ratio (as defined in the 2005 Credit Agreement). The
      2005
      Credit Agreement contains financial covenants that require us to maintain
      minimum interest coverage and maximum leverage ratios, and it is secured by
      the
      stock of a substantial portion of our subsidiaries.





During
      the third quarter of 2004, we completed a private placement, with registration
      rights, of $300 of 61⁄2% senior unsecured notes due in 2011 (Senior Notes) in
      order to refinance amounts outstanding under the $950 Term Loan Agreement.
      In the fourth quarter of 2004, these notes were exchanged for notes that were
      registered under the Securities Act of 1933. The proceeds from this offering
      were used to repay $294 of principal outstanding under the 2002 Term Loan
      Agreement, with the remainder used to pay a portion of the financing costs.





At
      June
      30, 2006 and 2005, we had borrowings of $695 and $559 outstanding, respectively,
      all of which are classified as long-term debt on the balance sheets.





In
      2006,
      2005 and 2004, we recorded interest expense, net of $(41), $(46), and $(50),
      respectively. Interest expense in 2005 included the write-off of financing
      fees
      of $(7) as a result of the termination of the 2002 Credit Agreements. Interest
      expense in 2004 included the write-off of financing fees of $(6) as a result
      of
      the refinancing and certain other transactions described above and the write-off
      of $(1) related to the termination of some of our interest rate caps that were
      no longer required (see Note 7, Financial Instruments, in our Notes to
      Consolidated Financial Statements for additional information). The weighted
      average interest rate on our borrowings charged by our lenders was 6.0%, 5.3%
      and 4.4%, respectively.


-15-





**Other
      Liquidity Matters**


International
      lines of credit and overdraft facilities totaled $32 at June 30, 2006 and $28
      at
      June 30, 2005, of which $14 and zero were outstanding at June 30, 2006 and
      2005, respectively. These lines of credit are subject to renewal
      annually.





On
      April
      28, 2005, our Board of Directors authorized our repurchase of up to $100 of
      our
      Common Stock over the succeeding two years and rescinded its May 2001
      authorization to repurchase up to $250 of our Common Stock. Under the April
      2005
      authorization, we repurchased 4 million shares for $63 in 2006. Since the April
      2005 authorization, we repurchased 5 million shares for $70. We had not
      repurchased any shares under the May 2001 authorization since fiscal
      2002.





On
      December 22, 2004, we completed the sale and partial leaseback of our corporate
      headquarters facility in Westchester, New York. Under the agreement, we received
      $49 in cash and will receive an additional $10 on the second anniversary of
      closing. The gain of $25, based on total consideration, was deferred and is
      being amortized over the initial 20-year lease term as a reduction in rent
      expense. During the lease term, we will make annual minimum lease payments
      of
      approximately $3, subject to increases every five years based on changes in
      the
      Consumer Price Index. In addition, we have leased additional space for three
      years in this facility at an annual cost of $1.





We
      believe that our liquidity, capital resources, cash flows and borrowing capacity
      are sufficient to fund normal capital expenditures, working capital
      requirements, the payment of dividends, debt service and the implementation
      of
      our strategic initiatives.








**Contractual
      Obligations and Commitments**


***(includes
      forward-looking information)***





For
      information regarding debt and other obligations, including lease commitments
      and contingencies, see Note 6, Goodwill and Other Intangible Assets, Net; Note
      11, Debt; and Note 13, Commitments and Contingencies, in our Notes to
      Consolidated Financial Statements.





In
      the
      normal course of business, we enter into long-term arrangements with suppliers
      for raw materials and merchandise and with other parties whose recordings or
      works we use in our products. These arrangements may contain minimum purchase
      requirements. We enter into these agreements to facilitate an adequate supply
      of
      materials and to enable us to develop better products for sale to our customers.
      The table below details our significant contractual obligations and the timing
      of payments due for those contracts with minimum purchase
      requirements.


-16-





**Contractual
                Obligations**
            
            **Less
                than one year**
            
            **One
                to three years**
            
            **Three
                to five years**
            
            **More
                than five years**Debt
                obligations:Senior
                Notes(1)
            
            
            ---
            
            
            ---
            
            
            300
            
            
            ---2005
                Revolving Credit facility(2)
            
            
            ---
            
            
            ---
            
            
            395
            
            
            ---Lease
                commitments:Operating
                leases
            
            
            25
            
            
            41
            
            
            31
            
            
            75Purchase
                commitments:World’s
                Finest Chocolate(3)
            
            
            56
            
            
            131
            
            
            138
            
            
            778Royalty
                contracts
            
            
            2
            
            
            2
            
            
            1
            
            
            1Pension
                and postretirement obligations(4)
            
            
            60
            
            
            121
            
            
            124
            
            
            322Service
                and outsource contracts(5)
            
            
            12
            
            
            15
            
            
            5
            
            
            ---**Total**
            
            **$**
            **155**
            
            **$**
            **310**
            
            **$**
            **994**
            
            **$**
            **1,176**


*(1)*
              *In
                  the third quarter of 2004, we issued 61⁄2% Senior Notes in a private
                  placement. We used the proceeds from this offering to refinance
                  amounts
                  outstanding under the Term Loan
                  Agreement.*
 *(2)*
              *This
                  relates to our 2005 Credit Agreement, which we entered on April
                  14, 2005
                  and amended on April 19, 2006.  See Note 11, Debt, in our Notes to
                  Consolidated Financial Statements for additional
                  information.*
 *(3)*
              *In
                  May 2000, QSP, Inc. entered into a licensing agreement with World’s Finest
                  Chocolate, Inc. to obtain the exclusive right to distribute World’s Finest
                  Chocolate products for fundraising purposes. This agreement has
                  been
                  amended several times, notably in 2003 when it was amended and
                  extended.
                  The commitments detailed above represent our minimum purchase requirements
                  of chocolate products from fiscal 2007 until the agreement terminates
                  in
                  calendar 2020. During the fourth quarter of 2006, we determined
                  that it
                  was probable that we will not meet the calendar year 2006 minimum
                  tonnage
                  purchase commitment under this agreement. Accordingly, the fiscal
                  2007
                  purchase commitment in this table reflects lower purchases and
                  the
                  resulting $(6) charge. See Note 6, Goodwill and Other Intangible
                  Assets,
                  Net, in our Notes to Consolidated Financial Statements for additional
                  information.*
 *(4)*
              *This
                  item includes payments that are expected to be made for pension
                  and
                  postretirement benefits. Amounts in the “More than five years” category
                  only include projected payments from fiscal 2012 through fiscal
                  2016. See
                  Note 8, Pension Plans and Other Postretirement Benefits, in our
                  Notes to
                  Consolidated Financial Statements for additional
                  information.*
 *(5)*
              *This
                  item includes a number of service contracts, such as product fulfillment
                  agreements and information technology license and maintenance agreements.
                  These contracts terminate at varying dates ranging from fiscal
                  2007
                  through fiscal 2010.*





**Fiscal
      2006 Outlook**


***(includes
      forward-looking information)***





During
      2006, we launched a new three-year plan, shifting our focus from stabilization
      to sustainable, top- and bottom-line growth by (1) diversifying the core
      business, (2) deepening customer relationships and (3) leveraging our global
      scale. We made significant strides toward this goal as gains were driven both
      by
      contributions from established businesses, reflecting a more stable active
      customer base, and by contributions from new businesses.





In
      fiscal
      2007, we expect to grow both revenues and profits in our reportable segments,
      principally driven by:





·
            Accelerating
                growth from newly launched initiatives including businesses in new
                international markets, the magazine*Every
                Day with Rachael Ray*and Taste of Home Entertaining.


·
            Further
                strengthening Reader’s Digest North America, Reader’s Digest International
                and QSP.


·
            Returning
                Books Are Fun to profitability through a five-part plan that includes
                new
                management, cost reduction, strengthening the sales force, focusing
                on the
                core book and gift businesses, and improving the business model.
                The goals
                of the plan are to maintain and expand Books Are Fun’s leading position in
                the display marketing business, improve operating profit margins
                and
                position the business for long-term revenue
                growth.


·
            Expanding
                our digital presence by integrating our existing food and Web activities
                with*Allrecipes.com*,
                the recently acquired leading home cooks
                website.


-17-


We
      expect
      these efforts will result in fiscal 2007 financial results as
      follows:





·
            Total
                company revenues to grow mid-single
                digits.


·
            Total
                company profitability to improve significantly, although partially
                offset
                by increased legal expenses, as we move our Books Are Fun lawsuits
                to
                trial, and the absence of certain gains recorded in 2006, including
                the
                reversal of a legal accrual and lower management
                compensation.


·
            Earnings
                per share in the range of $0.88 to $0.98 per share, excluding
                restructuring charges and other items that cannot be forecasted at
                this
                time.





We
      expect
      year-over-year revenues to grow in each of the four quarters and operating
      profits to grow in every quarter, except the first quarter, when operating
      losses will increase significantly because of increased investment spending
      and
      a planned shift in the timing of customer-acquisition marketing
      activities.





**Critical
      Accounting Policies**


***(includes
      forward-looking information)***





Our
      significant accounting policies are more fully described in Note 1, Organization
      and Summary of Significant Accounting Policies, in our Notes to Consolidated
      Financial Statements. The accounting policies described below are those that
      we
      believe are critical to an understanding of our financial statements and require
      management to make significant judgments. These judgments entail estimates
      and
      assumptions that are essential to determining the recorded amounts and their
      impact on our operating results. Due to the uncertainty inherent in these
      estimates and assumptions, actual results may differ. The determination of
      the
      accounting policies that are critical and the assumptions and estimates that
      we
      have made have been reviewed and discussed with the Audit Committee of our
      Board
      of Directors.





**Revenue
      Recognition**


Our
      primary revenue recognition policies for our key products are described
      below.





*Magazines* — ** Sales
      of
      our magazine subscriptions, less estimated cancellations, are deferred and
      recognized as revenues proportionately over the subscription period. Revenues
      from sales of magazines through the newsstand are recognized at the issue date,
      net of an allowance for returns. Advertising revenues are recorded as revenues
      at the time the advertisements are published, net of discounts and advertising
      agency commissions.





*Sponsor
      Fundraising Programs* —
Our
      sponsor fundraising program business, which operates principally through QSP,
      Inc., receives its revenues net of amounts due to its sponsors. Accordingly,
      we
      present revenues net of sponsors’ earnings. Sales of subscriptions to magazines
      published by other companies and sales of music products are recorded as
      revenues at the time orders are submitted to the publisher, net of bad debts
      and
      remittances to magazine and music publishers.





*Books,
      Display Marketing and Other Products* —
      Revenues are recorded when title passes, net of provisions for estimated returns
      and bad debts. For our display marketing products, title passes either at the
      point of sale or at the time of shipment. In certain circumstances, our
      promotion entitles the customer to a preview period. Revenue generated by these
      promotions is recognized after the preview period lapses.





The
      most
      significant element in our revenue recognition policy is the estimate of returns
      and bad debts, as noted below.


-18-





**Estimates
      of Returns and Bad Debt**


Our
      ability to accurately estimate returns and bad debt is critical in determining
      the amount of revenue to recognize and of promotion and agent costs to defer.
      We
      present our revenues net of an allowance for returns and bad debt.





We
      estimate returns for all products, as well as cancellations of magazine
      subscriptions, based on historical data, method of promotion and results of
      market testing for the products. Reserve levels are adjusted as actual return
      data is received. On a consolidated basis, our estimates of returns have not
      differed significantly from actual results.





Estimates
      of bad debts are prepared using historical data based on the type of product
      and
      promotion and the source of customer. We review our bad debt reserves
      periodically to ensure they are appropriately stated. If actual results differ
      from our estimates, the reserve is adjusted as actual bad debt data is received.
      On a consolidated basis, our estimates of bad debts have not differed
      significantly from actual results.





Revenues
      for our books and home entertainment and magazine businesses are principally
      driven by direct mail and, therefore, are the most sensitive to changes in
      payment rates and returns. Our Consumer Business Services businesses are much
      less susceptible to changes in payment rates and returns because the businesses
      in this segment collect most of their cash at the point of sale.





**Inventory
      Valuation**


We
      periodically assess our inventory for obsolescence and to ensure it is recorded
      at the lower of cost or market value. In estimating the necessary inventory
      reserve, we forecast demand for products on hand and assess market conditions,
      including potential usage in future promotions. We also consider the shelf-life
      of our perishable inventory. Adjustments to inventory reserves are recorded
      in
      product, distribution and editorial expenses on the statements of operations.





Throughout
      the year approximately half of our net inventory relates to Books Are Fun.
      Because of the nature of the display marketing business model, inventory
      reserves as a percentage of total inventory at Books Are Fun are lower than
      in
      our other businesses. We continually monitor Books Are Fun’s reserve levels and
      recorded a charge of $(7) in 2006 to lower the value of old and discontinued
      items.





Inventory
      for our remaining businesses principally relates to magazine paper and other
      products. During the last few years, reserve levels have declined for our other
      businesses because of continued efforts to better manage inventories.





**Deferred
      Promotion Costs and Related Amortization**


Promotion
      costs for our books and home entertaining advertising costs are deferred only
      if
      certain criteria are met, including whether the future profit expected to be
      generated by a promotional campaign is greater than the costs deferred.
      Estimates of revenues and profits to be generated and of returns are made using
      historical data based on the type of product, method of promotion and customer
      targeted. As actual results for a specific promotional campaign are received,
      the campaign is reassessed. To the extent that capitalized costs of the campaign
      exceed the profit expected to be generated, the difference is expensed
      immediately. Amortization related to deferred promotion expenses is included
      in
      promotion, marketing and administrative expenses on the statements of
      operations. On a consolidated basis, our estimates have not differed
      significantly from actual results.





**Pension
      Assumptions**


The
      calculation of pension income (expense) is based on various actuarial
      assumptions. We review these assumptions annually, together with actuarial
      consultants, to determine reasonable rates.


-19-





During
      our periodic review of assumptions used in determining the net pension income
      (expense) to be recorded in 2006 (our measurement date is March 31 of the
      previous fiscal year), we examined the assumed long-term rate of return on
      pension assets and the discount rate. Currently, the long-term rate of return
      on
      pension assets is the most significant factor in determining our net pension
      income (expense). The assumed long-term rate of return on pension assets
      represents the rate of return we expect our pension assets to earn over an
      extended time horizon. Accordingly, significant changes in this rate due to
      short-term fluctuations in market conditions are not appropriate.





In
      2006
      and 2005, our assumed long-term rate of return on pension assets, used to
      determine net pension income for our over-funded U.S. plan, was 8.5%. Based
      on
      our projections and expectations of future performance, we have not changed
      our
      long-term rate of return on pension assets for 2007. A 25 basis point decrease
      in the long-term rate of return on pension assets used for 2006 would have
      decreased net pension income by $(2). Because our U.S. Retirement Plan is
      over-funded, this would not have affected our funding strategy.





In
      2006
      and 2005, our assumed long-term rate of return on our international pension
      assets, used to determine the net pension expense, was 6.92%. Based on our
      projections and expectations of future performance, our long-term rate of return
      on international pension assets for fiscal 2007 remained flat at 6.94%. A 25
      basis point decrease in the weighted average long-term rate of return on pension
      assets used for 2006 would have increased net pension expense by approximately
      $(1).





The
      discount rate is currently not as significant an assumption in calculating
      the
      net pension income or benefit obligation for our U.S. plan because our plan
      is
      mature and includes a significant number of retirees who are currently receiving
      benefits. Accordingly, the period over which the obligation is discounted is
      much smaller than it would be for other employers’ plans. In both 2006 and 2005,
      the discount rate used to determine the pension income for our U.S. plans was
      5.75%. Our discount rate for the 2007 pension income will increase to 6.0%.
      A 25
      basis point decrease in the discount rate would decrease pension income by
      $(1).
      The discount rate is matched to yield curves reflective of the cash flows of
      our
      plan and also compared to indices of high-quality long-term corporate bonds
      of
      the appropriate duration.





For
      the
      international plans, the discount rate used to determine the pension expense
      was
      5.36% and 5.50% in 2006 and 2005, respectively. The weighted average discount
      rate projected for pension expense in 2007 is expected to decrease to 4.92%.
      This is primarily driven by the decrease in rates of high-quality long-term
      corporate bonds in the United Kingdom. A 25 basis point decrease in the discount
      rate would have increased our 2006 pension expense by approximately $(1). The
      discount rates are generally set by reference to yields of high-quality
      long-term corporate bonds of the appropriate duration.





Income
      and expenses associated with our pension plans are included in promotion,
      marketing and administrative expenses on the statements of operations. Impacts
      on respective countries vary depending on the nature of each individual
      plan.





**Restructuring
      Charges**


We
      establish restructuring accruals for severance costs, contract terminations
      and
      asset impairments as a result of costs incurred to streamline our organization
      and reposition certain businesses.




-20-


Restructuring
      charges are recorded in accordance with Financial Accounting Standards (SFAS)
      No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.”
This statement requires that a liability for a cost associated with an exit
      or
      disposal activity be recognized when the liability is incurred, as opposed
      to
      when management is committed to an exit plan. Such liabilities are recorded
      based on their fair value, as defined. The provisions of this statement apply
      to
      all costs accrued related to restructuring activities, including one-time
      severance benefits. However, because our severance benefits are not considered
      one-time, we recognize these benefits under the provisions of SFAS No. 112,
      “Employers’ Accounting for Postemployment Benefits,” and SFAS No. 88,
“Employers’ Accounting for Settlements and Curtailments of Defined Benefit
      Pension Plans and for Termination Benefits” (the impact of pension curtailments
      and settlements that are directly attributable to our restructuring actions
      were
      recorded in accordance with SFAS No. 88). As such, amounts for severance are
      recognized when a termination plan is developed and approved and when payment
      is
      probable and estimable. We review our restructuring plans periodically to
      determine the appropriateness of existing accruals and the accrual levels are
      adjusted accordingly. Restructuring charges for all other types of costs, such
      as contract terminations, are recorded in accordance with SFAS No. 146. Asset
      impairments are calculated in accordance with SFAS No. 144, “ Accounting
      for the Impairment or Disposal of Long-Lived Assets.”





The
      impact of restructuring charges is recorded in other operating items, net on
      the
      statements of operations. See Note 3, Other Operating Items, Net, in our Notes
      to Consolidated Financial Statements for further information.





**Long-Lived
      Assets**


Goodwill
      and intangible assets with indefinite lives are assessed for impairment
      annually, or on an interim basis if indicators of impairment are present. These
      assessments, which require a great deal of judgment, involve management’s
      estimates of future cash flows, market trends and other factors. If goodwill
      and
      intangibles with indefinite lives are determined to be impaired, a loss is
      recorded.





Management’s
      estimates of future cash flows take into consideration market trends and our
      internal projections of performance relative to other constraints, including
      the
      efficiency and effectiveness of sales channels and potential changes in market
      penetration. External factors, such as competition and the health of regional
      economies, must also be considered. Although these factors are critical to
      assessing impairment, estimates of fair value are also sensitive to small
      changes in profit margins and discount rates.





Intangible
      assets with finite lives must be assessed for impairment whenever changes in
      circumstances indicate that the assets may be impaired. We assess recoverability
      by comparing the asset’s carrying amount to the undiscounted future net cash
      flows expected to be generated by the asset. To the extent the carrying value
      of
      the asset exceeds its future cash flows, an impairment loss is recorded based
      on
      the fair value of the asset. Impairments are recorded in other operating items,
      net on the statements of operations. See Note 6, Goodwill and Other Intangible
      Assets, Net, in our Notes to Consolidated Financial Statements for further
      information.





In
      addition to the above, property,
      plant and equipment is reviewed for impairment whenever events or changes in
      circumstances indicate that the carrying amount of that asset may not be
      recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or
      Disposal of Long-Lived Assets.” We assess recoverability by comparing the
      asset’s carrying amount to the undiscounted future net cash flows expected to be
      generated by the asset. If we determine that the asset is impaired, the
      impairment recognized is the amount by which the carrying amount of the asset
      exceeds the fair value of the asset. Impairments are recorded in other operating
      items, net on the statements of operations. See Note 3, Other Operating Items,
      Net, in our Notes to Consolidated Financial Statements for further
      information.




-21-





**Income
      Taxes**


Income
      taxes are accounted for in accordance with SFAS No. 109, “Accounting for Income
      Taxes,” which requires that deferred tax assets and liabilities be recognized,
      using enacted tax rates, for the effect of temporary differences between the
      book and tax bases of recorded assets and liabilities. Deferred tax assets,
      including foreign tax credits and net operating losses, are reduced by a
      valuation allowance if it is “more likely than not” that some portion or all of
      the deferred tax assets will not be realized.





We
      are
      subject to tax in a number of locations, including many state and foreign
      jurisdictions. As might be expected, significant judgment is required when
      calculating our world-wide provision for income taxes. Because of this
      uncertainty, we establish consolidated tax liabilities based on an estimate
      of
      whether it is likely that additional taxes and interest will be due. In some
      cases, many years may elapse before an audit is completed with respect to items
      for which an accrual has been established. As settlements are reached, we adjust
      the corresponding accruals, if required, in the period in which the final
      determination is made.





**Stock
      Compensation**


In
      accordance with SFAS No. 123R, “Share Based Payment,” compensation cost
      recognized in 2006 is measured using the fair-value method. The fair value
      of
      options granted are estimated on the date of their grant using the Black-Scholes
      option-pricing model. This model uses various weighted average assumptions
      including risk-free interest rates, expected life, expected volatility and
      expected dividend yield.





The
      risk-free interest rate for the periods within the expected life of the option
      is based on the U.S. Treasury yield curve in effect at the time of grant. In
      2005 and 2004, the expected life was based on historical exercises and
      terminations. Due to the insignificant number of stock option exercises during
      the past three fiscal years, in 2006 we have estimated the expected life of
      options granted to be the midpoint between the average vesting term and the
      contractual term. The expected volatility for the periods with the expected
      life
      of the option is determined using historical volatilities based on historical
      closing stock prices. The expected dividend yield is based on our annual
      dividend in relation to our historical average stock price. The increase in
      the
      dividend yield is attributed to the increased quarterly dividend beginning
      February 15, 2005.





See
      Note
      9, Employee Equity Compensation Plans, in our Notes to Consolidated Financial
      Statements for further information.




**Quantitative
      and Qualitative Disclosures About Market Risk**


***(includes
      forward-looking information)***





The
      functional currency for our foreign operations is the local currency. In the
      normal course of business, significantly all of the transactions of our foreign
      operations occur in the local currency. We purchase forward contracts to
      minimize the effect of fluctuating currencies on specifically identifiable
      transactions. These transactions were minimal in 2006, 2005 and 2004. Based
      on
      our historical experience, we expect the foreign exchange gains and losses
      over
      the next year to be minimal.





Interest
      expense related to our 2005 Credit Agreement is sensitive to changes in the
      general level of U.S. interest rates. Based on our average debt outstanding
      under this agreement over the past twelve months, a 1% change in the interest
      rate charged on these borrowings would have affected our 2006 interest expense
      by $4.




Additional
      information is available in Note 7, Financial Instruments, in our Notes to
      Consolidated Financial Statements.


-22-




**Recent
      Accounting Standards**


***(includes
      forward-looking information)***





In
      June
      2006, the FASB issued FASB Interpretation 48, “Accounting for Uncertainty in
      Income Taxes - an Interpretation of SFAS 109” (FIN 48). FIN 48 clarifies the
      accounting for income taxes by prescribing a minimum recognition threshold
      a tax
      position is required to meet before being recognized in the financial
      statements. It also provides guidance on derecognition and measurement of tax
      positions. Disclosure requirements under this guidance will include a
      rollforward of the beginning and ending unrecognized tax benefits as well as
      specific detail related to tax uncertainties for which it is reasonably possible
      the amount of unrecognized tax benefit will significantly increase or decrease
      within a year. FIN 48 is effective for fiscal years beginning after December
      15,
      2006. We are still evaluating the impact of this standard on our financial
      statements.




-23-


*The
      Reader’s Digest Association, Inc. and Subsidiaries*





**Consolidated
      Statements of Operations**


**Years
                  ended June 30,***In
                  millions, except per share data*
              
              **2006**
              
              2005
              
              2004**Revenues**
              
              **$**
              **2,386.2**
              
              **$**
              **2,389.7**
              
              **$**
              **2,388.5**Product,
                  distribution and editorial expenses
              
              
              **(997.1**
              **)**
              
              (970.9
              )
              
              (972.9
              )Promotion,
                  marketing and administrative expenses
              
              
              **(1,240.0**
              **)**
              
              (1,337.5
              )
              
              (1,294.5
              )Goodwill
                  charge
              
              
              **(187.8**
              **)**
              
              (129.0
              )
              
              ---Other
                  operating items, net
              
              
              **(6.8**
              **)**
              
              14.1
              
              
              (8.8
              )**Operating
                  (loss) profit**
              
              
              **(45.5**
              **)**
              
              **(33.6**
              **)**
              
              **112.3**Other
                  (expense) income, net
              
              
              **(41.1**
              **)**
              
              (45.8
              )
              
              (46.2
              )**(Loss)
                  income before provision for income taxes**
              
              
              **(86.6**
              **)**
              
              **(79.4**
              **)**
              
              **66.1**Income
                  tax provision
              
              
              **(30.8**
              **)**
              
              (11.5
              )
              
              (16.6
              )**Net
                  (loss) income**
              
              **$**
              **(117.4**
              **)**
              **$**
              **(90.9**
              **)**
              **$**
              **49.5****Basic
                  and diluted (loss) earnings per share*****Basic
                  (loss) earnings per share***
                Weighted
                  average common shares outstanding
              
              
              **95.9**
              
              
              97.4
              
              
              97.1**Basic
                  (loss) earnings per share**
              
              **$**
              **(1.24**
              **)**
              **$**
              **(0.95**
              **)**
              **$**
              **0.50*****Diluted
                  (loss) earnings per share***
                Adjusted
                  weighted average common shares outstanding
              
              
              **95.9**
              
              
              97.4
              
              
              99.2**Diluted
                  (loss) earnings per share**
              
              **$**
              **(1.24**
              **)**
              **$**
              **(0.95**
              **)**
              **$**
              **0.49****Dividends
                  per common share**
              
              **$**
              **0.40**
              
              **$**
              **0.30**
              
              **$**
              **0.20**


*See
      accompanying Notes to Consolidated Financial Statements.*


-24-
 *The
            Reader’s Digest Association, Inc. and Subsidiaries*
 
 **Consolidated
            Balance Sheets**


**At
                June 30,***In
                millions, except share data*
            
            **2006**
            
            2005**Assets***Current
                assets*Cash
                and cash equivalents
            
            **$**
            **34.7**
            
            $
            37.7Accounts
                receivable, net
            
            
            **261.9**
            
            
            233.9Inventories
            
            
            **172.3**
            
            
            162.4Prepaid
                and deferred promotion costs
            
            
            **62.3**
            
            
            53.8Prepaid
                expenses and other current assets
            
            
            **173.1**
            
            
            144.9**Total
                current assets**
            
            
            **704.3**
            
            
            **632.7**Property,
                plant and equipment, net
            
            
            **119.3**
            
            
            119.3Goodwill
            
            
            **744.1**
            
            
            880.9Other
                intangible assets, net
            
            
            **134.4**
            
            
            137.8Prepaid
                pension assets
            
            
            **324.6**
            
            
            307.9Other
                noncurrent assets
            
            
            **95.4**
            
            
            102.0**Total
                assets**
            
            **$**
            **2,122.1**
            
            **$**
            **2,180.6****Liabilities
                and stockholders’ equity***Current
                liabilities*Accounts
                payable
            
            **$**
            **128.2**
            
            $
            109.8Accrued
                expenses
            
            
            **257.3**
            
            
            267.4Income
                taxes payable
            
            
            **40.6**
            
            
            34.5Unearned
                revenues
            
            
            **394.1**
            
            
            395.5Other
                current liabilities
            
            
            **9.8**
            
            
            12.4**Total
                current liabilities**
            
            
            **830.0**
            
            
            **819.6**Long-term
                debt
            
            
            **695.0**
            
            
            559.2Unearned
                revenues
            
            
            **131.2**
            
            
            133.0Accrued
                pension
            
            
            **108.7**
            
            
            121.5Postretirement
                and postemployment benefits other than pensions
            
            
            **94.2**
            
            
            96.7Other
                noncurrent liabilities
            
            
            **87.9**
            
            
            84.4**Total
                liabilities**
            
            **$**
            **1,947.0**
            
            **$**
            **1,814.4**Commitments
                and contingencies (Notes 6, 11 and 13)**Stockholders’
                equity**Preferred
                stock
            
            
            **28.8**
            
            
            28.8Common
                stock (par value $0.01 per share; authorized200,000,000
                shares; 145,922,062 issued in 2006 and 2005;
              95,047,776
                and 99,256,958 outstanding in 2006 and 2005,respectively)
            
            
            **1.5**
            
            
            1.5Unamortized
                restricted stock
            
            
            **---**
            
            
            (9.1
            )Paid-in
                capital
            
            
            **208.1**
            
            
            206.8Retained
                earnings
            
            
            **1,064.3**
            
            
            1,221.6Accumulated
                other comprehensive loss
            
            
            **(67.4**
            **)**
            
            (84.1
            )Treasury
                stock, at cost (50,874,286 and 46,665,104 shares in 2006and
                2005, respectively)
            
            
            **(1,060.2**
            **)**
            
            (999.3
            )**Total
                stockholders’ equity**
            
            
            **175.1**
            
            
            **366.2****Total
                liabilities and stockholders’ equity**
            
            **$**
            **2,122.1**
            
            **$**
            **2,180.6**







*See
      accompanying Notes to Consolidated Financial Statements.*


-25-
 *The
            Reader’s Digest Association, Inc. and Subsidiaries*
 
 **Consolidated Statements
            of Cash Flows**


**Years
                ended June 30,***In
                millions*
            
            **2006**
            
            2005
            
            2004**Cash
                flows from operating activities**Net
                (loss) income
            
            **$**
            **(117.4**
            **)**
            $
            (90.9
            )
            $
            49.5Depreciation
                and amortization
            
            
            **36.8**
            
            
            56.9
            
            
            63.2Magazine
                deferred promotion charge
            
            
            **---**
            
            
            ---
            
            
            27.2Asset
                impairments
            
            
            **190.6**
            
            
            129.0
            
            
            1.1Amortization
                of debt issue costs
            
            
            **1.5**
            
            
            10.3
            
            
            12.1Stock-based
                compensation
            
            
            **14.3**
            
            
            11.2
            
            
            10.2Net
                gain on sales of long-term assets
            
            
            **(4.1**
            **)**
            
            (14.3
            )
            
            (10.0
            )*Changes
                in assets and liabilities, net of effects of acquisitions and
                dispositions*Accounts
                receivable, net
            
            
            **(19.1**
            **)**
            
            3.6
            
            
            34.1Inventories
            
            
            **(7.8**
            **)**
            
            (7.7
            )
            
            6.4Prepaid
                and deferred promotion costs (including the amortization of
                previously
              deferred
                promotion costs)
            
            
            **(7.5**
            **)**
            
            54.0
            
            
            0.7Other
                assets
            
            
            **(25.7**
            **)**
            
            13.6
            
            
            4.3Unearned
                revenues
            
            
            **(9.2**
            **)**
            
            (9.0
            )
            
            (12.7
            )Income
                and deferred taxes, net
            
            
            **(0.3**
            **)**
            
            0.1
            
            
            1.6Accounts
                payable and accrued expenses
            
            
            **1.9**
            
            
            (7.1
            )
            
            (6.8
            )Other
                liabilities
            
            
            **(6.3**
            **)**
            
            (10.7
            )
            
            (6.5
            )**Net
                change in cash due to operating activities**
            
            
            **47.7**
            
            
            **139.0**
            
            
            **174.4****Cash
                flows from investing activities**Proceeds
                from sales of other long-term assets
            
            
            **0.9**
            
            
            6.7
            
            
            3.8Proceeds
                from sales of property, plant and equipment
            
            
            **3.7**
            
            
            62.8
            
            
            7.1Purchase
                of*Allrecipes.com,*net
                of cash acquired
            
            
            **(65.9**
            **)**
            
            ---
            
            
            ---Purchases
                of intangible assets
            
            
            **(0.5**
            **)**
            
            ---
            
            
            (1.3
            )Capital
                expenditures
            
            
            **(19.9**
            **)**
            
            (23.5
            )
            
            (16.1
            )**Net
                change in cash due to investing activities**
            
            
            **(81.7**
            **)**
            
            **46.0**
            
            
            **(6.5**
            **)****Cash
                flows from financing activities**Proceeds
                / (repayments) from borrowings, net
            
            
            **135.8**
            
            
            214.6
            
            
            43.9Proceeds
                from Senior Notes offering
            
            
            **---**
            
            
            ---
            
            
            300.0Repayments
                of term loan
            
            
            **---**
            
            
            (377.0
            )
            
            (488.4
            )Cash
                paid for financing fees
            
            
            **(0.3**
            **)**
            
            (2.2
            )
            
            (7.6
            )Proceeds
                from employee stock purchase plan and exercise of stock
                options
            
            
            **2.2**
            
            
            3.3
            
            
            2.5Dividends
                paid
            
            
            **(39.9**
            **)**
            
            (30.5
            )
            
            (20.7
            )Treasury
                stock repurchases
            
            
            **(65.2**
            **)**
            
            (5.0
            )
            
            ---Other,
                net
            
            
            **(3.7**
            **)**
            
            (3.0
            )
            
            0.5**Net
                change in cash due to financing activities**
            
            
            **28.9**
            
            
            **(199.8**
            **)**
            
            **(169.8**
            **)****Effect
                of exchange rate fluctuations on cash and cash
                equivalents**
            
            
            **2.1**
            
            
            **2.2**
            
            
            **0.9****Net
                change in cash and cash equivalents**
            
            
            **(3.0**
            **)**
            
            **(12.6**
            **)**
            
            **(1.0**
            **)**Cash
                and cash equivalents at beginning of year
            
            
            **37.7**
            
            
            50.3
            
            
            51.3**Cash
                and cash equivalents at end of year**
            
            **$**
            **34.7**
            
            **$**
            **37.7**
            
            **$**
            **50.3****Supplemental
                information**Cash
                paid for interest
            
            **$**
            **38.7**
            
            $
            36.8
            
            $
            34.2Cash
                paid for income taxes
            
            **$**
            **34.1**
            
            $
            21.2
            
            $
            28.7




*See
      accompanying Notes to Consolidated Financial Statements.*






-26-




*The
        Reader’s Digest Association, Inc. and Subsidiaries*
 
 **Consolidated
        Statements of Changes in Stockholders’ Equity**


Capital
                  Stock*In
                  millions*
              
              Preferred
                  Stock
              
              Common
                  Stock
              
              Unamortized
                  Restricted
                Stock
              
              Paid-in
                  Capital
              
              Retained
                  Earnings
              
              Accumulated
                  Other Comprehensive (Loss) Income
              
              Treasury
                  Stock, at Cost
              
              Total**Balance
                  at June 30, 2003**
              
              **$**
              **28.8**
              
              **$**
              **1.5**
              
              **$**
              **(12.7**
              **)**
              **$**
              **215.0**
              
              **$**
              **1,314.2**
              
              **$**
              **(109.2**
              **)**
              **$**
              **(1,024.7**
              **)**
              **$**
              **412.9***Comprehensive
                  income*Net
                  income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              49.5
              
              
              
              
              
              
              
              
              **49.5**Other
                  comprehensive income:Translation
                  gain
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              5.8
              
              
              
              
              
              **5.8**Net
                  unrealized gain on investments, net of deferred taxes of
                  $(0.1)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              0.2
              
              
              
              
              
              **0.2**Reclassification
                  adjustments for investment gains that are included in net income,
                  net of
                  deferred taxes of $0.3
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (0.5
              )
              
              
              
              
              **(0.5**
              **)**Net
                  realized loss on derivatives, net of nominal deferred taxes
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (0.1
              )
              
              
              
              
              **(0.1**
              **)**Reclassification
                  adjustments forderivative
                  losses that areincluded
                  in net income, net ofdeferred
                  taxes of $(0.5)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              0.9
              
              
              
              
              
              **0.9**Minimum
                  pension liability, net of deferred taxes of $(7.7)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              13.5
              
              
              
              
              
              **13.5***Total
                  comprehensive income*
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              **69.3**Stock
                  issued under various plans
              
              
              
              
              
              
              
              
              0.2
              
              
              (4.9
              )
              
              
              
              
              
              
              
              18.9
              
              
              **14.2**Common
                  Stock dividends
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (19.4
              )
              
              
              
              
              
              
              
              **(19.4**
              **)**Preferred
                  Stock dividends
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (1.3
              )
              
              
              
              
              
              
              
              **(1.3**
              **)****Balance
                  at June 30, 2004**
              
              **$**
              **28.8**
              
              **$**
              **1.5**
              
              **$**
              **(12.5**
              **)**
              **$**
              **210.1**
              
              **$**
              **1,343.0**
              
              **$**
              **(89.4**
              **)**
              **$**
              **(1,005.8**
              **)**
              **$**
              **475.7**
 
 -27-
 *The
          Reader’s Digest Association, Inc. and Subsidiaries*
 
 **Consolidated
          Statements of Changes in Stockholders’ Equity,
          continued**
 Capital
                  Stock*In
                  millions*
              
              Preferred
                  Stock
              
              Common
                  Stock
              
              Unamortized
                  Restricted
                Stock
              
              Paid-in
                  Capital
              
              Retained
                  Earnings
              
              Accumulated
                  Other Comprehensive (Loss) Income
              
              Treasury
                Stock,
                  at Cost
              
              Total**Balance
                  at June 30, 2004**
              
              **$**
              **28.8**
              
              **$**
              **1.5**
              
              **$**
              **(12.5**
              **)**
              **$**
              **210.1**
              
              **$**
              **1,343.0**
              
              **$**
              **(89.4**
              **)**
              **$**
              **(1,005.8**
              **)**
              **$**
              **475.7***Comprehensive
                  loss*Net
                  loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (90.9
              )
              
              
              
              
              
              
              
              **(90.9**
              **)**Other
                  comprehensive income:Translation
                  gain
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              8.1
              
              
              
              
              
              **8.1**Reclassification
                  adjustments for derivative losses that are included in net income,
                  net of
                  nominal deferred taxes
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              0.5
              
              
              
              
              
              **0.5**Minimum
                  pension liability, net of deferred taxes of $1.9
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (3.3
              )
              
              
              
              
              **(3.3**
              **)***Total
                  comprehensive loss*
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              **(85.6**
              **)**Stock
                  issued under various plans
              
              
              
              
              
              
              
              
              3.4
              
              
              (3.3
              )
              
              
              
              
              
              
              
              13.5
              
              
              **13.6**Common
                  Stock repurchased
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (7.0
              )
              
              **(7.0**
              **)**Common
                  Stock dividends
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (29.2
              )
              
              
              
              
              
              
              
              **(29.2**
              **)**Preferred
                  Stock dividends
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (1.3
              )
              
              
              
              
              
              
              
              **(1.3**
              **)****Balance
                  at June 30, 2005**
              
              **$**
              **28.8**
              
              **$**
              **1.5**
              
              **$**
              **(9.1**
              **)**
              **$**
              **206.8**
              
              **$**
              **1,221.6**
              
              **$**
              **(84.1**
              **)**
              **$**
              **(999.3**
              **)**
              **$**
              **366.2***Comprehensive
                  loss*Net
                  lossOther
                  comprehensive income:
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (117.4
              )
              
              
              
              
              
              
              
              **(117.4**
              **)**Translation
                  gain
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              9.4
              
              
              
              
              
              **9.4**Minimum
                  pension liability, net of deferred taxes of $(3.7)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              7.3
              
              
              
              
              
              **7.3***Total
                  comprehensive loss*
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              **(100.7**
              **)**Reclassification
                  of Unamortized
                Restricted
                  Stock to Paid-In Capital
              
              
              
              
              
              
              
              
              9.1
              
              
              (9.1
              )
              
              
              
              
              
              
              
              
              
              
              **---**Stock
                  issued under various plans
              
              
              
              
              
              
              
              
              
              
              
              10.4
              
              
              
              
              
              
              
              
              2.3
              
              
              **12.7**Common
                  Stock repurchased
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (63.2
              )
              
              **(63.2**
              **)**Common
                  Stock dividends
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (38.6
              )
              
              
              
              
              
              
              
              **(38.6**
              **)**Preferred
                  Stock dividends
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (1.3
              )
              
              
              
              
              
              
              
              **(1.3**
              **)****Balance
                  at June 30, 2006**
              
              **$**
              **28.8**
              
              **$**
              **1.5**
              
              **$**
              **---**
              
              **$**
              **208.1**
              
              **$**
              **1,064.3**
              
              **$**
              **(67.4**
              **)**
              **$**
              **(1,060.2**
              **)**
              **$**
              **175.1**
  *Accumulated
          Other Comprehensive Loss, net of tax, is comprised of foreign currency
          translation adjustments of ($31.8), ($42.5) and ($50.6) at June 30, 2006,
          2005
          and 2004 respectively; minimum pension liabilities of ($35.6), ($41.6)
          and
          ($38.3) at June 30, 2006, 2005 and 2004, respectively; and unrealized losses
          on
          derivatives of ($0.5) at*
 *December
          31, 2004.*
 *See
          accompanying Notes to Consolidated Financial Statements* *.*




-28-


*Unless
      otherwise indicated, references in Notes to Consolidated Financial Statements
      to
“we,” “our” and “us” are to The Reader’s Digest Association, Inc. and its
      subsidiaries. All references to 2006, 2005 and 2004, unless otherwise indicated,
      are to fiscal 2006, fiscal 2005 and fiscal 2004, respectively. Our fiscal year
      represents the period from July 1 through June 30.*





**Note
      1**  **Organization and Summary of Significant Accounting
      Policies**





**Description
      of Our Business**





We
      are a
      diversified media company that produces and distributes books, magazines and
      other products worldwide. We sell these and other products through direct
      marketing and direct sales channels. Our best known trademark is our flagship
      magazine, *Reader’s
      Digest* .
      We
      conduct business through three reportable segments: Reader’s Digest North
      America, Reader’s Digest International and Consumer Business Services. For
      further commentary regarding these segments, see Management’s Discussion and
      Analysis and Note 14, Segments.





**Basis
      of Presentation and Use of Estimates**





The
      accompanying consolidated financial statements include the accounts of The
      Reader’s Digest Association, Inc. and its majority-owned subsidiaries.
      Intercompany transactions and accounts have been eliminated in consolidation.
      These financial statements are prepared in conformity with U.S. generally
      accepted accounting principles, which require management to make estimates
      and
      assumptions that affect the reported amounts of assets and liabilities, the
      disclosure of contingent assets and liabilities at the date of the financial
      statements, and the reported amounts of operating revenues and expenses during
      the reporting period. These estimates are based on management’s knowledge of
      current events and actions that we may undertake in the future; however, actual
      results may ultimately differ from those estimates. The primary estimates
      underlying our consolidated financial statements include allowances for returns
      and doubtful accounts, valuations of inventories, recoverability of direct
      response advertising and subscriber acquisition costs, recoverability of
      goodwill and other intangible assets, income taxes, estimates of pension,
      postemployment and postretirement benefits and valuations of our stock options.





**Concentrations
      of Credit Risk**





Financial
      instruments that potentially expose us to concentrations of credit risk consist
      primarily of trade accounts receivable. However, we believe our concentrations
      of credit risk with respect to trade receivables are limited due to our large
      number of customers, their low individual dollar balances and their dispersion
      across many different geographic and economic environments.





**Cash
      and Cash Equivalents**





We
      consider all highly liquid investments with original maturities of three months
      or less at the date of purchase to be cash equivalents. The carrying amount
      approximates fair value based upon the short-term maturity of these
      investments.





**Inventories**





Inventories
      consist primarily of finished goods and raw materials (including paper) and
      are
      stated at the lower of cost or market value. For all inventories, cost is
      determined using the weighted **** average
      cost method, which approximates the first-in, first-out (FIFO) method.




-29-


**Long-Lived
      Assets**





*Property,
      Plant and Equipment, Net*





Assets
      that comprise property, plant and equipment, net are stated at cost less
      accumulated depreciation and amortization. Depreciation expense is generally
      calculated on a straight-line basis over the estimated useful lives of the
      assets: 10-40 years for buildings; 3-10 years for equipment, furniture and
      fixtures; and 5 years for software. Leasehold improvements are amortized on
      a
      straight-line basis over the initial term of the lease or the useful life of
      the
      improvement, whichever is shorter.





*Goodwill
      and Other Intangible Assets, Net*





Goodwill
      comprises the excess of costs over the fair value of net assets of acquired
      businesses. Other intangible assets, net comprises licensing agreements,
      customer lists, tradenames and other items. Acquired intangibles with finite
      lives are amortized, on a straight-line basis, over their estimated useful
      lives. See Note 6, Goodwill and Other Intangible Assets, Net, for additional
      information.





*Impairment
      of Long-Lived Assets*





We
      review
      for recoverability, at least annually, the carrying amount of goodwill and
      intangibles with indefinite lives. This assessment involves comparing the fair
      value of the reporting unit or asset, as applicable, to its carrying value.
      Recognition of the impairment, if any, is determined in accordance with the
      Financial Accounting Standards Board (FASB) Statement of Financial Accounting
      Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets.” See Note 6,
      Goodwill and Other Intangible Assets, Net, for additional
      information.





I ntangible
      assets with finite lives and property, plant and equipment are reviewed for
      impairment whenever events or changes in circumstances indicate that the
      carrying amount of that asset may not be recoverable in accordance with SFAS
      No.
      144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” We assess
      recoverability by comparing the asset’s carrying amount to the undiscounted
      future net cash flows expected to be generated by the asset. If we determine
      that the asset is impaired, the impairment recognized is the amount by which
      the
      carrying amount of the asset exceeds the fair value of the asset.




**Debt
      Issuance Costs**





Debt
      issuance costs consist of fees and expenses incurred in connection with our
      borrowings. These fees are amortized over the terms of the related debt
      agreements, which range from five to seven years. Capitalized debt issuance
      costs are included in other noncurrent assets on the balance sheets. To the
      extent we retire a significant portion of our borrowings, a proportionate amount
      of debt issue costs related to those borrowings is written off.




-30-


**Stock-Based
      Compensation**





Effective
      July 1, 2005, we adopted the fair-value recognition provision of SFAS No. 123R,
      “Share-Based Payment” (SFAS No. 123R) and Securities and Exchange Commission
      Staff Accounting Bulletin No. 107 (SAB 107), using the modified prospective
      transition method; therefore prior periods have not been restated. Prior to
      July
      1, 2005, we accounted for stock-based compensation under SFAS No. 123,
“Accounting for Stock-Based Compensation” (SFAS No. 123). As permitted by SFAS
      No. 123, compensation cost was recognized for stock-based compensation
      using the intrinsic value method under Accounting Principles Board (APB) Opinion
      No. 25, “Accounting for Stock Issued to Employees” (APB No. 25). Under this
      method, compensation cost was the excess, if any, of the quoted market price
      of
      the stock at the grant date over the amount an employee must pay to acquire
      the
      stock. Since we grant stock options with an exercise price equal to the market
      price at the date of grant, no compensation cost was recognized. Additional
      information is presented in Note 9, Employee Equity Compensation
      Plans.





**Financial
      Instruments**





Due
      to
      the short-term maturities of our cash, cash equivalents, receivables and
      payables, the carrying value of these financial instruments approximates their
      fair values. Due to variable interest rates and current market prices, the
      fair
      value of our $500.0 Revolving Credit Agreement and Senior Notes, respectively,
      approximate their carrying values. See Note 11, Debt, for additional information
      on our debt instruments.





**Pensions
      and Postretirement Benefits Other Than Pensions**





We
      account for our pension and postretirement benefits in accordance with SFAS
      No.
      87, “Employers’ Accounting for Pensions,” SFAS No. 88, “Employers’ Accounting
      for Settlements and Curtailments of Defined Benefit Pension Plans and for
      Termination Benefits” and SFAS No. 106, “Employers’ Accounting for
      Postretirement Benefits Other Than Pensions.” Pursuant to these statements,
      obligations are determined using actuarial models that incorporate estimates
      for
      employee turnover and mortality, increases in employee compensation and
      healthcare costs, and an employee’s age at retirement. These estimates are
      reviewed annually with actuarial consultants to determine the reasonableness
      of
      our assumptions. While these models help determine the obligation, SFAS No.
      87
      and No.106 attempt to match recognition of the obligation with the period over
      which our employees earn benefits. Because employees earn benefits over many
      years of service, the accounting rules require the recognition of certain events
      (including plan amendments and certain gains and losses) over multiple years
      rather than the year the event occurs. This principle also applies to
      recognition of the expected return on plan assets. Although the rate represents
      our expectation of the long-term performance of our asset portfolio, performance
      will likely vary in the short term. We amortize the difference between the
      actual and expected return on assets over a five-year period. Income and
      expenses associated with our pension plans are included in promotion, marketing
      and administrative expenses on the statements of operations.





In
      addition, pursuant to SFAS No. 87, we recognize a minimum pension liability
      in
      certain instances where the plan’s accumulated benefit obligation as of our
      measurement date, March 31, exceeds the fair value of plan assets. This amount
      is adjusted based on whether we have a net pension asset or liability. The
      minimum pension liability, as adjusted, is included in the accrued pension
      caption on our balance sheets. The offset is first applied to any unrecognized
      prior service cost and the remainder is included in accumulated other
      comprehensive loss in stockholders’ equity on our balance sheets.




-31-


**Revenues**





*Magazines*





Sales
      of
      our magazine subscriptions, less estimated cancellations, are deferred and
      recognized as revenues proportionately over the subscription period. Revenues
      from sales of magazines through the newsstand are recognized at the issue date,
      net of an allowance for returns. Advertising revenues are recorded as revenues
      at the time the advertisements are published, net of discounts and advertising
      agency commissions.





*Sponsor
      Fundraising Programs*





Our
      sponsor fundraising program business, which operates principally through QSP,
      Inc., receives its revenues net of amounts due to its sponsors. Accordingly,
      we
      present revenues net of sponsors’ earnings. Sales of subscriptions to magazines
      published by other companies and sales of music products are recorded as
      revenues at the time orders are submitted to the publisher, net of bad debts
      and
      remittances to magazine and music publishers.





*Books,
      Display Marketing and Other Products*





Revenues
      are recorded when title passes, net of provisions for estimated returns and
      bad
      debts. For our display marketing products, title passes either at the point
      of
      sale or at the time of shipment. In certain circumstances, our promotion
      entitles the customer to a preview period. Revenue generated by these promotions
      is recognized after the preview period lapses.





When
      we
      recognize revenues for most of our products, we also record an estimate of
      bad
      debts and returns. These estimates are based on historical data and the method
      of promotion. Reserve levels are adjusted as actual data is received. In the
      direct marketing business, returns and bad debts are tied to customer responses
      to our promotional efforts. Accordingly, we deduct estimates of returns and
      bad
      debts from gross revenue.





**Shipping
      and Handling**





Costs
      for
      shipping products to customers and the associated handling costs are expensed
      as
      incurred and are included in product, distribution and editorial expenses on
      the
      statements of operations.





In
      certain circumstances, shipping and handling costs are billed to the customer.
      These billings are recognized in revenue.





**Promotion
      Costs**





Non-direct
      advertising, including internal advertising costs and market testing and
      fulfillment costs, are expensed as incurred.





Direct
      response advertising consists primarily of promotion costs incurred, such as
      paper and postage, in connection with the sale of magazine subscriptions, books
      and other products. We account for costs of direct response advertising under
      the American Institute of Certified Public Accountants Statement of Position
      (SOP) 93-7, “Reporting on Advertising Costs.” Under SOP 93-7, costs
      associated with direct response advertising that can be directly linked to
      eliciting sales and result in probable future benefits are capitalized on a
      cost-pool-by-cost-pool basis. Books and home entertainment advertising costs
      are
      amortized over a period that is generally less than one year. We assess the
      carrying amount of our capitalized direct response advertising costs for
      recoverability on a periodic basis. Magazine related direct response advertising
      costs are expensed when the related promotion is mailed.


-32-


During
      the fourth quarter of 2004, we reassessed our accounting for magazine promotion
      costs in response to changes in our business, as well as the strategies and
      initiatives being undertaken by our magazine business. As a result of these
      changes and pursuant to SOP 93-7, effective July 1, 2004, we began expensing
      magazine deferred promotion costs when the promotion is mailed to prospective
      customers instead of deferring and amortizing such costs. As of June 30, 2004,
      we recorded a pre-tax charge of $(27.2) to reflect the impact of this change
      in
      circumstances on our existing asset. The remaining balance of $(77.1) was
      amortized in 2005, over the initial subscription period, generally one year.
      These amounts are included as a component of promotion, marketing and
      administration expenses on the statements of operations.




Promotion
      expense, which consists of both amortization of promotion costs and costs
      expensed as incurred, included on the statements of operations totaled $(700.7)
      in 2006; $(724.7) in 2005, including $(77.1) related to previously deferred
      magazine promotion costs; and $(678.5) in 2004, including $(27.2) related to
      our
      magazine deferred promotion charge. Prepaid and deferred promotion costs
      included on the balance sheets were $62.3 and $53.8 as of June 30, 2006 and
      2005, respectively.





Commissions
      earned by agents for new magazine subscribers are included in promotion,
      marketing and administrative expenses on the statements of operations. These
      costs are deferred and amortized over the related subscription term, typically
      one to three years. Amounts deferred and included in prepaid expenses and other
      current assets on the balance sheets were $21.7 and $22.7 as of June 30, 2006
      and 2005, respectively. Amounts included in other noncurrent assets on the
      balance sheets were $25.5 and $25.8 as of June 30, 2006 and 2005,
      respectively.





**Income
      Taxes**





Income
      taxes are accounted for under the provisions of SFAS No. 109, “Accounting for
      Income Taxes.” In accordance with SFAS No. 109, deferred income taxes, net of
      valuation allowances, reflect the future tax consequences of differences between
      the financial statement and tax bases of assets and liabilities. These deferred
      taxes are calculated by applying currently enacted tax rates. Valuation
      allowances are recorded when it is “more likely than not” that a deferred tax
      asset will not be realized.





**Basic
      and Diluted (Loss) Earnings Per Share**





Basic
      (loss) earnings per share is computed by dividing net (loss) income less
      preferred stock dividend requirements ($1.3 for each of 2006, 2005 and 2004)
      by
      the weighted average number of shares of Common Stock outstanding during the
      year.





Diluted
      earnings per share is computed in the same manner except that the weighted
      average number of shares of Common Stock outstanding  assumes
      the exercise and conversion of certain stock options and vesting of certain
      restricted stock. For the years ended June 30, 2006 and 2005, 14.4 million
      and
      15.2 million stock options and shares of restricted stock outstanding,
      respectively, were excluded from the diluted-loss per share calculations since
      the effect of including them would have been anti-dilutive. Accordingly, our
      diluted loss per share for these years is calculated using the basic weighted
      average number of common shares outstanding.





For
      2004,
      the assumed exercise and conversion of stock options and vesting of restricted
      stock were 2.2 million shares. In addition, stock options to purchase
      approximately 10.8 million shares of Common Stock that were outstanding during
      2004 were not included in the computation of diluted earnings per share since
      the effect of including these options would have been anti-dilutive.




-33-


**Foreign
      Currency Translation**





The
      functional currency for our foreign operations is the local currency. Revenues
      and expenses denominated in foreign currencies are translated at average monthly
      exchange rates prevailing during the year. The assets and liabilities of
      international subsidiaries are translated into U.S. dollars at the rates of
      exchange in effect at the balance sheet date. The resulting translation
      adjustment is reflected as a separate component of stockholders’ equity in
      accumulated other comprehensive (loss) income.








**Recent
      Accounting Standards**





In
      June
      2006, the FASB issued FASB Interpretation 48, “Accounting for Uncertainty in
      Income Taxes - an Interpretation of SFAS 109” (FIN 48). FIN 48 clarifies the
      accounting for income taxes by prescribing a minimum recognition threshold
      a tax
      position is required to meet before being recognized in the financial
      statements. It also provides guidance on derecognition and measurement of tax
      positions. Disclosure requirements under this guidance will include a
      rollforward of the beginning and ending unrecognized tax benefits as well as
      specific detail related to tax uncertainties for which it is reasonably possible
      the amount of unrecognized tax benefit will significantly increase or decrease
      within a year. FIN 48 is effective for fiscal years beginning after December
      15,
      2006. We are still evaluating the impact of this standard on our consolidated
      financial statements.








**Reclassifications
      and Prior Period Adjustment**





Certain
      reclassifications have been made to amounts in prior periods to conform to
      the
      current period presentation.





During
      the fourth quarter of 2005, we recorded an adjustment of $12.6, net of deferred
      taxes of $7.8, to retained earnings as of the earliest period presented. The
      adjustment reduced an over accrual for certain long-term employee-related
      liabilities which should have been adjusted in a period prior to fiscal 2001.
      The adjustment has been considered immaterial for all periods and has no impact
      on the statements of operations or the statements of cash flows for the periods
      presented.






**Note
      2**  **Acquisitions**





On
      April
      20, 2006, we purchased 100% of the outstanding stock of *Allrecipes.com* for
      $66.5, net of cash acquired of $2.5. Included in the purchase price is $5.3
      of
      consideration held in escrow to indemnify us for any potential breaches of
      the
      purchase agreement. This amount is expected to be released from escrow by the
      first half of fiscal 2008. *Allrecipes.com* is
      an
      online community food and cooking website that leverages an active and growing
      network of home cooks to generate revenue from advertising sponsorships and
      retail licensing. This acquisition provides us with a digital platform to
      further leverage our food and cooking titles. This synergy resulted in $50.5
      of
      goodwill, which is not deductible for tax purposes.





The
      acquisition was accounted for using the purchase method of accounting. *Allrecipes.com* operating ** results
      have been included in our consolidated financial statements since April 20,
      2006
      as part of our Reader’s Digest North America reportable segment. Pro forma
      results of operations, as if the *Allrecipes.com* acquisition
      had been made as of July 1, 2004, were not presented due to
      immateriality.


-34-


Acquired
      identified finite-lived intangibles, totaling $8.3, are comprised of: licenses,
      advertising relationships, non-compete agreements, website content and developed
      technologies. These intangible assets are amortized over their estimated useful
      lives, with a weighted-average amortization period of 5.3 years. The acquired
      tradename is considered an indefinite-lived intangible asset. The following
      table represents the fair values of assets acquired and liabilities assumed
      at
      the date of acquisition:





Amortization
                Life
              (in
                years)
            
            Fair
                Market ValueIdentified
                finite-lived intangible assets:Licenses
            
            
            3
            
            $
            1.3Advertising
                relationships
            
            
            4
            
            
            1.9Non-compete
                agreements
            
            
            2
            
            
            0.1Website
                content
            
            
            10
            
            
            2.1Developed
                technology
            
            
            4
            
            
            2.9Indefinite-lived
                tradename
            
            
            
            
            
            3.6Goodwill
            
            
            
            
            
            50.5Other
                net assets acquired
            
            
            
            
            
            4.1**Total
                purchase price net of cash acquired**
            
            
            
            
            **$**
            **66.5**








**Note
      3**  **Other Operating Items, Net**





Items
      included in Other Operating Items, Net consist of: 1) gains from the sales
      of
      certain non-strategic assets and 2) restructuring charges, representing the
      streamlining of our organizational structure and the strategic repositioning
      of
      our businesses, including associated asset impairments.





Gains
      from the sales of certain non-strategic assets for the years ended June 30,
      2006, 2005 and 2004 were $3.4, $14.1 and $6.2, respectively. Gains in 2006
      included $2.5 from the sale of our building in Mexico and $0.5 from the sale
      of
      certain fine art. Gains in 2005 included $7.0 from the sale of our buildings
      in
      Australia and Portugal, $3.0 from the sale of *Moneywise* magazine
      in the United Kingdom and *Crafting
      Traditions* magazine
      in the United States, $3.2 from the sales of certain fine art and $1.0 from
      the
      sale of other non-strategic assets. Gains in 2004 included $6.1 from the sale
      of
      our building in Hong Kong.





Restructuring
      charges are recorded in accordance with SFAS No. 146, “Accounting for Costs
      Associated with Exit or Disposal Activities.” Under SFAS No. 146, costs
      associated with restructuring actions, including one-time severance benefits,
      are only recorded once a liability has been incurred. SFAS No. 146 does not
      consider severance benefits determined pursuant to an existing formula as
      one-time benefits. As our severance programs do not qualify as one-time
      benefits, we recognize severance amounts pursuant to SFAS No. 112, “Employers’
Accounting for Postemployment Benefits” and SFAS No. 88, “Employers’ Accounting
      for Settlements and Curtailments of Defined Benefit Pension Plans and for
      Termination Benefits” (the impact of pension curtailments and settlements that
      are directly attributable to our restructuring actions are recorded in
      accordance with SFAS No. 88). Severance charges represent the cost to separate
      employees from our operations to streamline the organization. The separation
      is
      accomplished through a combination of voluntary and involuntary severance
      programs. As such, severance amounts are recorded when a termination plan is
      developed and approved, including the identification of positions to be
      separated, and when payment is probable and estimable. Other amounts related
      to
      restructuring actions, including charges to terminate contractual obligations
      in
      connection with streamlining activities, are recorded in accordance with SFAS
      No. 146. Asset impairments related to the carrying value of certain
      long-lived assets are calculated in accordance with the provisions of SFAS
      No.
      144.


-35-


We
      recorded restructuring charges on the statements of operations of $(10.2) in
      2006 and $(15.0) in 2004. In certain instances, circumstances arose that
      resulted in decisions to retain employees previously identified for termination,
      and in certain other instances the costs associated with actions identified
      were
      settled for less than originally anticipated. In these instances, the associated
      charges were reversed.




The
      table
      below outlines the activity related to the restructuring actions recorded in
      2006 and previous years.




**Initial
                year**
              **of
                charge**
            
            **Balance
                at**
              **June
                30, 2005**
            
            **(Adjustments)/**
              **Accruals**
            
            **Spending**
            
            **Balance
                at**
              **June
                30, 2006**2005
                & prior
            
            $
            10.1
            
            $
            (0.8
            )
            $
            (6.1
            )
            **$**
            **3.2**2006
            
            
            ---
            
            $
            7.5
            
            $
            (1.0
            )
            **$**
            **6.5****Total**
            
            **$**
            **10.1**
            
            **$**
            **6.7**
            
            **$**
            **(7.1**
            **)**
            **$**
            **9.7**








During
      2006, restructuring activities comprised:





·
            Charges
                of $(2.8) for severance, $(2.6) for asset impairments, and $(0.5)
                for
                other costs associated with the restructuring plan at Books Are Fun.
                These
                charges were taken at Books Are Fun to lower the cost base, upgrade
                the
                management team and sales force, and improve the business model.
                The
                actions associated with these initiatives are expected to be completed
                by
                the end of fiscal 2007. Asset impairment charges were primarily attributed
                to write-offs of capitalized software costs related to abandoned
                assets.
                The remaining costs are those incurred to close the Books Are Fun
                jewelry
                business and to terminate contractual lease obligations.





·
            Charges
                of $(3.5) for severance, $(0.2) for asset impairments, and $(1.4)
                in other
                costs to lower our cost base commensurate with our current revenues
                and in
                an effort to streamline our operations. Approximately 29%, 54% and
                17% of
                these costs related to Reader’s Digest North America, Reader’s Digest
                International and Consumer Business Services, respectively. These
                actions
                will be completed by the end of fiscal
                2007.





·
            Income
                of $(0.8) related to reversals, primarily of severance, of charges
                recorded in previous years. We review our restructuring plans periodically
                to determine the appropriateness of existing accruals in light of
                current
                circumstances. Accordingly, these charges were reversed because of
                the
                occurrence of events that affected our original plans.





During
      2005, restructuring activities comprised:





·
            Charges
                of $(3.6), primarily related to severance costs. These charges were
                taken
                to lower our cost base in commensuration with our current revenues
                and in
                an effort to streamline our operations. These severance costs related
                to
                the termination of positions, were substantially completed by June
                30, 2006, and of which 48% were located in Reader’s Digest North America,
                22% were located in Reader’s Digest International, 20% were located in
                Consumer Business Services and 10% related to Corporate.





·
            Income
                of $3.6 related to reversals, primarily severance, of charges recorded
                in
                previous years. We review our restructuring plans periodically to
                determine the appropriateness of existing accruals in light of current
                circumstances. Accordingly, these charges, principally consisting
                of
                severance, were reversed because of the occurrence of events that
                affected
                our original plans.


-36-


During
      2004, restructuring activities comprised:





·
            Charges
                of $(13.7) for severance and $(4.3) for contract terminations, asset
                impairments and costs associated with closing our Norway location.
                The
                severance charges related to streamlining operations in certain
                international markets and corporate departments. As a result of these
                actions, the employees were severed by June 30, 2006, of which
                50% were located in Reader’s Digest North America, 39% were located in
                Reader’s Digest International and 11% related to Corporate.




·
            Income
                of $1.3 related to pension curtailments as a result of employee
                terminations.





·
            These
                charges were partially offset by $1.7 of reversals of charges recorded
                in
                previous periods that are no longer necessary. We review our restructuring
                plans periodically to determine the appropriateness of existing accruals
                in light of current circumstances. Accordingly, these charges, principally
                consisting of severance, were reversed because of the occurrence
                of events
                that affected our original plans.








**Note
      4**  **Other (Expense) Income, Net**





**2006**
            
            2005
            
            2004Interest
                income
            
            **$**
            **6.9**
            
            $
            7.4
            
            $
            5.2Interest
                expense(1)
            
            
            **(47.9**
            **)**
            
            (53.6
            )
            
            (55.0
            )Net
                gain on the sales of certain investments(2)
            
            
            **---**
            
            
            ---
            
            
            3.8Net
                (loss) gain on foreign exchange
            
            
            **(0.5**
            **)**
            
            ---
            
            
            (0.1
            )Other
                (expense) income, net
            
            
            **0.4**
            
            
            0.4
            
            
            (0.1
            )**Total
                other (expense) income, net**
            
            **$**
            **(41.1**
            **)**
            **$**
            **(45.8**
            **)**
            **$**
            **(46.2**
            **)**





*(1)*  *In
      connection with the termination of the 2002 Credit Agreements, interest expense
      in 2005 included $(7.3) related to the expensing of the associated capitalized
      financing fees and the discontinuance of the related interest rate protection
      agreements. Interest expense in 2004 included $(7.3) related to the expensing
      of
      deferred financing fees because we refinanced a portion of our existing
      indebtedness, terminated some of our interest rate caps and repriced a portion
      of our borrowings. See Note 11, Debt, for additional
      information.*


*(2)*  *Net
      gain on the sales of certain investments in 2004 included proceeds of $2.7
      received in exchange for our interest in Schoolpop, Inc., which merged into
      an
      unrelated third party. This item also included sales of our shares in LookSmart,
      Ltd. of $0.8 in 2004.*





-37-





**Note
      5**  **Supplemental Balance Sheet
      Information**





The
      components of certain balance sheet accounts as of June 30 are as
      follows:





**Accounts
      Receivable, Net**


**2006**
            
            2005**Gross
                accounts receivable, trade**
            
            **$**
            **422.4**
            
            **$**
            **401.3**Beginning
                reserve for returns
            
            
            **(69.3**
            **)**
            
            (56.3
            )Additions
                to allowances(1)
            
            
            **(417.7**
            **)**
            
            (387.3
            )Actual
                returns(2)
            
            
            **424.9**
            
            
            374.3**Ending
                reserve for returns**
            
            
            **(62.1**
            **)**
            
            **(69.3**
            **)**Beginning
                reserve for bad debts
            
            
            **(98.1**
            **)**
            
            (98.1
            )Additions
                to allowances(1)
            
            
            **(100.4**
            **)**
            
            (97.0
            )Actual
                bad debts(2)
            
            
            **100.1**
            
            
            97.0**Ending
                reserve for bad debts**
            
            
            **(98.4**
            **)**
            
            **(98.1**
            **)****Ending
                reserve for returns and bad debts**
            
            
            **(160.5**
            **)**
            
            **(167.4**
            **)****Accounts
                receivable, net**
            
            **$**
            **261.9**
            
            **$**
            **233.9**




*(1)*
              *Additions
                  to allowances represent estimated reserves established at the time
                  of
                  revenue recognition for returns and bad debts in accordance with
                  SFAS No.
                  48, “Revenue Recognition When Right of Return Exists.” Amounts are
                  recorded as an offset to
                  revenues.*
 *(2)*
              *Actual
                  returns and bad debts include actual experience during the period
                  and the
                  effects of foreign currency translation.*




Inventories





**2006**
            
            2005Raw
                materials
            
            **$**
            **12.8**
            
            $
            11.9Work
                in process
            
            
            **7.2**
            
            
            5.6Finished
                goods
            
            
            **195.6**
            
            
            188.4**Gross
                inventory**
            
            
            **215.6**
            
            
            **205.9**Beginning
                inventory reserve
            
            
            **(43.5**
            **)**
            
            (42.7
            )Additions
                to reserve
            
            
            **(10.7**
            **)**
            
            (7.5
            )Inventory
                write-offs
            
            
            **10.9**
            
            
            6.7**Ending
                inventory reserve**
            
            
            **(43.3**
            **)**
            
            **(43.5**
            **)****Inventories,
                net**
            
            **$**
            **172.3**
            
            **$**
            **162.4**








-38-


**Property,
      Plant and Equipment, Net**


**2006**
            
            2005Land
            
            **$**
            **10.0**
            
            $
            10.1Buildings
                and building improvements
            
            
            **87.3**
            
            
            85.2Furniture,
                fixtures and equipment
            
            
            **89.9**
            
            
            97.2Software
            
            
            **75.9**
            
            
            67.9Leasehold
                improvements
            
            
            **25.6**
            
            
            19.6**288.7**
            
            
            **280.0**Accumulated
                depreciation and
              amortization*
            
            
            **(169.4**
            **)**
            
            (160.7
            )**Total
                property, plant and equipment, net**
            
            **$**
            **119.3**
            
            **$**
            **119.3**





* *Depreciation
      and amortization expense related to property, plant and equipment amounted
      to
      $20.3, $20.0 and $23.6 for the years ended June 30, 2006, 2005 and 2004,
      respectively.*








**Other
      Noncurrent Assets**


**2006**
            
            2005Deferred
                tax assets
            
            **$**
            **46.2**
            
            $
            39.4Other,
                principally operating assets
            
            
            **49.2**
            
            
            62.6**Total
                other noncurrent assets**
            
            **$**
            **95.4**
            
            **$**
            **102.0**





**Accrued
      Expenses**


**2006**
            
            2005Compensation
                and other employee benefits
            
            **$**
            **71.1**
            
            $
            80.5Royalties
                and copyrights payable
            
            
            **14.0**
            
            
            16.6Taxes,
                other than income taxes
            
            
            **8.2**
            
            
            7.3Accrued
                interest
            
            
            **11.6**
            
            
            9.0Other
                operating items, net (see Note 3)
            
            
            **9.7**
            
            
            10.1Other,
                principally operating expenses
            
            
            **142.7**
            
            
            143.9**Total
                accrued expenses**
            
            **$**
            **257.3**
            
            **$**
            **267.4**





**Other
      Noncurrent Liabilities**


**2006**
            
            2005Deferred
                tax liabilities
            
            **$**
            **11.6**
            
            $
            8.0Deferred
                gain related to our Westchester, NY facility sale and leaseback (see
                Note
                13)
            
            
            **21.6**
            
            
            22.8Other,
                principally operating liabilities
            
            
            **54.7**
            
            
            53.6**Total
                other noncurrent liabilities**
            
            **$**
            **87.9**
            
            **$**
            **84.4**







-39-





**Note
      6**  **Goodwill and Other Intangible Assets,
      Net**





The
      changes in the carrying amount of goodwill by reportable segment for the fiscal
      year ended June 30, 2006 are as follows:





**Reader’s
                Digest North America**
            
            **Consumer
                Business Services**
            
            **Total****Balance
                as of June 30, 2005**
            
            **$**
            **687.5**
            
            **$**
            **193.4**
            
            **$**
            **880.9**Additions
                as a result of the*Allrecipes.com
                a*cquisition
                (see Note 2)
            
            
            50.5
            
            
            ---
            
            
            **50.5**Impact
                of foreign currency translation on goodwill balances outside the
                United
                States
            
            
            ---
            
            
            0.5
            
            
            **0.5**Goodwill
                charge
            
            
            ---
            
            
            (187.8
            )
            
            **(187.8**
            **)****Balance
                as of June 30, 2006**
            
            **$**
            **738.0**
            
            **$**
            **6.1**
            
            **$**
            **744.1**





At
      least
      annually (in the third quarter), we review the carrying amount of goodwill
      and
      other intangibles with indefinite lives in our reporting units for
      recoverability. Reiman and Books Are Fun are our primary reporting units in
      Reader’s Digest North America and Consumer Business Services, respectively. In
      interim periods, we continually monitor changes in our businesses for indicators
      of impairment. Due to the shortfall in Books Are Fun’s operating performance
      relative to our expectations during our peak selling season, we were required
      to
      review goodwill balances related to this business in the second quarter of
      2006.
      The decline in performance was attributed to competitive pressure on margin
      and
      turnover of independent sales representatives. Based on our assessment, Books
      Are Fun recorded a charge of $(187.8) in the second quarter of 2006 to write
      off
      its remaining goodwill. During our annual review in 2005, we also recorded
      a
      goodwill charge of $(129.0). The fair value of Books Are Fun was determined
      by a
      third-party appraiser using a combination of discounted net cash flows and
      an
      assessment of comparable companies in the marketplace. The annual recoverability
      tests for the other reporting units were performed during the third quarter
      and
      we determined that no other goodwill and intangible losses have occurred.





The
      following categories of acquired intangible assets are included in other
      intangible assets, net as of June 30, 2006 and 2005:






**2006**
              
              2005**Gross**
              
              **Net**
              
              Gross
              
              Net**Intangible
                  assets with indefinite lives:**Tradenames
              
              **$**
              **93.3**
              
              **$**
              **93.3**
              
              $
              89.7
              
              $
              89.7**Intangible
                  assets with finite lives:**Licensing
                  agreements
              
              
              **60.0**
              
              
              **28.2**
              
              
              57.3
              
              
              31.9Customer
                  lists
              
              
              **138.3**
              
              
              **6.1**
              
              
              137.8
              
              
              16.2Other
                  intangibles, including tradenames and noncompete
                  agreements
              
              
              **9.2**
              
              
              **6.8**
              
              
              3.0
              
              
              ---**Total
                  intangible assets**
              
              **$**
              **300.8**
              
              **$**
              **134.4**
              
              **$**
              **287.8**
              
              **$**
              **137.8**


-40-


Amortization
      related to intangible assets with finite lives amounted to $(16.5), $(36.9)
      and
      $(39.6) for the years ended June 30, 2006, 2005 and 2004, respectively. The
      remaining weighted average amortization period of our intangible assets is
      3.1
      years. Our World’s Finest Chocolate licensing agreement (detailed below) is
      principally amortized over the initial 10-year contract term, with a portion
      being amortized over the remaining 15-year term of our amended agreement.
      Customer lists are being amortized principally between three and six years
      from
      the date of acquisition. Our most significant customer list intangible was
      purchased as part of the Reiman ** acquisition,
      which will be fully amortized over the next two years. See Note 2, Acquisitions,
      for details on the intangibles acquired as part of the *Allrecipes.com* acquisition.





Estimated
      fiscal year amortization expense for intangible assets with finite lives is
      as
      follows: fiscal 2007 - $12.7; fiscal 2008 - $8.2; fiscal 2009 - $7.6; fiscal
      2010 - $7.0 and fiscal 2011 - $1.1.





**Licensing
      Agreement**





In
      May
      2000, QSP, Inc. entered into a long-term licensing agreement with World’s Finest
      Chocolate, Inc. The cost associated with the agreement was assigned to licensing
      agreements and is included in other intangible assets, net on the balance
      sheets. In September 2002, this agreement was amended to extend the term of
      the
      original agreement by 10 years, reduce the annual minimum tonnage purchase
      requirements, favorably adjust pricing and permit QSP to sell World’s Finest
      Chocolate products through marketing channels other than fundraising, under
      specified circumstances. The cost associated with the agreement was assigned
      to
      licensing agreements and is included in other intangible assets, net on the
      balance sheets. Amounts paid to amend the agreement have been assigned to
      various amortization periods ranging from 5 to 15 years (the remaining period
      of
      the amended agreement). This asset will be substantially amortized by
      2010.





The
      approximate annual minimum purchase amounts and related charges under the
      amended agreement by calendar year are: 2005 - $58.8; 2006 - $51.5; 2007 -
      $64.4; 2008 - $66.0; 2009 - $67.6; and approximately $78.7 per year from 2010
      through 2020. These amounts are estimates based on defined minimum tonnage
      requirements, as stipulated in the amended agreement, and nominal price
      increases. During the fourth quarter of 2006, we determined that it was probable
      that we will not meet the calendar 2006 minimum tonnage purchase commitment
      under this agreement and, accordingly, recorded a charge of $(5.6). In 2005,
      we
      met the minimum purchase requirement under this agreement. However, in 2004,
      we
      did not meet the minimum purchase requirements and, accordingly, recorded a
      charge of $(0.8).








**Note
      7**  **Financial Instruments**





**Risk
      Management and Objectives**





The
      functional currency for our foreign operations is the local currency. In the
      normal course of business, substantially all of the transactions of our foreign
      operations occur in the local currency. We purchase forward contracts to
      minimize the effect of fluctuating currencies on specifically identifiable
      transactions. These transactions were minimal in 2006, 2005 and 2004.





As
      a
      matter of policy, we do not speculate in financial markets and, therefore,
      we do
      not hold financial instruments for trading purposes. We continually monitor
      foreign currency risk and our use of derivative instruments.


-41-





**Derivative
      Instruments**





Cash
      Flow
      Hedges - There were no material cash flow hedges as of June 30, 2006 or June
      30,
      2005. In 2004, we terminated our interest rate caps with a notional value of
      $250.0 and recognized the remaining unrealized loss on those instruments,
      $(1.3), in interest expense. In addition, in the fourth quarter of 2005, we
      terminated our 2002 Credit Agreements. As a result, we terminated our remaining
      interest rate caps with a notional value of $150.0 and recognized the remaining
      unrealized loss on those instruments, $(0.4) in interest expense.





As
      of
      June 30, 2004, the fair values of our interest rate caps were largely unchanged.
      For 2004, the fair value of our interest rate caps decreased, resulting in
      a
      loss of $(0.1), net of deferred taxes of zero. This change is reported in
      accumulated other comprehensive (loss) income, which is included in
      stockholders’ equity on the balance sheets. The unrealized gains and losses were
      deferred and recognized in earnings when the related interest expense was
      recognized.








**Note
      8**  **Pension Plans and Other Postretirement
      Benefits**





**Defined
      Benefit Pension Plans**





We
      offer
      defined benefit plans for all of our eligible employees in the United States
      and
      in several international markets. Our measurement date for these plans is March
      31. Contributions to these plans meet the minimum funding requirements in each
      respective market. Benefit payments are principally based on a combination
      of
      years of service and compensation.





**U.S.
      Plans**





In
      the
      U.S. we maintain funded and unfunded defined benefit plans. The Reader’s Digest
      Association, Inc. Retirement Plan (Retirement Plan) is our largest plan. It
      comprises almost 84% of our total U.S. benefit obligation and all of our U.S.
      plan assets.





Because
      the Retirement Plan is over-funded, we have not made any contributions in 2006,
      2005 or 2004, nor do we expect to make any contributions in fiscal 2007.





Our
      unfunded plans were established for certain officers. Since these plans are
      only
      available to certain executives, they are not qualified under the Internal
      Revenue Code (IRC). We fund the benefit payments under these plans as they
      arise.





The
      overriding principle followed in managing our Retirement Plan assets is to
      obtain a reasonable rate of return in terms of both income and appreciation,
      consistent with the “Prudent Man” Rule of the Employee Retirement Income
      Security Act of 1974 (ERISA), while providing liquidity to satisfy short-term
      obligations.





The
      table
      below details our current and target asset allocation as of our measurement
      date.




**Actual
                Allocation as of March 31,**
            
            **Target
                Allocation Range****Asset
                Class**
            
            **2006**
            
            2005Equities
            
            
            **69**
            **%**
            
            68
            %
            
            52%
                - 72
            %Fixed
                income
            
            
            **24**
            **%**
            
            26
            %
            
            23%
                - 35
            %Other
            
            
            **7**
            **%**
            
            6
            %
            
            0%
                - 19
            %Total
            
            
            **100**
            **%**
            
            **100**
            **%**





-42-





Equities
      include companies with both large and small market capitalizations, as well
      as
      listed companies in international markets. Our allocation tends to be heavily
      weighted in favor of large capitalized companies. More than half of the
      Retirement Plan’s funds are invested in equity markets because these investments
      tend to provide better returns and offer some protection from inflation. Fixed
      income securities are included in the portfolio to protect the Retirement Plan’s
      assets from inflation and to preserve capital. Other assets, including private
      equity and real estate investments, are utilized to a small extent to take
      advantage of investments that provide higher returns. The Retirement Plan allows
      investment managers to invest in derivative instruments, provided that certain
      criteria specified in the plan’s investment policy are satisfied.





The
      expected rate of return on plan assets is a significant driver in calculating
      our net pension (benefit) cost. In order to calculate our 2006 and 2005
      (benefit) cost, we used an expected return on plan assets of 8.50%. This rate
      was based on an analysis of historical returns generated by asset classes in
      which our funds are invested and on projected returns for portfolios with assets
      similar to ours.





Estimated
      benefit payments during the next 10 years are expected to be, by fiscal year:
      2007 - $42.2; 2008 - $41.9; 2009 - $42.7; 2010 - $45.0; 2011 - $41.9 and from
      2012 to 2016 - a total of $221.5.





**International
      Plans**





We
      also
      offer defined benefit pension plans in several markets outside the United
      States. For the material plans, in fiscal 2007, we expect to contribute
      $8.8.





The
      table
      below reflects the actual allocation of assets held for our international plans
      and the allocation required pursuant to our most recent investment policy for
      these plans. These percentages have been calculated on a weighted average basis
      because the assets comprised several plans.





**Actual
                Allocation as of March 31,**
            
            **Target
                Allocation****Asset
                Class**
            
            **2006**
            
            2005Equities
            
            
            **68**
            **%**
            
            64
            %
            
            61
            %Fixed
                income
            
            
            **32**
            **%**
            
            36
            %
            
            39
            %Total
            
            
            **100**
            **%**
            
            **100**
            **%**





Similar
      to the U.S. plans, the expected rate of return on plan assets is a significant
      driver in calculating the net pension (benefit) cost for our international
      plans. In order to calculate our 2006, 2005 and 2004 expense, we used a return
      on plan assets of 6.92%, 6.92% and 6.77%, respectively. These rates were based
      on a methodology similar to that used to determine the rate of return for our
      Retirement Plan.





Estimated
      benefit payments during the next 10 years are expected to be, by fiscal year:
      2007 - $11.8; 2008 - $11.8; 2009 - $13.0; 2010 - $12.7; 2011 - $13.2 and from
      2012 to 2016 - a total of $75.7.




-43-


**Assumptions**





The
      table
      below outlines the weighted average assumptions used to determine our projected
      benefit obligation as of year-end and pension (benefit) cost for the fiscal
      year
      for:





**U.S.
      plans:**





**Benefit
                obligation**
            
            **2006**
            
            2005
            
            2004Discount
                rate
            
            
            **6.00**
            **%**
            
            5.75
            %
            
            5.75
            %Compensation
                increase rate
            
            
            **4.00**
            **%**
            
            4.00
            %
            
            4.50
            %**Pension
                (benefit) cost**Discount
                rate
            
            
            **5.75**
            **%**
            
            5.75
            %
            
            6.25
            %Compensation
                increase rate
            
            
            **4.00**
            **%**
            
            4.50
            %
            
            4.50
            %Long-term
                rate of return on plan assets
            
            
            **8.50**
            **%**
            
            8.50
            %
            
            8.75
            %




**International
      plans:**





**Benefit
                obligation**
            
            **2006**
            
            2005
            
            2004Discount
                rate
            
            
            **4.92**
            **%**
            
            5.36
            %
            
            5.50
            %Compensation
                increase rate
            
            
            **3.80**
            **%**
            
            3.66
            %
            
            3.70
            %**Pension
                (benefit) cost**Discount
                rate
            
            
            **5.36**
            **%**
            
            5.50
            %
            
            5.58
            %Compensation
                increase rate
            
            
            **3.66**
            **%**
            
            3.70
            %
            
            3.63
            %Long-term
                rate of return on plan assets
            
            
            **6.92**
            **%**
            
            6.92
            %
            
            6.77
            %





-44-


Components
      of net periodic pension (benefit) cost are as follows:





**U.S.
                Plans****2006**
            
            2005
            
            2004Service
                cost
            
            **$**
            **10.2**
            
            $
            11.2
            
            $
            11.3Interest
                cost
            
            
            **29.7**
            
            
            29.7
            
            
            31.4Expected
                return on plan assets
            
            
            **(52.2**
            **)**
            
            (55.0
            )
            
            (50.1
            )Amortization
            
            
            **(0.7**
            **)**
            
            (0.7
            )
            
            (0.7
            )Recognized
                actuarial loss
            
            
            **4.2**
            
            
            1.0
            
            
            2.1**Net
                periodic pension (benefit) cost**
            
            **$**
            **(8.8**
            **)**
            **$**
            **(13.8**
            **)**
            **$**
            **(6.0**
            **)**





**International
                Plans****2006**
            
            2005
            
            2004Service
                cost
            
            **$**
            **6.2**
            
            $
            7.5
            
            $
            7.4Interest
                cost
            
            
            **14.7**
            
            
            14.8
            
            
            13.4Expected
                return on plan assets
            
            
            **(16.8**
            **)**
            
            (17.3
            )
            
            (14.0
            )Amortization
            
            
            **(0.4**
            **)**
            
            (0.4
            )
            
            (0.5
            )Recognized
                actuarial loss
            
            
            **2.9**
            
            
            2.2
            
            
            3.1Settlements
            
            
            **(0.6**
            **)**
            
            0.6
            
            
            (1.5
            )Curtailments
                and other items
            
            
            **(0.4**
            **)**
            
            (0.1
            )
            
            0.4**Net
                periodic pension (benefit) cost**
            
            **$**
            **5.6**
            
            **$**
            **7.3**
            
            **$**
            **8.3**


-45-


A
        reconciliation of the beginning and ending balances of benefit obligations
        and
        fair value of plan assets and the funded status of the defined benefit pension
        plans is as follows:
 
 **U.S.
                  Plans**
              
              **International
                  Plans****2006**
              
              2005
              
              **2006**
              
              2005**Change
                  in benefit obligation:**Benefit
                  obligation at beginning of year
              
              **$**
              **540.6**
              
              $
              542.0
              
              **$**
              **279.7**
              
              $
              267.4Service
                  cost
              
              
              **10.2**
              
              
              11.2
              
              
              **6.2**
              
              
              7.5Interest
                  cost
              
              
              **29.7**
              
              
              29.7
              
              
              **14.7**
              
              
              14.8Participant
                  contributions
              
              
              **---**
              
              
              ---
              
              
              **1.4**
              
              
              2.0Actuarial
                  loss
              
              
              **(10.7**
              **)**
              
              1.1
              
              
              **33.0**
              
              
              8.3Exchange
                  rate changes
              
              
              **---**
              
              
              ---
              
              
              **13.7**
              
              
              (0.6
              )Settlements
              
              
              **---**
              
              
              ---
              
              
              **(4.3**
              **)**
              
              (6.8
              )Benefits
                  paid
              
              
              **(42.1**
              **)**
              
              (43.4
              )
              
              **(12.1**
              **)**
              
              (12.9
              )**Benefit
                  obligation at end of year**
              
              
              **527.7**
              
              
              **540.6**
              
              
              **332.3**
              
              
              **279.7****Change
                  in plan assets:**Fair
                  value at beginning of year
              
              
              **635.3**
              
              
              626.4
              
              
              **237.3**
              
              
              221.5Actual
                  return on plan assets
              
              
              **85.1**
              
              
              44.8
              
              
              **51.7**
              
              
              20.8Employer
                  contribution
              
              
              **7.9**
              
              
              7.5
              
              
              **6.1**
              
              
              10.6Participant
                  contributions
              
              
              **---**
              
              
              ---
              
              
              **1.4**
              
              
              2.0Exchange
                  rate changes
              
              
              **---**
              
              
              ---
              
              
              **13.5**
              
              
              2.1Settlements
              
              
              **---**
              
              
              ---
              
              
              **(4.3**
              **)**
              
              (6.8
              )Benefits
                  paid
              
              
              **(42.1**
              **)**
              
              (43.4
              )
              
              **(12.1**
              **)**
              
              (12.9
              )**Fair
                  value at end of year**
              
              
              **686.2**
              
              
              **635.3**
              
              
              **293.6**
              
              
              **237.3****Funded
                  status**
              
              
              **158.5**
              
              
              94.7
              
              
              **(38.7**
              **)**
              
              (42.4
              )Unrecognized
                  actuarial loss
              
              
              **63.4**
              
              
              111.0
              
              
              **83.0**
              
              
              83.5Unrecognized
                  transition (asset)obligation
              
              
              **---**
              
              
              ---
              
              
              **(1.0**
              **)**
              
              (1.3
              )Unrecognized
                  prior service cost
              
              
              **(4.0**
              **)**
              
              (4.6
              )
              
              **(3.5**
              **)**
              
              (3.3
              )Employer
                  - fourth quartercontribution
              
              
              **1.8**
              
              
              1.9
              
              
              **1.8**
              
              
              1.7**Net
                  amount recognized**
              
              **$**
              **219.7**
              
              **$**
              **203.0**
              
              **$**
              **41.6**
              
              **$**
              **38.2**




The
      accumulated benefit obligation (the actuarial present value of benefits earned,
      excluding future compensation increase assumptions) for our U.S. plans was
      $519.7 and $531.6 as of June 30, 2006 and 2005, respectively. The accumulated
      benefit obligation for our international plans was $296.1 and $247.6 as of
      June
      30, 2006 and 2005, respectively.





**Other
      Postretirement Benefits**





We
      provide medical and dental benefits to certain retired employees and their
      dependents. The plans that provide these benefits cover all of our eligible
      employees in the United States who were hired before July 1, 2005 and, to a
      lesser extent, employees in Canada.





The
      table
      below outlines the weighted average assumptions used to determine our
      postretirement benefit obligation as of year-end and our postretirement cost
      for
      the fiscal year:





-46-





**Postretirement
                benefit obligation**
            
            **2006**
            
            2005
            
            2004Discount
                rate
            
            
            **6.00**
            **%**
            
            5.75
            %
            
            5.75
            %Healthcare
                cost trend rate assumed for next year
            
            
            **8.90**
            **%**
            
            10.00
            %
            
            11.50
            %Rate
                to which the cost trend rate is assumed to decline
            
            
            **5.00**
            **%**
            
            5.00
            %
            
            5.00
            %Number
                of years to ultimate trend rate
            
            
            **7**
            
            
            8
            
            
            9**Postretirement
                cost**Discount
                rate
            
            
            **5.75**
            **%**
            
            5.75
            %
            
            6.19
            %Healthcare
                cost trend rate assumed for next year
            
            
            **10.00**
            **%**
            
            11.50
            %
            
            13.00
            %Rate
                to which the cost trend rate is assumed to decline
            
            
            **5.00**
            **%**
            
            5.00
            %
            
            5.00
            %Number
                of years to ultimate trend rate
            
            
            **8**
            
            
            9
            
            
            10





Components
      of net periodic postretirement (benefit) cost are as follows:





**2006**
            
            2005
            
            2004Service
                cost
            
            **$****0.7**
            
            $1.1
            
            $1.3Interest
                cost
            
            
            **4.3**
            
            
            5.1
            
            
            6.0Amortization
            
            
            **(2.8**
            **)**
            
            (1.8
            )
            
            (1.0
            )**Net
                periodic postretirement (benefit) cost**
            
            **$**
            **2.2**
            
            **$**
            **4.4**
            
            **$**
            **6.3**





-47-


A
      reconciliation of the beginning and ending balances of benefit obligations
      and
      fair value of plan assets and the funded status of the plans is as
      follows:




**2006**
              
              2005**Change
                  in benefit obligation:**Benefit
                  obligation at beginning of year
              
              **$**
              **88.7**
              
              $
              92.1Service
                  cost
              
              
              **0.7**
              
              
              1.1Interest
                  cost
              
              
              **4.3**
              
              
              5.1Actuarial
                  (gain)
              
              
              **(12.6**
              **)**
              
              (4.5
              )Plan
                  amendments
              
              
              **(11.4**
              **)**
              
              ---Exchange
                  rate changes
              
              
              **0.2**
              
              
              0.2Benefits
                  paid
              
              
              **(5.1**
              **)**
              
              (5.3
              )**Benefit
                  obligation at end of year**
              
              
              **64.8**
              
              
              **88.7****Change
                  in plan assets:**Fair
                  value at beginning of year
              
              
              **---**
              
              
              ---Employer
                  contribution
              
              
              **5.1**
              
              
              5.3Benefits
                  paid
              
              
              **(5.1**
              **)**
              
              (5.3
              )**Fair
                  value at end of year**
              
              
              **----**
              
              
              **----****Funded
                  status**
              
              
              **(64.8**
              **)**
              
              (88.7
              )Unrecognized
                  actuarial gain
              
              
              **(18.6**
              **)**
              
              (5.9
              )Unrecognized
                  transition obligation
              
              
              **0.5**
              
              
              0.5Unrecognized
                  prior service cost
              
              
              **(16.5**
              **)**
              
              (8.0
              )Employer
                  contributions in the fourthquarter
              
              
              **1.5**
              
              
              1.2**Net
                  amount recognized**
              
              **$**
              **(97.9**
              **)**
              **$**
              **(100.9**
              **)**





On
      May
      19, 2004, the FASB issued FSP 106-2 “Accounting and Disclosure Requirements
      Related to the Medicare Prescription **** Drug,
      Improvement and Modernization Act of 2003” which supersedes FSP 106-1
“Accounting and Disclosure Requirements Related to the Medicare
      Prescription **** Drug,
      Improvement and Modernization Act of 2003,” which was issued on January 12,
      2004. This guidance relates to the Medicare Prescription Drug, Improvement
      and
      Modernization Act of 2003 (the Medicare Reform Act) signed into law on December
      8, 2003. The Medicare Reform Act introduced a prescription drug benefit under
      Medicare Part D (Part D) and a federal subsidy for sponsors of retiree
      healthcare benefit plans that provide a benefit that is at least “actuarially
      equivalent” to Part D. Based on the level of benefits provided under our retiree
      healthcare plan, the majority of retiree participants are eligible to receive
      benefits that are at least “actuarially equivalent” to those provided by Part D.
      Therefore, as of our March 31, 2004 measurement date, we reflected an $11.2
      benefit as an unrecognized actuarial gain. This gain will be amortized as a
      component of net periodic postretirement cost over ten years.





Assumed
      healthcare cost trend rates have a significant effect on the amounts reported
      for postretirement benefits. A one-percentage-point increase in assumed
      healthcare cost trend rates would increase the total of the service and interest
      cost components by $0.4 and the postretirement benefit obligation by $5.9 for
      the year ended June 30, 2006. A one-percentage-point decrease in assumed
      healthcare cost trend rates would decrease the total of the service and interest
      cost components by $(0.4) and the postretirement benefit obligation by $(5.1)
      for the year ended June 30, 2006.


-48-


Estimated
      benefit payments during the next 10 years are expected to be, by fiscal year:
      2007 - $ 6.5 ;
      2008 -
      $6.5; 2009 - $6.5; 2010 - $6.5; 2011 - $6.5; and from 2012 to 2016 - a total
      of
      $30.0. Estimated receipts pursuant to the Medicare Reform Act during the next
      10
      years are expected to be, by fiscal year: 2007 - $0.7; 2008 - $0.8; 2009 -
      $0.8;
      2010 - $0.9; 2011 - $0.9; and from 2012 to 2016 - a total of $5.0.




**Balance
      Sheet Classification**





Amounts
      recognized on the balance sheets related to our material pension and
      postretirement plans are as follows:





**Pension
                Benefits**
            
            **Other
                Benefits****2006**
            
            2005
            
            **2006**
            
            2005Assets
            
            **$**
            **325.0**
            
            $
            308.0
            
            **$**
            **---**
            
            $
            ---Liabilities
            
            
            **(114.9**
            **)**
            
            (127.0
            )
            
            **(97.9**
            **)**
            
            (100.9
            )Accumulated
                other comprehensive income
            
            
            **51.2**
            
            
            60.2
            
            
            **---**
            
            
            ---**Net
                amount recognized**
            
            **$**
            **261.3**
            
            **$**
            **241.2**
            
            **$**
            **(97.9**
            **)**
            **$**
            **(100.9**
            **)**





Balances
      of pension plans with projected and accumulated benefit obligations in excess
      of
      the fair value of plan assets are as follows:





**Plans
                with**
              **Projected
                Benefit Obligations in Excess**
              **of
                Plan Assets**
            
            **Plans
                with Accumulated Benefit Obligations in Excess of Plan
                Assets****2006**
            
            2005
            
            **2006**
            
            2005Projected
                benefit obligation
            
            **$**
            **370.5**
            
            $
            325.1
            
            
            **N/A**
            
            
            N/AAccumulated
                benefit obligation
            
            
            **N/A**
            
            
            N/A
            
            **$**
            **340.5**
            
            $
            299.9Fair
                value of plan assets
            
            **$**
            **222.6**
            
            $
            172.1
            
            **$**
            **222.6**
            
            $
            172.1








**Note
      9**  **Employee Equity Compensation
      Plans**





We
      maintain several employee compensation plans relating to stock or stock-based
      awards, including stock options, restricted stock and phantom stock.





The
      Compensation and Nominating Committee of the Board of Directors (the Committee)
      approved the 2005 Key Employee Long-Term Incentive Plan (the 2005 Plan) in
      August 2005. Under the 2005 Plan, the Committee may grant stock options, stock
      appreciation rights, restricted stock, restricted stock units, deferred stock,
      performance units, performance shares and other stock-based awards to eligible
      employees. The Committee may grant up to a maximum of 2,900,000 underlying
      shares of Common Stock under the 2005 Plan. In addition, 566,790 underlying
      shares available for grant under the 2002 Key Employee Long-Term Incentive
      Plan
      became available for issuance under the 2005 Plan.





As
      discussed in Note 1, Organization and Summary of Significant Accounting
      Policies, effective July 1, 2005, we adopted the fair-value recognition
      provisions of SFAS No. 123R and SAB 107 using the modified prospective
      transition method; therefore, prior periods have not been restated. Compensation
      cost recognized in 2006 includes compensation cost for all share-based payments
      granted prior to, but not yet vested as of July 1, 2005, based on the grant
      date fair value estimated in
      accordance with the original provisions of SFAS No. 123, and compensation cost
      for all share-based payments granted subsequent to July 1, 2005, based on the
      grant date fair value estimated in accordance with the provisions of SFAS No.
      123R.


-49-





*Stock
      Options*





Stock
      options are granted with exercise prices not less than the fair market value
      of
      our Common Stock at the time of the grant and with an exercise term (as
      determined by the Committee) not to exceed 10 years. The Committee determines
      the vesting period for our stock options. Generally, such stock options become
      exercisable equally over four years. Option awards usually provide for
      accelerated vesting upon retirement, death or disability. In 2006, 2005 and
      2004, we granted 1.3 million, 1.9 million and 1.7 million options,
      respectively.





In
      accordance with APB No. 25, no stock-based compensation cost related to stock
      options was recognized in the statements of operations for 2005 and 2004, as
      all
      options granted in these periods had an exercise price equal to the market
      price
      at the date of grant. As a result of adopting SFAS No. 123R, our loss before
      taxes and net loss for 2006 are $(6.6) and $(4.2) higher, respectively, than
      if
      we had continued to account for stock-based compensation under APB No. 25.
      This
      resulted in an increase in our reported basic and diluted loss per share of
      $(0.04) for 2006. Compensation expense is recognized in the promotion, marketing
      and administrative expenses line item of our statements of operations on a
      ratable basis over the vesting periods. There were no capitalized stock-based
      compensation costs at June 30, 2006. As of June 30, 2006, there was $6.6 of
      total unrecognized compensation cost related to nonvested stock options to
      be
      recognized over a weighted-average period of 1.2 years.





The
      intrinsic values of options exercised during 2006 and 2005 were not significant.
      The total cash received from the exercise of stock options was $0.7, $1.0 and
      zero for 2006, 2005 and 2004, respectively, and is classified as financing
      cash
      flows. Shares are issued from treasury stock upon exercise of the options.
      Prior
      to the adoption of SFAS No. 123R, we presented all tax benefits of deductions
      resulting from the exercise of stock options as operating cash flows in the
      statements of cash flows. SFAS No. 123R requires that cash flows from tax
      benefits attributable to tax deductions in excess of the compensation cost
      recognized for those options (excess tax benefits) be classified as financing
      cash flows. We did not have any excess tax benefits in 2006.





The
      fair
      values of the options granted were estimated on the date of their grant using
      the Black-Scholes option-pricing model on the basis of the following weighted
      average assumptions:





**2006**
            
            2005
            
            2004Risk-free
                interest rate
            
            
            **4.2**
            **%**
            
            3.4
            %
            
            3.3
            %Expected
                life
            
            
            **6.25
                years**
            
            
            4.1
                years
            
            
            4.1
                yearsExpected
                volatility
            
            
            **31.7**
            **%**
            
            32.9
            %
            
            35.7
            %Expected
                dividend yield
            
            
            **2.6**
            **%**
            
            1.2
            %
            
            1.4
            %Weighted-average
                fair value of optionsgranted
            
            **$**
            **4.39**
            
            $
            4.43
            
            $
            3.72





The
      risk-free interest rate for the periods within the expected life of the option
      is based on the U.S. Treasury yield curve in effect at the time of grant. In
      2005 and 2004, the expected life was based on historical exercises and
      terminations. Due to the insignificant number of stock option exercises during
      the past three fiscal years, in 2006 we have estimated the expected life of
      options granted to be the midpoint between the average vesting term and the
      contractual term. The expected volatility for the periods with the expected
      life
      of the option is determined using historical volatilities based on historical
      closing stock prices. The expected dividend yield is based on our annual
      dividend in relation to our historical average stock price. The increase in
      the
      dividend yield is attributed to the increased quarterly dividend beginning
      February 15, 2005.




-50-


Changes
      in outstanding options are as follows:








Options
              (000’s)
            
            Weighted
                Average Exercise Price
            
            Weighted
                Average Remaining Contractual Term (yrs.)
            
            Aggregate
                Intrinsic Value**Outstanding
                at****June
                30, 2003**
            
            
            **12,167**
            
            **$**
            **28.10**Granted
            
            
            1,731
            
            $
            13.42Exercised
            
            
            ---
            
            
            ---Canceled
            
            
            (1,416
            )
            $
            31.21**Options
                outstanding at****June
                30, 2004**
            
            
            **12,482**
            
            **$**
            **25.66**Granted
            
            
            1,855
            
            $
            15.74Exercised
            
            
            (66
            )
            $
            14.59Canceled
            
            
            (1,514
            )
            $
            30.20**Options
                outstanding at****June
                30, 2005**
            
            
            **12,757**
            
            **$**
            **23.76**Granted
            
            
            1,337
            
            $
            15.12Exercised
            
            
            (46
            )
            $
            14.26Canceled
            
            
            (1,284
            )
            $
            28.60**Options
                outstanding at****June
                30, 2006**
            
            
            **12,764**
            
            **$**
            **22.41**
            
            
            **5.1**
            
            **$**
            **0.7****Options
                vested or expected****to
                vest at June 30, 2006**
            
            
            **12,380**
            
            **$**
            **22.63**
            
            
            **5.0**
            
            **$**
            **0.7****Options
                exercisable at****June
                30, 2006**
            
            
            **9,252**
            
            **$**
            **25.19**
            
            
            **3.9**
            
            **$**
            **0.4****Options
                available for grant****at
                June 30, 2006**
            
            
            **3,598**




The
      table
      below presents the pro forma effect on net (loss) income and basic and diluted
      (losses) earnings per share if we had applied the fair-value recognition
      provision to options granted under our stock option plans in 2005 and 2004.
      For
      purposes of this pro forma disclosure, the values of the options are estimated
      using the Black-Scholes option-pricing model and amortized to expense over
      the
      options’ vesting periods.




2005
              
              2004**Net
                  (loss) income**
              
              
              As
                  reported
              
              $
              (90.9
              )
              $
              49.5Pro
                  forma
              
              $
              (97.1
              )
              $
              38.8**(Loss)
                  earnings per share**
              
              
              As
                  reported - basic
              
              $
              (0.95
              )
              $
              0.50Pro
                  forma - basic
              
              $
              (1.01
              )
              $
              0.39As
                  reported - diluted
              
              $
              (0.95
              )
              $
              0.49Pro
                  forma - diluted
              
              $
              (1.01
              )
              $
              0.38




For
      the
      years ended June 30, 2005 and 2004, $(6.9) and $(6.6), net of tax, respectively,
      of expenses related to restricted stock and other stock-based compensation
      are
      included in our net (loss) income and (loss) earnings per share, as reported.


-51-





*Restricted
      and Deferred Stock*





Restricted
      stock are shares of Common Stock that are subject to restrictions on transfer
      and risk of forfeiture until the fulfillment of specified conditions. In 2005
      and 2004, the market value of restricted stock awards on the date of grant
      was
      recorded as a reduction of capital stock. In connection with the adoption of
      SFAS No. 123R in 2006, we reclassified the unamortized restricted stock to
      paid-in capital. Restricted stock is expensed ratably over the term of the
      restriction period, ranging from two to four years.





Deferred
      stock are rights to receive shares of Common Stock upon the fulfillment of
      specified conditions. We offer deferred stock outside the United States.
      Deferred stock is similar to restricted stock in all respects, except that
      deferred stock is issued to the employee at the completion of the vesting
      period.





We
      recognized expense for 2006, 2005 and 2004 of $(7.7), $(11.2) and $(10.2),
      respectively, before taxes of $2.9, $4.2 and $3.8, respectively, for these
      awards. We granted 102,850 shares, 511,000 shares and 764,300 shares of
      restricted stock to employees during 2006, 2005 and 2004, respectively. In
      addition, we granted 71,300 shares, 118,900 shares and 119,400 shares of
      deferred stock to employees during 2006, 2005 and 2004,
      respectively.





A
      summary
      of the status of our nonvested shares for both restricted and deferred stock
      as
      of


June
      30,
      2006 is as follows:





**Nonvested
                Shares**
            
            Shares
              (000’s)
            
            Weighted
                Average Grant Date
              Fair
                ValueNonvested
                at June 30, 2005
            
            
            2,416
            
            $
            15.01Granted
            
            
            174
            
            $
            15.09Vested*
            
            
            (810
            )
            $
            15.58Forfeitures
            
            
            (105
            )
            $
            14.76Nonvested
                at June 30, 2006
            
            
            **1,675**
            
            **$**
            **14.76**




*** *The
      shares vested during 2006 include approximately 242,000 shares of our Common
      Stock surrendered by employees in order to fulfill their tax withholding
      obligations.*





The
      fair
      value of nonvested shares is determined based on the average of the high and
      low
      stock price of our Common Stock on the grant date. The weighted-average grant
      date fair values of nonvested shares granted during 2006, 2005 and 2004 were
      $15.09, $15.64 and $13.53, respectively. As of June 30, 2006, there was $4.5
      of
      total unrecognized compensation cost related to nonvested restricted and
      deferred stock arrangements to be recognized over a weighted-average period
      of
      1.5 years.





*Performance
      Shares*





Performance
      shares give the recipients the right to receive cash equal to the value of
      shares of Common Stock that are earned if specific performance goals are
      achieved during a specific performance period. Compensation cost related to
      performance shares is based on management’s best estimate as to whether or not
      the performance criteria will be satisfied and the market price of our shares
      on
      the date of the financial statements. This amount is recognized ratably over
      the
      performance period. Adjustments based on changes in our estimate of whether
      the
      performance criteria will be satisfied and changes in the market value of our
      shares are recorded in the period in which the change occurs. In 2004, we
      awarded performance shares for the 2004-2005 performance period. For this
      performance period, $4.9 was distributed in fiscal 2006. We have recorded $(1.9)
      and $(3.0) as expense during 2005 and 2004, respectively, for this award.


-52-


*Restricted
      Stock Units*





A
      restricted stock unit is the right to receive cash equal to the value of a
      share
      of Common Stock upon the fulfillment of specified conditions. Compensation
      cost
      related to restricted stock units granted in 2006 under the 2005 - 2007
      and
      2006-2008 plans are performance based awards. Compensation cost related to
      these
      awards is based on management’s best estimate as to whether or not the
      performance criteria will be satisfied and the market price of our shares on
      the
      date of the financial statements. This amount is recognized ratably over the
      performance period. Adjustments based on changes in our estimate of whether
      the
      performance criteria will be satisfied and changes in the market value of our
      shares are recorded in the period in which the change occurs. We granted 973,310
      restricted stock units in 2006 for the 2005-2007 and 2006-2008 performance
      periods. We have recorded $(3.7) and $(2.1) as expense during 2006 and 2005,
      respectively, for these awards.





*Employee
      Stock Purchase Plans*





Under
      the
      U.S. Employee Stock Purchase Plan (ESPP), we are authorized to issue up to
      2,650,000 shares of Common Stock (330,000 shares per annum), principally to
      our
      full-time employees in the United States, nearly all of whom are eligible to
      participate. Under the terms of the ESPP, employees can choose every six months
      to have up to 10% of their annual base earnings withheld to purchase Common
      Stock. Effective July 1, 2005, the purchase price of the shares to 95% of the
      market price of the stock on the last day of the purchase period. Prior to
      July
      1, 2005, the purchase price of the shares was 85% of the lower of the fair
      market values of the Common Stock on the first and last days of the six-month
      purchase period. In 2006, 2005 and 2004 approximately 22%, 27% and 25% of
      eligible employees participated in the ESPP, respectively.





Several
      of our international subsidiaries have employee stock purchase plans
      (international ESPP) under which we are authorized to issue up to 400,000 shares
      of Common Stock to our full-time employees. The terms of the international
      ESPP
      in most locations are essentially the same as the ESPP.





Under
      the
      ESPP and the international ESPP, employees purchased 110,663 shares in 2006,
      196,707 shares in 2005, and 215,011 shares in 2004





**Other
      Compensation Plans**





**Employee
      Ownership Plan and 401(k) Partnership (the 401(k) plan)** -
      The
      401(k) plan consists of both a profit-sharing plan and a savings plan under
      section 401(k) of the IRC. The savings plan component allows employees to make
      pre-tax contributions to their accounts, which may be invested in specified
      investment alternatives. We may match employee contributions to the extent
      determined by our Board of Directors. The matching contributions vest 20% per
      annum over a five-year period. Our contributions to the 401(k) plan, including
      matching contributions, were $3.6, $3.5 and $3.9 for 2006, 2005 and 2004,
      respectively.




-53-





**Note
      10**  **Income Taxes**





Income
      (loss) before provision for income taxes is as follows:





**2006**
            
            2005
            
            2004United
                States
            
            **$**
            **(189.1**
            **)**
            $
            (176.1
            )
            $
            33.0International
            
            
            **102.5**
            
            
            96.7
            
            
            33.1**Income
                (loss) before provision for income taxes**
            
            **$**
            **(86.6**
            **)**
            **$**
            **(79.4**
            **)**
            **$**
            **66.1**





Components
      of the provision (benefit) for income taxes
      attributable to income from operations are as
      follows:





**2006**
            
            2005
            
            2004**Current**U.S.
                federal
            
            **$**
            **4.7**
            
            $
            3.2
            
            $
            (9.5
            )U.S.
                state and local
            
            
            **(0.1**
            **)**
            
            1.3
            
            
            2.2International
            
            
            **28.5**
            
            
            27.2
            
            
            19.1**Total
                current**
            
            **$**
            **33.1**
            
            
            **31.7**
            
            
            **11.8****Deferred**U.S.
                federal
            
            **$**
            **(3.8**
            **)**
            
            (15.9
            )
            
            19.9U.S.
                state and local
            
            
            **3.0**
            
            
            (2.7
            )
            
            1.4International
            
            
            **(1.5**
            **)**
            
            (1.6
            )
            
            (16.5
            )**Total
                deferred**
            
            **$**
            **(2.3**
            **)**
            
            **(20.2**
            **)**
            
            **4.8****Provision
                for income taxes**
            
            **$**
            **30.8**
            
            **$**
            **11.5**
            
            **$**
            **16.6**





A
      reconciliation between the statutory U.S. federal income tax rate and the
      effective income tax rate is as follows:





**2006**
            
            2005
            
            2004U.S.
                statutory tax rate
            
            
            35.0
            %
            
            35.0
            %
            
            35.0
            %International
                operations
            
            
            (1.0
            )
            
            5.0
            
            
            (11.6
            )State
                taxes
            
            
            (1.0
            )
            
            3.8
            
            
            3.6Non
                taxable loss (gain) from disposition of assets
            
            
            0.6
            
            
            1.8
            
            
            (3.2
            )Changes
                in valuation allowance
            
            
            3.9
            
            
            (6.1
            )
            
            7.9Changes
                in tax accrual
            
            
            (0.3
            )
            
            6.2
            
            
            (8.0
            )Goodwill
                charge
            
            
            (75.9
            )
            
            (56.9
            )
            
            ---Other
                operating items
            
            
            (0.3
            )
            
            ---
            
            
            0.2Other
            
            
            3.3
            
            
            (3.3
            )
            
            1.2**Effective
                tax rate**
            
            
            **(35.7**
            **)%**
            
            **(14.5**
            **)%**
            
            **25.1**
            **%**




-54-


Components
      of deferred tax assets and liabilities are as follows:





**2006**
            
            2005Accounts
                receivable and other allowances
            
            **$**
            **56.7**
            
            
            52.8Net
                operating loss carryforwards
            
            
            **28.0**
            
            
            26.4Other
                operating items
            
            
            **3.6**
            
            
            4.7Tax
                credit carryforwards
            
            
            **69.8**
            
            
            44.7Deferred
                gain on sale of buildings
            
            
            **13.5**
            
            
            14.6Other
                accrued items
            
            
            **12.8**
            
            
            14.0**Gross
                deferred tax assets**
            
            
            **184.4**
            
            
            157.2Valuation
                allowance
            
            
            **(13.1**
            **)**
            
            (17.1
            )**Total
                net assets**
            
            
            **171.3**
            
            
            140.1Deferred
                compensation and other employee benefits
            
            
            **(26.6**
            **)**
            
            (18.7
            )Deferred
                promotion
            
            
            **(11.2**
            **)**
            
            (10.3
            )Depreciation
                and amortization
            
            
            **(37.7**
            **)**
            
            (15.4
            )Deferred
                agent commissions
            
            
            **(17.6**
            **)**
            
            (19.0
            )Other
            
            
            **(1.0**
            **)**
            
            (2.6
            )**Total
                net liabilities**
            
            
            **(94.1**
            **)**
            
            (66.0
            )**Net
                deferred taxes**
            
            **$**
            **77.2**
            
            **$**
            **74.1**








Balance
      sheet classifications of deferred tax assets and liabilities are as
      follows:





**2006**
            
            2005Prepaid
                expenses and other current assets
            
            **$**
            **46.3**
            
            $
            47.2Other
                noncurrent assets
            
            
            **46.2**
            
            
            39.4Other
                current liabilities
            
            
            **(3.7**
            **)**
            
            (4.5
            )Other
                noncurrent liabilities
            
            
            **(11.6**
            **)**
            
            (8.0
            )**Net
                deferred taxes**
            
            **$**
            **77.2**
            
            $
            **74.1**





We
      have
      concluded that it is more likely than not that the results of future operations
      will generate sufficient taxable income to realize the net deferred tax
      assets.





Net
      operating loss carryforwards of $129.8 at June 30, 2006, are available to reduce
      future tax obligations of certain foreign and U.S. companies. The net operating
      loss carryforwards have various expiration dates, the earliest being fiscal
      2007, and others having indefinite carryforward periods. In addition, foreign
      tax credits carryforwards amounting to $58.4 and alternative minimum tax credit
      carryforwards of $7.9 are available as of June 30, 2006. Foreign tax credit
      carryforwards have various expiration dates beginning in fiscal 2012;
      alternative minimum tax credit carryforwards have an indefinite
      life.





Approximately
      $3.7 of deferred tax expense and $1.9 of deferred tax benefit are included
      as a
      component of stockholders’ equity for 2006 and 2005, respectively.





A
      provision has not been made for U.S .
      income
      taxes and foreign withholding taxes that would be
      payable if undistributed earnings of the foreign subsidiaries of approximately
      $153.9 as of June 30, 2006, were distributed to us in the form of dividends
      because the company intends to permanently reinvest such foreign earnings.
      A
      determination of the amount of the unrecognized deferred tax liability related
      to undistributed earnings is not practical.





The
      company is undergoing various federal, foreign, state and local audits. The
      company has reasonably estimated and appropriately accrued for its probable
      liabilities.


-55-





**Note
      11**  **Debt**





Our
      primary debt obligations as of June 30, 2006 are our borrowings under our $500.0
      Five-Year Revolving Credit Agreement (2005 Credit Agreement) and $300.0 in
      senior unsecured notes.





**2005
      Credit Agreement**





On
      April
      14, 2005, we entered into a $400.0 Five-Year Revolving Credit Agreement to
      retire all outstanding borrowings under our Five-Year Revolving Credit and
      Competitive Advance Facility Agreement and $950.0 Term Loan Agreement
      (collectively referred to as the 2002 Credit Agreements) and for general
      corporate purposes. Financing fees of $(1.6) related to the 2005 Credit
      Agreement were deferred and are amortized on a straight-line basis over the
      life
      of the 2005 Credit Agreement. In connection with the termination of the 2002
      Credit Agreements, we recorded a write-off of $(7.3) in the fourth quarter
      of
      2005 related to the associated capitalized financing fees and the discontinuance
      of the related interest rate protection agreements.





On
      April
      19, 2006, we entered into an amendment to our 2005 Credit Agreement, which
      increased the aggregate principal amount available to $500.0, increased the
      maximum leverage ratio (as defined in the amendment) and increased pricing
      when
      the leverage ratio is at higher levels. The interest rate on the 2005 Credit
      Agreement is currently at LIBOR plus 125 basis points and is subject to change
      based on our leverage ratio (as defined in the 2005 Credit Agreement). The
      2005
      Credit Agreement contains financial covenants that require us to maintain
      minimum interest coverage and maximum leverage ratios, and it is secured by
      the
      stock of a substantial portion of our subsidiaries. Financing fees of $(0.3)
      related to the amendment to the 2005 Credit Agreement were deferred and are
      amortized on a straight-line basis over the life of the 2005 Credit Agreement.




**Senior
      Notes**





During
      the third quarter of 2004, we completed a private placement, with registration
      rights, of $300.0 of 61⁄2% senior unsecured notes due in 2011 (Senior Notes) in
      order to refinance amounts outstanding under the $950.0 Term Loan Agreement.
      In
      the fourth quarter of 2004, these notes were exchanged for notes that were
      registered under the Securities Act of 1933. The proceeds from this offering
      were used to repay $294.0 of principal outstanding under the $950.0 Term Loan
      Agreement, with the remainder used to pay a portion of the financing costs.





**Debt
      Maturities and Interest Expense**





Total
      debt maturities during the next five years are as follows:





2007
            
            $
            ---2008
            
            
            ---2009
            
            
            ---2010
            
            
            395.02011
            
            
            300.0Total
            
            $
            695.0





At
      June
      30, 2006 and 2005, we had borrowings of $695.0 and $559.2 outstanding,
      respectively, which are classified as long-term debt on the balance sheets.




-56-


In
      2006,
      2005 and 2004, we recorded interest expense, net of $(41.0), $(46.2), and
      $(49.8), respectively. Interest expense in 2005 included the write-off of
      financing fees of $(6.9) as a result of the termination of the 2002 Credit
      Agreements as well as the associated discontinuance of the related interest
      rate
      protection agreements of $(0.4). Interest expense in 2004 included the write-off
      of financing fees of $(6.0) as a result of the refinancing and certain other
      transactions described above and the write-off of $(1.3) related to the
      termination of some of our interest rate caps that were no longer required
      (see
      Note 7, Financial Instruments). The weighted average interest rate on our
      borrowings charged by our lenders in 2006, 2005 and 2004 was 6.0%, 5.3% and
      4.4%, respectively.





**Lines
      of Credit**





International
      lines of credit and overdraft facilities totaled $31.6 at June 30, 2006 and
      $27.7 at June
      30,
      2005, of which $13.7 and zero were outstanding at June 30, 2006 and 2005,
      respectively. These lines of credit are subject to renewal
      annually.








**Note
      12**  **Capital Stock**





Preferred
      stock consists of the following as of June 30:





**2006**
            
            2005**First
                preferred stock**,
              par
                value $1.00 per share;
              authorized
                40,000 shares;
              issued
                and outstanding 29,720 shares
            
            **$**
            **3.0**
            
            $
            3.0**Second
                preferred stock**,
              par
                value $1.00 per share;
              authorized
                120,000 shares;
              issued
                and outstanding 103,720 shares
            
            
            **10.3**
            
            
            10.3**Third
                subordinated preferred stock**,
              par
                value $1.00 per share;
              authorized
                230,000 shares;
              issued
                and outstanding 155,022 shares
            
            
            **15.5**
            
            
            15.5**Preference
                stock**,
              par
                value $0.01 per share;
              authorized
                25,000,000 shares;
              issued
                and outstanding none
            
            
            **---**
            
            
            ---**Total
                preferred stock**
            
            **$**
            **28.8**
            
            **$**
            **28.8**





All
      shares of preferred stock have a preference in liquidation of $100.00 per share.
      The difference between the aggregate par value and liquidation preference has
      been appropriated from retained earnings and is shown as part of the value
      of
      preferred stock. At our option and at any time, all preferred stock is
      redeemable at $105.00 per share plus accrued dividends. The terms of the first
      preferred stock and the second preferred stock provide for annual cumulative
      dividends of $4.00 per share. The terms of the third subordinated preferred
      stock provide for annual cumulative dividends of $5.00 per share. Preferred
      stockholders do not have any voting rights.




-57-


**Share
      Repurchase Authorization**





On
      April
      28, 2005, our Board of Directors authorized our repurchase of up to $100.0
      of
      our Common Stock over the succeeding two years and rescinded its May 2001
      authorization to repurchase up to $250.0 of our Common Stock. Under the April
      2005 authorization, we repurchased 4.3 million shares for $63.2 in 2006. Since
      the April 2005 authorization, we repurchased 4.7 million shares for $70.2.
      We
      had not repurchased any shares under the May 2001 authorization since fiscal
      2002.








**Note
      13**  **Commitments and
      Contingencies**





**General
      Litigation**





From
      time
      to time, we are involved in a variety of claims, lawsuits, investigations and
      proceedings that arise in the ordinary course of business. We cannot predict
      the
      ultimate outcome of these matters with certainty. Management believes that
      the
      ultimate outcome of these matters will not have a material adverse effect on
      our
      financial position or results of operations, although our results and cash
      flow
      could be significantly unfavorably affected in the reporting periods in which
      these matters are resolved.





**Supply
      and Service Agreements**





We
      maintain several long-term agreements with vendors primarily for the purchase
      of
      paper, printing and fulfillment services. These agreements expire at various
      times through fiscal 2010.





In
      the
      normal course of business, we enter into long-term arrangements with suppliers
      for raw materials and merchandise, including our agreement with World’s Finest
      Chocolate (see Note 6, Goodwill and Other Intangible Assets, Net, for additional
      information), and with other parties whose recordings or works we use in our
      products. These arrangements may contain minimum purchase requirements. We
      enter
      into these agreements to facilitate an adequate supply of materials and to
      enable us to develop better products for sale to our customers.





**Sale
      and Leaseback**





On
      December 22, 2004, we completed the sale and partial leaseback of our corporate
      headquarters facility in Westchester, New York. Under the agreement, we received
      $48.5 in cash and will receive an additional $10.0 on the second anniversary
      of
      closing. The gain of $24.7, based on total consideration, was deferred and
      is
      being amortized over the initial 20-year lease term as a reduction in rent
      expense. During the lease term, we will make annual minimum lease payments
      of
      approximately $3.1, subject to increases every five years based on changes
      in
      the Consumer Price Index. In addition, we have leased additional space for
      three
      years in this facility at an annual cost of $0.7.




-58-


**Lease
      Obligations**





We
      occupy
      certain facilities under lease arrangements and lease certain
      equipment.





Rental
      expense and sublease income are as follows:





**2006**
            
            2005
            
            2004Rental
                expense
            
            **$**
            **26.1**
            
            $
            23.6
            
            $
            18.3Sublease
                income
            
            
            **(5.8**
            **)**
            
            (5.5
            )
            
            (6.2
            )**Net
                rental expense**
            
            **$**
            **20.3**
            
            **$**
            **18.1**
            
            **$**
            **12.1**





Future
      minimum rental commitments, net of sublease income, for noncancelable operating
      leases for the next five fiscal years and thereafter (extending to 2025) are
      as
      follows:





**Minimum**
            
            **Minimum****Rental**
            
            **Sublease****Payments**
            
            **Income**
            
            **Net**2007
            
            $
            25.3
            
            $
            (6.0
            )
            $
            19.32008
            
            $
            22.6
            
            $
            (5.7
            )
            $
            16.92009
            
            $
            18.2
            
            $
            (4.9
            )
            $
            13.32010
            
            $
            16.2
            
            $
            (2.8
            )
            $
            13.42011
            
            $
            14.6
            
            $
            (2.6
            )
            $
            12.0Later
                years
            
            $
            75.1
            
            $
            (12.8
            )
            $
            62.3








**Note
      14**  **Segments**





Our
      businesses are structured into the same three reportable segments (Reader’s
      Digest North America, Reader’s Digest International and Consumer Business
      Services) that our chief operating decision maker uses to assess business
      performance. In addition to the reportable segments, we separately report
      Corporate Unallocated expenses, which are expenses not directly attributable
      to
      business unit performance. Similarly, we separately report the effects of
      previously deferred magazine promotion expense, goodwill charges and other
      operating items, net, because our chief operating decision maker does not factor
      in these items when assessing business unit performance. Here is a brief
      description of the activities included within our reportable
      segments.





**Reader’s
      Digest North America**





This
      segment comprises our operations in the United States and Canada that publish
      and market *Reader’s
      Digest* magazine, Reiman magazines and several special interest magazines. It also
      includes our operations in the United States and Canada that publish and market
      Books and Home Entertainment products (including Select Editions, Reader’s
      Digest Young Families, music and video products, and series and general books
      related to the following affinities: reading, home and health, and
      entertainment) as well as two new businesses, *Allrecipes.com* and
      Taste
      of Home Entertaining.




-59-


These
      businesses have a common focus on the direct marketing aspect of new customer
      acquisition at a minimal cost. The performance of *Reader’s
      Digest* magazine
      and our special interest magazines is driven primarily by circulation revenues
      and, secondarily, by advertising sales. Circulation is also the principal driver
      of performance for Reiman magazines, which have limited advertising revenues.
      The results of our Books and Home Entertainment business are driven by the
      size
      of our active customer base, new customer acquisition programs, response rates
      to promotional mailings, customer payment rates and membership in our continuity
      series business.





**Reader’s
      Digest International**





This
      segment comprises our operations outside of the United States and Canada, with
      our most significant markets in the United Kingdom, Germany, Central Europe
      and
      France. The businesses in this segment publish and market *Reader’s
      Digest* magazine
      (in numerous editions and languages) and books and home entertainment products
      (described above).





The
      performance of these businesses is driven by factors similar to those in the
      Reader’s Digest North America segment, except that overall results are less
      sensitive to changes in individual geographic market conditions due to the
      number of markets in which we operate. The results for *Reader’s
      Digest* magazine
      in international markets are driven primarily by circulation and secondarily
      by
      advertising revenues. The results of our books and home entertainment products
      in these markets are driven by the size of our active customer base, new
      customer acquisition programs, response rates to promotional mailings, customer
      payment rates and membership in our continuity series business.





**Consumer
      Business Services**





This
      segment comprises Books Are Fun, our display marketing business, and QSP, our
      youth fundraising businesses, in the United States and Canada.





Books
      Are
      Fun and QSP principally sell products through non-direct marketing channels,
      primarily through their sales forces. The performance of these businesses is
      driven by product selection, the number of accounts or events, the average
      sales
      per account or event, and the number of participants in fundraising programs.





**Intercompany
      Eliminations and Corporate Unallocated Expenses**





We
      present our segment revenues and operating (losses) profits consistently with
      how we manage our operations and how our chief operating decision maker reviews
      our results. Revenues and expenses attributable to intercompany transactions
      are
      included in the results of our reportable segments. Such amounts are eliminated
      (under the intercompany eliminations caption below) to reconcile our reportable
      segment amounts to consolidated amounts, as reported in the statements of
      operations. Accounting policies of our segments are the same as those described
      in Note 1, Organization and Summary of Significant Accounting Policies. In
      addition to intercompany revenues and expenses, we separately
      report Corporate Unallocated expenses, which cover expenses that are not
      directly attributable to business unit performance. Corporate
      Unallocated expenses include the cost of governance and other corporate-related
      expenses, as well as income and expenses associated with our U.S. pension plans
      and retiree healthcare benefits, and stock and executive compensation programs
      that are not allocated to the reportable segments.




-60-


We
      evaluate performance and allocate resources based on operating income from
      continuing operations excluding other operating items and Corporate Unallocated
      expenses. Identifiable assets by segment are those assets that are used in
      the
      operations of that business. Corporate assets consist primarily of cash and
      cash
      equivalents, certain prepaid expenses, marketable securities, certain pension
      assets, certain fixed assets and certain other current assets. Sales are
      attributed to countries based on selling location. Long-lived assets are
      primarily: property, plant and equipment, net; intangible assets, net; and
      prepaid pension benefits.





**Reportable
      Segment Financial Information**




**Years
                  ended June 30,****2006**
              
              2005
              
              2004*Revenues*Reader’s
                  Digest North America
              
              **$**
              **939.4**
              
              $
              917.3
              
              $
              919.5Reader’s
                  Digest International
              
              **$**
              **1,031.2**
              
              
              1,012.1
              
              
              969.5Consumer
                  Business Services
              
              **$**
              **445.6**
              
              
              485.1
              
              
              525.1Intercompany
                  eliminations
              
              **$**
              **(30.0**
              **)**
              
              (24.8
              )
              
              (25.6
              )**Total
                  revenues**
              
              **$**
              **2,386.2**
              
              **$**
              **2,389.7**
              
              **$**
              **2,388.5***Operating
                  (loss) profit*Reader’s
                  Digest North America
              
              **$**
              **114.5**
              
              $
              90.8
              
              $
              76.0Reader’s
                  Digest International
              
              
              **78.3**
              
              
              76.1
              
              
              57.0Consumer
                  Business Services
              
              
              **(2.7**
              **)**
              
              29.4
              
              
              59.0Previously
                  deferred magazine promotionexpense(1)
              
              
              ---
              
              
              (77.1
              )
              
              (27.2
              )Goodwill
                  charge(2)
              
              
              **(187.8**
              **)**
              
              (129.0
              )
              
              ---Corporate
                  Unallocated
              
              
              **(41.0**
              **)**
              
              (37.9
              )
              
              (43.7
              )Other
                  operating items, net(3)
              
              
              **(6.8**
              **)**
              
              14.1
              
              
              (8.8
              )**Total
                  operating (loss) profit**
              
              **$**
              **(45.5**
              **)**
              **$**
              **(33.6**
              **)**
              **$**
              **112.3***Intercompany
                  eliminations*Reader’s
                  Digest North America
              
              **$**
              **(11.3**
              **)**
              $
              (9.2
              )
              $
              (11.3
              )Reader’s
                  Digest International
              
              
              **(6.3**
              **)**
              
              (4.0
              )
              
              (3.3
              )Consumer
                  Business Services
              
              
              **(12.4**
              **)**
              
              (11.6
              )
              
              (11.0
              )**Total
                  intercompany eliminations**
              
              **$**
              **(30.0**
              **)**
              **$**
              **(24.8**
              **)**
              **$**
              **(25.6**
              **)***Assets*Reader’s
                  Digest North America
              
              **$**
              **1,172.7**
              
              $
              1,084.8
              
              $
              1,178.8Reader’s
                  Digest International
              
              
              **411.7**
              
              
              387.8
              
              
              421.8Consumer
                  Business Services
              
              
              **133.0**
              
              
              326.5
              
              
              456.2Corporate
              
              
              **404.7**
              
              
              381.5
              
              
              378.1**Total
                  assets**
              
              **$**
              **2,122.1**
              
              **$**
              **2,180.6**
              
              **$**
              **2,434.9**




(1)
              In
                  connection with our change to expensing magazine deferred promotion
                  costs
                  when the promotion is mailed to prospective customers, our reportable
                  segment operating (loss) profit in 2005 includes such expenses
                  as
                  incurred. Amortization of previously deferred promotion costs in
                  2005 and
                  our deferred promotion charge recorded in the fourth quarter of
                  2004 are
                  not included in segment results reviewed by our chief operating
                  decision
                  maker. For the year ended June 30, 2005, 81% of amortization of
                  previously
                  capitalized magazine promotion costs was related to Reader’s Digest North
                  America and 19% to Reader’s Digest International. For the year ended June
                  30, 2004, 45% of our magazine deferred promotion charge was related
                  to
                  Reader’s Digest North America and 55% to Reader’s Digest
                  International.




-61-


(2)
              The
                  goodwill charge related to Books Are Fun, part of the Consumer
                  Business
                  Services reportable segment, is not included in segment results
                  reviewed
                  by our chief operating decision maker. See Note 6, Goodwill and
                  Other
                  Intangible Assets, Net, for additional
                  information.
 
 (3)
              Other
                  operating items, net consists of gains on sales of certain non-strategic
                  assets, asset impairments and restructuring charges. Such items
                  are not
                  included in segment results reviewed by our chief operating decision
                  maker. See Note 3, Other Operating Items, Net, for further information.
                  In
                  previous periods, gains on sales of certain non-strategic assets
                  were
                  classified as other (expense) income, net, and have been reclassified
                  to
                  other operating items, net to conform to the current year presentation.




In
      2006,
      other operating items, net includes: 1) net restructuring charge of ($7.4),
      principally comprising severance and contract terminations, attributed: 15%
      to
      Reader’s Digest North America, 31% to Reader’s Digest International and 54% to
      Consumer Business Services, 2) asset impairments of ($2.8), primarily related
      to
      Books Are Fun, and 3) gains of $3.4 related to the sales of certain
      non-strategic assets.





In
      2005,
      other operating items, net includes gains of $14.1 related to the sales of
      certain non-strategic assets.





In
      2004,
      other operating items, net includes: 1) a restructuring charge of ($15.0),
      principally comprising severance and contract terminations, attributed: 12%
      to
      Reader’s Digest North America, 61% to Reader’s Digest International, 22% to
      Consumer Business Services and 5% to corporate departments that benefit the
      entire organization, and 2) gains of $6.2 related to the sales of certain
      non-strategic assets.




**Years
                  ended June 30,****2006**
              
              2005
              
              2004*Depreciation,
                  amortization and asset impairments*Reader’s
                  Digest North America
              
              **$**
              **16.0**
              
              $
              36.5
              
              $
              39.9Reader’s
                  Digest International
              
              
              **8.5**
              
              
              7.3
              
              
              8.1Consumer
                  Business Services
              
              
              **12.0**
              
              
              9.7
              
              
              11.5Goodwill
                  charge
              
              
              **187.8**
              
              
              129.0
              
              
              ---Corporate
              
              
              **3.1**
              
              
              3.4
              
              
              4.8**Total
                  depreciation, amortization and asset impairments**
              
              **$**
              **227.4**
              
              **$**
              **185.9**
              
              **$**
              **64.3***Capital
                  expenditures*Reader’s
                  Digest North America
              
              $
              3.9
              
              $
              1.4
              
              $
              1.9Reader’s
                  Digest International
              
              
              6.6
              
              
              12.9
              
              
              3.7Consumer
                  Business Services
              
              
              1.9
              
              
              1.4
              
              
              2.2Corporate
              
              
              7.5
              
              
              7.8
              
              
              8.3**Total
                  capital expenditures**
              
              **$**
              **19.9**
              
              **$**
              **23.5**
              
              **$**
              **16.1**
 
 The
        following table presents our consolidated net revenues by product:
 
 **Years
                  ended June 30,****2006**
              
              2005
              
              2004*Revenues*Books
              
              **$**
              **955.1**
              
              $
              971.6
              
              $
              968.5Magazines
                  - subscription and other
              
              
              **683.7**
              
              
              689.8
              
              
              702.7Magazines
                  - advertising
              
              
              **158.9**
              
              
              153.2
              
              
              150.0Music
                  and videos
              
              
              **264.1**
              
              
              262.7
              
              
              240.3Food
                  and gift
              
              
              **215.1**
              
              
              215.0
              
              
              228.7Other
              
              
              **109.3**
              
              
              97.4
              
              
              98.3**Total
                  revenues**
              
              **$**
              **2,386.2**
              
              **$**
              **2,389.7**
              
              **$**
              **2,388.5**





-62-


Information
      about geographic areas is as follows:




**Years
                  ended June 30,****2006**
              
              2005
              
              2004*Revenues*United
                  States
              
              $
              1,202.6
              
              $
              1,232.6
              
              $
              1,291.3International
              
              
              1,189.2
              
              
              1,162.6
              
              
              1,102.1Inter-area
              
              
              (5.6
              )
              
              (5.5
              )
              
              (4.9
              )**Total
                  revenues**
              
              **$**
              **2,386.2**
              
              **$**
              **2,389.7**
              
              **$**
              **2,388.5***Revenues
                  inter-area*United
                  States
              
              $
              (3.5
              )
              $
              (3.1
              )
              $
              (2.6
              )International
              
              
              (2.1
              )
              
              (2.4
              )
              
              (2.3
              )**Total
                  revenues inter-area**
              
              **$**
              **(5.6**
              **)**
              **$**
              **(5.5**
              **)**
              **$**
              **(4.9**
              **)***Long-lived
                  assets, net*United
                  States
              
              $
              1,309.7
              
              $
              1,444.6
              
              $
              1,638.1International
              
              
              61.9
              
              
              63.8
              
              
              75.3**Total
                  long-lived assets, net**
              
              **$**
              **1,371.6**
              
              **$**
              **1,508.4**
              
              **$**
              **1,713.4**
 -63-


**Report
      of Independent Registered Public Accounting Firm**





*The
      Stockholders and Board of Directors*


*The
      Reader’s Digest Association, Inc.*








We
      have
      audited the accompanying consolidated balance sheet of The Reader’s Digest
      Association, Inc. and subsidiaries as of June 30, 2006, and the
      related consolidated statements of operations, stockholders' equity, and cash
      flows for the year then ended. These financial statements are the responsibility
      of the Company's management. Our responsibility is to express an opinion on
      these financial statements based on our audit.





We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audit provides a
      reasonable basis for our opinion.





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the consolidated financial position of The Reader’s Digest
      Association, Inc. and subsidiaries at June 30, 2006, and the
      consolidated results of their operations and their cash flows for the year
      ended
      June 30, 2006, in conformity with U.S. generally accepted accounting
      principles.





We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of The Reader’s Digest
      Association, Inc.'s internal control over financial reporting as of June 30,
      2006, based on criteria established in Internal Control-Integrated Framework
      issued by the Committee of Sponsoring Organizations of the Treadway Commission
      and our report dated August 17, 2006 expressed an unqualified opinion
      thereon.





As
      discussed in Note 1 to the consolidated financial statements, the Company
      adopted Statement of Financial Accounting Standards No. 123(R), effective July
      1, 2005.










/s/
      Ernst
& Young LLP


Stamford,
      Connecticut


August
      17, 2006




-64-





**Report
      of Independent Registered Public Accounting Firm**





*The
      Stockholders and Board of Directors*


*The
      Reader’s Digest Association, Inc.*





We
      have
      audited management's assessment, included in the accompanying Management’s
      Report on Internal Control Over Financial Reporting, that The Reader’s Digest
      Association, Inc. and subsidiaries maintained effective internal control over
      financial reporting as of June 30, 2006, based on criteria established in
      Internal Control—Integrated Framework issued by the Committee of Sponsoring
      Organizations of the Treadway Commission (COSO). The Reader’s Digest
      Association, Inc.'s management is responsible for maintaining effective internal
      control over financial reporting and for its assessment of the effectiveness
      of
      internal control over financial reporting. Our responsibility is to express
      an
      opinion on management's assessment and an opinion on the effectiveness of the
      company's internal control over financial reporting based on our
      audit.





We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, evaluating management's assessment, testing and evaluating
      the design and operating effectiveness of internal control, and performing
      such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.





A
      company's internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with generally accepted accounting principles. A company's internal control
      over
      financial reporting includes those policies and procedures that (1) pertain
      to
      the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the company's
      assets that could have a material effect on the financial
      statements.





Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.





In
      our
      opinion, management's assessment that The Reader’s Digest Association, Inc. and
      subsidiaries maintained effective internal control over financial reporting
      as
      of June 30, 2006, is fairly stated, in all material respects, based on criteria
      established in Internal Control—Integrated Framework issued by the Committee of
      Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion,
      The Reader’s Digest Association, Inc. and subsidiaries maintained, in all
      material respects, effective internal control over financial reporting as of
      June 30, 2006, based on criteria established in Internal Control—Integrated
      Framework issued by the Committee of Sponsoring Organizations of the Treadway
      Commission (COSO).




-65-


We
      have
      also audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the consolidated balance sheet of The Reader’s
      Digest Association, Inc. and subsidiaries as of June 30, 2006, and the
      related consolidated statements of operations, stockholders’ equity, and cash
      flows for the year then ended, and our report dated August 17, 2006
      expressed an unqualified opinion on those consolidated financial
      statements.








/s/
      Ernst
& Young LLP




Stamford,
      Connecticut


August
      17, 2006




-66-


**Report
      of Independent Registered Public Accounting Firm**





*The
      Board of Directors and Stockholders*


*The
      Reader’s Digest Association, Inc.:*







We
      have
      audited the accompanying consolidated balance sheet of The Reader’s Digest
      Association, Inc. and subsidiaries as of June 30, 2005, and the related
      consolidated statements of operations, stockholders' equity, and cash flows
      for
      each of the years in the two-year period ended June 30, 2005. These
      consolidated financial statements are the responsibility of the Company's
      management. Our responsibility is to express an opinion on these consolidated
      financial statements based on our audits.






We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.






In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the financial position of The Reader’s Digest
      Association, Inc. and subsidiaries as of June 30, 2005, and the results of
      their operations and their cash flows for each of the years in the two-year
      period ended June 30, 2005, in conformity with U.S. generally accepted
      accounting principles.






/s/
      KPMG
      LLP


New
      York,
      New York


August
      30, 2005


-67-


**REPORT
      OF MANAGEMENT**




**MANAGEMENT
      RESPONSIBILITY FOR FINANCIAL INFORMATION**




Management
        of the company is responsible for the preparation and integrity of the financial
        statements and the related financial information appearing in this Annual
        Report. The financial statements were prepared in accordance with accounting
        principles generally accepted in the United States of America. The financial
        statements include amounts that are based on management’s best estimates and
        judgment. Financial information in this Annual Report is consistent with
        that in
        the financial statements.


Management
      is responsible for maintaining a system of internal accounting controls and
      procedures to provide reasonable assurance, at an appropriate cost/benefit
      relationship, that assets are safeguarded and that transactions are authorized,
      recorded and reported properly. The system of internal safeguards is
      characterized by a control oriented environment that includes written policies
      and procedures, careful selection and training of personnel, and audits by
      a
      professional staff of internal auditors.





Ernst
      & Young LLP, an independent registered public accounting firm, have audited
      and reported on our financial statements. Their report is also included in
      this
      Annual Report.





The
      Audit
      Committee of the Board of Directors, composed of independent directors, meets
      periodically with Ernst & Young LLP, the company’s internal auditors and
      management representatives to review internal control, auditing and financial
      reporting matters. Both Ernst & Young LLP and the internal auditors have
      unrestricted access to the Audit Committee and may meet with the Committee
      with
      or without management present.





**MANAGEMENT’S
      REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING**





Management
      is responsible for establishing and maintaining adequate internal control over
      financial reporting of the company as such term is defined in rule 13a-15(f)
      under the Securities Exchange Act of 1934.





Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. No evaluation of controls can provide absolute
      assurance that all control issues and instances of fraud, if any, have been
      detected. Also, projections of any evaluation of effectiveness to future periods
      are subject to the risk that controls may become inadequate because of changes
      in conditions, or that the degree of compliance with the policies or procedures
      may deteriorate.





Under
      the
      supervision and with the participation of the company’s management, including
      the company’s principal executive and principal financial officers, the company
      conducted an assessment of the effectiveness of the company’s internal control
      over financial reporting, based on Internal Control-Integrated Framework, issued
      by the Committee of Sponsoring Organizations of the Treadway Commission. Based
      on this assessment, management concluded that the company’s internal control
      over financial reporting was effective as of June 30, 2006.





Management’s
      assessment of the effectiveness of the company’s internal control over financial
      reporting has been audited by Ernst and Young LLP, an independent registered
      accounting firm, as stated in their report which is included in this Annual
      Report.




/s/
        Eric
        W. Schrier
 Chief
        Executive Officer
 
 /s/
        Michael S. Geltzeiler
 Senior
        Vice President and Chief Financial Officer




-68-


**Selected
      Financial Data**


*In
                millions, except per share data*
            
            **2006**
            
            2005
            
            2004
            
            2003
            
            2002**Statement
                of Operation Data**Revenues
            
            **$**
            **2,386.2**
            
            $
            2,389.7
            
            $
            2,388.5
            
            $
            2,474.9
            
            $
            2,368.6Operating
                (loss) profit*
            
            **$**
            **(45.5**
            **)**
            $
            (33.6
            )
            $
            112.3
            
            $
            141.1
            
            $
            157.1Net
                (loss) income
            
            **$**
            **(117.4**
            **)**
            $
            (90.9
            )
            $
            49.5
            
            $
            61.3
            
            $
            91.2Basic
                and diluted (loss) earnings per share
            
            **$**
            **(1.24)/$(1.24**
            **)**
            $
            (0.95)/$(0.95
            )
            $
            0.50/$0.49
            
            $
            0.61/$0.60
            
            $
            0.90/$0.89Dividends
                per common share
            
            **$**
            **0.40**
            
            $
            0.30
            
            $
            0.20
            
            $
            0.20
            
            $
            0.20**Balance
                Sheet Data**Cash
                and cash equivalents, short-term investments and marketable
                securities
            
            **$**
            **34.7**
            
            $
            37.7
            
            $
            50.4
            
            $
            52.1
            
            $
            114.7Total
                assets
            
            **$**
            **2,122.1**
            
            $
            2,180.6
            
            $
            2,434.9
            
            $
            2,591.7
            
            $
            2,684.1Long-term
                debt
            
            **$**
            **695.0**
            
            $
            559.2
            
            $
            637.7
            
            $
            834.7
            
            $
            818.0Stockholders’
                equity
            
            **$**
            **175.1**
            
            $
            366.2
            
            $
            475.7
            
            $
            412.9
            
            $
            484.5Weighted-average
                common shares outstanding (basic and diluted)
            
            
            **95.9/95.9**
            
            
            97.4/97.4
            
            
            97.1/99.2
            
            
            98.1/99.2
            
            
            100.2/100.6Book
                value per common share
            
            **$**
            **1.84**
            
            $
            3.76
            
            $
            4.90
            
            $
            4.21
            
            $
            4.83




*
              In
                  previous periods, gains (losses) on sales of certain non-strategic
                  assets
                  were included in other (expense) income, net, and have been reclassified
                  to other operating items, net, to conform to the current period
                  presentation. See Note 3, Other Operating Items, Net, for additional
                  information.







**Selected
            Quarterly Financial Data and Dividend and Market Information
            (Unaudited)**
 **Stock
                      Price Range****Net
                      (Loss) Income**
                  
                  **High-Low***In
                      millions, except per share data and shareholder
                      information*
                  
                  **Revenues**
                  
                  **Operating
                        (Loss) Profit**
                  **
                  **Dividends**
                    **Per
                      Share**
                  
                  **Amount**
                  
                  **Per
                      Share Basic**
                  
                  **Per
                      Share Diluted**
                  
                  **Common
                      Stock****2006****First
                      Quarter**
                  
                  **$**
                  **516.4**
                  
                  **$**
                  **(6.8**
                  **)**
                  **$**
                  **0.10**
                  
                  **$**
                  **(8.2**
                  **)**
                  **$**
                  **(0.09**
                  **)**
                  **$**
                  **(0.09**
                  **)**
                  **$**
                  **17.31
                      - $14.88****Second
                      Quarter**
                  
                  
                  **765.2**
                  
                  
                  **(76.2)**
                  ***
                  **$**
                  **0.10**
                  
                  
                  **(122.4**
                  **)**
                  
                  **(1.27**
                  **)**
                  
                  **(1.27**
                  **)**
                  **$**
                  **16.18
                      - $13.84****Third
                      Quarter**
                  
                  
                  **547.4**
                  
                  
                  **10.0**
                  
                  **$**
                  **0.10**
                  
                  
                  **1.0**
                  
                  
                  **0.01**
                  
                  
                  **0.01**
                  
                  **$**
                  **16.30
                      - $14.33****Fourth
                      Quarter**
                  
                  
                  **557.2**
                  
                  
                  **27.5**
                  
                  **$**
                  **0.10**
                  
                  
                  **12.2**
                  
                  
                  **0.13**
                  
                  
                  **0.13**
                  
                  **$**
                  **15.25
                      - $13.13****$**
                  **2,386.2**
                  
                  **$**
                  **(45.5**
                  **)**
                  **$**
                  **0.40**
                  
                  **$**
                  **(117.4**
                  **)**
                  **$**
                  **(1.24)***
                  
                  **$**
                  **(1.24)***
                  
                  **$**
                  **17.31
                      - $13.13****2005**First
                      Quarter
                  
                  $
                  490.0
                  
                  $
                  (35.9
                  )
                  $
                  0.05
                  
                  $
                  (30.3
                  )
                  $
                  (0.31
                  )
                  $
                  (0.31
                  )
                  $
                  16.07
                      - $12.50Second
                      Quarter
                  
                  
                  798.0
                  
                  
                  95.4
                  
                  $
                  0.05
                  
                  
                  57.8
                  
                  
                  0.59
                  
                  
                  0.58
                  
                  $
                  15.90
                      - $13.15Third
                      Quarter
                  
                  
                  544.9
                  
                  
                  (120.9)
                  ***
                  $
                  0.10
                  
                  
                  (129.6
                  )
                  
                  (1.33
                  )
                  
                  (1.33
                  )
                  $
                  17.83
                      - $13.75Fourth
                      Quarter
                  
                  
                  556.8
                  
                  
                  27.8
                  
                  $
                  0.10
                  
                  
                  11.2
                  
                  
                  0.11
                  
                  
                  0.11
                  
                  $
                  18.00
                      - $16.34**$**
                  **2,389.7**
                  
                  **$**
                  **(33.6**
                  **)**
                  **$**
                  **0.30**
                  
                  **$**
                  **(90.9**
                  **)**
                  **$**
                  **(0.95)***
                  
                  **$**
                  **(0.95**
                  **)**
                  **$**
                  **18.00
                      - $12.50**
 As
          of
          June 30, 2006, our Common Stock was listed on the New York Stock Exchange
          under
          the symbol RDA. At that time there were approximately 1,525 holders of
          record of
          our Common Stock.
 *
                The
                    sum of the four quarters’ earnings per share does not equal the full-year
                    earnings per share because each quarterly earnings per share
                    is calculated
                    using the weighted
 average
                    number of shares of Common Stock for the quarter while the full-year
                    earnings per share is calculated using the weighted average number
                    of
                    shares of Common Stock outstanding during the
                    year.
 **
                In
                    previous periods, gains (losses) on sales of certain non-strategic
                    assets
                    were included in other (expense) income, net, and have been reclassified
                    to other operating items, net, to conform to the current period
                    presentation. See Note 3, Other Operating Items, Net, for additional
                    information.
 ***
                Includes
                    goodwill charge of $(187.8) and $(129.0) in the second quarter
                    of 2006 and
                    third quarter of 2005, respectively. See Note 6, Goodwill and
                    Other
                    Intangible Assets, Net for further information.


*The
      Reader’s Digest Association, Inc. and Subsidiaries*




-
          69 -




**Corporate
        and Shareholder Information**
 
 **Stock
                  Listings:**
                Common
                  Stock
                New
                  York Stock Exchange, Symbol: RDA
                
                **Transfer
                  Agent and Registrar:**
                Mellon
                  Investor Services LLC
                P.O.
                  Box 3315
                South
                  Hackensack, NJ 07606
                www.melloninvestor.com/isd
                
                **Shareholder
                  Inquiries:**
                Domestic800-230-2771
                Foreign201-680-6578
                shrrelations@melloninvestor.com
                
                **ESPP
                  Holder Inquiries:**800-774-5474
                
                **TDD
                  Line:**
                Domestic800-231-5469
                Foreign201-680-6610
                
                **Annual
                  Meeting of Shareholders:**
                November
                  17, 2006, at 9:00 a.m.
                Reader’s
                  Digest Corporate Headquarters
                DeWitt
                  Wallace Auditorium
                Reader’s
                  Digest Road
                Chappaqua,
                  New York
                
                **Shareholder
                  Reports:**
                Copies
                  of the Proxy Statement and Annual Report on Form
                10-K
                  filed with the Securities and Exchange Commission
                are
                  available upon request and also are available at www.rda.com.
                
                **Shareholder
                  Information:**
                Individual
                  shareholders may direct their questions to:
                Carlos
                  A. Jimenez
                914-244-5308
                carlos_jimenez@rd.com
                
                **SEC
                  and NYSE Certifications:**
                The
                  certifications of our Chief Executive Officer and
                Chief
                  Financial Officer, required under Section 302 of the Sarbanes-Oxley
                  Act of
                  2002, have been filed as exhibits to our 2006 Annual Report on
                  Form 10-K.
                  Also, our Chief Executive Officer submitted the Fiscal 2005 annual
                  certification confirming our compliance with the NYSE corporate
                  governance
                  listing standards.
              **Direct
                  Stock Purchase**
                **Investor
                  Services Program:**
                This
                  program offers a convenient way to buy Reader’s Digest Common Stock. It
                  includes features such as dividend
                reinvestment,
                  optional cash investment and custodial service for stock certificates.
                
                For
                  complete information, contact:
                Mellon
                  Investor Services LLC
                P.O.
                  Box 3338
                South
                  Hackensack, NJ 07606
                800-242-4653
                
                **Investor
                  Relations:**
                Securities
                  analysts, institutional investors and other investment professionals
                  may
                  direct their inquiries to:
                Richard
                  E. Clark
                914-244-5425
                richard_clark@rd.com
                
                **Media
                  Relations:**
                Editors
                  and reporters may direct their questions to:
                William
                  K. Adler
                914-244-7585
                william_adler@rd.com
                
                **Product
                  Catalogs:**
                For
                  more information on our products, including free
                catalogs,
                  call 800-846-2100 or write to:
                Customer
                  Service at
                The
                  Reader’s Digest Association, Inc.
                
                **Global
                  Corporate Headquarters:**
                The
                  Reader’s Digest Association, Inc.
                Reader’s
                  Digest Road
                Pleasantville,
                  NY 10570-7000
                914-238-1000
                www.rda.com
                
                ©2006
                  The Reader’s Digest Association, Inc. Reader’s Digest, the Pegasus logo
                  and QSP are registered trademarks and English In 20 Minutes A Day
                  is a
                  trademark of The Reader’s Digest Association, Inc. The Family Handyman is
                  a registered trademark of RD Publications, Inc. Books Are Fun is
                  a
                  registered service mark of Books Are Fun, Ltd. Taste of Home, Taste
                  of
                  Home Entertaining and Backyard Living are registered trademarks
                  of Reiman
                  Media Group, Inc. Every Day with Rachael Ray is a trademark of
                  Rachael
                  Ray. Allrecipes is a registered trademark and service mark of
                  Allrecipes.com, Inc.
 
 -
            70 -