Following the liquidation of 114 corporate-owned Athlete's Foot stores, Moody's Investors Service recently downgraded the shoe retailer's $30 million franchise fee securitization two notches to Baa3' from Ba2'.

The single-tranche 4.2-year offering closed in September 2003, via placement agent UCC Capital Corp. Late last year, Athlete's Foot filed for Chapter 11 bankruptcy, and announced that it would voluntarily liquidate a block of company-owned stores as part of the reorganization plan (see ASR, 1/17/05). The bankruptcy did not impact the roughly 600 remaining individually owned stores.

Of the 114 stores liquidated, 32 were repurchased by existing franchisees, according to a release from Moody's. "The downgrade is due to the recent loss of royalty revenue to the securitization as a result of the closing of the company-owned stores. Though a portion of this lost revenue is expected to be replaced by collections from franchisees as well as the opening of new locations, the level of recovery remains uncertain," the rating agency said.

The 114 stores were throwing off about $2.8 million in royalties annually, said Bob D'Loren, president and CEO of UCC. "The net loss to the deal after the recovery of the 32 stores was about $2 million per year, for about a 15% to 17% drop in overall revenue; this does not pose any risk to the deal," D'Loren said.

The embedded debt service coverage triggers are not in danger of being breached at this point, according to D'Loren, and he added that the rating agencies are simply playing it safe. Athlete's Foot currently has upwards of 350 new stores under contract, and D'Loren expects Moody's to revisit the rating action once 100 or more stores come on line.

The potential damage to the Athlete's Foot brand was also factored into Moody's decision to downgrade the bonds. D'Loren has defended the resiliency of the trademark in the past, noting the growth of the franchise operation as a sign of the strength of the brand from a consumer standpoint. Moreover, the liquidation is a positive development for the franchisees, he maintains. The corporate-owned stores were consistently registering a substantial loss in the annual documentation sent out to individual franchisees. "Now that loss is gone," D'Loren said.

The mere fact that 32 stores were repurchased by existing franchisees is a testament to the strength of the trademark, noted another source familiar with the transaction.

Copyright 2005 Thomson Media Inc. All Rights Reserved.

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