Hechinger Liquidation Trust 10-Q 2006 Q2 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Check one

þ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended March 31, 2006 or

o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number 000-50160

HECHINGER LIQUIDATION TRUST

(Exact name of Registrant as specified in its charter)

Delaware	52-7230151
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
405 East Gude Drive, Suite 206, Rockville, Maryland	20850
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (301) 838-4311

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yesþ            Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

     Large accelerated filero       Accelerated filero       Non-accelerated filerþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yeso             Noþ

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

Yesþ             Noo

HECHINGER LIQUIDATION TRUST
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006

Description	Page
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Unaudited Statements of Net Assets in Liquidation		3
Unaudited Statements of Changes in Net Assets in Liquidation		4
Unaudited Statements of Cash Receipts and Disbursements		5
Notes to Unaudited Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		14
Item 3. Quantitative and Qualitative Disclosures About Market Risk		19
Item 4. Controls and Procedures		19
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings		20
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		21
Item 3. Defaults Upon Senior Securities		21
Item 4. Submission of Matters to a Vote of Security Holders		21
Item 5. Other Information		21
Item 6. Exhibits		21
SIGNATURES		22
INDEX TO EXHIBITS		23

2

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Hechinger Liquidation Trust
Unaudited Statements of Net Assets in Liquidation

($ in thousands)

	As of		As of
	March 31, 2006		September 30, 2005
Assets
Cash and cash equivalents
Cash designated as available for distribution to holders of impaired claims	$	3,254	$	3,054
Reserved cash		21,353		22,206
Other cash		2,154		1,389
Total cash and cash equivalents		26,761		26,649
Committee action settlement receivable		—		7,000
Preference receivables (net of costs of recovery of $156 and $152, respectively)		938		869
Other assets		3		3
Total assets		27,702		34,521
Liabilities
Unimpaired and convenience claims payable		1,337		1,337
Uncashed claims checks		334		361
Distributions payable		491		292
Estimated costs of liquidation
Wind-down reserve		862		1,436
Litigation reserve		461		730
Fleet loss contingency accrual		3,500		3,500
Total liabilities		6,985		7,656
Net Assets in Liquidation	$	20,717	$	26,865

See accompanying notes to unaudited financial statements.

3

Hechinger Liquidation Trust
Unaudited Statements of Changes in Net Assets in Liquidation

($ in thousands)

	For the three			For the three
	months ended			months ended
	March 31, 2006			March 31, 2005
Increase in Net Assets in Liquidation
Increase/(decrease) in estimated fair value of preference receivables, net	$	66		$	(67	)
Interest income		252			138
Other increases		2			998
Net increase in Net Assets in Liquidation before distributions authorized		320			1,069
Distributions authorized		(53	)		(142	)
Net increase in Net Assets in Liquidation after distributions authorized		267			927
Net Assets in Liquidation at beginning of period		20,450			28,520
Net Assets in Liquidation at end of period	$	20,717		$	29,447

	For the six			For the six
	months ended			months ended
	March 31, 2006			March 31, 2005
Increase in Net Assets in Liquidation
Increase/(decrease) in estimated fair value of preference receivables, net	$	35		$	(67	)
Decrease in estimated fair value of unimpaired and convenience claims payable		—			23
Interest income		486			260
Other increases		10			1,011
Net increase in Net Assets in Liquidation before distributions authorized		531			1,227
Distributions authorized		(6,679	)		(222	)
Net (decrease)/increase in Net Assets in Liquidation after distributions authorized		(6,148	)		1,005
Net Assets in Liquidation at beginning of period		26,865			28,442
Net Assets in Liquidation at end of period	$	20,717		$	29,447

See accompanying notes to unaudited financial statements.

4

Hechinger Liquidation Trust
Unaudited Statements of Cash Receipts and Disbursements

($ in thousands)

	For the six		For the six
	months ended		months ended
	March 31, 2006		March 31, 2005
Cash receipts
Collection of committee action settlement	$	7,000	$	—
Preference collections, before costs of recovery		118		3,670
Interest income		486		260
Other receipts		10		65
Total cash receipts		7,614		3,995
Cash disbursements
Costs of liquidation
Legal and professional fees
Litigation		269		1,112
Preference recoveries		152		951
Liquidation Trust operations		174		383
Operating expenses		400		939
Unimpaired and convenience claims		—		10
Reissued/(voided) claims checks, net		27		(123	)
Total cash disbursements		1,022		3,272
Increase in cash and cash equivalents before distributions paid		6,592		723
Distributions paid		6,480		166
Increase in cash and cash equivalents		112		557
Cash and cash equivalents at beginning of period		26,649		34,375
Cash and cash equivalents at end of period	$	26,761	$	34,932

See accompanying notes to unaudited financial statements.

5

Hechinger Liquidation Trust
Notes to Unaudited Financial Statements

1. Background and Basis of Presentation

Background

     Hechinger Liquidation Trust (the “Liquidation Trust”) was established effective October 26, 2001 (the “Effective Date”) in accordance with the Revised First Amended Consolidated Plan of Liquidation (the “Plan”) for Hechinger Investment Company of Delaware, Inc. and affiliates (the “Debtors”), confirmed by the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) by an order dated October 5, 2001.

     The Liquidation Trust has no authority to engage in any trade or business. The purpose of the Liquidation Trust is to (i) liquidate any and all remaining assets of the Debtors; (ii) pursue causes of action assigned to the Liquidation Trust, including preference, fraudulent conveyance and other avoidance actions; (iii) resolve, either consensually or through litigation, all disputed claims asserted against the Debtors (“Disputed Claims”), pursuant to the Plan; and (iv) make all distributions required under the Plan (“Distributions”), and payments to holders of claims allowed under the terms of the Plan (“Allowed Claims” and, together with the Disputed Claims, the “Claims”). The Liquidation Trust will terminate upon the earlier of (a) the fulfillment of its purpose by the liquidation of all of its assets and the distribution of the proceeds of the liquidation thereof in accordance with the Plan, or (b) by October 26, 2006, unless the Bankruptcy Court approves an extension of this term.

     Pursuant to the Bankruptcy Code, certain types of Allowed Claims will be paid in full under the Plan. Such Claims are therefore referred to as “Unimpaired Claims.” The Plan defines which types of Claims are paid in full.

     The Liquidation Trust exists primarily for the benefit of the majority of claimants who will not be repaid in full for the amounts the Debtors owed them as of the bankruptcy filing. These Claims are referred to as “Impaired Claims” because the rights of the claimants have been impaired by the Debtors’ bankruptcy. Each holder of an Allowed Claim in the Plan’s Class 4A (Senior Unsecured Claims), Class 4B (General Unsecured Claims), and Class 5 (Subordinated Debentures Claims) (each a “Class”) is deemed to hold a pro rata beneficial interest (the “Beneficial Interests”) in the Liquidation Trust based upon the amount of their Allowed Impaired Claim as compared to the total amount of all Impaired Claims ultimately Allowed. When and to the extent Disputed Impaired Claims become Allowed Impaired Claims, holders of such Claims become holders of Beneficial Interests in accordance with the Plan.

     The holders of Beneficial Interests receive all remaining net proceeds of the Liquidation Trust, if any, after the expenses and all creditors of the Liquidation Trust, including Allowed Unimpaired and Convenience Claims (certain small Claims to be paid at 7.5% of their Allowed amounts in accordance with the Plan) are paid, and all contingencies are resolved. Holders of each Class of Beneficial Interests (i.e., each Class of Impaired Claims) have the same rights, except with respect to payment of Distributions.

     Through March 31, 2006, the Liquidation Trust has authorized Distributions to holders of Beneficial Interests (i.e., to holders of Allowed Impaired Claims) of 10.2911% of the Allowed amount of the Impaired Claims, and established a reserve of 10.2911% of the estimated amount of Disputed Impaired Claims, based on the estimated amount of such Claims approved by the Bankruptcy Court for reserve purposes (the “Disputed Impaired Claims Reserve”).

6

Basis of Presentation

     The Liquidation Trust’s financial statements have been prepared using the liquidation basis of accounting. Under this method of accounting, the Statements of Net Assets in Liquidation reflect all assets and liabilities, including the projected total cost of liquidating the assets and winding down the affairs of the Liquidation Trust, at estimated fair value. Unimpaired Claims, to be paid in full, are reflected in the Statements of Net Assets in Liquidation as liabilities at estimated aggregate settlement amounts. The unpaid amount of the authorized Distributions to holders of Allowed Impaired Claims is also reflected as a liability. In addition, liabilities include loss contingency accruals for losses considered probable and estimable. The Statements of Changes in Net Assets in Liquidation primarily reflect authorized Distributions to holders of Beneficial Interests and changes in the estimated fair value of the Liquidation Trust’s assets and liabilities, including changes resulting from significant events in, or the resolution of, litigation pursued by the Liquidation Trust. The Liquidation Trust’s fiscal year ends on September 30.

     The accompanying unaudited financial statements reflect all adjustments, consisting only of normal recurring adjustments that are, in the opinion of the Liquidation Trustee, necessary for a fair statement of the results for the interim periods presented. Such financial statements and these notes thereto should be read in conjunction with the audited Liquidation Trust financial statements as of September 30, 2005 and September 30, 2004, and for the fiscal years ended September 30, 2005, September 30, 2004 and September 30, 2003, and the notes thereto.

     The amounts shown in this document are rounded and are therefore approximate.

2. Significant Accounting Policies

Use of Estimates

     The preparation of the financial statements in conformity with generally accepted accounting principles requires the Liquidation Trustee to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities. Actual results are likely to differ from those estimates and those differences may be significant.

Cash and Cash Equivalents

     The Liquidation Trust considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. The Liquidation Trust holds substantially all cash balances in operating and investment accounts in excess of federally insured limits. Cash is classified as: Designated as Available for Distribution to Holders of Impaired Claims, Reserved Cash and Other Cash (see Note 3).

Taxes

     The Liquidation Trust is intended to qualify as a liquidating trust for federal income tax purposes, and therefore should be taxable as a grantor trust. The holders of Beneficial Interests are treated as grantors; accordingly, their pro rata share of all items of income, gain, loss, deduction and credit is included in the income tax returns of the holders of Beneficial Interests.

     The Liquidation Trust pays applicable taxes on the taxable net income and gain allocable to holders of Disputed Impaired Claims on behalf of such holders. When such Disputed Claims are ultimately resolved, holders whose Disputed Claims were determined to be Allowed Claims receive Distributions from the Liquidation Trust net of taxes, if any, which the Liquidation Trust previously paid on their behalf.

     The Liquidation Trust incurs no taxable income or gain on its own behalf; therefore, no tax provision is recorded in the financial statements of the Liquidation Trust.

7

3. Cash and Cash Equivalents

     Cash is invested in highly liquid investments with a maturity of three months or less, and in accordance with Section 345 of the Bankruptcy Code or as otherwise permitted by order of the Bankruptcy Court. Under the terms of the Plan, the Liquidation Trust is not required to segregate funds for reserves (see Note 11).

     Cash Designated as Available for Distribution to Holders of Impaired Claims (“Available Cash”) is designated solely to assure the availability of funds for payment to holders of Impaired Claims who have not received their Distributions (see Notes 8 and 11).

     Available Cash consists of:

($ in thousands)

	As of		As of
	March 31, 2006		September 30, 2005
Distributions payable	$	491	$	292
Reserve for remaining disputed impaired claims at 10.2911% and 9.1%, respectively		2,763		2,762
Total available cash	$	3,254	$	3,054

     Reserved Cash is held by the Liquidation Trust to assure payment of the Liquidation Trust’s obligations in accordance with the Plan. Under the terms of the Plan, Reserved Cash is intended to provide for (a) operating expenses of the Liquidation Trust, (b) estimated payments to holders of Allowed Unimpaired and Convenience Claims in accordance with the Plan, and (c) payments which may become necessary if and as Disputed Unimpaired Claims become Allowed, or if certain specific contingencies should occur. See Note 11 for details of specific reserves and their related amounts.

     Other Cash is cash and cash equivalents not designated to a specific reserve or fund.

4. Committee Action Settlement Receivable

     The Liquidation Trust has been pursuing an adversary proceeding known as the “Committee Action” against certain former officers and directors of Hechinger Company (the “Officer and Director Defendants”), certain former lenders of the Debtors, and others (see Note 13).

     During September 2005, the Liquidation Trust reached a settlement with the Officer and Director Defendants with respect to the Committee Action. Pursuant to the terms of the agreement, $7.0 million in cash was paid to the Liquidation Trust during October 2005, and the Liquidation Trust dismissed the Committee Action as against the Officer and Director Defendants. The settlement has no effect on the Liquidation Trust’s claims against any other defendant in the Committee Action.

5. Preference Receivables

     The Liquidation Trust’s preference receivables are reflected in the accompanying Statements of Net Assets in Liquidation at their estimated fair value of $0.9 million, net of estimated costs of recovery of $0.2 million, as of both March 31, 2006 and September 30, 2005. Most of the value of preference receivables consists of the sole remaining preference recovery action being actively pursued. During June 2005, following the February 2005 trial of this action, the Bankruptcy Court awarded the Liquidation Trust $1.0 million. The defendant appealed the decision and award, and the appellate court upheld the Bankruptcy Court ruling in its entirety during March 2006. Although the defendant has further appealed the case, the Liquidation Trust believes that ultimate collection of the full award is likely.

8

     The fair value of Liquidation Trust assets is reassessed at least quarterly and adjustments to estimated fair values are reflected in the period in which they become known. The eventual net realizable value of preference receivables is likely to differ from their estimated net fair value and these differences may be significant.

6. Unimpaired and Convenience Claims Payable

     Unimpaired Claims payable represents the estimated aggregate settlement amount of Unimpaired Claims against the Debtors prior to the Effective Date of the Plan, which will be paid out at 100% of their Allowed amount. Such Claims are valued at the Liquidation Trust’s best estimate of the amount that will ultimately be allowed. Convenience Claims, also included in this classification, are not significant.

     Unimpaired and Convenience Claims payable consists of:

($ in thousands)

	As of		As of
	March 31, 2006		September 30, 2005
Allowed unimpaired claims	$	1,335	$	1,335
Estimated fair value of disputed unimpaired claims		—		—
Convenience claims		2		2
Total	$	1,337	$	1,337
Number of disputed unimpaired claims		3		3

     Pursuant to the Plan, certain fees and expenses which Kmart Corporation (“Kmart”) incurred in connection with the Debtors’ bankruptcy filing were allowed as an Unimpaired Claim. Allowed Unimpaired Claims as of March 31, 2006 and September 30, 2005 include this Claim, which has not yet been substantiated by Kmart as required by the Plan, at its estimated amount of $1.3 million.

     The amount asserted by the holders of the remaining Disputed Unimpaired Claims is insignificant as of March 31, 2006 and September 30, 2005. The Liquidation Trust believes that the likelihood of paying any of the Claims is remote and anticipates that each of these Claims will be expunged or waived; accordingly, no liability has been recorded with respect to the remaining Disputed Unimpaired Claims.

     Unimpaired Claims are valued by reviewing the facts available to the Liquidation Trust, including the Debtors’ records and information submitted by the claimants, and estimating the ultimate settlement value of the Claims. The fair value of Unimpaired Claims payable is reassessed at least quarterly and adjustments to estimated fair values are reflected in the period in which they become known. However, no assurance can be given as to the ultimate allowance, disallowance or settlement of the remaining Disputed Unimpaired Claims, individually or in the aggregate.

7. Uncashed Claims Checks

     Pursuant to the Plan, any Claims payments and Distributions which remain uncashed for 90 days following their issuance date are forfeited to the Liquidation Trust for distribution to other holders of Allowed Claims. Pending a final order from the Bankruptcy Court, the Liquidation Trust has treated such items as a liability. Such checks currently may be reissued upon timely request of the payee, subject to applicable fees.

9

8. Distributions Payable

     Distributions payable represents the amount of authorized Distributions which the Liquidation Trust has been unable to pay to holders of Allowed Impaired Claims. A number of holders of such Allowed Claims, while otherwise eligible for Distributions, have either not yet provided all information necessary for payment; were subject to an offsetting claim by the Liquidation Trust which had not yet been resolved; or, because they had not cashed a previous Distribution check, were not paid any subsequent Distributions. Until all such issues are resolved, the holder of an Allowed Claim may not receive a Distribution.

9. Estimated Costs of Liquidation

     The Wind-down Reserve and Litigation Reserve described below together constitute the estimated costs of liquidation in the accompanying Statements of Net Assets in Liquidation.

     Under the Plan, the Liquidation Trust was required to establish and fund a reserve to pay administration costs and costs of holding and liquidating the Liquidation Trust’s assets (the “Wind-down Reserve”). Substantially all of the day-to-day operations of the Liquidation Trust have been terminated; however, provision has been made for necessary management oversight and administrative, legal and accounting processes to continue through the end of 2006. These final items include resolution of the remaining Disputed Claims and all litigation (excluding the costs provided for in the Litigation Reserve), a final Distribution, if applicable, and filings with regulatory authorities and with the Bankruptcy Court.

     Pursuant to the Plan, the Liquidation Trust also established and funded a reserve to pay the costs of pursuing certain actions referred to as the “Bondholder Action” and the “Committee Action” (the “Litigation Reserve”). The amount of the Litigation Reserve as of March 31, 2006 and September 30, 2005 is intended to fund the appeal of the District Court’s Summary Judgment Decision and related judgment with respect to the Committee Action in the Court of Appeals (see Note 13).

     The fair value of the estimated costs of liquidation is reassessed at least quarterly and adjustments to estimated fair values are reflected in the period in which they become known. Actual costs are likely to differ from the estimated costs and these differences may be significant.

10. Fleet Loss Contingency Accrual

     The Fleet loss contingency accrual of $3.5 million represents the Liquidation Trust’s best estimate of the loss it may incur as a result of Fleet Retail Finance Inc. (“Fleet”), one of the defendants in the Bondholder Action, prevailing against the Liquidation Trust in this action. Under the terms of a stipulated order between Fleet and the Liquidation Trust which established the Fleet Reserve (the “Fleet Stipulation”), all as discussed in Notes 11 and 13, below, and subject to review by the Bankruptcy Court, Fleet may seek reimbursement of certain legal fees incurred in its defense of the Bondholder Action.

     The provision of a loss contingency accrual does not indicate that a liability has definitely been incurred; rather, in accordance with SFAS No. 5, “Accounting for Contingencies”, that it is probable that a liability has been incurred and the liability is reasonably estimable. The fair value of loss contingencies is reassessed at least quarterly and adjustments to estimated fair values are reflected in the period in which they become known. Actual costs are likely to differ from the estimated costs and these differences may be significant.

10

11. Bankruptcy Reserves Required

     The reserves for which Reserved Cash is maintained consist of the following:

($ in thousands)

	As of		As of
	March 31, 2006		September 30, 2005
Liability reserves
Fleet loss contingency accrual	$	3,500	$	3,500
Wind-down		862		1,436
Litigation		461		730
Unimpaired and convenience claims		1,337		1,337
Uncashed claims checks		334		361
Total liability reserves		6,494		7,364
Contingency reserves
Fleet		7,500		7,500
Litigation appeals provision		4,000		4,000
Excess disputed unimpaired claims		300		300
Preference settlement claims		59		42
Minimum reserve		3,000		3,000
Total contingency reserves		14,859		14,842
Total reserves	$	21,353	$	22,206

     A significant portion, or all, of the contingency reserve designated as the Fleet Reserve, established in the total amount of $11.0 million pursuant to the Fleet Stipulation, is likely to be drawn upon if Fleet, as a defendant in the Committee Action and the Bondholder Action, should ultimately prevail in both such actions. On an ongoing basis, the Liquidation Trust evaluates whether estimated losses from loss contingencies with respect to the Fleet Reserve should be recorded.

     The Fleet loss contingency accrual, totaling $3.5 million of the $11.0 million Fleet Reserve, has been recorded as a liability related to the resolution of the Bondholder Action in favor of Fleet (see Notes 10 and 13). Consistent with the Liquidation Trust’s assessment of the probability of a loss in accordance with SFAS No. 5, the $7.5 million Fleet Reserve balance remains classified as a contingency reserve as of March 31, 2006 because the Liquidation Trust has filed its notice of appeal from the adverse Summary Judgment Decision and related judgment in the Committee Action and does not consider Fleet likely to ultimately prevail in this Action.

     The litigation appeals provision represents cash held in reserve to allow the Liquidation Trust to pursue or defend a future trial and appeals of the Committee Action. The Liquidation Trustee designated this contingency reserve after concluding that future cash receipts of the Liquidation Trust might not be sufficient to fund such actions prospectively. No liability has been accrued in connection with such possible future actions because the Liquidation Trust has not determined that any such action required will necessitate additional funding of the Litigation Reserve.

     The minimum reserve, established pursuant to the Plan and intended to assure adequate liquidity for the Liquidation Trust, is to be maintained, subject to reduction by an order of the Bankruptcy Court, until the Liquidation Trust makes a final Distribution, if any, or is otherwise terminated.

11

12. Impaired Claims

     The Liquidation Trust’s estimate of Impaired Claims consists of:

($ in thousands)

	As of		As of
	March 31, 2006		September 30, 2005
Allowed impaired claims	$	706,043	$	706,043
Estimated fair value of disputed impaired claims		13,784		13,775
Total estimated impaired claims	$	719,827	$	719,818
Asserted value of disputed impaired claims	$	52,028	$	55,179
Number of disputed impaired claims		15		16

     During November 2005, the Liquidation Trust authorized a Distribution of 1.1911% of the Allowed amount to holders of Allowed Impaired Claims, which was paid during December 2005. Because this Distribution resulted from the $7.0 million proceeds of the Committee Action settlement, pursuant to the Plan, Kmart’s $150.0 million General Unsecured Claim was excluded from the Distribution.

     Distributions to holders of Allowed Impaired Claims have been authorized, through March 31, 2006, in the cumulative amount of 10.2911% of the Allowed amount of the Impaired Claims. A total of $70.6 million has been paid to holders of Allowed Impaired Claims through March 31, 2006. In conjunction with the authorized Distributions, as of March 31, 2006, the Liquidation Trust held a total of $3.3 million of Available Cash for Distribution to holders of Impaired Claims, including the $2.8 million Disputed Impaired Claims Reserve for Distribution to holders of Disputed Impaired Claims should such Disputed Claims become Allowed, and $0.5 million in Distributions payable to holders of Allowed Impaired Claims (see Notes 3 and 8). The Disputed Impaired Claims Reserve is determined based on the cumulative Distribution rate and on the estimated amount, approved by the Bankruptcy Court for reserve purposes, of each remaining Disputed Impaired Claim.

     No assurance can be given as to the ultimate allowance, disallowance or settlement of the remaining Disputed Impaired Claims, individually or in the aggregate.

13. Contingencies

     The Bondholder Action

     In March 2004 the District Court issued an opinion and order (collectively, the “Decision”) in the Bondholder Action, directing the entry of judgment in favor of Fleet and GECC. The Liquidation Trust appealed the Decision, and in July 2005 the Court of Appeals issued its Opinion affirming the March 2004 Decision. The Liquidation Trust’s motion for reconsideration and reversal of the Court of Appeals Opinion was denied by the Court of Appeals during August 2005, and the Liquidation Trust has determined not to pursue the action further. The Liquidation Trust may consequently incur certain claims by Fleet (see Notes 10 and 11).

     The Committee Action

     During July 2005, the District Court issued a memorandum opinion and order on pending summary judgment motions (collectively, the “Summary Judgment Decision”), dismissing the Liquidation Trust’s claims against Fleet Retail, GECC, and certain other defendants in the Committee Action. During August 2005, the District Court substantively denied the Liquidation Trust’s motion for reconsideration of the Summary Judgment Decision. During December 2005, the Liquidation Trust filed with the Court of Appeals its notice of appeal from the Summary Judgment Decision and related judgment in the Committee Action. A March 2006 mediation ordered and conducted by the Third Circuit Court of Appeals did not result in a settlement among the remaining parties to the Committee Action.

12

     During September 2005, the Liquidation Trust reached a settlement with the Officer and Director Defendants with respect to the Committee Action. Under the terms of the agreement, $7.0 million in cash was paid to the Liquidation Trust during October 2005, and the Liquidation Trust dismissed the Committee Action as against the Officer and Director Defendants. The settlement has no effect on the Liquidation Trust’s claims against any other defendant in the Committee Action.

     The various remaining defendants are vigorously opposing this action. There is no assurance that the Liquidation Trust will prevail on the appeal filed with respect to the Committee Action. While the Liquidation Trust is vigorously pursuing this litigation with the intent to obtain a very substantial recovery, the Liquidation Trust cannot predict with any certainty the outcome of the litigation or the amount or range of potential recoveries.

13

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     Reference is made to the unaudited financial statements of the Liquidation Trust as of March 31, 2006 and September 30, 2005 and for the three months and the six months ended March 31, 2006 and March 31, 2005, and the notes thereto (the “Unaudited Liquidation Trust Financial Statements”), included as Item 1. of this Form 10-Q. The following information concerning the Liquidation Trust’s financial performance and condition should be read in conjunction with the audited Liquidation Trust financial statements as of September 30, 2005 and September 30, 2004, and for the fiscal years ended September 30, 2005, September 30, 2004 and September 30, 2003, and the notes thereto.

     The Unaudited Liquidation Trust Financial Statements have been prepared on the same basis as the audited Liquidation Trust financial statements, using the liquidation basis of accounting, and, in the opinion of the Liquidation Trustee, contain all adjustments, consisting of normal recurring adjustments necessary for a fair presentation of the Liquidation Trust’s results for such periods. The Liquidation Trust’s results for the three months ended March 31, 2006 are not necessarily indicative of the results to be expected for any other interim period or any future fiscal year. All amounts are rounded and are therefore approximate.

I.Accounting Policies and Estimates

     The following discussion and analysis of the Liquidation Trust’s changes in net assets in liquidation, cash receipts and disbursements, and net assets in liquidation is based on the Unaudited Liquidation Trust Financial Statements which have been prepared in accordance with accounting principles generally accepted in the United States of America and in accordance with the liquidation basis of accounting. During preparation of these financial statements, the Liquidation Trustee is required to make certain estimates and assumptions which affect the reported amounts of assets and liabilities in liquidation at estimated fair value, including estimates and assumptions concerning resolution of disputed claims, resolution of current and potential litigation, and the fair value, and related disclosure, of contingent assets and liabilities. On an ongoing basis, the Liquidation Trustee evaluates and updates these estimates and assumptions based on historical experience and on various other assumptions the Liquidation Trustee believes are reasonable under the circumstances. Actual results may differ from these estimates and different assumptions would lead to different estimates.

     The Liquidation Trust’s critical accounting policies are described in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Liquidation Trust’s annual report on Form 10-K for the year ended September 30, 2005.

II.Changes in Net Assets in Liquidation

     Net assets in liquidation are subject to material change when either (a) Distributions to holders of Allowed Impaired Claims are authorized, or (b) estimates of the fair value of the Liquidation Trust’s assets and/or liabilities change, including as a result of significant events in, or the resolution of, litigation pursued by the Liquidation Trust. Both the authorization of Distributions and changes in estimates are non-cash changes. These changes are shown in the Liquidation Trust’s Statements of Changes in Net Assets in Liquidation and are discussed below.

     Most cash transactions, on the other hand, such as collection of receivables and payments of liabilities and Distributions, cause offsetting changes in the associated components of assets and liabilities, but do not change net assets in liquidation. The Liquidation Trust’s Statements of Cash Receipts and Disbursements show the results of these transactions, which are also discussed later under the heading “Cash Receipts and Disbursements.”

14

     The following table summarizes the significant changes in net assets in liquidation for the periods as indicated:

($ in thousands)

	For the three months ended
	March 31, 2006			March 31, 2005
Distributions authorized	$	(53	)	$	(142	)
Increase/(decrease) in estimated fair value of preference receivables, net		66			(67	)
Interest income and net other increases		254			1,136
Net increase in net assets in liquidation	$	267		$	927

($ in thousands)

	For the six months ended
	March 31, 2006			March 31, 2005
Distributions authorized	$	(6,679	)	$	(222	)
Increase/(decrease) in estimated fair value of preference receivables, net		35			(67	)
Interest income and net other increases		496			1,294
Net increase in net assets in liquidation	$	(6,148	)	$	1,005

A. Distributions authorized

     No new interim Distribution was authorized during the three months ended March 31, 2006; however, included in Distributions authorized for the three months ended March 31, 2006, the Liquidation Trust paid $0.1 million of applicable taxes on certain calendar year 2005 taxable net income and gain allocable to holders of Disputed Impaired Claims on behalf of such holders (the “2005 Tax Payment”). During November 2005, the Liquidation Trust authorized a Distribution of 1.1911% of the Allowed amount to holders of Allowed Impaired Claims, totaling $6.6 million, which was paid during December 2005. Because this Distribution resulted from the $7.0 million cash proceeds of the Committee Action settlement (discussed below under “Legal Proceedings”), pursuant to the Plan, Kmart’s $150.0 million General Unsecured Claim was excluded from the Distribution.

     No new interim Distribution was authorized during the three months or the six months ended March 31, 2005. Distributions at the then current cumulative rate of 8.1%, totaling $0.1 million, were authorized during the six months ended March 31, 2005 to holders of $1.7 million of Impaired Claims newly allowed during the period. In addition, included in Distributions authorized for the three months ended March 31, 2005, the Liquidation Trust paid $0.1 million of applicable taxes on certain calendar year 2004 taxable net income and gain allocable to holders of Disputed Impaired Claims on behalf of such holders (the “2004 Tax Payment”).

     As a result of the ongoing Claims resolution process, fewer Impaired Claims remain to be resolved as of each successive period.

B. Changes in estimated fair value of preference receivables, net

     The estimated fair value of preference receivables was adjusted during the three months and the six months ended March 31, 2006 based on settlements achieved in excess of previously estimated amounts as of March 31, 2006, offset by an increase in estimated costs of recovery as of December 31, 2005. Costs of recovery during the three months ended December 31, 2005 included contingent fees of $0.1 million payable to preference collections counsel with respect to additional value the Liquidation Trust recognized from waivers of otherwise valid Impaired Claims obtained in the course of preference settlements. The Liquidation Trust recognizes additional value from such Impaired Claims waivers with each additional Distribution, because Impaired Claims waivers decrease the amount of Claims the Liquidation Trust must pay in each subsequent Distribution. The $0.1 million of additional contingent fees recognized during the three months ended December 31, 2005 were related to the Distribution paid during December 2005.

15

     The estimated fair value of preference receivables was decreased by $0.1 million for additional collections costs during the three months ended March 31, 2005. The estimate otherwise remained unchanged for the three months and the six months ended March 31, 2005, because substantially all of the remaining cases settled during these periods were settled for the same amounts as their estimated value as of September 30, 2004.

C. Interest income and net other increases

     Interest income and net other increases during the three months and the six months ended March 31, 2006 consisted primarily of interest income. Interest income and net other increases during the three months and the six months ended March 31, 2005 consisted primarily of a $0.6 million settlement in connection with litigation against a former insurance company of the Debtors, a $0.4 million distribution in the liquidation of the Debtors’ former company-owned life insurance policy carrier, and interest income.

III.Cash Receipts and Disbursements

     The following table summarizes the cash receipts and disbursements for the periods as indicated:

($ in thousands)

	For the six months ended
	March 31, 2006		March 31, 2005
Cash receipts
Collection of committee action settlement	$	7,000	$	—
Preference collections, before costs of recovery		118		3,670
Other receipts		496		325
Total cash receipts		7,614		3,995
Cash disbursements
Legal and professional fees
Litigation		269		1,112
Preference recoveries		152		951
Liquidation Trust operations		174		383
Operating expenses		400		939
Claims payments		—		10
Reissued/(voided) claims checks, net		27		(123	)
Total cash disbursements		1,022		3,272
Distributions paid		6,480		166
Increase in cash and cash equivalents	$	112	$	557

A. Cash receipts

     During September 2005, the Liquidation Trust reached a settlement with certain former officers and directors of Hechinger Company (the “Officer and Director Defendants”) with respect to the Committee Action. Under the terms of the agreement, $7.0 million in cash was paid to the Liquidation Trust during October 2005.

     Cash receipts from collections of preference receivables have been ongoing since the preference actions were filed in mid-2001. Preference collections during the six months ended March 31, 2006 were nominal, resulting from collections efforts on recently settled cases and certain default judgments issued.

16

Collections during the six months ended March 31, 2005 were substantially higher than during the six months ended March 31, 2006, primarily because of four substantial preference recovery actions (totaling $3.3 million in settlement value), among others, which were settled immediately prior to trial and collected during the six months ended March 31, 2005.

     With the exception of one substantial case, no preference actions remain to be litigated as of March 31, 2006. In the one remaining case, the Bankruptcy Court awarded the Liquidation Trust $1.0 million. The defendant appealed the decision and award, and the appellate court upheld the Bankruptcy Court ruling in its entirety. Although the defendant has further appealed the case, the Liquidation Trust believes that ultimate collection of the full award is likely. Future preference receipts, other than from this one case, are expected to be insignificant.

     Other receipts resulted mainly from interest income.

B. Legal and professional fees

     Legal and professional fees reflect the activity level in various areas of the Liquidation Trust’s responsibilities.

     The litigation fees paid for the Bondholder Action and the Committee Action during the six months ended March 31, 2006 were significantly less than those paid during the six months ended March 31, 2005. Fees paid during the six months ended March 31, 2005 related to filing the Liquidation Trust’s appeal briefs in the Bondholder Action, and to defending various motions, including motions for summary judgment, filed by defendants in the Committee Action. During the six months ended March 31, 2006, however, fees related mainly to preparation of the initial appeal brief in the Committee Action, in addition to a $0.1 million payment to an expert in key matters.

     Total preference recovery fees during the six months ended March 31, 2006 were not comparable, as a percentage of preference collections, to such fees during the six months ended March 31, 2005. The collection fees for most preference settlements are contingent, and are set at a declining rate (generally ranging from 35% to 7% of collections) for larger cases. In addition, preference recovery fees include expenses incurred in support of preference collections and associated litigation. The costs incurred during the six months ended March 31, 2005 included $0.2 million of fees for expert reports in connection with preference litigation. In addition, during the six months ended March 31, 2005, the Liquidation Trust paid contingent fees of $0.1 million to its preference collections counsel with respect to additional value the Liquidation Trust recognized from waivers of otherwise valid Impaired Claims obtained in the course of preference settlements. The Liquidation Trust recognizes additional value from such Impaired Claims waivers with each additional Distribution, because Impaired Claims waivers decrease the amount of Claims the Liquidation Trust must pay in each subsequent Distribution. Substantially all of the Liquidation Trust’s preference recovery fees for the six months ended March 31, 2006 were additional contingent fees paid relative to the Distributions authorized during November 2005, rather than relating to preference collections received during the period.

     Legal and professional fees for Liquidation Trust operations include all legal, accounting, and other support services except for the expenses of prosecuting the Bondholder Action and the Committee Action, and expenses related to preference collections pursued on a contingency-fee basis. The higher fees for Liquidation Trust operations during the six months ended March 31, 2005 as compared to the six months ended March 31, 2006 resulted primarily from legal fees associated with settlement of claims against the Liquidation Trust, as well as prosecution of claims against certain former vendors of the Debtors. During the six months ended March 31, 2006, however, legal fees were minimal because most such cases were previously resolved.

17

C. Operating expenses

     Operating expenses during the six months ended March 31, 2006 were substantially lower than those during the six months ended March 31, 2005, primarily because, at the end of the six months ended March 31, 2005, the Liquidation Trust still had three full-time employees, while, as a result of its reduced level of operation, the Liquidation Trust required only part-time employees during the six months ended March 31, 2006. Approximately 60 percent of operating expenses for the six months ended March 31, 2006 consisted of annual insurance premiums for the Liquidation Trust, in an amount comparable to payments during the preceding years.

D. Distributions paid

     Distributions paid depend primarily on the amount of Allowed Impaired Claims, including Claims newly allowed, and on the Distributions authorized from time to time. During November 2005, the Liquidation Trust authorized a Distribution of 1.1911% of the Allowed amount to holders of Allowed Impaired Claims, totaling $6.6 million, of which $6.4 million was paid during December 2005. Because this Distribution resulted from the $7.0 million proceeds of the Committee Action settlement, pursuant to the Plan, Kmart’s $150.0 million General Unsecured Claim was excluded from the Distribution. In addition, during the six months ended March 31, 2006, the Liquidation Trust paid the 2005 Tax Payment. No new interim Distribution was authorized or paid during the six months ended March 31, 2005; however, holders of $1.1 million of Allowed Impaired Claims received payments at the then current cumulative Distribution rate of 8.1%. In addition, during the six months ended March 31, 2005, the Liquidation Trust paid the 2004 Tax Payment. In general, as a result of the ongoing Claims resolution process, fewer Impaired Claims remain to be resolved and paid as of each successive period.

IV.Net Assets in Liquidation

A. Assets

     The Liquidation Trust’s cash and cash equivalents balance of $26.8 million and $26.6 million as of March 31, 2006 and September 30, 2005, respectively, is classified as either (a) cash designated as available for distribution to holders of Impaired Claims (“Available Cash”), (b) Reserved Cash or (c) Other Cash.

     Available Cash is designated to assure the availability of funds for payment to holders of Impaired Claims who have not received authorized Distributions. The required amount of Available Cash of $3.3 million as of March 31, 2006 was based primarily on the cumulative Distribution rate of 10.2911%, for $28.5 million of Disputed Impaired Claims (at their estimated value for reserve purposes), as well as unpaid Distributions to holders of Allowed Impaired Claims who have not met all the requirements for a Distribution, or have not cashed a Distribution check and therefore have not been paid subsequent Distributions, in accordance with the Plan. The required amount of Available Cash of $3.1 million as of September 30, 2005 was based primarily on the then current cumulative Distribution rate of 9.1%, for $31.6 million of Disputed Impaired Claims (at their estimated value for reserve purposes) as well as unpaid Distributions to holders of Allowed Impaired Claims. The value of Disputed Claims, for the purpose of establishing adequate reserves, was estimated by the Liquidation Trust and approved by the Bankruptcy Court in an order establishing the amounts of Disputed Claims Reserves.

     Reserved cash is held by the Liquidation Trust to assure payment of the Liquidation Trust’s obligations. Under the terms of the Plan, reserved cash is intended to provide for (a) operating expenses of the Liquidation Trust, (b) estimated payments to holders of Allowed Unimpaired and Convenience Claims in accordance with the Plan, and (c) payments which may become necessary if and as Disputed Unimpaired Claims become allowed, or if certain specific contingencies should occur. Reserved cash decreased by $0.8 million from September 30, 2005 to March 31, 2006, to a balance of $21.4 million, primarily as a result of disbursements from the Wind-down and Litigation Reserves, as discussed below.

18

B. Liabilities and Reserves

     Estimated costs of liquidation decreased by $0.8 million, to a balance of $1.3 million as of March 31, 2006, compared to September 30, 2005. The decrease is due to disbursements totaling $0.5 million from the Wind-down Reserve and $0.3 million from the Litigation Reserve.

     The most significant component of liabilities and contingency reserves is the Fleet Reserve, established at a total of $11.0 million pursuant to a stipulated order between Fleet Retail Finance Inc. (“Fleet”) and the Liquidation Trust. A significant portion, or all, of the Fleet Reserve is likely to be drawn upon if Fleet, as a defendant in the Committee Action and the Bondholder Action, should ultimately prevail in both such actions. The Fleet loss contingency accrual, totaling $3.5 million of the $11.0 million Fleet Reserve, has been recorded as a liability related to the resolution of the Bondholder Action in favor of Fleet, as explained in “Legal Proceedings,” below. Consistent with the Liquidation Trust’s assessment of the probability of a loss in accordance with SFAS No. 5, the $7.5 million Fleet Reserve balance remains classified as a contingency reserve as of March 31, 2006 because the Liquidation Trust has appealed the adverse Summary Judgment Decision and related judgment in the Committee Action and does not consider Fleet likely to ultimately prevail in this Action.

V.Contingencies

     The Liquidation Trust is pursuing litigation against various parties, in particular the “Committee Action,” as described in “Legal Proceedings,” below. The Liquidation Trust cannot predict with any certainty the ultimate outcome of the remaining litigation or the amount or range of potential recoveries.

VI.Forward-Looking Statements

     This quarterly report on Form 10-Q contains forward-looking statements about the business, financial condition and prospects of the Liquidation Trust. The actual results of the Liquidation Trust could differ materially from those indicated by the forward-looking statements because of various risks and uncertainties, including, without limitation, the Liquidation Trust’s success in securing claims settlements on the terms currently contemplated in ongoing negotiations and in other estimates of settlement value, the effect of substantial delays in settling contingent assets and liabilities, resulting in a prolonged period of liquidation, economic conditions, changes in tax and other government rules and regulations applicable to the Liquidation Trust and other risks. These risks are beyond the ability of the Liquidation Trust to control, and in many cases, the Liquidation Trust cannot predict the risks and uncertainties that could cause its actual results to differ materially from those indicated by any forward-looking statements included in this Form 10-Q. When used in this quarterly report, the words “believes,” “estimates,” “plans,” “expects,” “anticipates” and other similar expressions as they relate to the Liquidation Trust or the Liquidation Trustee are intended to identify forward-looking statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     The Liquidation Trust does not hold any market risk sensitive instruments.

Item 4. Controls and Procedures

     The Liquidation Trust has designed and maintains disclosure controls and procedures to ensure that information required to be disclosed in its reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and regulations. These controls and procedures are also designed to ensure that such information is communicated to the Liquidation Trustee, to allow him to make timely decisions about required disclosures.

19

     The Liquidation Trust, including the Liquidation Trustee, has conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15. Based on that evaluation, the Liquidation Trustee concluded that the Liquidation Trust’s disclosure controls and procedures are effective as of March 31, 2006.

     There has been no change in the Liquidation Trust’s internal control over financial reporting that occurred during the Liquidation Trust’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Liquidation Trust’s internal control over financial reporting.

     The remaining responsibilities of the Liquidation Trust no longer require the full-time attention of the Liquidation Trustee or of Liquidation Trust employees. The Liquidation Trustee and one other employee are performing necessary management oversight and administrative, legal and accounting processes on a part-time basis, with periodic assistance from other former employees. While the Liquidation Trustee believes that these individuals will consistently make themselves available as needed to perform their assigned responsibilities, including functions related to internal control over financial reporting, there can be no assurance that this availability will continue. As a result, there may be future deficiencies in internal accounting controls related to a lack of segregation of duties.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

     Further background information about the following cases is disclosed in Part I, Item 3., “Legal Proceedings,” of the Liquidation Trust’s Form 10-K for the fiscal year ended September 30, 2005.

Bankruptcy Court Case

     As of December 31, 2005, one defendant in a preference litigation action had appealed a Bankruptcy Court award to the Liquidation Trust of $1.0 million to the United States District Court for the District of Delaware (the “District Court”). During March 2006, the District Court upheld the decision and award of the Bankruptcy Court. The defendant has further appealed the affirmation by the District Court to the United States Court of Appeals for the Third Circuit (the “Court of Appeals”). Prosecution of all other significant preference litigation has been completed.

Federal Court Cases

     The Bondholder Action

     In March 2004 the District Court issued an opinion and order (collectively, the “Decision”) in the Bondholder Action, directing the entry of judgment in favor of Fleet and GECC. The Liquidation Trust appealed the Decision, and in July 2005 the Court of Appeals issued its Opinion affirming the March 2004 Decision. The Liquidation Trust’s motion for reconsideration and reversal of the Court of Appeals Opinion was denied by the Court of Appeals during August 2005, and the Liquidation Trust has determined not to pursue the action further. The Liquidation Trust may consequently incur certain claims by Fleet, as described above under “Liabilities and Reserves.”

The Committee Action

     During July 2005, the District Court issued a memorandum opinion and order on pending summary judgment motions (collectively, the “Summary Judgment Decision”), dismissing the Liquidation Trust’s claims against Fleet Retail, GECC, and certain other defendants in the Committee Action. During August 2005, the District Court substantively denied the Liquidation Trust’s motion for reconsideration of the Summary Judgment Decision. During December 2005, the Liquidation Trust filed with the Court of Appeals its notice of appeal from the Summary Judgment Decision and related judgment in the Committee Action. A March 2006 mediation ordered and conducted by the Court of Appeals did not result in a settlement among the remaining parties to the Committee Action.

20

     During September 2005, the Liquidation Trust reached a settlement with the Officer and Director Defendants with respect to the Committee Action. Under the terms of the agreement, $7.0 million in cash was paid to the Liquidation Trust during October 2005, and the Liquidation Trust dismissed the Committee Action as against the Officer and Director Defendants. The settlement has no effect on the Liquidation Trust’s claims against any other defendant in the Committee Action.

     The various remaining defendants are vigorously opposing this action. There is no assurance that the Liquidation Trust will prevail on the appeal filed with respect to the Committee Action. While the Liquidation Trust is vigorously pursuing this litigation with the intent to obtain a very substantial recovery, the Liquidation Trust cannot predict with any certainty the outcome of the litigation or the amount or range of potential recoveries.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     None.

Item 3. Defaults Upon Senior Securities

     None.

Item 4. Submission of Matters to a Vote of Security Holders

     None.

Item 5. Other Information

     None.

Item 6. Exhibits

Exhibit
Number	Document
31.1	Certification by Liquidation Trustee
32.1	Liquidation Trustee’s Certification Pursuant to 18 U.S.C. Section 1350

21

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	HECHINGER LIQUIDATION TRUST
Date: May 15, 2006	By:	/s/ Conrad F. Hocking
	Name: Conrad F. Hocking
	Title: Liquidation Trustee

22

INDEX TO EXHIBITS
FORM 10-Q

Exhibit No.

31.1	Certification by Liquidation Trustee
32.1	Liquidation Trustee’s Certification Pursuant to 18 U.S.C. Section 1350

23