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STATUS ON LIONEL'S BANKRUPTCY;
HOW MUCH LONGER WILL IT LAST?

                                                 By Erol Gurcan

Those of us following the various legal proceedings in the 3 rail world know that Lionel has been in bankruptcy since November 15, 2004, now a period of 20 months. While that may not sound like a long time to some, by comparison, K-Line's bankruptcy was over and done with in 8 months, and they did not emerge from it. (K-Line's tooling and assets were purchased by its principal manufacturer Sanda Kan in April 2006, who in turn, licensed them to Lionel as part of a licensing and marketing agreement).  As some will recall, the only reason Lionel filed for chapter 11 bankruptcy protection (reorganization) according to company president and CEO Jerry Calabrese, was because of the $40.7 million dollar judgment obtained against it by MTH . On June 7, 2004, a jury in Detroit, Michigan awarded MTH that amount of money against Lionel and codefendant Korea Brass involving the alleged theft of trade secrets involving the design plans for articulated locomotives and misappropriation of MTH production schedules. Lionel appealed that judgment in January 2005, and the appeal was heard by the Sixth Circuit Court of Appeals in Cincinnati Ohio on June 7, 2006. A decision on the appeal is expected late this year or early next year.

The question now becomes, how much longer will Lionel remain in Chapter 11 bankruptcy, and when will they begin the process to emerge from it. A motion (an application for a court order) filed by Lionel's lawyers with the bankruptcy court last week, offers some answers (the information for this article was obtained from the motion papers).The motion is currently scheduled to be heard on July 25, 2006. (As a side note, a court conference concerning Union Pacific's trademark infringement lawsuit is scheduled for that day as well. That case has been stayed since Lionel filed for bankruptcy).

The key factor in the bankruptcy reorganization process will be the decision in the trade secrets appeal which is expected late this year/early in 2007. Lionel's lawyers have informed the bankruptcy court that they can not file a plan of reorganization (which would start the process to emerge from bankruptcy) until they know the outcome of the trade secrets appeal. The motion specifically requests that once there is a decision in the trade secrets appeal, Lionel be given 120 days (four months) after the decision in which to file a reorganization plan with the court. It also seeks an additional 60 days (two months) to allow other interested parties, such as Lionel's creditors (like MTH)  to file their own reorganization plan with the court.

The appeals court decision is important in the bankruptcy process because it will directly impact the terms of any reorganization that may be proposed and confirmed, and in particular, the recoveries provided to unsecured creditors. For example, if all or most of MTH's $40.7 million dollar judgment is affirmed, the recovery by other unsecured creditors would be small. If the appeals court reverses the jury's verdict, Lionel's unsecured creditors would be paid in full according to its lawyers motion papers (the total of all other unsecured claims other than those of MTH totals $12 million). Beyond the $40.7 million trade secrets judgment, MTH has a separate $17.5 million dollar claim filed with the bankruptcy court in August 2005, which also became the subject of a lawsuit filed with the bankruptcy court on June 12, 2006, to repel an earlier Lionel motion for discovery documents and depositions (the patent infringement lawsuit is currently stayed). In a nutshell, the MTH $40.7 million trade secrets judgment and $17.5 million dollar MTH patent infringement lawsuit are by far the two largest unsecured claims against Lionel, when compared with the other 12 million totals of all other unsecured creditors.

I expect that the bankruptcy court will grant Lionel's motion (its third request for an extension since filing for bankruptcy) because it is reasonable to conclude that a reorganization plan can not be proposed until the outcome of the single largest potential unsecured debt facing Lionel is determined. When one calculates that a decision in the trade secrets case is not rendered until at least late this year, a period of over four months, and another six months will go by before Lionel and/or others propose plans of reorganization to the bankruptcy court, it will be almost another year (mid 2007) before Lionel begins to emerge from bankruptcy. At the very least, and this is an optimistic possibility, in my opinion, it will take at least another nine months from the present time.

Lastly, as part of its motion rational for the extension, Lionel's attorneys have argued it has made substantial progress to date in their reorganization efforts to emerge from bankruptcy. Specifically, they cite that 1) in September 2004, Jerry Calabrese was hired as president and CEO and Mark Erickson as VP of Marketing and Business Development after terminating their prior CEO, 2) entered into licensing agreements with NASCAR and the New York City MTA, 3) they entered into a licensing and  marketing agreement with their principal manufacturer Sanda Kan to use the K-Line name and assets, and sell products under that name, 4) entered into a joint venture agreement with Creative Trains Company for the development TMCC II (which will be demonstrated publicly for the first time next week at the LCCA convention in Denver, Colorado, and 5) have began to rebuild their customer base by selling trains in more mainstream retail stores, instead of only through the hobby store route.  The bankruptcy court should be well aware of at least the agreements with Sanda Kan and Creative Trains, since it specifically approved them earlier this year. Moreover, Lionel's attorneys have stated its finances have improved, with earnings before interest, taxes, depreciation and amortization (EBITDA) of approximately $10.2 million (before restructuring costs) on sales of $56.6 million for the fiscal year ending December 31, 2005. By contrast, for the fiscal year ending December 31, 2004, EBITDA was only approximately $7.2 million on sales of $52.3 million. Furthermore, orders for the week ending July 2, 2006 were approximately $54.2 million to date, compared to $46.6 million for the same period last year.

I will continue keep all updated as necessary.