**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

 

**Form 10-Q**

 

**(Mark One)**

**x                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period endedMarch 31, 2006**

 

**or**

 

**o                               TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the transition periodfrom                    to                    .**

 

**Commission File Number: 000-30700**

 

**Crown Media Holdings, Inc.**

(Exact Name of Registrant as Specified in ItsCharter)

 

| **Delaware**                    | **84-1524410**      |
|---------------------------------|---------------------|
| (State or Other Jurisdiction of | (I.R.S. Employer    |
| Incorporation or Organization)  | Identification No.) |

 

**12700 Ventura Boulevard,**

**Suite 200**

**Studio City, California 91604**

(Address of Principal Executive Offices and ZipCode)

 

**(818) 755-2400**

(Registrant’s Telephone Number, Including AreaCode)

 

(Former Name, Former Address, and Former FiscalYear,

if Changed Since Last Report.)

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirements forthe past 90 days.  Yes  x      No  o

 

Indicate by check mark whether the registrant is a largeaccelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer  o |   | Accelerated filer  x |   | Non-accelerated filer  o |
|--------------------------------------|--------|--------------------------------|--------|------------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes  o      No  x

 

As of May 3, 2006, the number of shares of Class ACommon Stock, $.01 par value outstanding was 74,117,654, and the number ofshares of Class B Common Stock, $.01 par value, outstanding was 30,670,422.

 

 

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**TABLE OF CONTENTS**

** **
| ** **  | ** **                                                                                                                         | ** ** |
|-------------|------------------------------------------------------------------------------------------------------------------------------------|------------|
| **PART I**  | **Financial  Information**                                                                                                         | ** ** |
|        |                                                                                                                               |       |
| Item 1      | Financial  Statements (Unaudited)                                                                                                  |       |
|        | CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES                                                                                        |       |
|        | Condensed Consolidated Balance Sheets — December 31,  2005 and March 31, 2006 (Unaudited)                                     |       |
|        | Condensed Consolidated Statements of Operations and  Comprehensive Loss (Unaudited)   - Three Months Ended March 31, 2005 and 2006 |       |
|        | Condensed Consolidated Statements of Cash Flows  (Unaudited)   - Three Months Ended March 31, 2005 and 2006                        |       |
|        | Notes to Unaudited Condensed Consolidated Financial  Statements                                                                    |       |
|        |                                                                                                                               |       |
| Item 2      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                        |       |
|        |                                                                                                                               |       |
| Item 3      | Quantitative  and Qualitative Disclosures About Market Risk                                                                        |       |
|        |                                                                                                                               |       |
| Item 4      | Controls and  Procedures                                                                                                           |       |
|        |                                                                                                                               |       |
| **PART II** | **Other  Information**                                                                                                             | ** ** |
|        |                                                                                                                               |       |
| Item  1A    | Risk  Factors                                                                                                                      |       |
|        |                                                                                                                               |       |
| Item  5     | Other  Information                                                                                                                 |       |
|        |                                                                                                                               |       |
| Item 6      | Exhibits                                                                                                                           |       |
|        |                                                                                                                               |       |
| Signatures  |                                                                                                                               |       |

 

 

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*In this Form 10-Q the terms “CrownMedia Holdings” or the “Company,” refer to Crown Media Holdings, Inc.  and, unless the context requires otherwise,subsidiaries of Crown Media Holdings that operate or have operated ourbusinesses, Crown Media United States, LLC (“Crown Media United States”), CrownMedia Distribution, LLC (“Crown Media Distribution”), and, until completion ofthe sale of our international business in April 2005, Crown MediaInternational, LLC (“Crown Media International”) and Crown EntertainmentLimited (“Crown Entertainment”). The term “common stock” refers to our Class Acommon stock and Class B common stock, unless the context requires otherwise.*

 

*The names Hallmark and other product or service namesare trademarks or registered trademarks of their owners.*

 

**PART I. FINANCIAL INFORMATION**

 

**Item 1.  *FinancialStatements (Unaudited)***

 

 

**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED BALANCE SHEETS**

**(In thousands, except par valueand number of shares)**

** **
| ** **                                                                                          | ** ** | **As of**        | ** ** | **As of**     | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------|------------|---------------|------------|
| ** **                                                                                          | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
| ** **                                                                                          | ** ** | **2005**         | ** ** | **2006**      | ** ** |
|                                                                                                |       |             |       |          |       |
| ASSETS                                                                                              |       |             |       |          |       |
|                                                                                                |       |             |       |          |       |
| Cash and cash equivalents                                                                           |       | $                | 15,926     |          | $          | 6,510 |   |
| Accounts receivable, less allowance for  doubtful accounts of $1,565 and  $2,481, respectively |       | 65,935           |       | 59,444        |       |
| Program license fees — affiliates                                                              |       | 2,656            |       | 8,237         |       |
| Program license fees — non-affiliates                                                          |       | 106,542          |       | 104,925       |       |
| Receivable from RHI Entertainment                                                                   |       | 1,815            |       | 7             |       |
| Receivable from buyer of international business                                                     |       | 422              |       | 117           |       |
| Prepaid and other assets                                                                            |       | 6,051            |       | 5,324         |       |
| Prepaid program license fee assets                                                                  |       | 30,377           |       | 23,908        |       |
| Total current assets                                                                                |       | 229,724          |       | 208,472       |       |
|                                                                                                |       |             |       |          |       |
| Accounts receivable                                                                                 |       | 9,101            |       | 7,270         |       |
| Program license fees — affiliates                                                              |       | 5,036            |       | 11,545        |       |
| Program license fees — non-affiliates                                                          |       | 222,861          |       | 213,580       |       |
| Film assets, net                                                                                    |       | 380,322          |       | 372,092       |       |
| Subscriber acquisition fees, net                                                                    |       | 80,594           |       | 71,060        |       |
| Property and equipment, net                                                                         |       | 18,560           |       | 17,780        |       |
| Goodwill                                                                                            |       | 314,033          |       | 314,033       |       |
| Prepaid and other assets                                                                            |       | 13,595           |       | 12,933        |       |
| Total assets                                                                                        |       | $                | 1,273,826  |          | $          | 1,228,765 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

** **

**3**

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** **

**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED BALANCE SHEETS**

**(In thousands, except par valueand number of shares)**

**(continued)**

 
| ** **                                                                                                                                                        | ** ** | **As of**        | ** ** | **As of**     | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|---------------|------------|
| ** **                                                                                                                                                        | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
| ** **                                                                                                                                                        | ** ** | **2005**         | ** ** | **2006**      | ** ** |
|                                                                                                                                                              |       |             |       |          |       |
| LIABILITIES  AND STOCKHOLDERS’ DEFICIT                                                                                                                       |       |             |       |          |       |
|                                                                                                                                                              |       |             |       |          |       |
| LIABILITIES:                                                                                                                                                      |       |             |       |          |       |
| Accounts payable and accrued liabilities                                                                                                                          |       | $                | 29,876     |          | $          | 21,240 |   |
| Accrued restricted stock units                                                                                                                                    |       | 9,299            |       | 4,966         |       |
| Subscriber acquisition fees payable                                                                                                                               |       | 12,238           |       | 4,184         |       |
| License fees payable to affiliates                                                                                                                                |       | 2,730            |       | 11,461        |       |
| License fees payable to non-affiliates                                                                                                                            |       | 50,460           |       | 51,174        |       |
| Payables to affiliates                                                                                                                                            |       | 12,071           |       | 12,315        |       |
| Payables to RHI Entertainment                                                                                                                                     |       | 755              |       | —        |       |
| Payable to buyer of international business                                                                                                                        |       | 10,050           |       | 6,730         |       |
| Interest payable                                                                                                                                                  |       | 169              |       | 222           |       |
| Capital lease obligation                                                                                                                                          |       | 612              |       | 627           |       |
| Deferred revenue                                                                                                                                                  |       | 1,149            |       | 1,636         |       |
| Deferred credit from technical services  agreement                                                                                                                |       | 1,323            |       | 1,323         |       |
| Total current liabilities                                                                                                                                         |       | 130,732          |       | 115,878       |       |
|                                                                                                                                                              |       |             |       |          |       |
| Accrued liabilities                                                                                                                                               |       | 24,427           |       | 25,678        |       |
| License fees payable to affiliates                                                                                                                                |       | 586              |       | 475           |       |
| License fees payable to non-affiliates                                                                                                                            |       | 186,268          |       | 171,094       |       |
| Line of credit and interest payable to HC Crown                                                                                                                   |       | 86,309           |       | 87,954        |       |
| Note and interest payable to Hallmark Cards  affiliate                                                                                                            |       | —           |       | 70,576        |       |
| Payable to Hallmark Cards affiliates                                                                                                                              |       | 70,000           |       | —        |       |
| Payable to buyer of international business                                                                                                                        |       | 8,395            |       | 7,531         |       |
| Senior unsecured note to HC Crown, including  accrued interest                                                                                                    |       | 509,386          |       | 521,601       |       |
| Credit facility                                                                                                                                                   |       | 210,000          |       | 220,000       |       |
| Note and interest payable to Hallmark Cards  affiliate                                                                                                            |       | 135,187          |       | 137,691       |       |
| Capital lease obligation                                                                                                                                          |       | 16,170           |       | 16,008        |       |
| Company obligated mandatorily redeemable  preferred interest                                                                                                 |       | 14,537           |       | 15,023        |       |
| Deferred credit from technical services  agreement                                                                                                                |       | 5,018            |       | 4,534         |       |
| Total liabilities                                                                                                                                                 |       | 1,397,015        |       | 1,394,043     |       |
| Commitments and contingencies                                                                                                                                     |       |             |       |          |       |
| STOCKHOLDERS’ DEFICIT:                                                                                                                                       |       |             |       |          |       |
| Class A common stock, $.01 par value; 200,000,000  shares authorized; 74,117,654 shares issued and outstanding as of December  31, 2005, and March 31, 2006       |       | 741              |       | 741           |       |
| Class B common stock, $.01 par value;  120,000,000 shares authorized;  30,670,422 shares issued and outstanding as of December 31, 2005, and March  31, 2006 |       | 307              |       | 307           |       |
| Additional paid-in capital                                                                                                                                        |       | 1,423,815        |       | 1,428,936     |       |
| Accumulated deficit                                                                                                                                               |       | (1,548,052       | )          | (1,595,262    | )          |
| Total stockholders’ deficit                                                                                                                                  |       | (123,189         | )          | (165,278      | )          |
| Total liabilities and stockholders’ deficit                                                                                                                  |       | $                | 1,273,826  |          | $          | 1,228,765 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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**CROWN MEDIAHOLDINGS, INC. AND SUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS**

**(In thousands, except per sharedata)**

** **
| ** **                                                                                                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                      | ** ** | **2005**                         | ** ** | **2006** | ** ** |
| ** **                                                                                                                      | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Revenue:                                                                                                                        |       |                             |       |   |   |
| Subscriber fees                                                                                                                 |       | $                                | 4,610      |   | $ | 6,232 |   |
| Advertising                                                                                                                     |       | 33,333                           |       | 37,913 |   |
| Advertising by Hallmark Cards                                                                                                   |       | 543                              |       | 480 |   |
| Film asset license fees                                                                                                         |       | 2,083                            |       | 270 |   |
| Sublicense fees and other revenue                                                                                               |       | —                           |       | 78 |   |
| Total revenue, net                                                                                                              |       | 40,569                           |       | 44,973 |   |
| Cost of Services:                                                                                                               |       |                             |       |   |   |
| Programming costs:                                                                                                              |       |                             |       |   |   |
| Affiliates                                                                                                                      |       | 2,915                            |       | 2,656 |   |
| Non-affiliates                                                                                                                  |       | 25,107                           |       | 30,937 |   |
| Amortization of film assets                                                                                                     |       | 5,681                            |       | 8,864 |   |
| Subscriber acquisition fee amortization expense                                                                                 |       | 9,508                            |       | 7,790 |   |
| Amortization of capital lease                                                                                                   |       | 289                              |       | 289 |   |
| Other cost of services                                                                                                          |       | 1,507                            |       | 3,841 |   |
| Total cost of services                                                                                                          |       | 45,007                           |       | 54,377 |   |
| Selling, general and administrative expense                                                                                     |       | 12,152                           |       | 9,030 |   |
| Marketing expense                                                                                                               |       | 9,830                            |       | 4,257 |   |
| Depreciation and amortization expense                                                                                           |       | 1,350                            |       | 879 |   |
| Loss from continuing operations before interest expense                                                                    |       | (27,770                          | )          | (23,570 | ) |
| Interest expense                                                                                                                |       | (16,896                          | )          | (21,703 | ) |
| Loss before discontinued operations and cumulative effect of change in accounting  principle                               |       | (44,666                          | )          | (45,273 | ) |
| Loss from discontinued operations, net of tax                                                                                   |       | (6,241                           | )          | — |   |
| Gain from sale of discontinued operations, net  of tax                                                                          |       | —                           |       | 162 |   |
| Loss before cumulative effect of change in accounting principle                                                            |       | (50,907                          | )          | (45,111 | ) |
| Cumulative effect of change in accounting  principle                                                                            |       | —                           |       | (2,099 | ) |
| Net loss                                                                                                                        |       | $                                | (50,907    | ) | $ | (47,210 | ) |
| Other comprehensive income (loss):                                                                                              |       |                             |       |   |   |
| Foreign currency translation adjustment                                                                                         |       | (495                             | )          | — |   |
| Comprehensive loss                                                                                                              |       | $                                | (51,402    | ) | $ | (47,210 | ) |
| Weighted average number of Class A and Class B  shares outstanding, basic and diluted                                      |       | 104,533                          |       | 104,788 |   |
| Loss per share before discontinued operations  and cumulative effect of  change in accounting principle, basic and diluted |       | (0.43                            | )          | (0.43 | ) |
| Loss per share from discontinued operations,  basic and diluted                                                                 |       | (0.06                            | )          | (0.00 | ) |
| Cumulative effect of change in accounting  principle, basic and  diluted                                                   |       | (0.00                            | )          | (0.02 | ) |
| Net loss per share, basic and diluted                                                                                           |       | $                                | (0.49      | ) | $ | (0.45 | ) |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

5

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**CROWN MEDIAHOLDINGS, INC. AND SUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

** **
| ** **                                                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                      | ** ** | **2005**                         | ** ** | **2006** | ** ** |
|                                                                            |       |                             |       |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                           |       |                             |       |   |   |
| Net loss                                                                        |       | $                                | (50,907    | ) | $ | (47,210 | ) |
| Adjustments to reconcile net loss to net cash  used in operating activities:    |       |                             |       |   |   |
| Loss from discontinued operations                                               |       | 6,241                            |       | — |   |
| Gain on sale from discontinued operations                                       |       | —                           |       | (162 | ) |
| Depreciation and amortization                                                   |       | 48,511                           |       | 53,355 |   |
| Accretion on company obligated mandatorily  redeemable preferred  interest |       | 679                              |       | 487 |   |
| Provision for allowance for doubtful accounts  (recoveries)                     |       | (946                             | )          | 916 |   |
| Cumulative effect of change in accounting  principle                            |       | —                           |       | 2,099 |   |
| Stock-based compensation                                                        |       | 2,412                            |       | (1,907 | ) |
| Changes in operating assets and liabilities:                                    |       |                             |       |   |   |
| (Increase) decrease in accounts receivable                                      |       | (470                             | )          | 7,406 |   |
| Increase in receivable from buyer of  international business                    |       | —                           |       | 305 |   |
| Additions to program license fees                                               |       | (66,003                          | )          | (35,399 | ) |
| Additions to subscriber acquisition fees                                        |       | (1,493                           | )          | (421 | ) |
| (Increase) decrease in prepaid and other assets                                 |       | 1,148                            |       | 7,196 |   |
| Increase (decrease) in accounts payable and  accrued liabilities.               |       | 32,725                           |       | (24,901 | ) |
| Increase in interest payable                                                    |       | 12,755                           |       | 16,580 |   |
| Increase (decrease) in subscriber acquisition  fees payable                     |       | (2,435                           | )          | (8,054 | ) |
| Increase in license fees payable to affiliates                                  |       | 4,358                            |       | 8,620 |   |
| Increase (decrease) in payables to affiliates                                   |       | 204                              |       | 243 |   |
| Increase (decrease) in deferred revenue                                         |       | 362                              |       | 487 |   |
| Net cash used in continuing operating  activities                               |       | (12,859                          | )          | (20,360 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                           |       |                             |       |   |   |
| Purchases of property and equipment                                             |       | (248                             | )          | (3 | ) |
| Payments to buyer of international business                                     |       | —                           |       | (4,019 | ) |
| Net cash used in investing activities                                           |       | (248                             | )          | (4,022 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                           |       |                             |       |   |   |
| Proceeds from the issuance of common stock upon  exercise of stock options |       | —                           |       | 114 |   |
| Proceeds from tax sharing agreement with  Hallmark Cards                        |       | 21,400                           |       | 5,000 |   |
| Borrowings under the credit facility                                            |       | —                           |       | 10,000 |   |
| Principal payments under capital lease  obligations                             |       | (157                             | )          | (148 | ) |
| Net cash provided by financing activities                                       |       | 21,243                           |       | 14,966 |   |
| CASH FLOWS FROM DISCONTINUED OPERATIONS (Revised — See Note 2):       |       |                             |       |   |   |
| Net cash used in discontinued operating  activities                             |       | (4,999                           | )          | — |   |
| Net cash used in discontinued investing  activities                             |       | 51                               |       | — |   |
| Net cash used in discontinued financing activities                              |       | (411                             | )          | — |   |
| Effect of exchange rate changes on cash                                         |       | (133                             | )          | — |   |
| Net cash used in discontinued operations                                        |       | (5,492                           | )          | — |   |
| Net increase in cash and cash equivalents                                       |       | 2,644                            |       | (9,416 | ) |
| Cash and cash equivalents, beginning of period                                  |       | 12,102                           |       | 15,926 |   |
| Cash and cash equivalents, end of period                                        |       | $                                | 14,746     |   | $ | 6,510 |   |
| Supplemental disclosure of cash and non-cash  activities:                       |       |                             |       |   |   |
| Interest paid                                                                   |       | $                                | 4,961      |   | $ | 4,288 |   |
| Income taxes paid                                                               |       | $                                | 493        |   | $ | 3 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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**CROWN MEDIAHOLDINGS, INC. AND SUBSIDIARIES**

**NOTES TOUNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**For the Three Months Ended March31, 2005 and 2006**

 

 

**1. Business and Organization**

 

***Organization***

 

Crown Media Holdings, Inc. (“Crown Media Holdings,” “CrownMedia” or the “Company”), through its subsidiaries, owns and operates paytelevision channels (collectively the “Hallmark Channel” or the “channel”)dedicated to high quality, entertainment programming for adults and families,in the United States. The Hallmark Channel is operated and distributed by CrownMedia United States, LLC (“Crown Media United States”). Significant investorsin Crown Media Holdings include Hallmark Entertainment Investments Co. (“HallmarkEntertainment Investments”), a subsidiary of Hallmark Cards, Incorporated (“HallmarkCards”), the National Interfaith Cable Coalition, Inc. (“NICC”), and,indirectly through their investments in Hallmark Entertainment Investments,Liberty Media Corporation (“Liberty Media”) and J.P. Morgan Partners (BHCA), L.P. (“J.P. Morgan”).

 

***Sale of the InternationalBusiness***

 

In April 2005, the Company completed the sale of  itsinternational business to a group of investors comprised of Equity Partners, 3iand U.K. executive David Elstein (collectively, “Sparrowhawk,” the “buyer” orthe “buyer of  international business”). The sale included theinternational versions of the Hallmark Channel distributed outside the UnitedStates, the international rights to over 580 titles in the Crown Media filmlibrary, and the Network Operations Center based in Denver, Colorado.  TheCompany received cash proceeds of $209.3 million, net of the prepaymentdescribed below, and recognized an accounting loss of $6.5 million from thesale. Approximately $4.7 million of transaction costs were incurred by theCompany in connection with the sale.

Subsequentto the sale, the Company has no continuing economic involvement with theoperations of the international business.

 

***Strategic Alternatives for the Company***

 

TheCompany announced on August 18, 2005, that its Board of Directors hadauthorized the Company to explore strategic alternatives for the Company,including a potential sale of the Company to a third party.  In support ofthis initiative, a Special Committee of independent directors of the Board ofDirectors was overseeing the process.

 

OnApril 17, 2006, the Company announced that after extensive review of strategicalternatives the Board of Directors has decided to terminate this process andfully commit the Company’s resources to continuing to operate its channels andother programming services.   The Companywill continue to explore ways in which it can improve its capital structure.

 

***Liquidity***

 

As of March 31, 2006, theCompany had $6.5 million in cash and cash equivalents on hand. As of March 31,2006, the Company had borrowed $220.0 million from a $240.0 million revolvingbank credit, which matures May 31, 2007.

 

The Company’s principalsources of funds are currently available cash on hand, cash generated byoperations, tax sharing payments from Hallmark Cards and amounts availableunder the Company’s revolving bank credit facility. Payments under the taxsharing agreement are affected by Hallmark Cards’ tax position and its abilityto utilize the Company’s tax losses.  TheCompany received $5.0 million in tax sharing payments in January 2006 and doesnot currently expect to receive any additional cash payments during 2006. TheCompany currently has $20.0 million of 

 

7

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unused revolving creditcommitments.

 

The ability of theexisting sources of liquidity to be sufficient to fund the Company’soperations, depend upon the Company’s ability to achieve forecasts.  In particular, continued growth in subscriberrevenue and advertising revenue, as well as maintaining the cash flow fromlibrary sales, are required.  As aresult, any decline in the popularity of the Hallmark Channel, any significantfuture modifications to the Company’s distribution agreements, an economicdecline in the advertising market, an increase in program acquisition costs, anincrease in competition or other adverse operating conditions would impact theCompany’s liquidity and its ability to fund the current level ofoperations.  To the extent that the Companyrequires additional capital and additional drawings on the bank credit facilityare either not available or insufficient, the Company would be forced to seekadditional funding from the issuance of debt or equity securities, a sale ofcertain assets or from strategic transactions which provide capital. There canbe no assurance that the Company would be able to secure additional financingor complete any such transactions.

 

The Company expects tocontinue making investments in programming, marketing and distribution duringthe next twelve months ending March 31, 2007. However, the Company’s liquidityposition has demanded that all areas of expenses, including programming,marketing and distribution be closely monitored and controlled.  In April, 2006, the Company commenced a costreduction program, including reducing the number of personnel and marketingactivities.  Management anticipates thatthese actions will result in approximately $10.0 to $13.0 million in annualcost reductions when compared to the 2005 year. The Company will also seek to sublicense certain of its programmingrights but expects that programming expenses and cost of services will increasewhen compared to these items for 2005.

 

The Company’s principal usesof funds for 2006 are expected to include the payment of 2005 and 2006operating expenses, accounts payable and accrued expenses, licensing ofprogramming, and interest under its bank credit facility.

 

The Company currentlybelieves that cash on hand, cash generated by operations, and availability onits bank credit facility, will be sufficient to fund the Company’s operationsand meet its liquidity needs through March 31, 2007.

 

The Company’s bank creditfacility will expire on May 31, 2007.   If the Company is not able toarrange for the extension, refinancing or replacement of the bank creditfacility prior to its maturity and the bank draws down on the irrevocableletter of credit provided by Hallmark Cards in support of the bank creditfacility, or alternatively Hallmark Cards purchases the interests of thelending banks, Hallmark Cards would have all obligations and the rights of thelending banks under the bank credit facility.  In that event, HallmarkCards could demand payment of outstanding amounts at any time.  If the Companyhas not retired the bank credit facility prior to its maturity, it is theCompany’s intent to extend the bank credit facility upon its maturity, whichmight require continuation of a letter of credit from Hallmark Cards or othersteps by the Company.

 

Upon maturity of the creditfacility on May 31, 2007, the lending group led by JP Morgan Chase has theright to elect to forego the receipt of cash to pay the principal amount of thecredit facility in full, which is provided for under the terms of an irrevocableletter of credit provided by Hallmark Cards, but instead can elect to initiate a process to foreclose onthe Company’s assets. Such foreclosure proceedings, which we view as aremote possibility, would affect our ability to continue our operations. Priorto any such possible foreclosure proceedings, however, the Company wouldconsider various alternatives as indicated below.  In the alternative, the Company has the rightto cause Hallmark Cards, pursuant to the terms of the waiver and standby purchaseagreement (“Waiver Agreement”) described below, to exercise its option topurchase all of the outstanding indebtedness under the credit facility and thecredit facility would then be subject to terms of the Waiver Agreement not todemand payment prior to May 31, 2007.

 

Due to the Company’sliquidity issues and its possible inability to meet its obligations when theycome due in May 2007 under the Waiver Agreement described below, the Companyanticipates that prior to May 31, 2007, it will be necessary to either extendor refinance (i) the bank credit facility and (ii) $678.0 million covered bythe promissory notes described below payable to affiliates of Hallmark Cards.As part of a combination of actions and in order to obtain additional funding,the Company may consider various alternatives, including refinancing the bank 

 

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credit facility, raisingadditional capital through the issuance of equity or debt securities, a sale ofcertain assets or other strategic alternatives.

 

**2. Summary of Significant Accounting Policies and Estimates**

 

***Interim FinancialStatements***

 

Inthe opinion of management, the accompanying condensed consolidated balancesheets and related interim consolidated statements of operations and cashflows, include all adjustments, consisting of normal recurring items necessaryfor their fair presentation in conformity with accounting principles generallyaccepted in the United States. Interim results are not necessarily indicativeof results for a full year. These consolidated financial statementsshould be read in conjunction with the audited consolidated financialstatements and the notes to those statements for the year ended December 31,2005, including the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2005.

 

***Basis of Presentation***

 

The condensed consolidated financial statements includethe consolidated accounts of Crown Media Holdings, including those of itswholly owned subsidiaries. All significant intercompany balances andtransactions have been eliminated in consolidation.

 

In February 2005, the Company signed a definitiveagreement to complete the sale of its international business and, accordingly,classified the operating results of the international business as discontinuedoperations in the accompanying statements of operations for all periodspresented. The Company’s discontinued operations consisted of the internationalchannel operations and the international rights to the film library assets. TheCompany closed such sale in April 2005.

 

***Use of Estimates***

 

TheCompany’s condensed consolidated financial statements are prepared inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”). These accounting principles require the Company to makecertain estimates, judgments and assumptions. The Company believes that theestimates, judgments and assumptions made when accounting for items and matterssuch as customer retention patterns, allowance for bad debts, useful lives ofassets, ultimate revenue used in the film asset amortization calculations, cashflow projections used in various asset valuations, income taxes, reserves andother provisions for contingencies are reasonable, based on informationavailable at the time they are made. These estimates, judgments and assumptionscan affect the reported amounts of assets and liabilities as of the date of theconsolidated financial statements, as well as the reported amounts of revenueand expenses during the periods presented. Actual results could differ fromthese estimates.

 

***Film Assets and Film Library Impairment***

 

The Company amortizes itsfilm assets using the individual-film-forecast-computation method over amaximum period of 9.25 years from the date of acquisition. The individual-film-forecast-computationmethod amortizes such assets in the same ratio that current period actualrevenue bears to estimated ultimate future revenues.

On a quarterly basis, theCompany assesses whether events or circumstances have changed indicating thatthe fair value of a film is lower than its unamortized cost or carrying value.If the carrying value of any individual film asset exceeds its fair value, thefilm asset is written-down to its estimated fair value. A discounted cash flowmodel, based on management’s anticipated ultimate future revenue of the film,is used to estimate the fair value of the individual films. The Companyconsiders the following factors, among others, in estimating ultimate futurerevenue for each film:  (*a*) the operating environment expected for the next severalyears, (*b*) the size of thelibrary as a whole, (*c*)historical license fee revenue per film, (*d*)each title’s age, quality, and marketability, (*e*)existing sales plans including the amount of product desired to be sold eachyear, (f) future performance estimates, (g) assumptions and estimatesunderlying past and future estimates, and (h) risk factors that could effectfuture 

 

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operations of theLibrary.  In estimating a film’s fair value, the Company considers thosecash outflows necessary to generate the film’s cash inflows such asexploitation, residual and participation costs and taxes.  The discountrate used in the Company’s discounted cash flow model is based upon management’sestimate of the rate a purchaser would require related to the risks anduncertainties surrounding the timing and probability of the cash flowestimates.

 

TheCompany reviews its estimates of ultimate future revenues and participation costsas of each reporting date to reflect currently available information. Estimatedultimate future revenues are based on the history of each film and similarfilms, sales and marketing plans, and other factors, all of which requiresignificant judgment and estimation by management. Differences betweenamortization expense determined using the new estimates and any amountspreviously expensed during that current fiscal year are charged or credited tothe statement of operations in the period in which the estimates are revised.

 

Foruse of the film assets on the Hallmark Channel and the Hallmark Movie Channel,the Company estimates the fair value of the internal usage based upon theportion of the film’s ultimate revenues attributable to the term of the licensewindow. The Company first calculates the amount of cost attributable to theinternal use using the individual-film-forecast-computation method describedabove and then expenses such amounts ratably over the term of the licensewindow.

 

***Cash and Cash Equivalents***

 

Cashand cash equivalents include highly liquid investments with original maturitiesof three months or less that are readily convertible into cash and are notsubject to significant risk from fluctuations in interest rates. As a result,the carrying amount of cash and cash equivalents approximates fair value.

 

***Allowance for Doubtful Accounts***

 

The allowance for doubtful accounts is based upon theCompany’s assessment of probable loss related to uncollectible accountsreceivable.  The Company’s bad debtrecovery was $946,000 for the three months ended March 31, 2005. The Company’sbad debt expense was $916,000 for the three months ended March 31, 2006.

 

***Program License Fees***

 

Program license fees are paid in connection with theacquisition of the rights to air programs acquired from others. Program rightsare generally deferred and then amortized on a straight-line basis over theircontractual license periods or anticipated usage. Crown Media Holdingsperiodically evaluates the realizability of these deferred license fees inrelation to the estimated future revenues.

 

Estimates of net realizable value for program licensefees are determined using future estimated advertising revenues and anticipatedpatterns of programming usage on a day part basis as it pertains to programminglicensed to the channel. These estimates of expected annual future estimatedrevenues are compared to net book value of the program license fee assets todetermine if the programming assets are expected to be recovered. Where theanalysis indicates the costs are in excess of the estimated net realizablevalue, an impairment is recognized.

 

***Subscriber Acquisition Fees***

 

Subscriberacquisition fees are generally required to be paid to obtain carriage ondomestic pay distributors systems. Under certain of these agreements with paydistributors, Crown Media United States is obligated to pay subscriberacquisition fees if defined subscriber levels are met or in order to obtainadditional carriage of the Hallmark Channel by those pay distributors. Such costs areaccrued when Crown Media United States receives notice from the distributorsthat they have met the contractual penetration percentage or subscriber count.

 

Subscriber acquisition fees are amortized over thecontractual life of the distribution agreements (ranging from 4 to 9 years) as a reduction of subscriber fee revenue. If theamortization expense exceeds the cumulative subscriber fee revenue recognized,or to be recognized, on a per distributor basis, the excess amortization isincluded as a 

 

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component of cost ofservices. Crown Media Holdings assesses the recoverability of these costsperiodically by comparing the net carrying amount to the estimates of futuresubscriber fee and advertising revenues. It also assesses the recoverabilitywhen events such as changes in distributor relationships occur or otherindicators suggest impairment.

 

***Property and Equipment***

 

Property and equipment are stated at historical cost.Equipment under capital leases are initially recorded at the present value ofthe minimum lease payments.

 

Depreciation on equipment is calculated using thestraight-line method over the estimated useful lives of the assets. Equipmentheld under capital leases and leasehold improvements are amortizedstraight-line over the shorter of the lease term or estimated useful life ofthe asset.

 

When property and equipment is sold or otherwisedisposed of, the cost and related accumulated depreciation or amortization areremoved from the accounts and any resulting gain or loss is included in income.The costs of normal maintenance and repairs are charged to expense whenincurred.

 

***Long-Lived Assets***

 

TheCompany reviews long-lived assets, other than goodwill and other intangibleassets with indefinite lives, for impairment whenever facts and circumstancesindicate that the carrying amounts of the assets may not be recoverable. Animpairment loss is recognized if the carrying amount of the asset is notrecoverable and exceeds its fair value. Recoverability of assets to be held andused is measured by comparing the carrying amount of an asset to the estimatedundiscounted future net cash flows expected to be generated by the asset. Ifthe asset’s carrying value is not recoverable, an impairment charge isrecognized for the amount by which the carrying amount of the asset exceeds itsfair value. The Company determines fair values by using a combination ofcomparable market values and discounted cash flows, as appropriate.

 

Goodwillis reviewed for impairment annually on November 30 or whenever an event occursor circumstances change that indicates fair value might be below carryingvalue. Goodwill is carried at historical cost if the estimated fair value isgreater than the carrying amounts. However, if estimated fair value is lessthan the carrying amount, goodwill is reduced to estimated fair value throughan impairment charge to the Company’s consolidated statements of operations.

 

***Revenue Recognition***

 

Subscriberrevenue from pay television distributors is recognized as revenue when anagreement is executed, programming is provided, the price is determinable, andcollectibility is reasonably assured. Subscriber fees from pay televisiondistributors are recorded net of amortization of subscriber acquisition costsin accordance with Emerging Issues Task Force No. 01-9 (“EITF No. 01-9”) , *Accounting for Consideration Given by a Vendor to a Customer (Includinga Reseller of the Vendor’s Products)*. If the amortization expenseexceeds the revenue recognized on a per distributor basis, the excessamortization is included as a component of cost of services.

 

Advertisingrevenues are recognized as earned in the period in which the advertising istelecast. Revenue is recognized as commercial spots or long form programmingare aired and as ratings guarantees to advertisers are achieved. Advertisingrevenues are recorded net of agency commissions. Agency commissions arecalculated based on a stated percentage applied to gross billing revenue for theCompany’s broadcasting operations. Customers remit the gross billing amount tothe agency and the agency remits gross billings less their commission to theCompany. Payments received in advance of being earned are recorded as deferredrevenue.

 

Revenue from film asset licensing agreements isrecognized in accordance with Statement of Position (“SOP”) 00-02,*Accounting by Producers or Distributors of Films*.Revenues are recognized when all of the following have occurred:  an agreement is executed, the film isavailable for exhibition by the licensee, the license fee is fixed ordeterminable, collectibility is reasonably assured and the cost of each film isknown or reasonably determinable. 

 

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Revenue from film assetlicensing agreements containing multiple film titles is allocated among thevarious film titles based on their relative estimated fair values. Paymentsreceived from licensees prior to the availability of a film are recorded asdeferred revenue. Fees payable with terms in excess of one year are discountedfor revenue recognition purposes at the customer’s estimated incrementalborrowing rate in accordance with Accounting Principles Board (“APB”) OpinionNo. 21, *Interest on Receivables and Payables.*

 

***Taxes on Income***

 

Pursuant to the tax sharing agreement entered into withHallmark Cards in March 2003, the Company’s results of operations for taxpurposes became a part of the Hallmark Cards consolidated federal tax return asof and subsequent to March 2003. However, the Company continues to account for income taxes on a separatereturn basis. Accordingly, the Company accounts for income taxes using an assetand liability method which requires the recognition of deferred tax assets andliabilities for the expected future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases and net operating loss and taxcredit carryforwards. Deferred tax assets and liabilities are measured usingenacted tax rates expected to be applied to taxable income in the years inwhich those temporary differences are expected to be recovered or settled. TheCompany reduces deferred tax assets by a valuation allowance if it is morelikely than not that some portion or all of the deferred tax assets will not berealized. Any payments received from Hallmark Cards underthe tax sharing agreement are recorded as an increase in additional paid-incapital and any future utilization of deferred tax assets generated after March2003 will be recorded as a reduction in paid-in capital, to the extent paymentswere previously received from Hallmark Cards for such benefits under the taxsharing agreement.

 

***Stock-Based Compensation***

 

Duringthe first quarter of fiscal 2006, we adopted the provisions of, and account forstock-based compensation in accordance with, the Financial Accounting StandardsBoard’s (“FASB”) Statement of Financial Accounting StandardsNo. 123—revised 2004 (“SFAS 123R”), “*Share-Based Payment*”which replaced` Statement of Financial Accounting Standards No. 123 (“SFAS123”), “*Accounting for Stock-Based Compensation*”and supersedes APB Opinion No. 25 (“APB 25”), “*Accountingfor Stock Issued to Employees*.” Under the fair value recognitionprovisions of this statement, stock-based compensation cost is measured at thegrant date based on the fair value of the award and is recognized as expense ona straight-line basis over the period during which the holder is required toprovide services in exchange for the award, i.e., usually the vesting period.We elected the modified-prospective method, under which prior periods are notrevised for comparative purposes. The valuation provisions of SFAS 123R applyto new grants and to grants that were outstanding as of the effective date andare subsequently modified. Estimated compensation for grants that wereoutstanding as of the effective date will be recognized over the remainingservice period using the compensation cost estimated for the SFAS 123 pro formadisclosures.

 

Inconnection with the adoption of SFAS 123R, we recorded total compensation cost related to RSUs granted under the Plan of $2.1million as a cumulative catch-up adjustment during the three months ended March31, 2006. See Note 12 for further information regarding our stock-basedcompensation assumptions and expenses, including pro forma disclosures forprior periods as if we had recorded stock-based compensation expense.

 

Upon exercise of outstanding stockoptions, we will issue common stock.

***Net Loss per Share***

 

Basic net loss per share is computed by dividing the netloss for the period by the weighted average number of common shares outstandingduring the period. Diluted net loss per share is computed based on the weightedaverage number of common shares and potentially dilutive common sharesoutstanding. The calculation of diluted net loss per share excludes potentialcommon shares if the effect would be antidilutive. Potential common sharesconsist of incremental common shares issuable upon the exercise of stockoptions and restricted stock units. Approximately 1.4 million and 864,000 stockoptions for the three months ended March 31, 2005 and 2006, respectively, havebeen excluded from the calculations of earnings per share because their effectwould have been antidilutive.

 

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***Translation of Foreign Currency***

 

Through April 26, 2005, the balance sheets andstatements of operations and comprehensive loss of certain Crown Media Holdings’foreign subsidiaries were measured using local currency as the functionalcurrency. Revenues, expenses and cash flows of such subsidiaries weretranslated into United States dollars at the average exchange rates prevailingduring the period. Assets and liabilities were translated at the rates ofexchange at the balance sheet date. Translation gains and losses were deferredas a component of accumulated other comprehensive income (loss). Foreigncurrency transaction gains and losses recorded upon the remeasurement offinancial assets and liabilities denominated in currencies other than thefunctional currency of the subsidiary were included in determining net loss forthe period.

 

***Concentration of Credit Risk***

 

Financial instruments,which potentially subject Crown Media Holdings to a concentration of creditrisk, consist primarily of cash, restricted cash, cash equivalents and accountsreceivable. Generally, Crown Media Holdings does not require collateral tosecure receivables. Crown Media Holdings has no significant off-balance sheetfinancial instruments with risk of accounting losses.

 

***Reclassifications***

 

Certain reclassifications have been made to conformprior periods’ financial information to the current presentation.

 

***Cash Flows***

 

In 2005, the Company has separately disclosed theoperating, investing and financing portions of the cash flows attributable toits discontinued operations, which in prior periods were reported on a combinedbasis as a single amount.

 

***Recently Issued Accounting Pronouncements***

 

InMay 2005, the FASB issued SFAS No. 154, *AccountingChanges and Error Corrections—Replacement of APB Opinion No. 20 and FASBStatement No. 3* (SFAS 154). SFAS 154 replaces APB OpinionNo. 20, *Accounting Changes,*and FASB Statement No. 3, *ReportingAccounting Changes in Interim Financial Statements,* and changes therequirements for the accounting for and reporting of a change in accountingprinciple. Opinion No. 20 previously required that most voluntary changes inaccounting principle be recognized by including in net income of the period ofthe change the cumulative effect of changing to the new accounting principle.SFAS 154 requires retrospective application to prior periods’ financialstatements of changes in accounting principle. SFAS 154 defines retrospectiveapplication as the application of a different accounting principle to prioraccounting periods as if that principle had always been used or as theadjustment of previously issued financial statements to reflect a change in thereporting entity. SFAS 154 also requires that a change in depreciation,amortization, or depletion method for long-lived, non-financial assets beaccounted for as a change in accounting estimate affected by a change inaccounting principle. We are required to adopt the provisions of SFAS 154 as ofJanuary 1, 2006.

 

SFAS No. 155*, Accounting for Certain Hybrid Financial Instruments — AnAmendment of FASB Statement No. 133 and 140.*  InFebruary 2006, the FASB issued SFAS No. 155, “Accounting for CertainHybrid Financial Instruments — An Amendment of FASB StatementNo. 133 and 140” (“SFAS 155”). SFAS 155 simplifies theaccounting for certain hybrid financial instruments that contain an embeddedderivative that otherwise would have required bifurcation. SFAS 155 alsoeliminates the interim guidance in FASB Statement No. 133, which providesthat beneficial interest in securitized financial assets is not subject to theprovisions of FASB Statement No. 133. SFAS 155 is effective for allfinancial instruments acquired or issued after the beginning of an entity’sfirst fiscal year that begins after September 15, 2006. The Company doesnot believe that the adoption of SFAS 155 will have an effect on itsfinancial statements.

 

 

FASB Staff PositionNo. FAS No. 123(R)-4*,Classification of Options and Similar Instruments Issued as EmployeeCompensation That Allow for Cash Settlement upon the Occurrence of a ContingentEvent.*  In February 

 

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2006, the FASB issuedFASB Staff Position No. FAS 123(R)-4, “Classification of Options andSimilar Instruments Issued as Employee Compensation That Allow for CashSettlement upon the Occurrence of a Contingent Event.” This position amendsSFAS 123R to incorporate that a cash settlement feature that can beexercised only upon the occurrence of a contingent event that is outside theemployee’s control does not meet certain conditions in SFAS 123R until itbecomes probable that the event will occur. The guidance in this FASB StaffPosition shall be applied upon initial adoption of Statement 123R. Thispronouncement currently does not have an impact on the Company’s financialstatements.

 

**3. Subscriber Acquisition Fees**

 

Subscriber acquisition fees are comprised of thefollowing:

 

| ** **                            | ** ** | **As of December 31,** | ** ** | **As of March 31,** | ** ** |
|---------------------------------------|------------|------------------------|------------|---------------------|------------|
| ** **                            | ** ** | **2005**               | ** ** | **2006**            | ** ** |
| ** **                            | ** ** | **(In thousands)**     | ** ** |
| Subscriber  acquisition fees, at cost |       | $                      | 221,594    |                | $          | 193,087 |   |
| Accumulated  amortization             |       | (141,000               | )          | (122,027            | )          |
| Subscriber acquisition fees, net      |       | $                      | 80,594     |                | $          | 71,060 |   |

 

*Of the net balance at March 31,2006, the Company expects $16.8 million will be recognized as a reduction ofsubscriber fee revenue and $54.3 million will be recognized as subscriberacquisition fee expense in future periods.*

* *

*As of December 31, 2005, and March31, 2006, the consolidated balance sheets also reflect subscriber acquisitionfees payable of $12.2 million and $4.2 million, respectively. For the threemonths ended March 31, 2005 and 2006, Crown Media United States made cashpayments of $3.9 million and $8.0 million, respectively.*

 

**4. Program License Fees**

 

Program license fees are comprised of the following:

 

| ** **                                                      | ** ** | **As of December 31,** | ** ** | **As of March 31,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|---------------------|------------|
| ** **                                                      | ** ** | **2005**               | ** ** | **2006**            | ** ** |
| ** **                                                      | ** ** | **(In thousands)**     | ** ** |
| Program license fees — RHI Entertainment Distribution |       | $                      | 164,752    |                | $          | 173,199 |   |
| Program license fees — NICC                                |       | 9,411                  |       | 22,039              |       |
| Program license fees — other affiliates                    |       | 368                    |       | 368                 |       |
| Program license fees — non-affiliates                      |       | 365,429                |       | 364,287             |       |
| Program license fees, at cost                                   |       | 539,960                |       | 559,893             |       |
| Accumulated amortization                                        |       | (202,865               | )          | (221,606            | )          |
| Program license fees, net                                       |       | $                      | 337,095    |                | $          | 338,287 |   |

 

Programmingcosts for the three months ended March 31, 2005 and 2006, were $28.0 millionand $33.6 million, respectively.

 

AtDecember 31, 2005, and March 31, 2006, $30.4 million and $23.9 million ofprogram license fees were included in prepaid program license fee assets on theaccompanying condensed consolidated balance sheets as the Company had madepayments, but the airing windows had not commenced.

 

License fees payable are comprised of the following:

 

| ** **                                                      | ** ** | **As of December 31,** | ** ** | **As of March 31,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|---------------------|------------|
| ** **                                                      | ** ** | **2005**               | ** ** | **2006**            | ** ** |
| ** **                                                      | ** ** | **(In thousands)**     | ** ** |
| License fees payable — RHI Entertainment Distribution |       | $                      | 22,704     |                | $          | 21,906 |   |
| License fees payable — NICC                                |       | 3,315                  |       | 11,936              |       |
| License fees payable — non-affiliates                      |       | 214,025                |       | 200,362             |       |
| Total license fees payable                                      |       | 240,044                |       | 234,204             |       |
| Less current maturities                                         |       | (53,190                | )          | (62,635             | )          |
| Long-term license fees payable                                  |       | $                      | 186,854    |                | $          | 171,569 |   |

 

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**5. Property and Equipment**

 

Property and equipment are comprised of the following:

 
| ** **                        | ** ** | **As of December 31,** | ** ** | **As of March 31,** | ** ** | **Depreciable Life** | ** ** |
|-----------------------------------|------------|------------------------|------------|---------------------|------------|----------------------|------------|
| ** **                        | ** ** | **2005**               | ** ** | **2006**            | ** ** | **(In years)**       | ** ** |
| ** **                        | ** ** | **(In thousands)**     | ** ** | ** **          | ** ** |
| Technical equipment and computers |       | $14,650                |       | $14,660             |       | 3-5                  |       |
| Leased assets                     |       | 17,363                 |       | 17,363              |       | 15                   |       |
| Furniture, fixtures and equipment |       | 1,235                  |       | 1,235               |       | 5                    |       |
| Leasehold improvements            |       | 3,344                  |       | 3,348               |       | 3-7                  |       |
| Construction-in-progress          |       | 18                     |       | 7                   |       |                 |       |
| Property and equipment, at cost   |       | 36,610                 |       | 36,613              |       |                 |       |
| Accumulated depreciation          |       | (18,050                | )          | (18,833             | )          |                 |       |
| Property and equipment, net       |       | $18,560                |       | $17,780             |       |                 |       |

 

Depreciation expense related to property and equipmentwas $900,000 and $783,000 for the three months ended March 31, 2005 and 2006,respectively.

 

Softwareand other intangible assets of $2.0 million and $1.7 million as of December 31,2005, and March 31, 2006, respectively, have been included in prepaid and otherassets in the accompanying condensed consolidated balance sheets.

 

**6. Credit Facility**

 

 The Company has a credit agreement with asyndicate of banks, led by JP Morgan Chase Bank, under which the banks haveextended to the Company a secured revolving credit facility of up to $240.0million, which includes up to $20.0 million of letters of credit. Borrowingsunder the revolving credit facility are no longer contingent upon the approvalof Hallmark Cards, but are contingent upon the approval of the Company’s Boardof Directors.  The Company and thelending banks originally entered into the facility in 2001 and havesubsequently amended the terms of this facility, with the most recent amendmentdated as of April 28, 2006 and executed on May 8, 2006.  The facility is guaranteed by the Company’ssubsidiaries and is secured by all tangible and intangible property of CrownMedia Holdings and its subsidiaries.

 

Each loan underthe bank credit facility bears interest at a Eurodollar rate or an alternatebase rate as the Company may request at the time of borrowing in accordancewith the credit agreement.  TheEurodollar rate is based on the London interbank market for Eurodollars, andremains in effect for the time period of the loan ranging from one, two, three,six or twelve months.  The alternate rateis based upon the prime rate of JP Morgan Chase Bank, a certificate of depositrate or the Federal Funds effective rate, which is adjusted whenever the rateschange.  The Company is required to pay acommitment fee of 0.15% per annum (0.2% from March 1, 2005, to April 27, 2006)of the committed, but not outstanding, amounts under the revolving creditfacility, payable in quarterly installments.

 

AtDecember 31, 2005, and March 31, 2006, Crown Media Holdings had outstandingborrowings of $210.0 million and $220.0 million, respectively, under the creditfacility and there were no letters of credit outstanding. At December 31, 2005,$210.0 million of the outstanding balance bore interest at the Eurodollar rate(5.39% at December 31, 2005). At March 31, 2006, $220.0 million of theoutstanding balance bore interest at the Eurodollar rate (5.82% at March 31,2006). Interest expense on borrowings underthe credit facility for the three months ended March 31, 2005 and 2006, was$3.9 million, and $2.9 million, respectively.

 

***Covenants***

 

Thecredit facility, as amended, contains a number of affirmative and negativecovenants.  The Company’s Annual Reporton Form 10-K contains a detailed description of these covenants.

 

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By an Amendment No. 9 dated as of March 21, 2006, to the agreement forthe bank credit facility, Hallmark Cards has been provided the right, by givingfive business days written notice, to purchase all of the bank lenders’interest in the loans under the bank credit facility for an amount equal to theprincipal plus accrued, unpaid interest and other amounts owing to any of thelending banks.  Under the WaiverAgreement described below, we can cause Hallmark Cards to complete such apurchase.  We view this purchase right asan alternative to the lending banks drawing down on the letter of creditdescribed below.

By an Amendment No. 10, dated as of April 28, 2006, to the creditagreement, the maturity date of the credit facility has been extended to May31, 2007 and the size of the revolving credit facility has been increased from$220.0 million to $240.0 million.  Additionally,the amendment provided for the following: (1) 0.25% reduction in the interest rate in the case ofEurodollar Loans, from 1.0% per annum to 0.75% per annum, (2) 0.05% reductionin the commitment fee from 0.20% per annum to 0.15% per annum and (3) amendmentto the limitation on Restricted Payments to allow us to issue common stock ormake payments pursuant to employees’ restricted stock unit agreements.  Amendment No. 10 also deleted certain eventsof defaults no longer relevant and the following negative covenants: (1)changing the location of the Company’s chief executive office or the Company’sname, (2) making capital expenditures, (3) incurring cash program acquisitionguarantees in excess of a certain amount, (4) using the proceeds of the loansfor any purpose other than set forth in the Credit Agreement, (5) permittingEBITDA (as defined in the Credit Agreement) to be less than specified amountsper quarter and (6) permitting payments to television distributors forsubscribers to be greater than certain amounts.

The Company was incompliance with its debt covenants at March 31, 2006.

**7. Related Party Long-Term Obligations**

 

***Waiver and Standby Purchase Agreement***

 

 Under the Waiver Agreement dated March 21,2006, Hallmark Cards agreed to defer all payments due on any of the followingobligations and, except where noted, payment of interest thereon until May 31,2007 or an earlier date as described below as the waiver termination date,whereupon all of these amounts become immediately due and payable (the “WaiverPeriod”):

•                                          Note, datedDecember 14, 2001, in the original principal amount of $75.0 million, payableto HC Crown. (See *Line of Credit Payable to HC Crown*below.)

•                                          10.25% senior unsecured discount note, dated August 5, 2003, in the initialaccreted value of $400.0 million, payable to HC Crown.  (See *Senior Unsecured Note*below.)

•                                          $70.0 million account payable to HallmarkEntertainment Holdings arising out of the saleto Crown of the Hallmark Entertainment film library. (See *Promissory Note with Hallmark Entertainment Holdings*below.)

•                                          Note, dated as ofOctober 1, 2005, in the principal amount of $132.8 million, payable to Hallmark EntertainmentHoldings. (See *Promissory Note with Hallmark EntertainmentHoldings*below.)

•                                          All obligationsof the Company under the bank credit facility to Hallmark Cards, Incorporatedby virtue of Hallmark Cards’ deemed purchase of participations in all of theobligations under a letter of credit which Hallmark Cards has given in supportof the facility or the purchase by Hallmark Cards of all these obligationspursuant to Amendment No. 9 to the bank credit facility.

Hallmark Cards has agreedthat it will not accelerate the maturity of any of the foregoing obligations orinitiate collection proceedings during the Waiver Period.  Interest will continue to accrue on theseobligations during the Waiver Period. The Company will continue to pay thebanks and/or Hallmark Cards interest on the credit facility during the WaiverPeriod.

 

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The waiver termination date is May 31, 2007 or earlier upon occurrenceof any of the following events:  (a) theCompany fails to pay any principal or interest, regardless of amount, due onany indebtedness with an aggregate principal amount in excess of $5.0 millionor any other event or condition occurs that results in any such indebtednessbecoming due prior to its scheduled maturity, provided that the waiver will notterminate if the Company reduces the principal amount of such indebtedness to$5.0 million or less within five business days of a written notice oftermination from Hallmark Cards; (b) certain bankruptcy events occur; (c) theCompany defaults in its payment of licensing fees under the Second Amended andRestated Program License Agreement with RHI Entertainment Distribution(formerly known as Hallmark Entertainment Distribution); (d) a representationand warranty of the Company in the Waiver Agreement is false or misleading inany material respect; or (e) the Company fails to pay interest on the deferredobligations listed above or to perform any covenants in the Waiver Agreement.

Under the Waiver Agreement, if the bank’s lenders under the bank creditfacility accelerate any of the indebtedness under the bank credit facility orseek to collect any indebtedness under it, then the Company may elect toexercise its right to require that Hallmark Cards or its designated subsidiaryexercise an option to purchase all the outstanding indebtedness under the bankcredit facility as provided in the bank credit facility.  All expenses and fees in connection with thispurchase would be added to the principal amount of the credit facilityobligations.

The Waiver Agreement does not limit any existingrights of Hallmark Cards or its affiliates to offset amounts owed to us underthe Hallmark Tax Sharing Agreement and Hallmark Cards’ share of the amountspayable under the December 1, 2005, agreement with NICC (described in Note 14)against these obligations.  Pursuant tothe Waiver Agreement, the Company must make prepayments on the outstanding debtfrom 100% of any “Excess Cash Flow” during the Waiver Period.   “Excess Cash Flow” is defined as 1) the netproceeds of any debt or equity financings or sale of assets; 2) the net cashproceeds from the incurrence by the Company of indebtedness; 3) the net cashproceeds from the sale, transfer or release by the Company of assets outsidethe ordinary course of business; and 4) if positive, the consolidated net cash flow from operations of Crown Holdings for anycalendar quarter as shown in an SEC report, less cash funds used to pay currentoperating expenses and to pay or establish reasonable reserves for futureexpenses, indebtedness payments, and capital improvements and replacements asdetermined by the Board of Directors of the Company.

Asconsideration for the Waiver Agreement, we converted the $70.0million account payable to Hallmark Entertainment Holdings arising out of our purchase of the HallmarkEntertainment film library to a promissory note bearing interest at LIBORplus 3% per annum.  This note is payable in full on May 31,2007.   We also agreed to:

 

•        amend the 2001 and 2005 notes describedabove to add the accrued but unpaid interest, currently and annually, to theoutstanding principal amounts ;

 

•        use  our  commerciallyreasonable efforts to refinance all of  our  obligations toHallmark Cards and affiliates noted above ;  and

 

•        comply with  our covenants and obligations under the bank credit facility .

 

In addition, we provided  arelease to Hallmark Cards and related parties for any matters prior to the dateof the Waiver Agreement and relating to the capacity of the released parties asbeneficiaries of  our obligations under the Waiver Agreement orthe deferred obligations listed above.

 

***Hallmark Letter of Credit***

 

Pursuant to Amendment No. 8to the bank credit facility, Hallmark Cards has provided an irrevocable letterof credit issued to JP Morgan Chase Bank by Citibank, N.A. in the originalamount of $320.0 million, as credit support for our obligations under theCompany’s credit facility (the “credit facility”).  The support letter of credit was reduced to$220.0 million upon the consummation of the sale of the Company’s internationalbusiness and the reduction of the aggregate outstanding credit exposure of itslenders to $220.0 million.  Drawdownsunder the letter of credit may be made for amounts due and payable under thecredit facility and upon the occurrence of certain other events.  Any proceeds received by JP Morgan Chase Bankfrom drawing under this support letter of credit will not be applied to repaythe Company’s obligations, but will be used to purchase on the part of HallmarkCards from the 

 

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bank lenders subordinatedparticipations in our obligations under its bank credit facility, junior inpayment to the bank lenders under the bank credit facility.  We agreed to pay Hallmark Cards’ the amountsresulting from the 2.0% reduction in the interest rate and the 0.3% reductionin the commitment fee payable by the Company under the bank credit facility asprovided in Amendment No. 8.  Inaddition, we agreed to pay the fee charged by Citigroup for the letter ofcredit which was 0.625% of the amount of the letter of credit.

 

In conjunction withAmendment No. 10, Hallmark Cards has extended its letter of credit to correlateto the maturity date of the credit facility and also has increased the size ofthe letter of credit from $220.0 million to $240.0 million.  In consideration of this extension andincrease in the size of the letter of credit, the Company agreed to continue topay Hallmark Cards the difference between the interest rate formerly chargedthe Company before the letter of credit was available and the rate now chargedwith the backing of the letter of credit. Since the interest rate was further reduced in Amendment No. 10 to LIBORplus 0.75%, the interest differential now payable to Hallmark Cards is 2.25% ofthe outstanding indebtedness under the credit facility. In addition, the Companyagreed to continue to pay the fee charged by Citigroup for the letter of creditwhich was increased to 0.875% of the amount of the letter of credit.

 

***Senior Unsecured Note***

 

InAugust 2003, the Company issued a senior unsecured note to HC Crown for $400.0million. A portion of the proceeds was used to repurchase the Company’soutstanding trust preferred securities, and the balance of the proceeds, afterexpenses, was used to reduce amounts outstanding under its bank creditfacility.

 

The seniorunsecured note payable to HC Crown does not require cash payments until August2007. Instead, the principal amount of the senior unsecured note accretes at10.25% per annum, compounding semi-annually, to $596.6 million at August 5,2007.  From that date, interest at 10.25%per annum will be payable semi-annually on the accreted value of the seniorunsecured note to HC Crown.  The notematures on August 5, 2011, and is pre-payable by Crown Media Holdings atany time after August 5, 2004, without penalty. At December 31, 2005, and March31, 2006, $509.4 million and $521.6 million, respectively, of principal andaccreted interest were included in the senior unsecured note payable in theaccompanying consolidated balance sheets. The note purchase agreement for thesenior unsecured note contains certain covenants which restrict on the part ofthe Company, among other matters, from the incurrence of any additionalindebtedness, the repurchase or other acquisitions of the Company’s stock,investments in other parties and the incurrence of liens on the Company’sassets.  As a fee for the issuance of thenotes, the Company paid $3.0 million to HC Crown, which was initiallycapitalized and is being amortized as additional interest expense over the termof the note payable.

 

***Line of Credit Payable to HC Crown***

 

On December 14,2001, the Company executed a $75.0 million promissory note with HC Crownmaturing on the earlier of six months from the termination of the bank creditfacility or December 21, 2007.  Due tothe Waiver Agreement, the line of credit and related interest are not due untilMay 31, 2007. This line of credit is subordinate to the bank credit facility.The rate of interest under this line of credit is equal to LIBOR plus threepercent. At December 31, 2005, and March 31, 2006, borrowings under the notewere $75.0 million and $86.3 million, respectively. Accrued interest on thenote of $11.3 million and $1.6 million are included in line of credit andinterest payable to HC Crown as of December 31, 2005, and March 31, 2006,respectively, on the accompanying condensed consolidated balance sheets. AtDecember 31, 2005, and March 31, 2006, the outstanding balances bore interestat the Eurodollar rates of 7.08% and 7.54%, respectively.

 

***Promissory Note with HallmarkEntertainment Holdings***

 

As considerationfor extending the demand period for the possible reimbursement of amounts drawnon the letter of credit supporting the credit facility, the Company agreed toconvert a portion of its license fees payable to Hallmark affiliates, whichwere approximately $132.8 million, to a promissory note bearing interest atLIBOR plus 3% per annum.  The term of thepromissory note began on October 1, 2005 and is payable in full on August 31,2006 (amended to May 31, 2007, by the Waiver Agreement).  Accrued interest on the note of $2.4 millionand $4.9 million, respectively, is included in note and interest payable toHallmark Cards affiliate as of December 31, 2005, and March 31, 2006, on theaccompanying condensed consolidated balance sheets. Due to the WaiverAgreement, interest is not due until May 31, 2007. At December 31, 2005, andMarch 31, 2006, $132.8 million of the 

 

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outstanding balance boreinterest at the Eurodollar rates of 7.08% and 7.54%. This note was transferredto a subsidiary of Hallmark Cards prior to the sale by Hallmark Cards of itsinterests in Hallmark Entertainment LLC, now called RHI Entertainment LLC (“RHIEntertainment”).

 

 

***Promissory Notewith Hallmark Entertainment Holdings***

 

As considerationfor extending the demand period for the possible reimbursement of amounts drawnon the letter of credit supporting the credit facility, the Company agreed toconvert its payable to a Hallmark Cards affiliate, which was approximately$70.4 million, to a promissory note bearing interest at LIBOR plus 3% perannum.  The term of the promissory notebegan on March 21, 2006, and is payable in full on May 31, 2007. Accruedinterest on the note of $162,000 is included in note and interest payable toHallmark Cards affiliate as of March 31, 2006, on the accompanying condensedconsolidated balance sheets. Due to the Waiver Agreement, interest is not dueuntil May 31, 2007. At March 31, 2006, $70.4 million of the outstanding balancebore interest at the Eurodollar rates of 7.54%.

 

***Interest Paid toHC Crown***

 

Interest expensepayable to HC Crown, which formerly was payable to the Company’s bank syndicateand resulted from a reduction in the interest rate and commitment fee payableto the Company’s bank syndicate in Amendment No. 8 to the Company’s creditfacility, was $3.2 million and $62,000 at December 31, 2005 and March 31, 2006,respectively.  Such interest expensepayable to HC Crown was $362,000 and $1.1 million for the three months endedMarch 31, 2005 and 2006, respectively.

 

**8. Related Party Transactions**

 

***Tax SharingAgreement***

 

OnMarch 11, 2003, Crown Media Holdings became a member of Hallmark Cardsconsolidated federal tax group and entered into a federal tax sharing agreementwith Hallmark Cards (the “tax sharing agreement”). Hallmark Cards includesCrown Media Holdings in its consolidated federal income tax return.  Accordingly, Hallmark Cards has benefitedfrom past tax losses and may benefit from future federal tax losses, which maybe generated by Crown Media Holdings. Based on the tax sharing agreement, Hallmark Cards has agreed to payCrown Media Holdings all of the benefits realized by Hallmark Cards as a resultof including Crown Media Holdings in its consolidated income tax return.  These benefits are estimated and paid 75% incash on a quarterly basis and the balance when Crown Media Holdings becomes afederal taxpayer.  A final true-upcalculation is completed within 15 days after Hallmark Cards files itsconsolidated federal income tax return for the year.  Pursuant to the true-up calculation, CrownMedia Holdings is obligated to reimburse Hallmark Cards the amount that anyestimated payments have exceeded the actual benefit realized by Hallmark Cardsand Hallmark Cards is obligated to pay Crown Media Holdings the amount that anyactual benefit exceeds the estimated payments. Under the tax sharing agreement, at Hallmark Cards’ option, thenon-interest bearing balance of the 25% in federal tax benefits may be appliedas an offset against any amounts owed by Crown Media Holdings to any member ofthe Hallmark Cards consolidated group under any loan, line of credit or otherpayable, subject to limitations under any loan indentures or contractsrestricting such offsets. During the third quarter of 2005, Hallmark Cards used$30.0 million of the approximately $45.7 million balance of this 25% balance tooffset intercompany debt.

 

TheCompany received $21.4 million and $5.0 million under the tax sharing agreementduring the three months ended March 31, 2005 and 2006, respectively. Anypayments received from Hallmark Cards or credited against amounts owed by CrownMedia Holdings to any member of the Hallmark Cards consolidated group under thetax sharing agreements are recorded as an addition to paid-in capital in theaccompanying consolidated statements of stockholders’ equity.

 

***Services Agreement with Hallmark Cards***

 

TheCompany has an intercompany services agreement with Hallmark Cards, which wasentered into in 2003 for a term of three years and then extended for anadditional year through January 1, 2007. Under the agreement, 

 

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Hallmark Cards providesCrown Media Holdings with tax, risk management, health safety, environmental,insurance, legal, treasury and cash management services and real estateconsulting services.  Under theagreement, the Company agreed to pay Hallmark Cards $515,000 per year for theseservices, plus out-of-pocket expenses and third party fees, payable in arrearson the last business day of each quarter. This amount was increased to $530,000for 2006. However, the Company has not been paying these amounts as they aredue. For the three months ended March 31, 2005 and 2006, Crown Media Holdingshad accrued $129,000 and $133,000, respectively, under the agreement. AtDecember 31, 2005, and March 31, 2006, non-interest bearing unpaid accruedservice fees and unreimbursed expenses of $10.1 million and $10.2 million,respectively, were included in payable to affiliates in the accompanyingcondensed consolidated balance sheets.

 

***Trademark Agreement with Hallmark Cards***

 

CrownMedia United States has a trademark license agreement with Hallmark Licensing,Inc. for use of the “Hallmark” mark for the Hallmark Channel and for theHallmark Movie Channel.  During thesecond quarter of 2006, Hallmark Cards extended the trademark licenseagreements for the Hallmark Channel and the Hallmark Movie Channel to September1, 2007. The Company is not required to pay any fees under the trademarklicense agreements.

 

**9. Company Obligated Mandatorily Redeemable Preferred Interest and NICCLicense Agreements**

 

VISN owns a $25.0 millioncompany obligated mandatorily redeemable preferred interest in Crown MediaUnited States (the “preferred interest”) issued in connection with aninvestment by the Company in Crown Media United States. On November 13, 1998,the Company, Vision Group, VISN and Henson Cable Networks, Inc. signed anamended and restated company agreement governing the operation of Crown MediaUnited States, which agreement was further amended on February 22, 2001,January 1, 2002, March 5, 2003, January 1, 2004, November 15, 2004  and December 1, 2005 (the “company agreement”).

 

 Under the companyagreement, the members agreed that if during any year ending afterJanuary 1, 2005 and prior to December 31, 2009, Crown Media UnitedStates has net profits in excess of $10.0 million, and the preferred interesthas not been redeemed, Crown Media United States will redeem the preferred interestin an amount equal to the lesser of: (i) such excess net profits; (ii) $5.0million; or (iii) the amount equal to the preferred liquidation preference onthe date of redemption.  Crown MediaUnited States may voluntarily redeem the preferred interest at any time,however, it is obligated to do so on the date of redemption (December 31,2010). Due to the mandatory redemption provision of the preferred interest, onJuly 1, 2003, the preferred interest was remeasured at fair value andreclassified to non-current liabilities in accordance with the provisions ofSFAS No. 150. The preferred interest has a liquidation preference of $25.0million.

 

InDecember 2005, Crown Media Holdings entered into an agreement with NICC,which replaced a prior program production agreement and settled various disputewhich had arisen under the prior agreement. In the new agreement, the Company agreed to fund and license thefollowing programming produced by NICC through the end of 2007:

 

•                                          A SundayMorning one-hour series entitled “New Morning with Naomi Judd” at a cost of$3.5 million in 2005, $4.6 million in 2006 and $5.6 million in 2007.  The2006 and 2007 amounts are payable quarterly in those years.

 

•                                          A weekdayone-hour daily series entitled “New Morning” at a cost of $1.9 million in 2005,$4.2 million in 2006 and $5.1 million in 2007.  The 2005 amount includes adeferred amount of $535,000 to be paid as indicated below for deferredpayments.  The 2006 and 2007 amounts are payable quarterly in those years.

 

•                                          A Sunday morningprogramming block, broadcast from 6 a.m. to 12 noon, at a cost ofapproximately $485,000 in 2005, $5.8 million in 2006 and $5.8 million,increased by a percentage equal to the increase in the Consumer Price Index, in2007.  These amounts include deferred 

 

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payments of $125,000 for2005 and $1.5 million for each of 2006 and 2007.  The 2006 and 2007amounts not deferred are payable quarterly in those years.

 

Inaddition, Crown Media Holdings agreed to finish funding four specials, theproduction of which had been commenced prior to the amendment, at a totaladditional cost of $1.4 million in 2005 and 2006, and to fund an additional twonon-dramatic specials, to be produced in 2006 and 2007, at a total cost of $1.3million.  A quarter of the amounts for the additional two specials waspaid in January 2006, another quarter is payable in June 2006 and the remainingone-half is payable in June 2007, or upon a change in control (that is, a saleor merger where the aggregate ownership of Crown Media Holdings by the currentowners becomes less than 50%).  The Hallmark Channel is not obligated tobroadcast the latter two specials.  Crown Media Holdings will also provide$2.0 million in each of 2005, 2006 and 2007 to fund the development by NICC of “madefor television” movies and will pay NICC an additional $1.0 million if themovie “A Reason to Believe”, which was to be produced under the prioragreement, is not ultimately produced.  The 2005 amount includes a deferredpayment of $1.8 million; the 2006 amount is payable semi-annually in 2006; the2007 amount is payable in January 2007; and the possible additional $1.0million is payable in July, 2006 or, if sooner, a change in control.  TheHallmark Channel will have a right of first negotiation to acquire broadcastrights to the movies resulting from this development and, if it elects not toacquire these rights, may still recover a portion of its funding if the moviesare produced for others.  In addition, NICC will receive $45,000 inconsulting fees from a series which RHI Entertainment has produced, payable nolater than July, 2006, and a deferred payment of $750,000 as the last paymentfor certain terminated obligations.

 

Thedeferred payments mentioned above are payable to NICC on December 31, 2007or upon a change in control, whichever comes first.  Added to the deferredamounts will be (1) interest at the rate charged by NICC’s prime lender or(2) if NICC sells Crown Media Holdings common stock to finance any deficit,the increase in the sale price of the common stock between the time NICC sellsthe stock to fund a deferred amount and a market price of the Crown MediaHoldings common stock on the date the deferred amounts are paid by Crown MediaHoldings.

 

Inthe event there is a change of control of Crown Media Holdings prior to theexpiration of the agreement (i.e., December 31, 2007), NICC will immediatelyreceive a $15.0 million “termination payment,” any remaining portions of thepayments for the non-dramatic specials and the “made for television” moviedevelopment described above and the deferred payments described above. The Hallmark Channel will be obligated to continue to broadcast and pay for theSunday “New Morning with Naomi Judd” and weekday “New Morning” series and theSunday morning programming block for an additional six months following thechange in control, after which all funding and broadcast obligations to NICCwill cease.  Also, under existing obligations, Crown Media Holdings wouldbe required to redeem the $25.0 million preferred interest of NICC in CrownMedia United States, LLC, for that amount plus accrued interest at LIBOR fromNovember 27, 2005.

 

Ifthere has not been a change of control of the Company by June 30, 2007,Crown Media Holdings is required to negotiate with NICC for a period of 60 daysregarding continuation of the programming commitments.  If at the end ofthe negotiating period the parties have not reached agreement and Crown MediaHoldings is not willing to continue the programming commitments at the samelevels, NICC may compel Crown Media Holdings to buy all NICC’s outstandingshares of Crown Media Holdings common stock at the then current market value bya written notice given no later than November 1, 2007.  If NICC sellsmore than 50% of the shares of Crown Media Holdings common stock which it ownedas of February 22, 2001, except as part of a sale of Crown Media Holdings,most of the commitments and obligations related to programming as describedabove cease (at the option of Crown Media United States) at the end of the thencurrent broadcast season (approximately August 31).

 

During the three monthsended March 31, 2005 and 2006, Crown Media United States paid NICC $2.6 millionand $7.5 million, respectively, pursuant to the company agreement, as amended.

 

**10.  RHI Entertainment**

 

***Costs Incurred on Crown Media Holdings’Behalf***

 

Since inception, RHI Entertainment has at times paidcertain costs on behalf of Crown Media Holdings. Non-interest bearingunreimbursed costs of $567,000 and $0 are included in payable to RHIEntertainment in the 

 

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accompanying condensedconsolidated balance sheets as of December 31, 2005, and March 31, 2006,respectively.

 

***Film Asset Services Agreement with RHIEntertainment***

 

The Company has a film asset services agreement with RHIEntertainment, under which RHI Entertainment provides Crown Media Holdings withservices related to the administration, distribution and other exploitation ofthe Company’s film assets. In consideration for the services provided by RHIEntertainment, Crown Media Holdings was, prior to the sale of the Company’sinternational operations, obligated to pay a service fee of $1.5 million peryear, payable in quarterly installments of $375,000. At December 31, 2005, andMarch 31, 2006, non-interest bearing unpaid accrued service fees of $188,000and $0 were included in payable to RHI Entertainment in the accompanyingcondensed consolidated balance sheets. Following the sale of the Company’sinternational operations, the annual fee for these services was reduced to$750,000 per year.

 

***Program License Agreements with RHIEntertainment Distribution***

Crown Media United States haslicensed programming for distribution in the United States from HallmarkEntertainment Distribution, now RHI Entertainment Distribution, since1998.  It currently licenses thisprogramming under a Second Amended and Restated Program LicenseAgreement dated as of January 1, 2005 (“Second Restated Agreement”).  This Second Restated Agreement expires onDecember 31, 2008.

Under the Second Restated Agreement, RHIEntertainment Distribution is required to produce and deliver to Crown MediaUnited States, and Crown Media United States is required to order and licensefrom RHI Entertainment Distribution, 13 original movies and 3 originalmini-series in 2005, 31 original movies and 6 original mini-series in 2006 and18 original movies and 3 original mini-series in 2007.   Crown Media United States may, however,completely cancel the 2007 commitment to order 18 original movies and 3original mini-series or it may reduce the number of original movies it isrequired to license in each of 2006 and 2007 by up to six movies per year.  Crown Media United States has exercised thisoption to reduce the original movies produced in 2006 to 12 movies. Crown MediaUnited States has exclusive rights to these original movies and mini-seriesduring a three year exhibition window (the window is five years for certainholiday-themed movies and movies produced in 2005).  Crown Media United States may exhibit theoriginal movies and mini-series in any television media in the United States,its territories and possessions (together with Puerto Rico), including pay perview and high definition television. Crown Media United States may alsosublicense its exhibition rights in any television media regarding the originaland other movies and mini-series covered by the agreement to third parties,subject to the reasonable consent of RHI Entertainment Distribution.  The license fee payable for the originalmovies produced in 2005 is $1,600,000 per movie; in 2006 is $1,680,000 permovie and in 2007 is $1,764,000 per movie. If the movies are produced for the Hallmark Channel’s “Mystery Movie”series, the license fees are increased by $200,000 and if they areholiday-themed movies, the license fees are increased by $100,000.  The license fees for mini-series produced in2005 are $800,000 per hour; in 2006 are $840,000 per hour; and in 2007 are$882,000 per hour.   Crown Media UnitedStates must also share any revenues from video on demand or pay per viewexploitation with RHI Entertainment Distribution.

In addition to the original movies and mini-Series,Crown Media United States has agreed to license from RHI EntertainmentDistribution 22 “off-network” movies and mini-series in 2005 and a maximum of15 such movies and mini-series in 2006 through 2008.  These programs generally will not have beenseen on cable television in the United States prior to their exhibition on theHallmark Channel.  The license feespayable for the off-network movies are $268,029 per movie in 2005; $281,420 permovie in 2006; $295,491 per movie in 2007 and $310,266 per movie in 2008.  The license fees payable for the off-networkmini-series are $335,024 per hour in 2005; $351,775 per hour in 2006; $369,364per hour in 2007 and $387,832 per hour in 2008. Crown Media United States’ initial exhibition period for theseoff-network movies and mini-series is three years and Crown Media United States’exhibition rights are exclusive in all television media in the United States,including Puerto Rico.  Crown MediaUnited States’ exhibition rights to these off-network movies and mini-series donot, however, include pay per view or video on demand.  RHI Entertainment Distribution has an optionto require Crown Media United States to license these off-network movies andmini-series for an additional, consecutive three year period at a cost of 50%of the initial license fee.

 

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Crown Media United States has also agreed to licenseup to 143 older movies and mini-series from the RHI Entertainment DistributionLibrary for a three year exclusive exhibition window, at an approximate totalcost of $57.5 million.  Most of thesemovies and mini-series have previously been exhibited on the Hallmark Channeland Hallmark Movie Channel.

 

Bothunder the current and previous agreements with RHI Entertainment Distribution,if Crown Media United States sub-licenses any licensed program to a thirdparty, it must equally share with RHI Entertainment Distribution the excess, ifany, of the sublicensing fee over the initial program license fee paid by theCrown Media United States.  Crown MediaUnited States did not sub-license any licensed program to a third party duringthe three months ended March 31, 2005 and 2006.

 

Programming costsrelated to the RHI Entertainment Distribution program agreements were $6.7million and $9.8 million for the three months ended March 31, 2005 and 2006,respectively. As of December 31, 2005, and March 31, 2006, $22.7 million and$21.9 million, respectively, are included in license fees payable tonon-affiliates in the accompanying consolidated balance sheets. Crown MediaHoldings paid RHI Entertainment Distribution $0 and $7.4 million for licensefees during the three months ended March 31, 2005 and 2006, respectively.

 

**11. Employee Incentives**

 

Crown Media Holdings has one stock plan, the Amended andRestated Crown Media Holdings, Inc. 2000 Long Term Incentive Plan (the “Plan”).The Plan covers two types of share-based compensation, a Stock Option Plan anda Restricted Stock Unit Plan (RSU) that are subject to FAS 123R commencing onJanuary 1, 2006.

 

***Stock Option Plan***

 

Crown Media Holdings may grant options for up to 10.0million shares under the Plan. The stock options expire 10 years from the dateof grant and generally vest over service periods that range from date of grantto four years.  Certain option and shareawards provide for accelerated vesting if there is a change in control (asdefined in the Plan).

 

***StockCompensation***

Beginning with our first quarter offiscal 2006, we adopted SFAS 123R. We currently use the Black-Scholes optionpricing model to determine the fair value of stock options. The determinationof the fair value of stock-based payment awards on the date of grant using anoption-pricing model is affected by our stock price as well as assumptionsregarding a number of complex and subjective variables. These variables includeour expected stock price volatility over the term of the awards, actual andprojected employee stock option exercise behaviors, risk-free interest rate andexpected dividends.

We estimate the expected term ofoptions granted by taking the average of the vesting term and the contractualterm of the option. We estimate the expected volatility of our common stock byusing historical volatility. We base the risk-free interest rate that we use inthe option valuation model on U.S. Treasury zero-coupon issues with remainingterms similar to the expected term on the options. We do not anticipate payingany cash dividends in the foreseeable future and therefore use an expecteddividend yield of zero in the option valuation model. We are required to estimateforfeitures at the time of grant and revise those estimates in subsequentperiods if actual forfeitures differ from those estimates. We use historicaldata to estimate pre-vesting option forfeitures and record stock-basedcompensation expense only for those awards that are expected to vest. The fairvalue of all stock-based payment awards is amortized on a straight-line basisover the requisite service periods of the awards, which are generally thevesting periods.

Total stock-based compensationprovision recognized on our consolidated statement of operations as a componentof selling, general and administrative expense for the quarter endedMarch 31, 2006, is $1.9 million ($1.9 million compensation provisionrelated to restricted stock units and $6,000 compensation expense related tostock options).

 

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The following table sets forth thepro forma amounts of net income and net loss per share, for the three monthsended March 31, 2005, that would have resulted if we had accounted for ouremployee stock options under the fair value recognition provisions of SFAS 123:

**Pro Forma Effects**

**(In thousands, except per shareamounts)**

** **

| ** **                                                   | ** ** | **Three Months  Ended March 31, 2005** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------------|------------|
|                                                         |       |                                   |       |
| Net loss                                                     |       | $                                      | (50,907    | ) |
| Pro forma stock options expense at estimated fair value |       | (168                                   | )          |
| Stock option expense included in net loss                    |       | 7                                      |       |
| Pro forma net loss                                           |       | $                                      | (51,068    | ) |
| Weighted average shares                                      |       | 104,533                                |       |
| Pro forma net loss per share, basic and diluted              |       | $                                      | (0.49      | ) |

 

As of March 31, 2006, there was$3,000 of unrecognized compensation cost, adjusted for estimated forfeitures,related to non-vested stock options granted to our employees. Totalunrecognized compensation cost will be adjusted for future changes in estimatedforfeitures.

***General StockOption Information***

The following table sets forth thesummary of option activity under our stock option program for the three monthsended March 31, 2006:
| ** **                 | ** ** | **Shares  (in thousands)** | ** ** | **Exercise  Price  Per Option** | ** **  | **Weighted-   Average  Exercise  Price  Per Option** | ** ** | **Aggregate  Intrinsic  Value** | ** ** | **Weighted-  Average  Fair Value** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** |
|----------------------------|------------|----------------------------|------------|---------------------------------|-------------|------------------------------------------------------|------------|---------------------------------|------------|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                 | ** ** | ** **                 | ** ** | ** **                      | ** **  | ** **                                           | ** ** | ** **                      | ** ** | ** **                         | ** ** | ** **                                           | ** ** |
| Balance, December 31, 2005 |       | 867                        |       |                            |        | $                                                    | 10.42      |                            |       |                               |       |                                                 |       |   |
| Options cancelled          |       | (3                         | )          | $                               | 12.50-16.38 |                                                 | $          | 13.53                           |       |                               |       |                                                 |       |   |   |
| Balance, March 31, 2006    |       | 864                        |       |                            |        | $                                                    | 10.40      |                            | $          | 0.00                               |       | $                                                    | 3.64       |   | 2.91 |   |
| Exercisable                |       | 859                        |       |                            |        | $                                                    | 10.41      |                            | $          | 0.00                               |       | $                                                    | 3.64       |   | 2.89 |   |
|                            |            |                            |            |                                 |             |                                                      |            |                                 |            |                                    |            |                                                      |            |  |  |  |  |

 

Information regarding stock optionsat March 31, 2006, is summarized below: 
| **Options Outstanding**                   | ** ** | **Options Exercisable** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|
| **Range of  Exercise Prices  Per Option** | ** ** | **Shares  Outstanding** | ** ** | **Weighted Average  Remaining  Contractual Life** | ** ** | **Weighted Average  Exercise Price  Per Option** | ** ** | **Exercisable  Shares** | ** ** | **Weighted Average  Exercise Price  Per Option** | ** ** |
| ** **                                | ** ** | **(In thousands)**      | ** ** | **(In years)** | ** ** | ** ** | ** ** | **(In thousands)** | ** ** | ** ** | ** ** |
| $6.30-10.50                               |       | 535                     |       | 1.38 |   | $ | 9.11 |   | 530 |   | $ | 9.10 |   |
| $10.51-12.60                              |       | 242                     |       | 5.75 |   | $ | 11.50 |   | 242 |   | $ | 11.50 |   |
| $12.61-14.70                              |       | 43                      |       | 4.09 |   | $ | 14.00 |   | 43 |   | $ | 14.00 |   |
| $14.71-21.00                              |       | 44                      |       | 4.80 |   | $ | 16.60 |   | 44 |   | $ | 16.60 |   |
|                                      |       | 864                     |       | 2.91 |   | $ | 10.40 |   | 859 |   | $ | 10.41 |   |
|                                           |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

***General Restricted Stock UnitInformation***

 

The Company’s restricted stock units(“RSUs”) vest based on either employment or performance conditions. CertainRSUs vest in one-third increments on the anniversary grant date based oncontinuing employment 

 

24

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(“Employment RSUs”). Other RSUs vest on the thirdanniversary date of the grant date, provided that the price of the Company’sClass A common stock is at least $14 or higher on that date (“Performance RSUs”).

 

The Company’s RSUs are settled in either common stockor cash as determined by the Company’s Board of Directors. The Company hashistorically settled the RSUs in cash, and considering such past practices, hasclassified its RSUs as liability awards for accounting purposes.

 

Prior to the adoption of SFAS 123R, we recognized theestimated compensation cost of employment restricted stock units over thevesting term, including changes in fair value at each reporting period. Theestimated compensation cost was and continues to be based on the fair value ofour stock price at the end of each reporting period. We will continue torecognize the compensation cost, net of estimated forfeitures, over the vestingterm and include changes in fair value at each reporting period.

 

The Company made an offer in May2003 to senior management and vice presidents to exchange their options forEmployment RSUs, resulting in a total of 5,126,732 options exchanged for2,050,693 Employment RSUs. The Employment RSUs vest over three years inone-third increments on the anniversary of the grant date each year and theCompany is accruing expense related to the Employment RSUs ratably over eachincrement’s vesting period using the price of our Class A common stock on thelast day of the reporting period.

 

In May 2004, the Company’s Board of Directors approvedan additional grant to employees of 1,065,000 RSUs. The Employment RSUs, whichconstitute 70% of the award granted in 2004, vest in equal one-thirdinstallments over the next three years on the anniversary of the grant dateeach year. The Performance RSUs, constituting 30% of the award granted in 2004,vest on the 3rd anniversary of the grant date, provided that theprice of the Company’s common stock is $14 or higher on that date.

 

TheCompany recorded $2.4 million of compensation expense and $1.9 million ofcompensation benefit associated with the Employment and Performance RSUs duringthe three months ended March 31, 2005 and 2006, respectively, which has beenrecorded as a liability for RSUs in the accompanying consolidated balance sheetand is included in selling, general and administrative expense in theaccompanying consolidated statement of operations. The Company settled certain Employment RSUsduring the three months ended March 31, 2005, for approximately $4.2 million incash. InJanuary 2006, the Company settled vested Employment RSUs to one executive forapproximately $4.4 million.

 

In June2005, the Company’s Board of Directors approved a grant to those Directors whowere not employees of the Company or of Hallmark Cards or its affiliatedcompanies, of 70,884 RSUs.  The RSUs vestin equal one-third installments over three years on the anniversary of thegrant dates each year.

 

In August 2005, the Company’s Board of Directorsapproved an additional grant of 828,000 Employment and Performance RSUs toemployees. The Employment RSUs, which constitute 50% of the award granted in2005, vest in equal one-third installments over the next three years on theanniversary of the grant date each year. The Performance RSUs, constituting 50%of the award granted in 2005, vest on the 3rd anniversary of thegrant date, provided that the price of the Crown common stock is $14 or higheron that date.

 

InAugust 2005, the Company’s Board of Directors approved an additional grant toone executive of 115,000 RSUs (“CEO Grant”). The Employment RSUs, whichconstitute 50% of the award granted in 2005, vest in equal one-thirdinstallments on dates which are three months, six months and nine months,respectively, after the grant date. The Company settled additional vested RSUsheld by this executive for approximately $165,000 in cash in February 2006. ThePerformance RSUs, constituting the remaining 50% of the award granted in 2005,vest on the 3rd anniversary of the grant date, provided that theprice of the Crown common stock is $14 or higher on that date.

 

UnderFAS 123R, the fair value of each Employment RSU grant is estimated using aBlack-Scholes Merton option pricing model. The fair value of each Performance RSU grant is estimated at eachreporting date using a Monte Carlo Lattice option pricing model. Beginning in2006, the Company is applying a forfeiture rate to the Employment RSUs asrequired by SFAS No. 123R.

 

25

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| ** **                             | ** ** | ** **         | ** ** | **Weighted-Average  Remaining** | ** ** |
|----------------------------------------|------------|--------------------|------------|---------------------------------|------------|
| **Employment RSUs**                    | ** ** | **Units**          | ** ** | **Contractual Term**            | ** ** |
| ** **                             | ** ** | **(in thousands)** | ** ** | ** **                      | ** ** |
|                                   |       |               |       |                            |       |
| Outstanding Balance, December 31, 2005 |       | 1,477,343          |       |                            |       |
|  Units settled in cash            |       | (493,195           | )          |                            |       |
| Outstanding Balance, March 31, 2006    |       | 984,148            |       | 1.44                            |       |

 

 

The closing price of a share of our common stock onDecember 31, 2005, was $9.17 and $6.34 on March 31, 2006.

** **
| ** **                                           | ** ** | ** **         | ** ** | **Weighted-Average  Remaining** | ** ** |
|------------------------------------------------------|------------|--------------------|------------|---------------------------------|------------|
| **Performance RSUs**                                 | ** ** | **Units**          | ** ** | **Contractual Term**            | ** ** |
| ** **                                           | ** ** | **(in thousands)** | ** ** | ** **                      | ** ** |
|                                                 |       |               |       |                            |       |
| Outstanding at December 31, 2005, and March 31, 2006 |       | 688,500            |       | 1.81                            |       |

 

At December 31, 2005, the 2004 Performance RSUs werevalued at $1.61 per unit, the 2005 Performance RSUs were valued at $4.36 perunit, and the CEO Performance RSUs were valued at $1.23 per unit. At March 31,2006, the 2004 Performance RSUs were valued at $0.48 per unit, the 2005Performance RSUs were valued at $1.99 per unit, and the CEO Performance RSUshad nominal value per unit. The CEO Performance grant is not expected to besettled by May 28, 2006.

 

The following table includes assumptions used to valuethe Employment and Performance RSUs at March 31, 2006.

** **

| ** **               | ** ** | **2004 Grant** | ** ** | **2005 Grant** | ** ** | **CEO  Performance  Grant** | ** ** | **CEO  Employment  Grant** | ** ** |
|--------------------------|------------|----------------|------------|----------------|------------|-----------------------------|------------|----------------------------|------------|
| Expected volatility      |       | 40.79          | %          | 42.82          | %          | 46.38                       | %          | 46.38                      | %          |
| Expected dividends       |       | 0              |       | 0              |       | 0                           |       | 0                          |       |
| Expected Term (in years) |       | 1.17           |       | 2.38           |       | 0                           |       | 0.13                       |       |
| Risk -free rate          |       | 4.82           | %          | 4.82           | %          | 4.63                        | %          | 4.63                       | %          |

 

The following table includes assumptions used to valuethe Performance RSUs at January 1, 2006.

 

 

| ** **               | ** ** | **2004 Grant** | ** ** | **2005 Grant** | ** ** | **CEO Grant** | ** ** |
|--------------------------|------------|----------------|------------|----------------|------------|---------------|------------|
| Expected volatility      |       | 39.34          | %          | 48.87          | %          | 40.04         | %          |
| Expected dividends       |       | 0              |       | 0              |       | 0             |       |
| Expected Term (in years) |       | 1.42           |       | 2.67           |       | 0.46          |       |
| Risk -free rate          |       | 4.38           | %          | 4.37           | %          | 4.37          | %          |

 

Inconnection with the adoption of SFAS 123R, we recorded total compensation costs related to RSUs granted under the Plan of $2.1million as a cumulative catch-up adjustment during the three months ended March31, 2006. The Performance RSUs were not previously recorded on the Company’sfinancial statements as a liability, as it was not deemed probable that theseunits would be settled based on the performance of the Company’s common stock.

 

26

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| ** **                                           | ** ** | ** **         | ** ** | **Weighted-Average  Remaining** | ** ** |
|------------------------------------------------------|------------|--------------------|------------|---------------------------------|------------|
| **Board of Directors RSUs**                          | ** ** | **Units**          | ** ** | **Contractual Term**            | ** ** |
| ** **                                           | ** ** | **(in thousands)** | ** ** | ** **                      | ** ** |
| ** **                                           | ** ** | ** **         | ** ** | ** **                      | ** ** |
| Outstanding at December 31, 2005, and March 31, 2006 |       | 32,467             |       | 0.71                            |       |

 

**12. Employee Benefits**

 

***Deferred Compensation Plans***

 

The Company sponsors a deferred compensationplan for its management. Participants in this plan earn interest on theirdeferred compensation. The Company’s deferred compensation obligations for thisplan are included in its consolidated balance sheet in long-term accruedliabilities. The deferred compensation liability as of December 31, 2005,and March 31, 2006, was $3.2 and $3.0 million, respectively. The Companyhas suspended this plan for 2006 and there will be no deferrals of employeecompensation earned in 2006.  The Companywill, however, continue to pay interest on amounts deferred in previous yearsand pay out these amounts in accordance with the terms of the plan.

 

**13. Segment Reporting**

 

The Company’s continuingoperations are currently organized into two principal divisions representingoperating segments: domestic channels and film distribution. The Companyevaluates performance and allocates resources based on the results of thesesegments. The key operating performance criteria used in this evaluationinclude revenue, operating income (loss) and total assets.  The results of operations of our internationalchannel operating segment are not included in the segment reporting as they areclassified separately as discontinued operations in the Company’s consolidatedfinancial statements (see note 15).

 

The following tables present theCompany’s key performance measures (in thousands):

 

*March 31, 2005*

 
| ** **                                                    | ** ** | ** **   | ** ** | **Film**         | ** ** | ** **      | ** ** | ** **       | ** ** |
|---------------------------------------------------------------|------------|--------------|------------|------------------|------------|-----------------|------------|------------------|------------|
| ** **                                                    | ** ** | **Domestic** | ** ** | **Distribution** | ** ** | **Adjustments** | ** ** | **Consolidated** | ** ** |
|                                                          |       |         |       |             |       |            |       |             |       |
| Total revenues                                                |       | $38,486      |       | $7,413           |       | $(5,330         | )(1)       | $40,569          |       |
| Programming costs                                             |       | (31,829      | )          | (104             | )          | 3,911           |  (1)  | (28,022          | )          |
| Amortization of film assets                                   |       | —       |       | (7,092           | )          | 1,411           |  (1)  | (5,681           | )          |
| Subscriber acquisition fee amortization expense               |       | (10,354      | )          | —           |       | 846             |  (1)  | (9,508           | )          |
| Operating costs                                               |       | (1,689       | )          | (269             | )          | 162             |  (1)  | (1,796           | )          |
| Selling, marketing, general and  administrative expenses |       | (17,556      | )          | (5,964           | )          | 188             |       | (23,332          | )          |
| Loss from continuing operations                               |       | (22,942      | )          | (6,016           | )          | 1,188           |       | (27,770          | )          |
| Interest expense                                              |       | (1,096       | )          | (17,186          | )          | 1,386           |       | (16,896          | )          |
| Loss from discontinued operations                             |       | —       |       | (6,241           | )          | —          |  (3)  | (6,241           | )          |
| Net loss                                                      |       | $(24,038     | )          | $(29,443         | )          | $2,574          |       | $(50,907         | )          |
|                                                          |       |         |       |             |       |            |       |             |       |
| Total assets                                                  |       | $790,867     |       | $521,170         |       | $222,983        |  (2)  | $1,535,020       |       |

 

27

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*March 31, 2006*

* *
| ** **                                              | ** ** | ** **   | ** ** | **Film**         | ** ** | ** **      | ** ** | ** **       | ** ** |
|---------------------------------------------------------|------------|--------------|------------|------------------|------------|-----------------|------------|------------------|------------|
| ** **                                              | ** ** | **Domestic** | ** ** | **Distribution** | ** ** | **Adjustments** | ** ** | **Consolidated** | ** ** |
|                                                    |       |         |       |             |       |            |       |             |       |
| Total revenues                                          |       | $44,701      |       | $5,822           |       | $(5,550         | )(1)       | $44,973          |       |
| Programming costs                                       |       | (41,018      | )          | (263             | )          | 7,688           |  (1)  | (33,593          | )          |
| Amortization of film assets                             |       | —       |       | (4,358           | )          | (4,506          | )(1)       | (8,864           | )          |
| Subscriber acquisition fee amortization expense         |       | (8,637       | )          | —           |       | 847             |  (1)  | (7,790           | )          |
| Operating costs                                         |       | (3,687       | )          | (443             | )          | —          |       | (4,130           | )          |
| Selling, marketing, general and administrative expenses |       | (11,032      | )          | (3,134           | )          | —          |       | (14,166          | )          |
| Loss from continuing operations                         |       | (19,673      | )          | (2,376           | )          | (1,521          | )          | (23,570          | )          |
| Interest expense                                        |       | (3,144       | )          | (18,559          | )          | —          |       | (21,703          | )          |
| Gain on sale of discontinued operations                 |       | —       |       | 162              |       | —          |  (3)  | 162              |       |
| Cumulative effect of change in accounting principle     |       | —       |       | (2,099           | )          | —          |       | (2,099           | )          |
| Net loss                                                |       | $(22,817     | )          | $(22,872         | )          | $(1,521         | )          | $(47,210         | )          |
|                                                    |       |         |       |             |       |            |       |             |       |
| Total assets                                            |       | $824,272     |       | $404,493         |       | $—         |       | $1,228,765       |       |

----

 

(1) Represents elimination of intersegment transactions.

(2) Represents assets from discontinued operations.

(3) Represents gains and losses from discontinued operations.

 

Fiveof our distributors each accounted for more than 10% of our consolidated subscriberrevenue for both the three months ended March 31, 2005 and 2006, and togetheraccounted for a total of 84% and 90% of consolidated subscriber revenue at thatdate, respectively.  Three of ourdistributors each accounted for more than 15% of our consolidated subscribersfor both the three months ended March 31, 2005 and 2006, and together accountedfor 57% and 60% of our subscribers on that date, respectively.

 

**14.  Assets Held for Sale andDiscontinued Operations**

 

OnFebruary 23, 2005, the Company signed an agreement for the sale of theseassets and obtained other agreements enabling the Company to then conduct thesale on an “as is” basis.  The saleclosed on April 26, 2005. The accompanying condensed consolidatedstatements of operations and cash flows for the three months endedMarch 31, 2005, present the associated results of operations and cashflows of the international assets as “discontinued operations.”

 

The net loss from discontinued operations during each of the threemonths ended March 31, 2005 and 2006, consisted of the following:

 

 

| ** **                        | ** ** | **As of March 31, 2005** | ** ** | **As of March 31, 2006** | ** ** |
|-----------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                        | ** ** | **(In thousands)**       | ** ** |
|                              |       |                     |       |                     |       |
| Revenue                           |       | $                        | 26,214     |                     | $          | — |   |
| Costs and expenses                |       | (30,190                  | )          | —                   |       |
| Interest expense                  |       | (1,772                   | )          | —                   |       |
| Income tax provision              |       | (493                     | )          | —                   |       |
| Loss from discontinued operations |       | $                        | (6,241     | )                        | $          | — |   |

 

28

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EffectiveFebruary 23, 2005, the Company ceased depreciating and amortizing certainof the international assets held for sale. Had the Company not ceased such depreciation and amortization, the lossfor discontinued operations for the three months ended March 31, 2005would have included an additional $995,000 of depreciation and amortizationexpense and an additional $1.8 million of amortization of film assets.

 

Interestexpense includes an allocation of interest related to the Company’s bank creditfacility that was required to be paid as a result of the sale.  The allocation was required by EmergingIssues Task Force (“EITF”) Issue No. 87-24, *Allocation of Interest toDiscontinued Operations*.  Suchinterest expense amounted to $1.4 million for the three months ended March 31,2005.  Upon receipt of cash from thesale, the Company was required to repay and retire $100.0 million of theCompany’s bank credit facility.

 

**15. Commitments and Contingencies**

 

In the normalcourse of business, the Company has entered into agreements that commit it tomake cash payments in future periods with respect to non-cancelable leases andprogramming contracts.

 

**16. Subsequent Events**

 

By an AmendmentNo. 10, dated as of April 28, 2006, to the credit agreement, the maturity dateof the credit facility has been extended to May 31, 2007 and the size of therevolving credit facility has been increased from $220.0 million to $240.0million.  For additional informationregarding this Amendment, see Note 6 above.

 

In April 2006, theCompany terminated approximately 21 employees in conjunction with its costsavings efforts. The Company estimates that its severance costs will beapproximately $2.0 to $4.0 million.

 

29

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**ITEM 2.  *Management’sDiscussion and Analysis of Financial Condition and Results of Operations***

 

The following discussion and analysis of the Company’sfinancial condition and results of operations should be read in conjunctionwith the “Management’s Discussion and Analysis of Financial Condition andResults of Operations” of the Company’s Annual Report on Form 10-K for the yearended December 31, 2005.

 

**Description of Business and Overview**

 

*Current Business*

 

Crown Media Holdings, Inc. (“Crown Media Holdings,” “CrownMedia” or the “Company”), through its subsidiaries, owns and operates paytelevision channels (collectively the “Hallmark Channel,” the “Hallmark MovieChannel,” the “channel” or collectively the “channels”) dedicated to highquality, entertainment programming for adults and families, in the UnitedStates. In addition, the Company owns a film library with approximately 600titles.  The library product is used onthe Hallmark Channel, the Hallmark Movie Channel and sold to third parties.

 

With 71.9 millionsubscribers in the United States at March 31, 2006, Crown Media Holdings is the39th most widely distributed advertising-supported cable channel inthe United States. For the first quarter of 2006, we finished the quarter asthe 10th highest rated advertising-supported cable channel for totalday ratings and the 10th highest rated advertising-supported cablechannel in prime time as measured by Nielsen Research.

 

We launched our second24-hour linear channel, the Hallmark Movie Channel, during the first quarter of2005.  The Hallmark Movie Channel focuseson movies and mini-series and utilizes content from our film library forprogramming.  At March 31, 2006, we hadapproximately 340,000 subscribers to the Hallmark Movie Channel. We plan todevelop the Hallmark Movie Channel as an additional revenue source.  While it can play a critical role in terms ofcontract renewals with the various distributors and can justify itself on thatbasis, it can also stand on its own in terms of its business model.  It will generate advertising revenue in 2006and as distribution continues to expand, the financial contribution of theHallmark Movie Channel may continue to grow.

 

As mentioned above, theCompany owns a film library comprised of approximately 600 titles.  Through our subsidiary, Crown MediaDistribution, we sell license rights in the United States to titles in thelibrary to a variety of customers. In addition, the Company utilizes the filmlibrary for programming content on the Hallmark Channel and Hallmark MovieChannel. We have increased the internal use of the film assets on the HallmarkChannel as a result of a decision to air more movies on the Hallmark Channel.

 

As the Hallmark Channel andthe Hallmark Movie Channel continue to develop, the core focus for the businessremains unchanged.  First, distributionmust continue to expand. While the ratings performance of the Hallmark Channelranks in or near the top ten of cable networks according to Nielsen, in termsof distribution, the Hallmark Channel is only in the top 40 cable networks.Increased distribution can have a positive impact on our subscriber revenue(depending on any subscriber acquisition fees incurred) and should increase ouradvertising revenue as advertisers pay higher rates to cable networks that aremore broadly distributed. However, combining growing distribution withincreasing ratings is more powerful in terms of advertising revenue. As aresult, the Hallmark Channel will continue to focus on enhancing itsprogramming schedule through the acquisition of new series, additional originalmovies such as the recent Mystery Movies, and through unique schedulingconcepts.

 

In addition, we willcontinue to make library sales. Our film library is a large collection of awardwinning movies and mini-series, which is unique in that it is such a largecollection of family oriented films.

 

*Current Challenges*

 

TheHallmark Channel faces challenges on the distribution front.  The distribution agreements are importantbecause they affect our number of subscribers, which in turn has a major impacton our subscriber fees, the number of persons viewing our programming, and thusrates charged for advertising. We have an ongoing focus on growing 

 

30

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our subscriber base. Thecurrent and long-term distribution challenges will be renewing our distributionarrangements with the multiple system operators as they expire. Majordistribution agreements expire from December 2006 through December 2010; ofthese distribution agreements, agreements accounting for approximately 80% ofour subscriber base at December 31, 2005 will terminate and be the subject ofrenewal negotiations prior to or on December 31, 2007. While the economics ofthe renewals and potential cash incentive payments are unknown and could have asignificant impact on our business, we believe that the success of the HallmarkChannel in terms of ratings and the environment we have created with ourprogramming schedule will enhance our renewal discussions. We also believe thatour ability to offer to multiple systems operators a second channel, theHallmark Movie Channel, as well as programming for their other distributionplatforms such as video-on-demand, are value added components of the renewal equation.  In October 2005, we entered into a renewal ofour distribution agreements with one of the major distributors in the UnitedStates for a period of 3.3 years.

 

Domestic telephone companiesare entering into the business of distributing television channels tohouseholds through their wire-lines. We have reached agreement with severaltelephone companies which permit the carriage of the Hallmark Channel and MovieChannel and are negotiating with others. We expect that subscribers to these telephone services will in largepart be customers previously served by existing cable television companies andsatellite television companies.  To date,subscribers and revenues through telephone companies have been insignificant.

 

Three factors havecontributed to the ratings improvements of the Channel: acquired series andmovies, original productions and marketing. Acquired series such as *Perry Mason*, *Walker, Texas Ranger* and *M*A*S*H* haveconsistently delivered strong ratings across all day-parts.  Original productions are our most highprofile programs and generate the channel’s highest ratings.  Original productions are significant inhelping our distribution and advertising sales teams sell the channel.Substantially, all of our original programming is provided by RHIEntertainment.

 

To continue the ratingsgrowth and enhance the demographics of our viewers, the Hallmark Channel mustcontinue to invest in programming and marketing.  For the Hallmark Channel to continue toincrease its attractiveness to distributors and advertisers, it has to increaseits ratings and draw a younger more upscale audience, which is generally moreattractive to advertisers.

 

Delivering strong ratingsgrowth to larger audiences has made it possible for our advertising sales togrow rapidly over the last few years.  Toadvertisers, the Hallmark Channel offers a strong brand, positive environmentand family friendly programming with a successful growth pattern.  These characteristics have enabled thechannel to sell to advertisers in the packaged goods and pharmaceuticalindustries.  The next step for theHallmark Channel will be to deliver the younger more upscale audience needed togain advertisers from the more lucrative financial services and automotiveindustries.

 

**Strategic Alternatives for the Company**

 

The Company announced on August 18, 2005, that itsBoard of Directors authorized the Company to explore strategic alternatives forthe Company, including a potential sale of the Company to a third party.  In support of this initiative, a SpecialCommittee of independent directors of the Board of Directors was formed tooversee the process. On April 17, 2006, the Company announced that, afterextensive review of various strategic alternatives, the Board of Directors hasdecided to terminate this process and fully commit the Company’s resources tocontinuing to operate its channels.   TheCompany will continue to explore ways in which it can improve its capitalstructure.

 

**InternationalBusiness**

 

Please see Note 1in Item 1 — Sale of the International Business of Notes to Unaudited CondensedConsolidated Financial Statements in this Report.

 

**Revenue from Continuing Operations**

 

*Our revenue consists primarily of subscriber fees, advertising and filmasset license fees.*

* *

*31*

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* *

*Subscriber Fees*

* *

Subscriber fees are generallypayable to us on a per subscriber basis by pay television distributors for theright to carry our channels. Generally, we pay certain television distributorsup-front subscriber acquisition fees to carry our channel. Subscriber acquisition fees that we pay are capitalized and amortized over thecontractual term of the applicable distribution agreement as a reduction insubscriber fee revenue. If the amortization expense exceeds the revenuerecognized on a per distributor basis, the excess amortization is included as acomponent of cost of services. At the time we sign a distribution agreement, weevaluate the recoverability of the costs we incur against the incrementalrevenue directly and indirectly associated with each agreement.

 

Rates we receive per subscriber vary according to:

 

                                                •              the level of sophistication and degree of competitionin the market;

 

                                                •              the relative position in the market of the distributorand the popularity of the channel;

 

                                                •              the packaging arrangements for the channel; and

 

                                                •              other commercial terms and length of the contract term.

 

We are in continuous negotiations with ourexisting distributors to increase our subscriber base in order to enhance ouradvertising results. We are often subject to requests by distributors to paysubscriber acquisition fees for additional subscribers or to waive or acceptlower subscriber fees if certain numbers of additional subscribers areprovided. We also may help fund the distributors’ efforts to market ourchannels or we may permit distributors to offer limited promotional periodswithout payment of subscriber fees. As we continue our efforts to addsubscribers, our domestic subscriber revenue will continue to be negatively affectedby subscriber acquisition fee amortization, waiver of subscriber fees and bulkdiscounts resulting from the attainment of certain subscriber levels; however,we believe that as a result of these measures, our subscriber counts willincrease which in turn will allow us to attract additional advertisers andcommand higher advertising rates.

 

Our channel is usually offered as one of a numberof channels on either a basic tier or part of other program packages and is notgenerally offered on a stand-alone basis. Thus, while a cable orsatellite customer may subscribe and unsubscribe to the tiers and programpackages in which our channel is placed, these customers do not subscribe andunsubscribe to our channel alone.  We arenot provided with information from the distributors on their overall subscriberchurn and in what manner their churn rates affect our subscriber counts;instead, we are provided information on the total number of subscribers whoreceive the Hallmark Channel.

 

Our subscriber count depends on the number ofdistributors carrying the Hallmark Channel and the size of such distributors aswell as the program tiers on which our channel is carried by thesedistributors. From time to time, we experience decreases in the number ofsubscribers as promotional periods end, or as a distributor arrangement isamended or terminated by us or the distributor. Changes to distributionarrangements in the first quarter of 2006 have not been significant. Managementanalyzes the estimated effect each new or amended distribution agreement willhave on revenues and costs. Based upon these analyses, management endeavors toachieve a fair combination of subscriber commitments and subscriber acquisitionfees with each of our domestic distributors.

 

#### A*dvertising*

Advertising sales generally are made on the basisof a price per advertising spot or per unit of audience measurement (forexample, a ratings point). Thus, our advertising revenues are heavily dependenton the viewership of our channel.

 

32

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Our advertising rates are generally calculated onthe basis of an agreed upon price per unit of audience measurement in returnfor a guaranteed commitment by the advertiser. We commit to provide advertiserscertain rating levels in connection with their advertising. Revenue is recordednet of estimated delivery shortfalls, which are usually settled by providingthe advertiser additional advertising time. Advertising rates also vary by timeof year due to seasonal changes in television viewership.

 

*Film Asset License Fees*

 

Crown Media Distribution generates revenue from the filmassets by granting licenses to exhibit the films to third parties in the UnitedStates We are also using the films as programming for the Hallmark Channel andthe Hallmark Movie Channel. Customers for our film assets consist of othertelevision channels, home video distributors and brokers who resell rights toour film assets. License fees for our film assets are generally negotiatedbased, among other things, upon the size of the potential audience who will beviewing the programming. The marketfor our film library is typically seasonal, with over half of the annual salesoccurring in the fourth quarter.  Thisseasonality is generally due to the timing of our customers’ program schedulingactivities.

 

**Cost of Services**

 

Our cost of servicesconsists primarily of program license fees, amortization of our film assets;subscriber acquisition fee expense; the cost of signal distribution;administration, distribution and other exploitation of our film assets; and thecost of promotional segments that are aired between programs. We expect cost ofservices to continue to increase in the future as we expand our existingmarkets and third party programming to support our advertising strategy.

 

**Critical Accounting Policies, Judgmentsand Estimates**

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresCrown Media Holdings to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

 

Forfurther information regarding our critical accounting policies, judgments andestimates, please see the Notes to Unaudited Consolidated Financial Statementscontained in this Report and “Critical Accounting Policies, Judgments andEstimates” of the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2005, filed with the SEC. These policies, judgmentsand estimates concern, among other things, the film assets, allowance fordoubtful accounts, program license fees, subscriber acquisition fees,long-lived assets, revenue recognition and stock-based compensation.

 

**Effects of Transactions with Related andCertain Other Parties**

 

In 2006 and in prior years, we entered into a number ofsignificant transactions with Hallmark Cards and its subsidiaries. Thesetransactions include, among other things, programming, trademark licenses,administrative services, a line of credit, a tax sharing agreement, theissuance of four promissory notes and a waiver agreement. For information regarding such transactions andtransactions with other related parties, please see “Effects of Transactionswith Related and Certain Other Parties” of the Company’s Annual Report on Form10-K for the year ended December 31, 2005, filed with the SEC and Note 7of Notes to Unaudited Condensed Consolidated Financial Statements in Item 1 ofthis Report.

 

## **SelectedHistorical Consolidated Financial Data of Crown Media Holdings**

 

In the table below, we provide selected historicalconsolidated financial and other data of Crown Media Holdings and itssubsidiaries. The following selected consolidated statement of operations datafor three months ended March 31, 2005 and 2006, are derived from the unauditedfinancial statements of Crown Media Holdings and its 

 

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subsidiaries. This datashould be read together with the consolidated financial statements and relatednotes included elsewhere in this Form 10-Q.

 
| ** **                                                    | ** ** | **Three Months Ended March 31,** | ** ** | **2006 vs.** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|--------------|------------|
| ** **                                                    | ** ** | **2005**                         | ** ** | **2006**     | ** ** | **2005** | ** ** |
| Revenues:                                                     |       |                             |       |         |       |   |   |
| Subscriber fees                                               |       | $                                | 4,610      |         | $          | 6,232 |   | 35 | % |
| Advertising                                                   |       | 33,876                           |       | 38,393       |       | 13 | % |
| Film asset license fees                                       |       | 2,083                            |       | 270          |       | -87 | % |
| Sublicense fees and other revenue                             |       | —                           |       | 78           |       | 100 | % |
| Total revenues                                                |       | 40,569                           |       | 44,973       |       | 11 | % |
| Cost of Services:                                             |       |                             |       |         |       |   |   |
| Programming costs                                             |       | 28,022                           |       | 33,593       |       | 20 | % |
| Amortization of film assets                                   |       | 5,681                            |       | 8,864        |       | 56 | % |
| Subscriber acquisition fee amortization                       |       | 9,508                            |       | 7,790        |       | -18 | % |
| Operating costs                                               |       | 1,796                            |       | 4,130        |       | 130 | % |
| Total cost of services                                        |       | 45,007                           |       | 54,377       |       | 21 | % |
| Selling, general and administrative expense                   |       | 13,502                           |       | 9,909        |       | -27 | % |
| Marketing expense                                             |       | 9,830                            |       | 4,257        |       | -57 | % |
| Loss from continuing operations  before interest expense |       | (27,770                          | )          | (23,570      | )          | -15 | % |
| Interest expense                                              |       | (16,896                          | )          | (21,703      | )          | 28 | % |
| Loss from continuing operations                               |       | (44,666                          | )          | (45,273      | )          | 1 | % |
| Loss from discontinued operations                             |       | (6,241                           | )          | —       |       | -100 | % |
| Loss on sale from discontinued operations                     |       | —                           |       | 162          |       | 100 | % |
| Cumulative effect of change in accounting principle           |       | —                           |       | (2,099       | )          | 100 | % |
| Net loss                                                      |       | $                                | (50,907    | )            | $          | (47,210 | ) | -7 | % |
|                                                          |       |                             |       |         |       |   |   |
| **Other Data:**                                               | ** ** | ** **                       | ** ** | ** **   | ** ** | ** ** | ** ** |
| Net cash used in operating activities                         |       | $                                | (12,859    | )            | $          | (20,360 | ) | 58 | % |
| Capital expenditures                                          |       | $                                | (248       | )            | $          | (3 | ) | -99 | % |
| Net cash provided by financing activities                     |       | $                                | 21,243     |         | $          | 14,966 |   | -30 | % |
| Net cash used in discontinued operations                      |       | $                                | (5,492     | )            | $          | — |   | -100 | % |
| Total domestic day household ratings (1)(3)                   |       | 0.705                            |       | 0.742        |       | 5 | % |
| Total domestic primetime household ratings (2)(3)             |       | 0.962                            |       | 1.121        |       | 17 | % |
| Subscribers at period end                                     |       | 67,716                           |       | 71,852       |       | 6 | % |

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(1) Total day is the time period measured from the time each day thebroadcast of commercially sponsored programming commences to the time suchcommercially sponsored programming ends.

(2) Primetime is defined as 8:00 - 11:00 P.M. in the United States.

(3) These Nielsen ratings are for the time period January 1 throughMarch 31.

 

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### ***Results ofOperations***

#### *Three Months Ended March 31, 2005 Compared to ThreeMonths Ended March 31, 2006*

*Revenue.*

 

 Our revenue from continuing operations, whichis comprised of subscriber fees, advertising and film asset license fees,increased 11% to $45.0 million for the three months ended March 31, 2006. Our 35% increase to $6.2 million in subscriber fee revenue for the threemonths ended March 31, 2006, was a result of the expiration of free carriageperiods for certain of our domestic distributors. Many of the distributiondeals we have require us to provide a period of free carriage to the cableoperator. Subscriber acquisition fee expense recorded as a reduction of revenuewas $2.2 million for the three months ended March 31, 2006, and $3.2 millionfor the comparable period in 2005. Subscribers have increased as a result ofpreviously amended distribution agreements in the United States, which providedfor incentives for growth in distribution. The ability to increase oursubscriber base is important both in terms of growing our subscriber revenueand our advertising sales.

 

The increase in advertising revenue to $38.4 million forthe three months ended March 31, 2006, compared to $33.9 million for the threemonths ended March 31, 2005, reflects the growth in domestic subscribers, anincrease in household primetime ratings, and an increase in advertising rates.As we continue to grow distribution and ratings, we are able to attractadditional advertisers to our domestic Channel, which generally puts upwardpressure on advertising rates. The number of our advertisers increased from 425at March 31, 2005, to 427 at March 31, 2006. Generally, as we have expanded ourdomestic subscribers and provided higher rated programming, our advertisingrevenues have increased. The three factors noted above, subscriber universe,ratings and advertising rates are the three critical drivers of advertisingsales. We anticipate growth across each of these factors to continue.

 

Among the 65 ad-supported cable channels in the UnitedStates market, the Hallmark Channel ranked10th in totalday with a 0.742 household rating for the first quarter of 2006 and 10thfor primetime with a 1.121 household rating for the same quarter based onNielsen ratings. This ratings performance is significant, particularly becausethe Hallmark Channel is not a fully distributed network. Most of the channelsthat rate above the Hallmark Channel have higher levels of distribution.

 

Revenue from the sale of ourfilm assets totaled $270,000 for the three months ended March 31, 2006, compared with $2.1million for the comparable period in 2005.  We had minimal library salesin the first quarter of 2006 and did not enter into any agreements in thatquarter. Generally, our library sales are condensed in the second half of theyear as this coincides with our customers scheduling of the upcomingprogramming schedules.

 

*Cost ofservices. *Cost ofservices as a percent of revenue increased to 121% in 2006, as compared to 111%in 2005. This increase was primarily due to the changes in operating expensesexplained below.

 

Total programming costs forthe three months ended March 31, 2006, increased 20% due to our focus on retaining and acquiring higher quality seriesprogramming and the related amortization. The $3.2 million increase inamortization of film assets was primarily due to an increase in the internaluse of the library assets by the Hallmark Movie Channel for the three monthsended March 31, 2006, substantially offset by the reduction in third partylicenses of library assets.

 

Asnoted above, the Company amended distribution agreements with multiple systemoperators in prior periods. Generally, our distribution agreements require theCompany to pay subscriber acquisition fees to distributors for additionalsubscribers, which the Company amortizes over the remaining life of thedistribution agreement. As we fully amortized certain of our agreementswith our domestic distributors, oursubscriber acquisition fee amortization expense for the period ended March 31,2006, as compared to the prior year period, decreased 18%.

 

The Company’s bad debt recovery was $946,000 for thethree months ended March 31, 2005, as compared to the Company’s bad debtexpense of $916,000 for the three months ended March 31, 2006. Additionally,playback, transponder and uplink expense increased $618,000 quarter overquarter.

 

*Selling,general and administrative expense.* Our selling, general and administrativeexpense decreased 27% primarily due to a compensation credit associated withthe decline in our stock price and the related obligation to purchaserestricted stock units partially offset by increases in consulting expenses andaudit fees associated with our execution of requirements under Sarbanes-Oxley.With the implementation of our cost reduction plans, we intend that selling,general and administrative expenses will continue to decrease during 2006 whencompared to 2005.

 

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*Marketing expense. *Our marketing expensedecreased 57% primarily due to the elimination of the Mystery Movie marketingcampaign for the Hallmark Channel in the first quarter of 2006 as compared tothe first quarter of 2005. With the implementation of our cost reduction plan,we expect that marketing expense during 2006 will continue to decrease whencompared to 2005.

 

*Interestexpense. *Interest expense increased for the three months endedMarch 31, 2006, compared to March 31, 2005, by $4.8 million.  This increase was primarily due to the $2.5million interest on our $132.8 million note payable to Hallmark Cardsaffiliates commencing October 1, 2005. This increase was also due to intereston our $400.0 million senior unsecured note payable commencing August 5, 2003,which involves interest paid on compounded amounts and was $12.2 million forthe quarter ended March 31, 2006, and $11.7 million for the quarter ended March31, 2005. Additionally, interest expense payable to HC Crown, which formerlywas payable to the Company’s bank syndicate and resulted from a reduction inthe interest rate and commitment fee payable to the Company’s bank syndicate inAmendment No. 8 to the Company’s credit facility, was $362,000 and $1.1 millionfor the three months ended March 31, 2005 and 2006, respectively.

 

*Loss fromContinuing Operations. *Loss fromoperations for the three months ended March 31, 2006, was $45.3 million. Lossfrom continuing operations for the three months ended March 31, 2005, was $44.7million. Our loss from continuing operations increased due to the factors notedabove.

 

*Loss fromDiscontinued Operations. *Loss fromdiscontinued operations for the three months ended March 31, 2005, was $6.2million as compared to $0 for the three months ended March 31, 2006. Loss fromdiscontinued operations decreased because the Company sold the internationalbusiness on April 26, 2005.

 

*Cumulative effect of change in accountingprinciple.  *On January 1,2006, we adopted SFAS 123R. The totalcompensation cost related to performance RSUs granted under the Plan net ofestimated forfeitures was $2.1 million, which was recorded as a cumulativecatch-up adjustment during the three months ended March 31, 2006. Under prioraccounting treatment, the performance RSUs were not classified as a liabilityas it was deemed improbable that these RSUs would settle based upon theperformance of our Class A common stock.

 

## **Liquidity andCapital Resources**

 

Cash used in operating activities from continuingoperations was $12.9 million and $20.4 million for the three months ended March31, 2005 and 2006. During the first quarter of 2006, the Company made paymentsof $8.0 million for subscriber acquisition fees and $7.4 million for licensefees payable to RHI Entertainment as compared to payments of $3.9 million and$0 for the same items during first quarter of 2005. As RHI Entertainment is nolonger a related party, the Company is required to make payments under the termsof the contract.

 

Cash used in investingactivities was $248,000 and $4.0 million for the three months ended March 31,2005 and 2006, respectively.  Thisincrease is due to payments to the buyer of the international business during2006. The Company sold the international business on April 26, 2005, andwill continue to make payments to the buyer of the international business inaccordance with the sale agreement.

 

Cash provided by financing activities was $21.2 millionand $15.0 million for the three months ended March 31, 2005 and 2006,respectively. During the quarters ending March 31, 2005 and 2006, we receivedproceeds of $21.4 million and $5.0 million, respectively, from our tax sharingagreement with Hallmark Cards. We borrowed $10.0 million under our creditfacility to cover the cash we used in operating and investing activities duringthe first quarter of 2006.

 

Cashused in discontinued operations was $5.5 million and $0 for the three monthsended March 31, 2005 and 2006, respectively. Cash was used primarily to fund operating expenditures related to lossesfrom discontinued operations of $6.2 million for the three months ended March31, 2005. The significant decrease in cash used by discontinued operations is because theCompany sold the international business on April 26, 2005.

 

The following table aggregates all of our contractualcommitments as of March 31, 2006.

 

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| ** **                                                                                     | ** ** | **Scheduled Payments by Period** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| **Contractual Obligations**                                                                    | ** ** | **Total**                        | ** ** | **Less than 1 Year** | ** ** | **2-3 Years** | ** ** | **4-5 Years** | ** ** | **After 5 Years** | ** ** |
| Credit facility and interest payable                                                           |       | $                                | 220.2      |   | $ | 0.2 |   | $ | 220.0 |   | $ | — |   | $ | — |   |
| Company obligated mandatorily redeemable  preferred interest, including accretion         |       | 25.0                             |       | — |   | 5.0 |   | 20.0 |   | — |   |
| HC Crown line of credit and interest payable                                                   |       | 88.0                             |       | — |   | 88.0 |   | — |   | — |   |
| Senior unsecured note to HC Crown, including accretion                                         |       | 596.6                            |       | — |   | — |   | — |   | 596.6 |   |
| Note payable to Hallmark Cards affiliate                                                       |       | 137.7                            |       | — |   | 137.7 |   | — |   | — |   |
| Capital lease obligations                                                                      |       | 16.5                             |       | 0.6 |   | 1.4 |   | 1.7 |   | 12.8 |   |
| Operating leases (off-balance sheet commitments)                                               |       | 12.9                             |       | 4.0 |   | 5.9 |   | 2.6 |   | 0.4 |   |
| Other obligations                                                                              |       |                             |       |   |   |   |   |   |   |   |   |
| Program license fees payable to non-affiliates                                                 |       | 222.4                            |       | 51.2 |   | 100.8 |   | 60.1 |   | 10.3 |   |
| Program license fees payable to affiliates                                                     |       | 12.0                             |       | 11.5 |   | 0.5 |   | — |   | — |   |
| Program license fees payable for non-affiliate future windows  (off-balance sheet commitments) |       | 193.4                            |       | 66.9 |   | 78.3 |   | 34.7 |   | 13.5 |   |
| Program license fees payable for affiliate future windows  (off-balance sheet commitments)     |       | 25.2                             |       | 22.7 |   | 2.5 |   | — |   | — |   |
| Subscriber acquisition fees                                                                    |       | 4.2                              |       | 4.2 |   | — |   | — |   | — |   |
| Deferred compensation and interest                                                             |       | 2.9                              |       | — |   | 2.9 |   | — |   | — |   |
| Payable to buyer of international business                                                     |       | 14.3                             |       | 6.7 |   | 6.7 |   | 0.9 |   | — |   |
| Other payables to buyer of international business                                              |       | 6.9                              |       | 1.0 |   | 2.0 |   | 1.6 |   | 2.3 |   |
| Payable to Hallmark Cards affiliates                                                           |       | 70.6                             |       | — |   | 70.6 |   | — |   | — |   |
| Total Contractual Cash Obligations                                                             |       | $                                | 1,648.8    |   | $ | 169.0 |   | $ | 722.3 |   | $ | 121.6 |   | $ | 635.9 |   |

 

 

*Cash Flows*

 

As of March 31, 2006, the Companyhad $6.5 million in cash and cash equivalents on hand. As of March 31, 2006,the Company had borrowed $220.0 million from a $240.0 million revolving bankcredit, which matures May 31, 2007.

 

The Company’s principalsources of funds are currently available cash on hand, cash generated byoperations, tax sharing payments from Hallmark Cards and amounts availableunder the Company’s revolving bank credit facility. Payments under the taxsharing agreement are affected by Hallmark Cards’ tax position and its abilityto utilize the Company’s tax losses.  TheCompany received $5.0 million in tax sharing payments in January 2006 and doesnot currently expect to receive any additional cash payments during 2006. TheCompany currently has $20.0 million of unused revolving credit commitments.

 

The ability of theexisting sources of liquidity to be sufficient to fund the Company’soperations, depend upon the Company’s ability to achieve forecasts.  In particular, continued growth in subscriberrevenue and advertising revenue, as well as maintaining the cash flow fromlibrary sales, are required.  As aresult, any decline in the popularity of the Hallmark Channel, any significantfuture modifications to the Company’s distribution agreements, an economicdecline in the advertising market, an increase in program acquisition costs, anincrease in competition or other adverse operating conditions would impact theCompany’s liquidity and its ability to fund the current level ofoperations.  To the extent that theCompany requires additional capital and additional drawings on the bank creditfacility are either not available or insufficient, the Company would be forcedto seek additional funding from the issuance of debt or equity securities, asale of certain assets or from strategic transactions which provide capital.There can be no assurance that the Company would be able to secure additionalfinancing or complete any such transactions.

 

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The Company expects tocontinue making investments in programming, marketing and distribution duringthe next twelve months ending March 31, 2007. However, the Company’s liquidityposition has demanded that all areas of expenses, including programming,marketing and distribution be closely monitored and controlled.  In April, 2006, the Company commenced a costreduction program, including reducing the number of personnel and marketingactivities.  Management anticipates thatthese actions will result in approximately $10.0 to $13.0 million in annualcost reductions when compared to the 2005 year. The Company will also seek to sublicense certain of its programmingrights but expects that programming expenses and cost of services will increasewhen compared to these items for 2005.

 

The Company’s principal usesof funds for 2006 are expected to include the payment of 2005 and 2006operating expenses, accounts payable and accrued expenses, licensing ofprogramming, and interest under its bank credit facility.

 

The Company currentlybelieves that cash on hand, cash generated by operations, and availability onits bank credit facility, will be sufficient to fund the Company’s operationsand meet its liquidity needs through March 31, 2007.

 

The Company’s bank creditfacility will expire on May 31, 2007.   If the Company is not able toarrange for the extension, refinancing or replacement of the bank creditfacility prior to its maturity and the bank draws down on the irrevocableletter of credit provided by Hallmark Cards in support of the bank creditfacility, or alternatively Hallmark Cards purchases the interests of thelending banks, Hallmark Cards would have all obligations and the rights of thelending banks under the bank credit facility.  In that event, HallmarkCards could demand payment of outstanding amounts at any time.  It is theCompany’s intent to extend the bank credit facility upon its maturity, whichmight require continuation of a letter of credit from Hallmark Cards or othersteps by the Company.

 

Upon maturity of the credit facilityon May 31, 2007, the lending group led by JP Morgan Chase has the right toelect to forego the receipt of cash to pay the principal amount of the creditfacility in full, which is provided for under the terms of an irrevocableletter of credit provided by Hallmark Cards described, but instead can elect to initiate a process to foreclose onthe Company’s assets. Such foreclosure proceedings, which we view as aremote possibility, would affect our ability to continue our operations. Priorto any such possible foreclosure proceedings, however, the Company wouldconsider various alternatives as indicated below.  In the alternative, the Company has the rightto cause Hallmark Cards, pursuant to the terms of the Waiver Agreement, toexercise its option to purchase all of the outstanding indebtedness under theCredit Agreement and the credit facility would then be subject to HallmarkCards agreement not to demand payment prior to May 31, 2007.

 

Due to the Company’sliquidity issues and its possible inability to meet its obligations when theycome due in May 2007 under the Waiver Agreement described below, the Companyanticipates that prior to May 31, 2007, it will be necessary to either extendor refinance (i) the bank credit facility and (ii) $678.0 million covered bythe promissory notes described below payable to affiliates of Hallmark Cards.As part of a combination of actions and in order to obtain additional funding,the Company may consider various alternatives, including refinancing the bankcredit facility, raising additional capital through the issuance of equity ordebt securities, a sale of certain assets or other strategic alternatives.

 

***Bank Credit Facility, HC Crown Loans, andTax Sharing Agreement***

 

For information regardingour Bank Credit Facility, HC Crown Loans and Tax Sharing Agreement, please see “BankCredit Facility, HC Crown Loans, and Tax Sharing Agreement” of the Company’sAnnual Report on Form 10-K for the year ended December 31, 2005, filed with theSEC and Notes 6, 7 and 8 of Notes to Unaudited Condensed ConsolidatedFinancial Statements in this Report.

 

## **Risk Factors and Forward-Looking Statements**

 

Thediscussion set forth in this Form 10-Q contains statements concerning potentialfuture events. Such forward-looking statements are based on assumptions byCrown Media Holdings management, as of the date of this Form 10-Q includingassumptions about risks and uncertainties faced by Crown Media Holdings.Readers can identify 

 

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these forward-looking statements by their use of such verbs as “expects,”“anticipates,” “believes,” or similar verbs or conjugations of such verbs. Ifany of management’s assumptions prove incorrect or should unanticipatedcircumstances arise, Crown Media Holdings’ actual results, levels of activity,performance, or achievements could materially differ from those anticipated bysuch forward-looking statements. Among the factors that could cause actualresults to differ materially are those discussed in this Report below and inthe Company’s filings with the Securities and Exchange Commission, includingthe Risk Factors stated in the Company’s Form 10-K Report for the year endedDecember 31, 2005. Such Risk Factors include among others:  Competition for distribution of channels,viewers, advertisers and the acquisition of programming; fluctuations in theavailability of programming; fluctuations in demand for programming which weair on our channels; our ability to address our liquidity needs; our incurrenceof losses; and our substantial indebtedness affecting our financial conditionand results.

 

Thereare stated below certain Risk Factors which contain significant changes fromthose stated in the Company’s Form 10-K Report for the year ended December 31,2005. Crown Media Holdings will not update any forward-looking statementscontained in this Form 10-K to reflect future events or developments.

 

If we do not successfullyaddress the risks described below and in our prior Reports mentioned above, ourbusiness, prospects, financial condition, results of operations or cash flowcould be materially adversely affected. The trading price of our Class A commonstock could decline because of any of these risks.

##  

**Risks Relating to Our Business**

 

***Our liquidity is dependent on externalfunds.***

 

Because we currently operate at a loss, we may have anegative cash flow and any unanticipated significant expense or any developmentthat hampers our growth in revenue or decreases any of our revenue, wouldresult in the need for additional external funds in order to continueoperations. We have no arrangements for any such additional externalfinancings, whether debt or equity, and are not certain whether any such newexternal financing would be available on acceptable terms. Any new debt financingwould require the cooperation and agreement of existing lenders.

 

Further, as discussed in this report under “Liquidityand Capital Resources” above, we need to extend, refinance or replace our bankline of credit on or prior to May 31, 2007, or to extend or replace borrowingsfrom Hallmark Cards by May 31, 2007, that would result from the banks drawingupon the irrevocable letter of credit supporting the bank credit facility, andto extend or refinance license fees and payables to Hallmark Cards and itssubsidiaries on or prior to May 31, 2007.

 

Upon maturity of the creditfacility on May 31, 2007, the lending group led by JP Morgan Chase has theright to elect to forego the receipt of cash to pay the principal amount of thecredit facility in full, which is provided for under the terms of anirrevocable letter of credit provided by Hallmark Cards, but instead can electto initiate a process to foreclose on the Company’s assets. Such foreclosureproceedings, which weview as a remote possibility, could affectour ability to continue our operations. Prior to any such possible foreclosureproceedings, the Company would consider various alternatives as indicatedbelow.  The Company could alsocause Hallmark Cards, pursuant to the terms of the Waiver Agreement, toexercise its option to purchase all of the outstanding indebtedness under thecredit agreement and the credit facility would then be subject to HallmarkCards agreement not to demand payment prior to May 31, 2007.

 

***We could lose the right to use the name “Hallmark”because we have limited-duration license agreements, which could harm ourbusiness.***

 

We license the name “Hallmark” from Hallmark Licensing,Inc., a subsidiary of Hallmark Cards, for use in the names of our channels.This license will expire on September 1, 2007. If Hallmark Cards determines notto renew the trademark license agreements for any reason, including failure tocomply with Hallmark Cards’ programming standards, we would be forced tosignificantly revise our business plan and operations, and could experience asignificant erosion of our subscriber base and advertising revenue,particularly in the United States.

 

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### **AvailableInformation**

 

**We will make available free ofcharge through our website, www.hallmarkchannel.com, the Annual Report, ourquarterly reports on Form 10-Q, our current reports on Form 8-K, and amendmentsto such reports, as soon as reasonably practicable after we electronically fileor furnish such material with the Securities and Exchange Commission.**

 

**Additionally, we will makeavailable, free of charge upon request, a copy of our Code of Business Conductand Ethics, which is applicable to all of our employees, including our seniorfinancial officers. Requests for a copy of this code should be addressed to theGeneral Counsel at 12700 Ventura Boulevard, Studio City, California  91604.**

 

**Item 3.  *Quantitative andQualitative Disclosures About Market Risk***

 

We only invest in instruments that meet high credit andquality standards, as specified in our investment policy guidelines. Theseinstruments, like all fixed income instruments, are subject to interest raterisk. The fixed income portfolio will decline in value if there is an increasein interest rates. If market interest rates were to increase immediately anduniformly by 10% from levels as of March 31, 2006, the decline of the fairvalue of the fixed income portfolio would not be material.

 

As of March 31, 2006, our cash, cash equivalents andshort-term investments had a fair value of $6.5 million, which were invested incash and short-term commercial paper. The primary purpose of these investingactivities has been to preserve principal until the cash is required to fundoperations. Consequently, the size of this portfolio fluctuates significantlyas cash is provided by and used in our business.

 

The value of certain investments in this portfolio canbe impacted by the risk of adverse changes in securities and economic marketsand interest rate fluctuations. At March 31, 2006, all of our investments inthis category were in fixed rate instruments or money market type accounts. Adecrease in interest rates has the effect of reducing our future annualinterest income from this portfolio, since funds would be reinvested at lowerrates as the instruments mature. Over time, any net percentage decrease in ourinterest rates could be reflected in a corresponding net percentage decrease inour interest income. For the three months ended March 31, 2006, the impact ofinterest rate fluctuations, changed business prospects and all other factorsdid not have a material impact on the fair value of this portfolio, or on ourincome derived from this portfolio.

 

We have not used derivative financial instruments forspeculative purposes. As of March 31, 2005, we are not hedged or otherwiseprotected against risks associated with any of our investing or financingactivities.

 

***We are exposed to market risk.***

 

We are exposed to market risk, including changes tointerest rates. To reduce the volatility relating to these exposures, we mayenter into various derivative investment transactions in the near term pursuantto our investment and risk management policies and procedures in areas such ashedging and counterparty exposure practices. We have not and will not usederivatives for speculative purposes.

 

Though we intend to use risk management controlpolicies, there will be inherent risks that may only be partially offset by ourhedging programs should there be any unfavorable movements in interest rates orequity investment prices.

 

***Our interest income and expense is subjectto fluctuations in interest rates.***

 

Our material interest bearing assets consisted of cashequivalents and short-term investments. The balance of our interest bearingassets was $6.5 million, or less than 1% of total assets, as of March 31, 2006.Our material liabilities subject to interest rate risk consisted of capitallease obligations, our bank credit facility, our line of credit with HC Crown,our note payable to HC Crown, and our note payable to a Hallmark Cardsaffiliate. The balance of those 

 

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liabilities was $1.1billion, or 76% of total liabilities, as of March 31, 2006. Net interestexpense for the three months ended March 31, 2006, was $21.7 million, 48%, ofour total revenue. Our net interest expense of these liabilities is sensitiveto changes in the general level of interest rates, primarily U.S. and LIBORinterest rates. In this regard, changes in U.S. and LIBOR interest rates affectthe fair value of interest bearing liabilities.

 

**Item 4.  *Controls and Procedures.***

 

***a.  Disclosure Controls and Procedures***

 

Ourmanagement  evaluated, with theparticipation of our Chief Executive Officer and our Chief Financial Officer,the effectiveness of our disclosure controls and procedures as of the end ofthe period covered by this Quarterly Report on Form 10-Q. Based on thisevaluation, our Chief Executive Officer and our Chief Financial Officer haveconcluded that our disclosure controls and procedures were not effective as ofthe end of the period covered by this Quarterly Report on Form 10-Q because wehave not yet completed the remediation of the material weaknesses discussed inour Annual Report on Form 10-K for the year ended December 31, 2005 (“2005 Form10-K”).

 

***b.  Changes in Internal Control over FinancialReporting***

 

Therewere no changes in the Company’s internal control over financial reporting thatoccurred during the quarter ended March 31, 2006, that materially affected, orare reasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

 

***c.  Remediation of Weakness in Internal Controlover Financial Reporting***

 

Asdiscussed in more detail in our 2005 Form 10-K, as of December 31, 2005, we didnot maintain effective controls over  (a)the review of the consolidated statement of cash flows; (b) the underlyinginformation supporting the amounts included in the Company’s annual and interimconsolidated financial statements; and (c) the information available subsequentto the financial reporting close process for appropriate recognition anddisclosure in the Company’s annual and interim consolidated financialstatements. In addition, the Company’s controls over access to the general ledgerand certain accounting application systems were not designed effectively toprovide adequate segregation of duties. Specifically, the following design deficiencies were identified: (a)certain members of accounting management had the ability to both initiate andapprove journal entries; (b) certain members of accounting management had theability to initiate and approve the payment of invoices and sign checks; and(c) a member of accounting management had access to an accounting applicationsystem and the ability to change information included therein without reviewand approval.

 

Inorder to identify controls to address certain of the material weaknessesdiscussed above, management is in the process of evaluating existing policiesand controls related to (a) the review of the consolidated statement of cashflows; (b) the underlying information supporting the amounts included in theCompany’s annual and interim consolidated financial statements; and (c) theinformation available subsequent to the financial reporting close process forappropriate recognition and disclosure in the Company’s annual and interimconsolidated financial statements.

 

Managementhas implemented, or plans to implement, the measures described below toremediate certain of the material weaknesses described above:

 

•                  Management’s Ability to BothInitiate and Approve Journal Entries — We have designed controls which wereimplemented in the second quarter of 2006 to ensure that no personnel of theCompany can both initiate and approve journal entries.

 

•                  Management’s Ability to BothInitiate, Approve the Payment of Invoices and Sign Checks - We have designedcontrols which were implemented in the second quarter of 2006 to ensure that nopersonnel of the Company can both initiate and approve the payment of invoicesand sign checks.

 

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•                  Management’s Ability toChange Accounting Applications without Review or Approval - We have designedcontrols which were implemented in the second quarter of 2006 to ensure that nopersonnel of the Company can make changes to accounting applications withoutappropriate review and approval.

 

 

Theaforementioned material weaknesses will not be considered remediated until newprocesses are fully implemented, operate for a reasonable period of time, aretested by management, and we conclude that they are operating effectively. Weanticipate that we will report in our Quarterly Report on Form 10-Q for thesecond quarter of 2006 that material weaknesses in our internal control overfinancial reporting continue to exist and that our disclosure controls andprocedures are not effective as of June 30, 2006.

 

Weare fully committed to remediating our material weaknesses in internal controlover financial reporting, and we believe we are taking the appropriate steps toproperly address these issues during 2006. However, the remediation of thedesign of the deficient controls and the associated testing efforts are notcomplete, and may require further remediation.

 

**PART II.  OTHER INFORMATION**

 

**Item1A.  *Risk Factors***

 

See“Risks Relating to Our Business” in Part I, Item 2 above for information onchanges to risk factors.

 

**Item5.*  OtherInformation.***

 

Chris Moseley, ExecutiveVice President, Chief Marketing Officer of the Company left the Company at theend of April of 2006.  On April 12, 2006,the Company and Ms. Moseley executed a severance agreement to a payment ofsalary for the remainder of the term of her employment agreement and one year’ssalary, which amount to $923,556 and a payment of $152,052, which represents apayment of a pro rata bonus, unused vacation time and the remaining carallowance provided for in her employment agreement.  Additionally, Ms. Moseley’s severanceagreement also provides for a payment or reimbursement of COBRA coveragethrough July 15, 2007, a relocation cost of $35,000 if Ms. Moseley relocatesfrom the Los Angeles area prior to October 2006 and settlement in June 2006 ofrestricted stock units which will vest in May 2006.

 

**Item 6.  *Exhibits***

 

**INDEX TO EXHIBITS**

 
| **Exhibit Number** |   | **Exhibit  Title**                                                                                                                                                                                                         |
|--------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                |   | Amended and Restated Certificate of Incorporation  (previously filed as Exhibit 3.1 to our Registration Statement on Form S-1/A  (Amendment No. 2), Commission File No. 333-95573, and incorporated herein by  reference). |
| 3.2                |   | Amendment to the Amended and Restated Certificate of  Incorporation (previously filed as Exhibit 3.2 to our Quarterly Report on  Form 10-Q filed on July 31, 2001 and incorporated herein by reference).                   |
| 3.3                |   | Amended and Restated By-Laws (previously filed as  Exhibit 3.2 to our Registration Statement on Form S-1/A (Amendment No. 3),  Commission File No. 333-95573, and incorporated herein by reference).                       |
| 10.1               |   | $70,414,087  Promissory Note, dated March 21, 2006, made  by Crown Media Holdings, Inc. in favor of Hallmark Entertainment Holdings,  Inc.                                                                                 |
| 10.2               |   | Trademark License Extension Agreement (Hallmark Movie  Channel), dated as of April 10, 2006, by and between Hallmark Licensing, Inc.  and Crown Media United States, LLC.                                                  |
| 10.3               |   | Trademark License Extension Agreement (Hallmark  Channel), dated as of April 10, 2006, by and between Hallmark Licensing, Inc.  and Crown Media United States, LLC.                                                        |

 

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| 10.4 |   | Letter  agreement, dated April 12, 2006, between Chris Moseley and Crown Media  Holdings, Inc.                                                                                                                                                                                                                     |
|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.5 |   | Amendment  No. 10, dated as of April 28, 2006, to  the Credit, Security, Guaranty and Pledge Agreement, dated as of August 31,  2001, among Crown Media Holdings, Inc. as Borrower, the Guarantors named  therein, the Lenders named therein and JPMorgan Chase Bank as Administrative  Agent and as Issuing Bank. |
| 10.6 |   | Letter Agreement, dated May 2, 2006, by and between Hallmark Cards,  Incorporated and Crown Media Holdings, Inc.                                                                                                                                                                                                   |
| 31.1 |   | Rule  13a-14(a) Certification executed by the Company’s President and Chief  Executive Officer.                                                                                                                                                                                                               |
| 31.2 |   | Rule  13a-14(a) Certification executed by the Company’s Executive Vice President  and Chief Financial Officer.                                                                                                                                                                                                |
| 32   |   | Section  1350 Certifications.                                                                                                                                                                                                                                                                                      |

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* Management contract or compensating plan or arrangement.

 

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**SIGNATURES**

 

 

Pursuant to the requirements of the Securities ExchangeAct of 1934, this report has been signed below by the following persons onbehalf of the registrant and in the capacities and on the dates indicated.

 

                                          CROWNMEDIA HOLDINGS, INC.

 
| **Signature** | ** **            | **Title** | ** **              | **Date** |
|---------------|-----------------------|-----------|-------------------------|----------|
|          |                  |      |                    |     |   |
| By:           | /s/ DAVID J. EVANS    |      | Director and Principal  |     | May 10, 2006 |
|          | David J. Evans        |      | Executive Officer       |     |   |
|          |                  |      |                    |     |   |
| By:           | /s/ WILLIAM J. ALIBER |      | Principal Financial and |     | May 10, 2006 |
|          | William J. Aliber     |      | Accounting Officer      |     |   |
|          |                  |      |                    |     |   |

 

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