Tableof Contents

 

 

 

**UNITED STATES SECURITIES 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 OF1934**

 

**For the quarterly period ended September 30,2010**

 

**or**

 

**o****         TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the transition period from                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 Identification No.) |
| Incorporation or Organization)  |       |                                 |

 

**12700 Ventura Boulevard,**

**Suite 200**

**Studio City, California  91604**

(Address of Principal Executive Offices and ZipCode)

 

**(818) 755-2400**

(Registrant’s Telephone Number, IncludingArea Code)

 

 

(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 1934during the preceding 12 months (or such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files).  Yes o  No o

 

Indicate by check mark whether the registrant is a largeaccelerated filer, an accelerated filer, a non-accelerated filer or a smallerreporting company.  See definition of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Checkone):

 

| Large accelerated filer o                     |   | Accelerated filer o         |
|-----------------------------------------------|--------|-----------------------------|
|                                          |   |                        |
| Non-accelerated filer x                       |   | Smaller reporting company o |
| (do not check if a smaller reporting company) |   |                        |

 

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 November 1, 2010, the number of shares of Class ACommon Stock, $.01 par value outstanding was 359,675,936.

 

 

 

----

Table of Contents

 

**TABLE OF CONTENTS**

 
| ** **       | ** **                                                                                                   | **Page** |
|------------------|--------------------------------------------------------------------------------------------------------------|----------|
| **PART I**  | **Financial Information**                                                                                    |     |
|             |                                                                                                         |     |
| Item  1          | Financial  Statements (Unaudited)                                                                            | 3        |
|             | CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES                                                             |     |
|             | Condensed Consolidated Balance Sheets — December 31,  2009 andSeptember 30, 2010  (Unaudited) | 3        |
|             | Condensed  Consolidated Statements of Operations (Unaudited)                                                 | 5        |
|             | - Three and  Nine Months Ended September 30, 2009 and 2010                                              |     |
|             | Condensed  Consolidated Statements of Cash Flows (Unaudited)                                                 | 6        |
|             | - Nine  Months Ended September 30, 2009 and 2010                                                        |     |
|             | Notes to Unaudited Condensed Consolidated Financial  Statements                                              | 7        |
|             |                                                                                                         |     |
| Item 2           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                  | 23       |
|             |                                                                                                         |     |
| Item 3           | Quantitative  and Qualitative Disclosures About Market Risk                                                  | 47       |
|             |                                                                                                         |     |
| Item 4           | Controls and  Procedures                                                                                     | 48       |
|             |                                                                                                         |     |
| **PART II** | **Other  Information**                                                                                       | 48       |
|             |                                                                                                         |     |
| Item 1           | Legal Proceedings                                                                                            | 48       |
|             |                                                                                                         |     |
| Item  6          | Exhibits                                                                                                     | 49       |
|             |                                                                                                         |     |
| Signatures       |                                                                                                         | 51       |

 

2

----

Table ofContents

 

*In this Form 10-Q the terms “CrownMedia Holdings” and the “Company” refer to Crown Media Holdings, Inc. and,unless the context requires otherwise, subsidiaries of Crown Media Holdingsthat operate or have operated our businesses including Crown Media UnitedStates, LLC (“Crown Media United States”). The term “common stock” refers toour Class A common stock and Class B common stock, unless the contextrequires otherwise.  As part of therecapitalization transactions described below, each outstanding share of Class Bcommon stock was reclassified as a share of Class A common stock and the Class Bcommon stock was eliminated.*

 

*The name Hallmark and other product or service names are trademarks orregistered trademarks of their owners.*

 

**PART I.FINANCIAL INFORMATION**

 

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

 

**CROWN MEDIAHOLDINGS, INC. AND SUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                 | ** ** | **As of December 31,** | ** ** | **As of September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                 | ** ** | **2009**                              | ** ** | **2010**                               | ** ** |
|                                                                                       |       |                                  |       |                                   |       |
| ASSETS                                                                                     |       |                                  |       |                                   |       |
|                                                                                       |       |                                  |       |                                   |       |
| Cash and cash equivalents                                                                  |       | $                                     | 10,456     |                                   | $          | 36,150 |   |
| Restricted cash                                                                            |       | —                                |       | 20,019                                 |       |
| Accounts receivable, less  allowance for doubtful accounts of  $476 and $224, respectively |       | 68,817                                |       | 62,978                                 |       |
| Program license fees                                                                       |       | 106,825                               |       | 98,690                                 |       |
| Prepaid program license fees                                                               |       | 1,778                                 |       | 10,727                                 |       |
| Prepaid and other assets                                                                   |       | 2,271                                 |       | 2,351                                  |       |
| Total current assets                                                                       |       | 190,147                               |       | 230,915                                |       |
|                                                                                       |       |                                  |       |                                   |       |
| Program license fees                                                                       |       | 178,332                               |       | 138,939                                |       |
| Property and equipment, net                                                                |       | 13,176                                |       | 12,522                                 |       |
| Goodwill                                                                                   |       | 314,033                               |       | 314,033                                |       |
| Prepaid and other assets                                                                   |       | 2,373                                 |       | 891                                    |       |
| Total assets                                                                               |       | $                                     | 698,061    |                                   | $          | 697,300 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

3

----

Table ofContents

 

**CROWN MEDIA HOLDINGS, INC.AND SUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATEDBALANCE SHEETS**

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

**(continued)**

 
| ** **                                                                                                                                                                                                                                    | ** ** | **As of December 31,** | ** ** | **As of September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                                                                                                                                    | ** ** | **2009**                              | ** ** | **2010**                               | ** ** |
| ** **                                                                                                                                                                                                                                    | ** ** | ** **                            | ** ** | ** **                             | ** ** |
| LIABILITIES  AND STOCKHOLDERS’ DEFICIT                                                                                                                                                                                                   |       |                                  |       |                                   |       |
|                                                                                                                                                                                                                                          |       |                                  |       |                                   |       |
| LIABILITIES:                                                                                                                                                                                                                                  |       |                                  |       |                                   |       |
| Accounts payable and accrued  liabilities                                                                                                                                                                                                     |       | $                                     | 19,642     |                                   | $          | 22,857 |   |
| Audience deficiency reserve  liability                                                                                                                                                                                                        |       | 17,872                                |       | 31,144                                 |       |
| License fees payable                                                                                                                                                                                                                          |       | 99,494                                |       | 94,047                                 |       |
| Payables to Hallmark Cards  affiliates                                                                                                                                                                                                        |       | 23,745                                |       | 5,543                                  |       |
| Credit facility and interest  payable                                                                                                                                                                                                         |       | 1,002                                 |       | —                                 |       |
| Notes and interest payable  to HCC                                                                                                                                                                                                            |       | 345,314                               |       | 45,350                                 |       |
| Company obligated  mandatorily redeemable preferred  interest                                                                                                                                                                                 |       | 22,902                                |       | 24,619                                 |       |
| Total current liabilities                                                                                                                                                                                                                     |       | 529,971                               |       | 223,560                                |       |
|                                                                                                                                                                                                                                          |       |                                  |       |                                   |       |
| Accrued liabilities                                                                                                                                                                                                                           |       | 24,484                                |       | 21,333                                 |       |
| License fees payable                                                                                                                                                                                                                          |       | 82,881                                |       | 44,016                                 |       |
| Notes and interest payable  to HCC                                                                                                                                                                                                            |       | —                                |       | 387,658                                |       |
| Senior secured note to HCC,  including accrued interest                                                                                                                                                                                       |       | 758,755                               |       | —                                 |       |
| Total liabilities                                                                                                                                                                                                                             |       | 1,396,091                             |       | 676,567                                |       |
|                                                                                                                                                                                                                                          |       |                                  |       |                                   |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                                                                                                |       |                                  |       |                                   |       |
|                                                                                                                                                                                                                                          |       |                                  |       |                                   |       |
| Redeemable preferred stock, $.01 par value; $1,000 liquidation preference;  10,000,000 and 1,000,000 shares authorized; 0  and 185,000 shares issued and outstanding as of December 31, 2009, and  September 30, 2010, respectively |       | —                                |       | 191,860                                |       |
|                                                                                                                                                                                                                                          |       |                                  |       |                                   |       |
| STOCKHOLDERS’ DEFICIT:                                                                                                                                                                                                                   |       |                                  |       |                                   |       |
| Class A common stock,  $.01 par value; 200,000,000 and 500,000,000 shares authorized; 74,117,654 and  359,675,936 shares issued and outstanding as of December 31, 2009, and  September 30, 2010, respectively                 |       | 741                                   |       | 3,597                                  |       |
| Class B common stock,  $.01 par value; 120,000,000 and 0 shares  authorized; 30,670,422 and 0 shares issued and outstanding as of  December 31, 2009, and September 30, 2010, respectively                                     |       | 307                                   |       | —                                 |       |
| Paid-in capital                                                                                                                                                                                                                               |       | 1,456,788                             |       | 1,993,390                              |       |
| Accumulated deficit                                                                                                                                                                                                                           |       | (2,155,866                            | )          | (2,168,114                             | )          |
| Total stockholders’ deficit                                                                                                                                                                                                              |       | (698,030                              | )          | (171,127                               | )          |
| Total liabilities and  stockholders’ deficit                                                                                                                                                                                             |       | $                                     | 698,061    |                                   | $          | 697,300 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

4

----

Tableof Contents

 

**CROWN MEDIA HOLDINGS, INC.AND SUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                                                                                                | ** ** | **Three Months Ended********September 30,** | ** ** | **Nine Months Ended********September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                                                | ** ** | **2009**                                                   | ** ** | **2010**                                                  | ** ** | **2009** | ** ** | **2010** | ** ** |
| Revenue:                                                                                                                  |       |                                                       |       |                                                      |       |   |   |   |   |
| Subscriber fees                                                                                                           |       | $                                                          | 15,998     |                                                      | $          | 13,973 |   | $ | 47,153 |   | $ | 46,839 |   |
| Advertising                                                                                                               |       | 46,296                                                     |       | 48,499                                                    |       | 153,177 |   | 149,427 |   |
| Advertising by Hallmark  Cards                                                                                            |       | 191                                                        |       | —                                                    |       | 525 |   | 208 |   |
| Other revenue                                                                                                             |       | 334                                                        |       | 48                                                        |       | 1,098 |   | 133 |   |
| Total revenue, net                                                                                                        |       | 62,819                                                     |       | 62,520                                                    |       | 201,953 |   | 196,607 |   |
| Cost of Services:                                                                                                         |       |                                                       |       |                                                      |       |   |   |   |   |
| Programming costs                                                                                                         |       |                                                       |       |                                                      |       |   |   |   |   |
| Hallmark Cards affiliates                                                                                                 |       | 315                                                        |       | 437                                                       |       | 914 |   | 1,274 |   |
| Non-affiliates                                                                                                            |       | 31,365                                                     |       | 30,809                                                    |       | 94,282 |   | 89,343 |   |
| Contract termination                                                                                                      |       | —                                                     |       | —                                                    |       | — |   | 103 |   |
| Other costs of services                                                                                                   |       | 3,405                                                      |       | 3,092                                                     |       | 11,905 |   | 8,399 |   |
| Total cost of services                                                                                                    |       | 35,085                                                     |       | 34,338                                                    |       | 107,101 |   | 99,119 |   |
| Selling, general and  administrative expense (exclusive of depreciation and amortization expense  shown separately below) |       | 12,208                                                     |       | 12,294                                                    |       | 35,000 |   | 36,581 |   |
| Marketing expense                                                                                                         |       | 339                                                        |       | 7,114                                                     |       | 5,956 |   | 8,551 |   |
| Depreciation and  amortization expense                                                                                    |       | 495                                                        |       | 347                                                       |       | 1,462 |   | 1,113 |   |
| Loss on sale of film assets                                                                                               |       | —                                                     |       | —                                                    |       | — |   | 155 |   |
| Income from operations  before interest and income  tax  expense                                                          |       | 14,692                                                     |       | 8,427                                                     |       | 52,434 |   | 51,088 |   |
| Interest income                                                                                                           |       | 115                                                        |       | —                                                    |       | 375 |   | 43 |   |
| Interest expense                                                                                                          |       | (24,999                                                    | )          | (2,509                                                    | )          | (75,774 | ) | (53,622 | ) |
| (Loss) income from  operations before income tax expense                                                                  |       | $                                                          | (10,192    | )                                                         | $          | 5,918 |   | $ | (22,965 | ) | $ | (2,491 | ) |
| Income tax expense (Note 6)                                                                                               |       | —                                                     |       | —                                                    |       | — |   | (2,897 | ) |
| Net(loss) income and  comprehensive (loss) income                                                                         |       | $                                                          | (10,192    | )                                                         | $          | 5,918 |   | $ | (22,965 | ) | $ | (5,388 | ) |
| Imputed preferred stock  dividends from amortization of  discount on preferred stock                                      |       | —                                                     |       | (6,860                                                    | )          | — |   | (6,860 | ) |
| Net loss and comprehensive  loss to common stockholders                                                                   |       | $                                                          | (10,192    | )                                                         | $          | (942 | ) | $ | (22,965 | ) | $ | (12,248 | ) |
| Weighted average number of  common shares  outstanding,  basic and diluted                                                |       | 104,788                                                    |       | 359,676                                                   |       | 104,788 |   | 192,552 |   |
| Net (loss) income per common  share, basic                                                                                |       | $                                                          | (0.10      | )                                                         | $          | 0.00 |   | $ | (0.22 | ) | $ | (0.06 | ) |
| Net (loss) income per common  share, diluted                                                                              |       | $                                                          | (0.10      | )                                                         | $          | 0.00 |   | $ | (0.22 | ) | $ | (0.06 | ) |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

5

----

Tableof Contents

 

**CROWN MEDIA HOLDINGS, INC.AND SUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

** **
| ** **                                                                           | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2009**                                                | ** ** | **2010** | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Net loss                                                                             |       | $                                                       | (22,965    | ) | $ | (5,388 | ) |
| Adjustments to reconcile net  loss to net cash provided by operating activities:     |       |                                                    |       |   |   |
| Loss on sale of film assets                                                          |       | —                                                  |       | 155 |   |
| Depreciation and  amortization                                                       |       | 99,319                                                  |       | 93,186 |   |
| Accretion on company  obligated mandatorily redeemable preferred interest            |       | 1,560                                                   |       | 1,717 |   |
| Provision for allowance for  doubtful accounts                                       |       | 1,128                                                   |       | 44 |   |
| Loss on sale of fixed asset                                                          |       | —                                                  |       | 2 |   |
| Debt issuance costs                                                                  |       | —                                                  |       | 1,049 |   |
| Income tax expense                                                                   |       | —                                                  |       | 2,897 |   |
| Stock-based (benefit)  compensation                                                  |       | (550                                                    | )          | 233 |   |
| Changes in operating assets  and liabilities:                                        |       |                                                    |       |   |   |
| Decrease in accounts  receivable                                                     |       | 7,894                                                   |       | 5,795 |   |
| Additions to program license  fees                                                   |       | (79,829                                                 | )          | (41,946 | ) |
| Decrease (increase) in  prepaid and other assets                                     |       | 4,964                                                   |       | (10,126 | ) |
| (Decrease) increase in  accounts payable, accrued and other liabilities              |       | (5,538                                                  | )          | 14,311 |   |
| Increase in interest payable                                                         |       | 49,481                                                  |       | 33,820 |   |
| Decrease in license fees  payable                                                    |       | (22,375                                                 | )          | (44,312 | ) |
| Increase in payables to  affiliates                                                  |       | 278                                                     |       | 78 |   |
| Net cash provided by  operating activities                                           |       | 33,367                                                  |       | 51,515 |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                               |       |                                                    |       |   |   |
| Purchases of property and  equipment                                                 |       | (371                                                    | )          | (729 | ) |
| Payments to buyer of  international business                                         |       | (691                                                    | )          | (686 | ) |
| Net cash used in investing  activities                                               |       | (1,062                                                  | )          | (1,415 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                |       |                                                    |       |   |   |
| Funding of restricted cash  account                                                  |       | —                                                  |       | (20,019 | ) |
| Borrowings under the credit  facility                                                |       | 18,062                                                  |       | — |   |
| Principal payments on the  credit facility                                           |       | (44,121                                                 | )          | (1,000 | ) |
| Accretion of interest on  notes payable to HCC                                       |       | —                                                  |       | 868 |   |
| Payments for debt issuance  costs under the troubled debt restructuring              |       | —                                                  |       | (3,596 | ) |
| Principal payments on  capital lease obligations                                     |       | (601                                                    | )          | (659 | ) |
| Net cash used in financing  activities                                               |       | (26,660                                                 | )          | (24,406 | ) |
| Net increase in cash and  cash equivalents                                           |       | 5,645                                                   |       | 25,694 |   |
| Cash and cash equivalents,  beginning of period                                      |       | 2,714                                                   |       | 10,456 |   |
| Cash and cash equivalents,  end of period                                            |       | $                                                       | 8,359      |   | $ | 36,150 |   |
|                                                                                 |       |                                                    |       |   |   |
| Supplemental disclosure of  cash and non-cash activities:                            |       |                                                    |       |   |   |
| Interest paid                                                                        |       | $                                                       | 22,022     |   | $ | 15,079 |   |
| Reduction of additional  paid-in capital for obligation under  tax sharing agreement |       | $                                                       | 4,893      |   | $ | 5,501 |   |
| Asset acquired through  capital lease obligation                                     |       | $                                                       | —     |   | $ | 232 |   |
| Additional paid-in capital  from imputed dividends on preferred stock                |       | $                                                       | —     |   | $ | 6,860 |   |
| Increase in accumulated  deficit from imputed dividends on preferred stock           |       | $                                                       | —     |   | $ | (6,860 | ) |
| Non-cash activities related  to the troubled debt restructuring:                     |       |                                                    |       |   |   |
| Acceleration of prepaid and  other assets                                            |       | $                                                       | —     |   | $ | 475 |   |
| Satisfaction of payable to  Hallmark Cards affiliates                                |       | —                                                  |       | (23,798 | ) |
| Issuance of new notes and  interest payable to HCC                                   |       | —                                                  |       | 432,140 |   |
| Satisfaction of old notes  and interest payable to HCC                               |       | —                                                  |       | (340,697 | ) |
| Satisfaction of senior  secured note to HCC, including accrued interest              |       | —                                                  |       | (797,423 | ) |
| Issuance of preferred stock                                                          |       | —                                                  |       | 185,000 |   |
| Issuance of common stock                                                             |       | —                                                  |       | 2,856 |   |
| Elimination of Class B  common stock designation                                |       | —                                                  |       | (307 | ) |
| Additional paid-in capital  from preferred and common stock  issuance                |       | —                                                  |       | 541,754 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

6

----

Tableof Contents

 

**CROWN MEDIA HOLDINGS, INC.AND SUBSIDIARIES**

**NOTES TOUNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**For the Three and Nine MonthsEnded September 30, 2009 and 2010**

 

**1. Business and Organization**

 

***Organization***

 

Crown Media Holdings, Inc. (“Crown Media Holdings”or the “Company”), through its wholly-owned subsidiary, Crown Media UnitedStates, LLC (“Crown Media United States”), owns and operates pay televisionchannels (collectively the “Channels” or the “channels”) dedicated to highquality, entertainment programming for adults and families, in the UnitedStates. At June 29, 2010, following the recapitalization of the Company asdescribed below, the significant investor in the Company was H C Crown Corp. (“HCC”),a subsidiary of Hallmark Cards, Incorporated (“Hallmark Cards”).

 

TheCompany’s continuing operations are currently organized into one operating segment,the channels.

 

***Recapitalization of the Company***

 

On June 29, 2010the Company consummated a series of recapitalization transactions (the “Recapitalization”)pursuant to a Master Recapitalization Agreement dated February 26, 2010,by and among the Company, Hallmark Cards, HCC and related entities.

 

Among other things, theRecapitalization included the following:

 

·                  Exchange of approximately $1.162 billion ofdebt (the “HCC Debt”) for new debt, preferred stock and common stock;

 

·                  Mergers of two intermediate holding companies,Hallmark Entertainment Investments Co. (“HEI”) and Hallmark EntertainmentHoldings, Inc. (“HEH”), with and into the Company (collectively, the “Mergers”);

 

·                  Reclassification of shares of Class Bcommon stock into shares of Class A common stock upon the filing of theSecond Amended and Restated Certificate of Incorporation; and

 

·                  Approval and authorization for the futurefiling of the Third Amended and Restated Certificate of Incorporation, theprincipal effect of which would be a reverse split of shares of common stock atsuch time as authorized by the Company’s Board of Directors.

 

The following wereissued in exchange for HCC Debt:

 

·                  $315.0 million principal amount of new debtissued pursuant to the terms of the credit agreement between the Company andHCC (the “Credit Agreement”) in two tranches: (i) the $200.0 million Term A Loan bearing interest at 9.5% perannum through December 31, 2011, and 12% thereafter and (ii) the$115.0 million Term B Loan bearing interest at 11.5% through December 31,2011, and 14.0% thereafter (collectively, the “New Debt”) (see Note 5);

 

·                  185,000 shares of the Company’s Series AConvertible Preferred Stock (“Preferred Stock”), $0.01 par value, with theterms summarized under “Preferred Stock Terms” in Item 2 *Management’s Discussion and Analysis of FinancialCondition and Results of Operations* below; and

 

·                  254,887,860 shares of the Company’s Class Acommon stock in exchange for the residual amount of HCC Debt converted at$2.5969 per share.

 

 Immediately after consummation of the Mergers and issuance of commonstock in partial exchange for HCC Debt, HCC owned approximately 90.3% of theCompany’s Class A common stock and all of the outstanding

 

7

----

Table ofContents

 

Preferred Stock.

 

In addition, thetransactions resulted in the following:

 

·                  The decrease of the authorized Preferred Stockto 1,000,000 shares; the increase of the authorized shares of Class Acommon stock to 500,000,000 shares; and the elimination of the Class Bcommon stock;

 

·                  Amendment No. 2 to the Tax SharingAgreement between the Company and Hallmark Cards, to among other things,(i)  permit Hallmark Cards to defer any future tax benefit payable to theCompany for application against future tax liabilities of the Company and (ii) allowthe Company to deduct interest accrued on the 10.25% Senior Secured Note fromJanuary 1, 2010,  through June 29,2010; and (iii) provide for the treatment of the Recapitalization underthe Tax Sharing Agreement (see Note 6 below);

 

·                  Execution of the registration rights agreement,by and among the Company, HCC and certain HEIC stockholders;

 

·                  Extension of the Company’s $30.0 millionrevolving line of credit to June 30, 2011, and Hallmark Card’s agreementto guarantee up to $30.0 million for such revolving line of credit (see Notes 4and 5 below); and

 

·                  A Stockholders Agreement, by and among theCompany, HCC and Hallmark Cards, pursuant to which, among other things,Hallmark Cards entities agreed not to acquire, through December 31, 2013,additional shares of Class A common stock, subject to certain exceptions,and agreed to certain restrictions on their ability to sell or transfer sharesof Class A common stock until December 31, 2013 and, subject tolesser restrictions, until December 31, 2020.

 

See“Recapitalization” in Note 5 for the accounting treatment of theRecapitalization.

 

***Liquidity***

 

Asof September 30, 2010, the Company had $36.2 million in cash and cashequivalents on hand.  Also available tothe Company was the full $30.0 million bank credit facility which expires June 30,2011.  Day-to-day cash disbursementrequirements have typically been satisfied with cash on hand and operating cashreceipts supplemented with the borrowing capacity available under the bankcredit facility and, prior to the Recapitalization, forbearance by HallmarkCards and its affiliates.

 

TheCompany’s management anticipates that the principal uses of cash during thetwelve month period ending September 30, 2011, will include the payment ofoperating expenses, accounts payable and accrued expenses, programming costs,and nominal interest of approximately $30.0 million to $45.0 million due underthe New Debt issued in the Recapitalization. Subject to the legal availability of funds and approval by the Company’sboard of directors, the Company may also pay approximately $19.5 million forcash dividends on Preferred Stock during the nine months ending September 30,2011; at the option of the Company’s board of directors, such dividends, ifany, may be paid in the form of additional shares of Preferred Stock.

 

AtSeptember 30, 2010, the Company also had an additional $20.0 million ofcash, the use of which is restricted to payment of the $25.0 million companyobligated, mandatorily redeemable preferred interest payable to VISN ManagementCorp. (“VISN,” a wholly-owned subsidiary of National Interfaith Cable Coalition, Inc.,“NICC”) on December 31, 2010.  TheCompany believes that it will be able to fund all, or substantially all, of theremaining $5.0 million with cash provided by operating activities.

 

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

 

***Interim FinancialStatements***

 

Inthe opinion of management, the accompanying condensed consolidated balancesheets and related interim condensed consolidated statements of operations andcash flows include all adjustments, consisting of normal recurring itemsnecessary for their fair presentation in conformity with accounting principlesgenerally accepted in the United States. Interim results are not necessarilyindicative of results for a full year. Thesecondensed

 

8

----

Table ofContents

 

consolidated financial statements should be read inconjunction with the consolidated financial statements and the notes to thosestatements, included in the Company’s Annual Report on Form 10-K for theyear ended December 31, 2009.

 

***Basis of Presentation***

 

The condensed consolidated financial statements includethe accounts of Crown Media Holdings and its wholly-owned subsidiaries. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

 

Thepreparation of financial statements in accordance with generally acceptedaccounting principles requires the consideration of events or transactions thatoccur after the balance sheet date but before the financial statements areissued. Depending on the nature of the subsequent event, financial statementrecognition or disclosure of the subsequent event is required.  Subsequent events have been evaluated.

 

***Use of Estimates***

 

Thepreparation of the accompanying consolidated financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions about future events. Theseestimates and the underlying assumptions affect the amounts of assets andliabilities reported, disclosures about contingent assets and liabilities, andreported amounts of revenues and expenses. Such estimates include thecollectability of accounts receivable, the valuation of goodwill, intangibleassets, and other long-lived assets, legal contingencies, indemnifications, andassumptions used in the calculation of income taxes, among others. Asignificant non-recurring use of estimates occurred in the course of recordingthe Company’s June 2010 troubled debt restructuring which required thatthe Company estimate the fair values of preferred stock and common stock issuedin the Recapitalization.

 

Allof the estimates that are employed are based on management’s best estimates andjudgment. Management evaluates its estimates and assumptions on an ongoingbasis using historical experience and other factors, including the currenteconomic environment, which management believes to be reasonable under thecircumstances. Management adjusts such estimates and assumptions when facts andcircumstances dictate. Illiquid credit markets, volatile equity, foreigncurrency, and energy markets, and declines in consumer spending have combinedto increase the uncertainty inherent in such estimates and assumptions. As futureevents and their effects cannot be determined with precision, actual resultscould differ significantly from these estimates. Changes in those estimatesresulting from continuing changes in the economic environment will be reflectedin the financial statements in future periods.

 

***Allowance for Doubtful Accounts***

 

The allowance for doubtful accounts is based upon theCompany’s assessment of probable loss related to uncollectible accountsreceivable.  The Company uses a number offactors in determining the allowance, including, among other things, collectiontrends. The Company’s bad debt expense was $235,000 and $12,000 for the threemonths ended September 30, 2009 and 2010, respectively. The Company’s baddebt expense was $1.1 million and $44,000 for the nine months ended September 30,2009 and 2010, respectively.

 

***Fair Value of Financial Instruments***

 

*Financial Accounting Standards Board (“FASB”) Accounting StandardsCodification*(the*“ASC”*)*Topic 820*, *Fair Value Measurementsand Disclosures*, provides guidance which defines fair value,establishes a framework for measuring fair value and specifies disclosuresabout fair value measurements.  On January 1, 2008 we adoptedthat portion of the standard that relates to those financial assets andliabilities and nonfinancial assets and liabilities which are recognized ordisclosed at fair value on a recurring basis (that is, at leastannually).  On January 1, 2009, subject to the FASB’s delayedimplementation, we adopted the remaining provisions of the standard.  After adoption, we now determine fair valueas an exit price, representing the price that would be received to sell anasset or paid to transfer a liability in an orderly transaction between marketparticipants.

 

9

----

Table ofContents

 

TheCompany does not have balance sheet items carried at fair value on a recurringbasis as well as similar assets and liabilities. Significant balance sheetitems which are subject to non-recurring fair value measurements consistof impairment valuations of goodwill and property and equipment. The standardhas not had a significant impact on the determination of fair value related tonon-financial assets and non-financial liabilities in 2010.

 

***Net Income (Loss) per Share***

 

Basic net income (loss) per share for each period iscomputed by dividing net income (loss) attributable to common stock by theweighted average number of common shares outstanding during the period. Dilutednet income (loss) per share for each period is computed by dividing net income(loss) attributable to common stock by the weighted average number of commonshares plus potentially dilutive common shares outstanding except whenever anysuch effect would be antidilutive. Potential common shares consist of incremental common shares issuableupon the exercise of stock options. Approximately 88,000 and 66,000 stock options for the three months andnine months ended September 30, 2009 and 2010, respectively, have beenexcluded from the determination of diluted net income or loss per share becausethe individual effect in each instance was antidilutive.

 

Holders of Preferred Stock are entitled tomandatory, cumulative quarterly dividends at the following annual rates: 0%during 2010, 14% during 2011 and 16%, (the perpetual rate) during 2012 and allperiods thereafter.  In addition to theirrights to Preferred Stock dividends, holdersof Preferred Stock are entitled to participate in common stock dividends, ifany, on an “as if converted” basis.  Thepotential conversion of Preferred Stock into approximately 71.2 million sharesof common stock has been excluded from the diluted loss per share calculationbecause the effect would be antidilutive.

 

The Company has estimated that the absence ofperpetual rate dividends during 2010 and 2011 resulted in an implicit discountof $17.4 million in the estimated fair value of Preferred Stock upon issuanceat June 29, 2010.  Such discount isbeing amortized through December 31, 2011. Amortization is reflected in the accompanying condensed consolidatedfinancial statements as an increase in accumulated deficit and redeemablepreferred stock.  During the three andnine months ended September 30, 2010, amortization amounted to $6.9million.  During the three months ending December 31,2010, an additional $7.1 million will be amortized.  The remaining $3.4 million will be amortizedduring 2011. Such amortization is reflected as an adjustment tonet income to derive net income attributable to common stockholders.

 

***Concentration of Credit Risk***

 

Financial instruments, which potentially subject CrownMedia Holdings to a concentration of credit risk, consist primarily of cash,cash equivalents and accounts receivable. Generally, Crown Media Holdings doesnot require collateral to secure receivables. Crown Media Holdings has nosignificant off-balance sheet financial instruments with risk of accountinglosses.

 

Fiveof our distributors each accounted for more than 10% of our consolidatedsubscriber revenue for both the three months ended September 30, 2009 and2010, and together accounted for a total of 76% and 78% of consolidatedsubscriber revenue during the three months ended September 30, 2009 and2010, respectively.  Three of ourdistributors each accounted for approximately 15% or more of our consolidatedsubscribers for the three months ended September 30, 2009 and 2010,respectively, and together accounted for 61% and 60% of our subscribers duringthe three months ended September 30, 2009 and 2010, respectively.

 

Fiveand six of our distributors each accounted for more than 10% of ourconsolidated subscriber revenue for the nine months ended September 30,2009 and 2010, and together accounted for a total of 76% and 80% ofconsolidated subscriber revenue during the nine months ended September 30,2009 and 2010, respectively.  Three ofour distributors each accounted for approximately 15% or more of ourconsolidated subscribers for the nine months ended September 30, 2009 and2010, respectively, and together accounted for 61% and 60% of our subscribersduring the nine months ended September 30, 2009 and 2010, respectively.

 

Fourand five of our programming content providers accounted for more than 10% ofour total license fees payable for the nine months ended September 30,2009 and 2010, respectively, and together accounted for a total of

 

10

----

Table of Contents

 

83%and 92% of the consolidated programming liability, respectively.

*** ***

***Recently Issued Accounting Pronouncements***

 

InOctober 2009, the FASB issued Accounting Standards Update, 2009-13,Revenue Recognition (*ASC Topic 605*):*Multiple Deliverable Revenue Arrangements —A Consensus of the FASB Emerging Issues Task Force.* This updateprovides application guidance on whether multiple deliverables exist, how thedeliverables should be separated and how the consideration should be allocatedto one or more units of accounting. This update establishes a selling pricehierarchy for determining the selling price of a deliverable. The selling priceused for each deliverable will be based on vendor-specific objective evidence,if available, third-party evidence if vendor-specific objective evidence is notavailable, or estimated selling price if neither vendor-specific or third-partyevidence is available. The Company will be required to apply this guidance forfiscal years beginning on or after June 15, 2010, prospectively forrevenue arrangements entered into or materially modified after January 1,2011; however, earlier application is permitted. The Company has not determinedthe impact that this update may have on its financial statements.

 

InJanuary 2010, the FASB issued guidance that requires reporting entities tomake new disclosures about recurring or nonrecurring fair-value measurementsincluding significant transfers into and out of Level 1 and Level 2 fair valuemeasurements and information on purchases, sales, issuances, and settlements ona gross basis in the reconciliation of Level 3 fair value measurements. Theguidance is effective for annual reporting periods beginning afterDecember 15, 2009, except for Level 3 reconciliation disclosures that areeffective for annual periods beginning after December 15, 2010. Theadoption of this guidance did not have a material impact on our consolidatedfinancial statements.

 

***Health Care Reform***

 

Duringthe first quarter of 2010, the U.S. Congress passed and the President signedinto law the Patient Protection and Affordable Care Act as well as the HealthCare and Education Reconciliation Act of 2010, which represent significantchanges to the current U.S. health care system. The legislation is far-reachingand is intended to expand access to health insurance coverage over time byincreasing the eligibility thresholds for most state Medicaid programs andproviding certain other individuals and small businesses with tax incentives tosubsidize a portion of the cost of health insurance coverage. The legislationincludes requirements that most individuals obtain health insurance coverageand that most large employers offer coverage to their employees or payfinancial penalties. Some of the more significant changes, including therequirement that individuals obtain coverage, do not become effective until2014 or later. It is too early to fully understand the impacts of thelegislation on our business.

 

**3. Program License Fees**

 

Program license fees are comprised of the following:

 
| ** **                                             | ** ** | **As of December 31,** | ** ** | **As of September 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| ** **                                             | ** ** | **2009**                              | ** ** | **2010**                               | ** ** |
| ** **                                             | ** ** | **(In thousands)**               | ** ** |
| Program license fees —  non-affiliates            |       | $                                     | 597,206    |                                   | $          | 584,597 |   |
| Program license fees —  Hallmark Cards affiliates |       | 12,668                                |       | 14,567                                 |       |
| Program license fees, at  cost                         |       | 609,874                               |       | 599,164                                |       |
| Accumulated amortization                               |       | (324,717                              | )          | (361,535                               | )          |
| Program license fees, net                              |       | $                                     | 285,157    |                                   | $          | 237,629 |   |

 

At December 31, 2009,and September 30, 2010, $1.8 million and $10.7 million, respectively, ofprogram license fees were included in prepaid and other assets on theaccompanying condensed consolidated balance sheets because the related licenseperiods had not commenced.

 

License fees payable are comprised of the following:

 

11

----

Tableof Contents

 
| ** **                                             | ** ** | **As of December 31,** | ** ** | **As of September 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| ** **                                             | ** ** | **2009**                              | ** ** | **2010**                               | ** ** |
| ** **                                             | ** ** | **(In thousands)**               | ** ** |
| License  fees payable — non-affiliates            |       | $                                     | 171,966    |                                   | $          | 126,764 |   |
| License fees payable —  Hallmark Cards affiliates |       | 10,409                                |       | 11,299                                 |       |
| Total license fees payable                             |       | 182,375                               |       | 138,063                                |       |
| Less current maturities                                |       | (99,494                               | )          | (94,047                                | )          |
| Long-term license fees  payable                        |       | $                                     | 82,881     |                                   | $          | 44,016 |   |

 

Inthe regular course of evaluating the remaining usefulness of its variousprogram licenses, the Company may determine that certain licenses may be oflittle future program value to it.  Insuch instances, the Company shortens the estimated remaining lives to zero,thereby accelerating amortization of the remaining net book value.  During the three months ended March 31,2010, such changes in estimates resulted in additional amortization of programlicense fees of $227,000; the Company made no such changes in estimates duringthe three and nine months ended September 30, 2009, and the three monthsended June 30 and September 30, 2010.

 

**4. Credit Facility**

 

Inconnection with the Recapitalization, the Company entered into Amendment No. 17to the Company’s amended credit agreement with JP Morgan Chase Bank, effective June 29,2010.  Amendment No. 17, among other things, extended thematurity date of the credit facility provided by the creditagreement to June 30, 2011, from August 31, 2010. Pursuant to Amendment No. 16 to the credit facility, entered into on March 2,2010, the maximum amount that may be borrowed under the credit facility is$30.0 million.

 

AmendmentNo. 17 terminated the Hallmark Cards Subordination and SupportAgreement.  The Hallmark Cards Facility Guarantee remains in place and anintercreditor agreement among HCC, JP Morgan Chase Bank and the Company wasentered into, which among other things defines the lien priorities and allowsfor payments to HCC pursuant to the Recapitalization.  The credit facilityis guaranteed by Hallmark Cards and the Company’s subsidiaries and is securedby all tangible and intangible assets of the Company and its subsidiaries.Interest under the credit facility is equal to the LIBOR Rate (as defined inAmendment No. 17) plus 2.25%, in the case of a Eurodollar Loan (as definedin Amendment No. 17), and the Alternate Base Rate (as defined in AmendmentNo. 17) plus 1.25%, in the case of an Alternate Base Rate Loan.

 

Thecredit facility, as amended, contains a number of affirmative and negativecovenants.  The affirmative and negative covenants and default provisionsare described in the Company’s Annual Report on Form 10-K. The Company wasin compliance with these covenants as of September 30, 2010.

 

AtDecember 31, 2009, and September 30, 2010, the Company hadoutstanding borrowings of $1.0 million and $0, respectively, under the creditfacility and there were no letters of credit outstanding. At December 31,2009, all of the outstanding balance bore interest at the Eurodollar rate(2.49% weighted average rate at December 31, 2009). Interest expense on borrowings under the creditfacility for each of the three months ended September 30, 2009 and 2010,was $53,000 and $0, respectively. Interestexpense on borrowings under the credit facility for each of the nine monthsended September 30, 2009 and 2010, was $342,000 and $4,000, respectively.

 

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

 

***Recapitalization***

 

Forfinancial reporting purposes, the Recapitalization has been accounted for as atroubled debt restructuring in accordance with the guidance of *ASC**Topic 470-60 Debt—Troubled DebtRestructurings*. Identification of the Recapitalization as atroubled debt restructuring involved both qualitative and quantitative aspects.Among the qualitative aspects considered were (i) the Company’s expectationsthat it would have been unable to fulfill the debt service requirementsassociated with approximately $342.2 million of principal and interestpayable to HCC on May 1, 2010 upon the expiration of the waiver agreement(which was extended to August 31, 2010 pursuant to the masterrecapitalization agreement), along with an additional $784.6 million ofprincipal and interest that would become immediately due pursuant tocross-default provisions, and (ii) the going concern opinion rendered bythe Company’s independent registered public accounting firm in connection withthe financial statements included in the Company’s Annual Report onForm 10-K for the year ended December 31, 2009. Quantitatively,Hallmark

 

12

----

Table of Contents

 

Cardsis deemed to have granted a “concession” within the meaning of *ASC**470-60*. Prior toconsummation of the Recapitalization, the weighted average interest rate of HCCdebt was approximately 8.3%. After consideration of (x) the estimated fairvalues of Preferred Stock and Common Stock issued in the Recapitalization and(y) the debt service requirements of New Debt, the overall effectiveinterest rate on the New Debt resulting from the Recapitalization is less than1%.

 

Pursuantto the guidance in the *ASC*, we(1) recorded the issuance of Preferred Stock and Common Stock at theirrespective estimated fair values as of June 29, 2010 and (2) recordedNew Debt in an amount equal to the residual of (i) the carrying value ofHCC Debt less (ii) the estimated fair values of such Preferred Stock andCommon Stock.  New Debt has beenapportioned between the Term A and Term B Loans on the basis of their relativefair values.  The amounts by which theapportioned Term Loans exceeded the respective stated amounts of principal arebeing amortized over the terms of the loans as reductions of the interest expense that otherwise would arise from thestated cash interest rates.  Theresulting effective interest rates are approximately 0.789% and 1.002%, for theTerm A Loan and Term B Loan, respectively. If, and when, any of the available pay-in-kind options (where interestis added to principal) are exercised, the effects of such elections will berecognized prospectively.

 

TheMergers of HEI and HEH involved non-substantive subsidiaries of Hallmark Cards.The Mergers were recorded at carry-over basis pursuant to the guidance of *ASC 805-50 Business Combinations—Related Issues*.HEIC and HEH did not have assets other than their investment in the Company.

 

Duringthe third quarter of 2010 the Company determined that its preferred stockshould have been classified in temporary equity due to Hallmark Cards’ controlof the Company’s Board of Directors and its voting securities.  Accordingly, the Company corrected theclassification of its $185 million preferred stock to present it as temporaryequity.  The redeemable preferred stockpresented in the accompanying condensed consolidated balance sheet as ofSeptember 30, 2010 also includes the third quarter imputed dividend ofapproximately $6.9 million.

 

Thefollowing table summarizes the accounting for the Recapitalization:

 
| ** **                                                                                                    | ** ** | ** ** | ** ** | **In thousands** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------|------------|
| **Pre-Recapitalization**                                                                                      |       |       |       |                  |       |
| HCC Debt                                                                                                      |       |       |       | $                     | 1,161,918  |   |
| Deferred debt issuance costs                                                                                  |       |       |       | (475                  | )          |
| Transaction costs                                                                                             |       |       |       | (3,596                | )          |
|                                                                                                          |       |       |       | $                     | 1,157,847  |   |
|                                                                                                          |       |       |       |                  |       |
| **Post-Recapitalization**                                                                                     |       |       |       |                  |       |
| New Debt                                                                                                      |       |       |       | $                     | 432,140    |   |
| Preferred stock, $185,000 shares, $0.01 par value,  $1,000 liquidation preference                             |       |       |       | 185,000               |       |
| Common stock, $0.01 par value                                                                                 |       |       |       | 2,549                 |       |
| Additional paid-in capital                                                                                    |       |       |       |                  |       |
| Fair values of new preferred stock and common  stock, less liquidation preference and par value, respectively |       | $          | 541,754    |                  |       |   |
| Transaction costs related to new preferred stock  and common stock                                            |       | (2,547     | )          | 539,207               |       |
| Transaction costs related to the New Debt included  in selling, general and administrative expense            |       |       |       | (1,049                | )          |
|                                                                                                          |       |       |       | $                     | 1,157,847  |   |
|                                                                                                               |            |            |            |                       |            |  |  |

 

See“Recapitalization of the Company” in Note 1 for information regarding the debtobligations owed to HCC immediately prior to the Recapitalization. See Note 2for information related to an imputed discount that arose with the issuance ofPreferred Stock and the related effect on the determination of net income(loss) per share.

 

***Related Party Long-Term Obligations***

 

The aggregatematurities of related party long-term debt and future interest (assuming noutilization of the payment-in-kind options) for each of the five yearssubsequent to September 30, 2010, are as follows:

 

13

----

Table of Contents

 
| ** **                                                                                                                                          | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                          | ** ** | **Total**                                 | ** ** | **Less  than 1  Year** | ** ** | **2 Years** | ** ** | **3 Years** | ** ** | **4 Years** | ** ** | **5 Years** | ** ** |
| ** **                                                                                                                                          | ** ** | **(In thousands)**                   | ** ** |
| Term A note, due December 31, 2013, interest  payable quarterly to HCC at 9.5% per annum through December 31, 2011 and  12% thereafter(1) |       | $                                         | 276,578    |   | $ | 32,392 |   | $ | 22,756 |   | $ | 23,984 |   | $ | 197,446 |   | $ | — |   |
| Term B note, due December 31, 2013, interest  payable quarterly to HCC at 11.5% per annum through December 31, 2011  and 14% thereafter   |       | 167,091                                   |       | 16,558 |   | 15,386 |   | 16,089 |   | 119,058 |   | — |   |
|                                                                                                                                                |       | $                                         | 443,669    |   | $ | 48,950 |   | $ | 38,142 |   | $ | 40,073 |   | $ | 316,504 |   | $ | — |   |

 

----

(1)          The Company anticipates making a principal paymenton the Term A note of approximately $8.6 million, which is the Company’sestimated principal payment based on the excess cash flow provisions discussedunder Note 5.

 

TheCompany paid principal and interest of $88,000 in June 2010 and principaland interest of $8.1 million in October 2010 on the Term A and Term Bnotes.  The $8.1 million of principal andinterest was included in notes and interest payable to HCC on the accompanyingconsolidated balance sheet at September 30, 2010.

 

***Senior Secured Note***

 

In August 2003,the Company issued a senior note to HCC for $400.0 million. Cash payments forinterest were not required from inception through June 29, 2010. Theprincipal amount of the senior secured note accreted at 10.25% per annum,compounding semi-annually, to June 29, 2010.  At December 31, 2009, $758.8 million ofprincipal and interest were included in the senior note payable in theaccompanying consolidated balance sheet. The Company’s obligations under thisnote, including $797.4 million of principal and accrued interest, wereterminated in connection with the Recapitalization.

 

***Notes and Interest Payable to HCC***

 

On December 14,2001, the Company executed a $75.0 million promissory note with HCC.  Interest was payable in cash, quarterly inarrears five days after the end of each calendar quarter. The rate of interestunder this note was LIBOR plus 5% per annum (5.29% at December 31, 2009).At December 31, 2009, $108.6 million is reported as note payable toHallmark Cards affiliate and $1.5 million is reported as interest payable toHallmark Cards affiliate on the accompanying consolidated balance sheet.Interest of $6.3 million was paid in 2009, interest of $1.5 million was paid onJanuary 5, 2010, interest of $1.4 million was paid on April 2, 2010,and interest of $1.4 million was paid on June 29, 2010.  The Company’s obligations under this note,including $108.6 million of principal, were terminated in connection with theRecapitalization.

 

OnOctober 1, 2005, the Company converted approximately $132.8 million of itslicense fees payable to a Hallmark Cards affiliate to a promissory notesubsequently transferred to HCC.  Therate of interest under this note was LIBOR plus 5% per annum (5.29% at December 31,2009). At December 31, 2009, $170.1 million is reported as note payable toHCC and $2.3 million is reported as interest payable to HCC on the accompanyingconsolidated balance sheet. Interest of $9.8 million was paid in 2009, interestof $2.3 million was paid on January 5, 2010, interest of $2.2 million waspaid on April 2, 2010, and interest of $2.3 million was paid on June 29,2010.  The Company’s obligations under this note,including $170.1 of principal, were terminated in connection with theRecapitalization.

 

OnMarch 21, 2006, the Company converted approximately $70.4 million of itspayable to a Hallmark Cards affiliate to a promissory note subsequentlytransferred to HCC. The rate of interest under this note was LIBOR plus 5% perannum (5.29% at December 31, 2009). At December 31, 2009, $62.0million is reported as note payable to HCC and $838,000 is reported as interestpayable to HCC on the accompanying consolidated balance sheet. Interest of $3.6million was paid in 2009, interest of $838,000 was paid on January 5,2010, interest of $814,000 was paid on

 

14

----

Table of Contents

 

April 2,2010, and interest of $820,000 was paid on June 29, 2010.   The Company’s obligations under this note,including $62.0 million of principal, were terminated in connection with theRecapitalization.

 

***Hallmark Guarantee; Interest and Fee Reductions***

 

HallmarkCards has provided to JPMorgan Chase Bank under the credit facility theHallmark Cards facility guarantee.  Theguarantee is unconditional for obligations of the Company under the bank creditfacility.  If any payment is made on theguarantee, it will be treated as a purchase of the lending bank’s interest inthe credit facility. Prior to April 2009, Hallmark Cards’ credit supportfor the Company’s bank credit facility consisted of supplying a letter ofcredit.

 

Theabove mentioned credit support provided by Hallmark Cards resulted inreductions in the interest rate and commitment fees under the credit facility;however, the Company agreed to pay and has paid an amount equal to thereductions in the interest rate and commitment fees to Hallmark Cards.  On April 1, 2009, the interest rate andcommitment fees under the renewed credit facility increased and the Companybegan paying Hallmark Cards a smaller reduction amount of the interest rate andcommitment fees equal to 0.75% and 0.125%. Interest expense paid to HCC in connection with the JPMorgan Chase Bankcredit facility was $15,000 and $0 for the three months ended September 30,2009, and 2010, respectively. Interest expense paid to HCC in connection withthe credit facility was $1.0 million and $2,000 for the nine months ended September 30,2009, and 2010, respectively. Commitment fee expense for the threemonths ended September 30, 2009 and 2010, was $9,000 and $10,000,respectively. Commitment fee expense for the nine months ended September 30,2009 and 2010, was $36,000 and $32,000, respectively.

 

***Other Agreementswith Hallmark Cards and Affiliates***

 

See Item 2 *Management’s Discussion and Analysis of FinancialCondition and Results of Operations* below for discussion regardingother agreements with Hallmark Cards and its affiliates.

 

**6. Related Party Transactions**

 

***Tax SharingAgreement***

 

*Overview*

 

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 subsequent tax losses and may benefit from future federal tax losses,which may be generated by Crown Media Holdings. Based on the tax sharing agreement, Hallmark Cards has agreed to pay CrownMedia Holdings all of the benefits realized by Hallmark Cards as a result ofincluding Crown Media Holdings in its consolidated income tax return.  Through December 31, 2009, thesebenefits have been paid 75% in cash on a quarterly basis with the balanceapplied as an offset against other amounts owed by Crown Media Holdings to anymember of the Hallmark Cards consolidated group under any loan, line of creditor other payable, subject to limitations under any loan indentures or contractsrestricting such offsets.  As a result ofthe Recapitalization, the tax agreement has been amended to provide that 100%of any such benefit will be deferred for application against future taxliabilities of the Company.  Pursuant tothe amendment to the tax sharing agreement in August 2003, the benefitthat would otherwise result from interest accrued on the 10.25% senior securednote will not be available to the Company until such interest is paid in cash.As a result of the Recapitalization, such interest accrued from January 1,2010, through June 29, 2010, will be treated as a deduction under theamended tax sharing agreement.

 

AtDecember 31, 2009, the Company owed Hallmark Cards $8.5 million under thetax sharing agreement for 2009. The liability was satisfied on June 29,2010, in connection with the Recapitalization. The Company owed $5.5 millionunder the amended tax sharing agreement for the nine months ended September 30,2010.

 

15

----

Table ofContents

 

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 have been recorded as additions to paid-in capital inthe accompanying consolidated statements of stockholders’ (deficit) equity. Anyamounts owed or payments made to Hallmark Cards or to any member of theHallmark Cards consolidated group under the tax sharing agreement have beenrecorded as reductions to paid-in capital.

 

Thefirst payment by the Company pursuant to theamended tax sharing agreement will occur after the first fullquarter following the closing of the RecapitalizationTransactions and will be made in respect of the period commencing from January 1,2010, through the last day of the first full quarter followingthe closing. The Company expects to make its first cash payment throughthe fourth quarter of 2010 prior to December 31, 2010, for tax liabilitiesincurred under the tax sharing agreement as amended.

 

Historically,the Company has accounted for income taxes as if it were a separate taxpayernot included in the consolidated tax return of Hallmark Cards.  For tax purposes, the Recapitalizationgenerated cancellation of debt income which is currently estimated atapproximately $200.0 million.  Accordingly,the Company is expected to generate federal and state taxable income in 2010for both regular tax and alternative minimum tax (“AMT”) purposes.  For regular tax purposes, this income will befully offset by net operating loss carryforwards.  However, for federal AMT purposes, losscarryforwards can be used against AMT income but are limited to 90% of AMTincome.  As a result, the Company hasrecorded an income tax expense of approximately $2.9 million for the estimatedAMT in its consolidated statements of operations. The Company is not able torecognize an offsetting deferred tax benefit from the AMT credit carryforwardbecause of its full valuation allowance on deferred tax assets.

 

However,as a result of being included in the consolidated tax return of Hallmark Cards,this AMT expense is not required to be paid to the Internal Revenue Service norto Hallmark Cards under the tax sharing agreement. Accordingly, the Company hasreduced the liability for the aforementioned AMT and credited paid-in capital.The net result for AMT calculated as if the Company is a separate taxpayer is acharge to the consolidated statements of operations and a corresponding creditto paid-in capital.

 

***Services Agreement with Hallmark Cards***

 

HallmarkCards provides Crown Media Holdings with tax, risk management, health safety,environmental, insurance, legal, treasury, human resources, and cash managementservices and real estate consulting services. In exchange, the Company is obligated to pay Hallmark Cards a fee, plusout-of-pocket expenses and third party fees, in arrears on the last businessday of each quarter. Fees for HallmarkCards’ services were $455,000 for 2009 and are scheduled to be $387,000 for2010. Intercompany service fee expense for the three months ended September 30,2009 and 2010, was $114,000 and $97,000, respectively. Intercompany service feeexpense for the nine months ended September 30, 2009 and 2010, was$341,000 and $290,000, respectively.

 

At December 31, 2009, and September 30, 2010,non-interest bearing unpaid accrued service fees and unreimbursed expenses of $15.2million and $42,000, respectively, were included in payable to affiliates onthe accompanying consolidated balance sheets. The $15.2 million outstanding at December 31,2009, was satisfied on June 29, 2010, in connection with theRecapitalization. For the year ended December 31, 2009, and the ninemonths ended September 30, 2010, out-of-pocket expenses and amounts paidto third parties on the Company’s behalf by Hallmark Cards  were $420,000 and $78,000, respectively.

 

***Guarantees with Hallmark Cards***

 

OnFebruary 24, 2010, the Company executed a letter of credit/guarantycommitment with respect to a certain lease agreement with 12700 Investments, Ltd.for the office space at 12700 Ventura Boulevard, Studio City,California.   The landlord required that Crown Media United States,the entity which executed the lease, provide a letter of credit of $1.6 millionsecuring certain obligations of Crown Media United States.  Consequently,Hallmark Cards has agreed to guarantee the issuer of such letter of creditagainst any loss thereon pursuant to the guaranty. As an inducement for Hallmark Cards to issue the guaranty, Crown MediaUnited States has agreed to pay Hallmark Cards a fee which equals 0.75% perannum of the outstanding letter of credit obligation.  Additionally, in the event 

 

16

----

Table of Contents

 

that Hallmark Cards is required to pay any amountunder the guaranty, Crown Media United States must reimburse Hallmark Cards forany such amount plus any fees and charges associated with making such payment,any interest applicable to such amount and any costs and expenses of HallmarkCards in connection with protecting its rights under the guaranty.

 

OnSeptember 2, 2008, Hallmark Cards issued a guaranty for the benefit ofCrown Media United States, which guaranty pertains to a lease agreement withParamount Group, Inc. for the office space at 1325 Avenue of the Americas,New York, New York.  As a condition to executing the lease agreement, thelandlord required Hallmark Cards to guaranty all obligations of Crown MediaUnited States under the lease agreement.  As an inducement for HallmarkCards to issue the guaranty, Crown Media United States has paid Hallmark Cardsa fee which equals 0.28% per annum of the outstanding obligation under thelease agreement. Additionally, in the event that Hallmark Cards is required topay any amount under the guaranty, Crown Media United States must reimburseHallmark Cards for any such amount plusany fees and charges associated with making such payment, any interestapplicable to such amount and any costs and expenses of Hallmark Cards inconnection with protecting its rights under the guaranty.

 

Fromtime to time, in the normal course of business, Hallmark Cards has guaranteedthe Company’s performance on certain of the Company’s other obligations. IfHallmark Cards has to perform under these obligations, the Company thentypically repays Hallmark Cards.

 

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

 

VISN owns a $25.0 million company obligated mandatorilyredeemable preferred interest in Crown Media United States (the “preferredinterest”). On November 13, 1998, the Company, VISN, Vision GroupIncorporated and Henson Cable Networks, Inc. signed an amended andrestated company agreement governing the operation of Crown Media United States(the “company agreement”), 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 “December 2005 NICC SettlementAgreement”).

 

Crown Media United States may voluntarily redeem the$25.0 million preferred interest at any time; however, it is obligated to do sono later than December 31, 2010. The terms of the Recapitalizationrequired the Company to set aside in its own name an unspecified amount, not toexceed $25.0 million, for the sole purpose of redeeming the preferred interest. The $20.0 million set aside as of September 30,2010, is reflected as restricted cash in the accompanying condensed,consolidated balance sheet.  Due to themandatory redemption provision of the preferred interest, on July 1, 2003,the preferred interest was remeasured at fair value and the difference is beingaccreted and recorded as interest expense.

 

On January 2, 2008, the Company and NICC resolved anumber of disputes with the execution of an agreement (the “ModificationAgreement”) which, among other things, immediately extinguished NICC’sconditional right to require the Company to repurchase all of the shares of theCompany’s Class A common stock then owned by NICC (“Put Right”).  In addition, the Modification Agreement alsosettled the dispute with respect to whether the termination payment provisionexpired with, or survived, the December 31, 2007 expiration of the December 2005NICC Settlement Agreement. The Company agreed to pay NICC $3.8 million in threeequal installments payable each January 20 of 2008, 2009 and 2010.  The Company also agreed to provide NICC atwo-hour broadcast period granted each Sunday morning during the two yearperiod ending December 31, 2009. The Company is also obligated to pay NICC an estimated $3.7 million inyearly installments at the rate of 6% of the outstanding liquidation preferenceof the preferred interest.

 

During the three months ended September 30, 2009and 2010, Crown Media United States paid NICC $40,000 and $0, respectively,related to the company agreement as amended. During the nine months ended September 30,2009 and 2010, Crown Media United States paid NICC $4.6 million and $2.8million, respectively, related to the company agreement as amended.

 

**8. Share-Based Compensation**

 

Approximately 200,000 stock options expired, withoutbeing exercised, in August 2009 following the resignation of one of theCompany’s executives in May 2009. Such options were fully vested at thetime of resignation.

 

17

----

Table ofContents

 

The Company recorded $134,000 and $124,000 ofcompensation expense  associated with theemployment and performance restricted stock units (RSUs) during the threemonths ended September 30, 2009 and 2010, respectively, which have beenincluded in selling, general and administrative expense on the accompanyingcondensed consolidated statements of operations. The Company recorded $303,000of compensation benefit and $233,000 of compensation expense  associated with the employment andperformance restricted stock units (RSUs) during the nine months ended September 30,2009 and 2010, respectively, which have been included in selling, general andadministrative expense on the accompanying condensed consolidated statements ofoperations.

 

Asof December 31, 2009, and September 30, 2010, there was nounrecognized compensation cost, related to non-vested stock options granted tothe Company’s employees. The closing priceof a share of the Company’s common stock was $1.45 on December 31, 2009,and $2.39 on September 30, 2010, which is used to calculate the RSUliability. As of December 31, 2009, and September 30, 2010,there was unrecognized compensation cost, related to non-vested RSUs granted tothe Company’s employees, in the amount of $190,000 and $416,000, respectively,using the aforementioned stock prices. Actual compensation costs recognized infuture periods may vary based upon fluctuations in stock price and forfeitures.

 

The Company issued cash settlements related to the RSUsof $1.5 million during the year ended December 31, 2009, and $163,000during both the three and nine months ended September 30, 2010.

 

InMay 2009, the then CEO terminated his employment and his share appreciation rights (“SARs”) wereforfeited at that time.  The Companyrecorded $0 and $247,000 in compensation benefit related to SARs for the threeand nine months ended September 30, 2009, on the Company’s condensedconsolidated statement of operations as a component of selling, general andadministrative expense.  The SARs wererecorded as a liability until termination.

 

**9.  Long Term Incentive Plan**

 

Inthe second quarter of 2009, the Company granted Long Term IncentiveCompensation Agreements (“LTI Agreements”) to each vice president, senior vicepresident and executive vice president of the Company.  The target award under each LTI Agreements isa percentage of the employee’s base salary and range from $26,000 to$469,000.  Of each award, 50% is anEmployment Award and 50% is a Performance Award.  The Employment Award will vest and be settledin cash on August 31, 2011, subject to earlier pro rata settlement asprovided in the LTI Agreement.  ThePerformance Award will vest and be settled in cash 50% on December 31,2010, and 50% on December 31, 2011, in accordance with the Companyperformance criteria concerning adjusted EBITDA and cash flow and subject toearlier pro rata settlement as provided in the LTI Agreement. Early settlementis provided in the case of involuntary termination of employment without causeon or after January 1, 2010, death or disability.  Potential payouts under the PerformanceAwards depend on achieving 90% or higher of a target threshold and range from0% to 150% of the target award.  The Company’sCompensation Committee has the ability to increase or decrease the payout basedon an assessment of demographics achieved, relative market conditions andmanagement of expenses.

 

Inthe first quarter of 2010, the Company granted LTI Agreements to each vicepresident, senior vice president and executive vice president of theCompany.  The target award under each LTIAgreements is a percentage of the employee’s base salary and range from $25,000to $536,000.  Of each award, 50% is anEmployment Award and 50% is a Performance Award.  The Employment Award will vest on August 31,2012, and be settled in cash within 30 days thereafter, subject to earlier prorata settlement as provided in the LTI Agreement.  The Performance Award will vest on December 31,2012, and be settled in cash the later of 30 days thereafter or 15 days afterthe Company issues its audited financials for 2012, but by no later than March 15,2013. Vesting of the Performance Award will be determined in accordance with the Company performance criteriaconcerning adjusted EBITDA and cash flow and subject to earlier pro ratasettlement as provided in the LTI Agreement. Early settlement is provided inthe case of involuntary termination of employment without cause on or after January 1,2011, death or disability.  Potentialpayouts under the Performance Awards depend on achieving 90% or higher of atarget threshold and range from 0% to 150% of the target award.  The Company’s Compensation Committee has theability to increase or decrease the payout based on an assessment ofdemographics achieved, relative market conditions and management of expenses.

 

18

----

Tableof Contents

 

TheCompany recorded $104,000 and $309,000 of expense included in selling, generaland administrative expense in the accompanying consolidated statement of operationsfor the three months ended September 30, 2009 and 2010,  related to these agreements. The Companyrecorded $398,000 and $1.0 million of expense included in selling, general andadministrative expense in the accompanying consolidated statement of operationsfor the nine months ended September 30, 2009 and 2010,  related to these agreements. Additionally,the $540,000 and $1.6 million liability for these agreements was included inaccounts payable and accrued liabilities in the accompanying consolidated balancesheets at December 31, 2009, and September 30, 2010.

 

**10. Fair Value**

 

The following table presents the carrying amounts andestimated fair values of certain of the Company’s financial instruments at December 31,2009, and September 30, 2010.

 
| ** **                                                   | ** ** | **December 31, 2009** | ** ** | **September 30, 2010**                                              | ** ** |
|--------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **Carrying**                    | ** ** | **Significant  Unobservable********Inputs********(Level 3)********Fair** | ** ** | **Carrying** | ** ** | **Significant  Unobservable********Inputs********(Level 3)********Fair** | ** ** |
| ** **                                                   | ** ** | **Amount**                      | ** ** | **Value**                                                                     | ** ** | **Amount** | ** ** | **Value** | ** ** |
| ** **                                                   | ** ** | **(In thousands)**         | ** ** |
|                                                         |       |                            |       |                                                                          |       |   |   |   |   |
| Senior secured note to HCC, including accrued  interest      |       | $                               | 758,755    |                                                                          | $          | 641,635 |   | $ | — |   | $ | — |   |
| Note and interest payable to HCC                             |       | 110,062                         |       | 93,074                                                                        |       | — |   | — |   |
| Note and interest payable to HCC                             |       | 62,845                          |       | 53,144                                                                        |       | — |   | — |   |
| Note and interest payable to HCC                             |       | 172,407                         |       | 145,795                                                                       |       | — |   | — |   |
| Term A note and interest payable to HCC                      |       | —                          |       | —                                                                        |       | 270,482 |   | 199,056 |   |
| Term B note and interest payable to HCC                      |       | —                          |       | —                                                                        |       | 162,526 |   | 119,600 |   |
| Company obligated mandatorily redeemable preferred  interest |       | 22,902                          |       | 19,800                                                                        |       | 24,619 |   | 24,125 |   |
|                                                              |            |                                 |            |                                                                               |            |  |  |  |  |  |  |  |  |

 

*ASC Topic 820* defines fair value ofa liability as the price that would be paid to transfer a liability in anorderly transaction between market participants at the measurement date. Whendetermining fair value, the Company considers the principal or mostadvantageous market in which the Company would transact and the market-basedrisk measurements or assumptions that market participants would use in pricingthe liability, such as inherent risk, transfer restrictions, and credit risk.Level 3 is defined as inputs that are generally unobservable and typically reflectmanagement’s estimates of assumptions that market participants would use inpricing the liability.

 

The carrying amounts shown in the table are included onthe accompanying consolidated balance sheets under the indicated captions. Thevaluation of the Company obligated mandatorily redeemable preferred interest isbased on the preferred liquidation preference being payable in full on December 31,2010.

 

The Company estimates the fair value of its debt to HCCon a quarterly basis.

 

Accounts payable and receivable are carried atreasonable estimates of their fair values because of the short-term nature ofthese instruments. Interest rates on borrowings under the bank credit facilityare for relatively short periods and variable. Therefore, the fair value of thisdebt is not significantly affected by fluctuations in interest rates.  The credit spread on the debt is fixed, butthe market credit spread will fluctuate.

 

Estimates of the fair value of certain of the Company’sfinancial instruments are presented in the tables above. As a result of recentmarket conditions, the Company’s debt obligations with HCC and the mandatorilyredeemable 

 

19

----

Table of Contents

 

preferred interest have limited or no observable marketdata available. Fair value measurements for these instruments are included inLevel 3 of the fair value hierarchy of *ASC Topic 820*. These fair value measurements are based primarily upon the Company’sown estimates and are often based on its current pricing policy, the currenteconomic and competitive environment, the characteristics of the instrument,credit and interest rate risks, and other such factors. Therefore, the resultscannot be determined with precision, cannot be substantiated by comparison toquoted prices in active markets, and may not be realized in an immediatesettlement of the liability. Additionally, there are inherent uncertainties inany fair value measurement technique, and changes in the underlying assumptionsused, including discount rates, liquidity risks, and estimates of future cashflows, could significantly affect the fair value measurement amounts.

 

The majority of the Company’s debt has been transactedwith HCC.

 

**11.Commitments and Contingencies**

 

OnJuly 13, 2009, a lawsuit was brought in the Delaware Court of Chanceryagainst each member of the Board of Directors of the Company, Hallmark Cardsand its affiliates, as well as the Company as a nominal defendant, by aminority stockholder of the Company regarding the then proposedRecapitalization. The plaintiff is S. Muoio & Co. LLC which ownedbeneficially approximately 5.8% of the Company’s Class A common stock atthe time of the complaint, according to the complaint and filings with the SEC.The lawsuit claims to be a derivative action and a class action on behalf ofthe plaintiff and other minority stockholders of the Company. The lawsuitalleges, among other things, that, the defendants have breached fiduciaryduties owed to the Company and minority stockholders in connection with theRecapitalization transactions. The lawsuit includes allegations that theconsummation of the Recapitalization transactions would result in an unfairamount of equity issued to the majority stockholders, thereby reducing theminority stockholders’ equity and voting interests in the Company, and that themajority stockholders would be able to eliminate the minority stockholdersthrough a short-form merger. The complaint requested the court enjoin thedefendants from consummating the Recapitalization transactions and awardplaintiff fees and expenses incurred in bringing the lawsuit.

 

OnJuly 22, 2009, a Stipulation Providing for Notice of Transaction (the ‘‘Stipulation’’)was filed with the Delaware Court of Chancery. The Stipulation provided thatthe Company could not consummate the transaction contemplated in theRecapitalization transactions until not less than seven weeks after providingthe plaintiff with a notice of the terms of the proposed transaction, includingcopies of the final transaction agreements. If the plaintiff moved forpreliminary injunctive relief with respect to any such transaction, the partieswould establish a schedule with the Court of Chancery to resolve such motionduring the seven week period. In addition, following the decision of the Courtof Chancery, the Company would not consummate any transaction for a period ofat least one week, during which time any party may seek an expedited appeal. TheStipulation further provided that the plaintiff would withdraw its motion forpreliminary injunction filed on July 13, 2009 and that the action would bestayed until the earlier of providing the notice of a transaction or anannouncement by the Company that it was no longer considering a transaction.

 

Bya letter of February 28, 2010, the plaintiff in this lawsuit informed theSpecial Committee of the Board of Directors, which considered and negotiatedthe Recapitalization, that the plaintiff objected to the proposedrecapitalization on the terms set forth in the term sheet dated February 9,2010. The plaintiff asserted, among other things, that the transactionscontemplated by the term sheet would unfairly dilute the economic and votinginterests of the Company’s minority stockholders, that the transactions shouldbe subject to a vote of the majority of the minority stockholders and that theproposed transactions remain inadequate. The plaintiff indicated that if theCompany executed definitive documents for the Recapitalization, the plaintiffwould pursue the litigation. The February 26, 2010 agreements executed bythe Company for the Recapitalization materially followed the provisions in theearlier term sheet.

 

Noticeof the terms of the proposed Recapitalization, including copies of the executeddefinitive documents for the Recapitalization, was provided to the plaintiff onMarch 1, 2010. On March 11, 2010, the plaintiff filed an amendedcomplaint raising similar allegations of breach of fiduciary duty againstHallmark Cards and the director defendants and seeking rescission of theRecapitalization rather than a preliminary injunction enjoining theconsummation of the Recapitalization, or alternatively, an award of rescissorydamages. If the Company is forced to

 

20

----

Table of Contents

 

rescindthe Recapitalization, short-term debt would increase to approximately $1.2billion, plus accrued interest. A trial took place in September 2010 andthe parties are currently preparing post trial briefs to be submitted to thecourt.  A decision of the court isexpected to be issued in the first quarter of 2011.

 

Fromtime to time, the Company, together with, in some instances, certain of itsdirectors and officers is a defendant or codefendant in legal actions involvingvarious claims incident to the conduct of its business.  It is notcurrently possible to predict the outcome of the proceeding discussedabove.  Legal fees incurred to defend theproceeding will be expensed as incurred. Approximately $4.0 million has beenrecorded in accounts receivable and accounts payable and accrued liabilities onthe accompanying balance sheet at September 30, 2010, related to amountsto be reimbursed by the insurance company.

 

**12. Third Party Indemnity**

 

InDecember 2006, the Company sold its film library consisting of domesticrights and certain international ancillary rights to approximately 620television movies, mini-series and series (the “Crown Library”) to RHIEntertainment LLC (“RHI”).  As a condition of the sale, the Company agreedto pay up to $22.5 million for residuals and profit participations related toRHI’s domestic exploitation of the Crown Library for a ten-year period ending December 14,2016. The Company estimated the fair value of this obligation to beapproximately $10.6 million at December 15, 2006, assuming the maximumpayout. Any revisions to this estimated liability will be reflected as gain(loss) from sale of film assets in future periods. In 2006, the Companyrecorded an $8.2 million gain related to the sale of these film assets.

 

InDecember 2009 the Company concluded that payments for residuals and participationsunder its liability to RHI would occur generally later than originallyestimated in December 2006. Accordingly, the Company reduced the carrying amount of the liability by$682,000 and recognized a corresponding gain from sale of film assets in theaccompanying statement of operations. InJuly 2010, the Company received notification of pending requests forpayments of approximately $8.0 million related to exploitation of the CrownLibrary through mid-2010.  Accordingly,the Company increased the carrying amount of the liability by $155,000 andrecognized a corresponding loss from sale of film assets in the accompanyingstatement of operations.

 

Carryingamounts of this liability of $13.9 million and $14.6 million as of December 31,2009, and September 30, 2010, respectively, are included in accruedliabilities on the accompanying consolidated balance sheets.  The aggregate amount of payments that theCompany will make under this obligation is dependent upon the relative successRHI achieves in exploiting these film assets. However, in no event will the aggregate cash payments under thisobligation exceed $22.5 million.  At September 30,2010, the maximum future payout remaining under this agreement is $19.9million. The timing of such payments is dependent upon not only the timing ofRHI’s exploitation of these film assets but RHI’s administrative processes bywhich it will request payments from the Company. Accordingly, it is likelythat, during the remaining term of this liability, the carrying amount will beadjusted as additional information becomes available to the Company.

 

**13.  Martha Stewart Agreement**

 

In January 2010, the Company entered into amulti-year agreement with Martha Stewart Living Omnimedia, Inc. (“MarthaStewart Living”) to exclusively televise original episodes of the daytime homeand lifestyle series *The Martha Stewart Show*on Hallmark Channel beginning September 2010. As part of the agreement,Martha Stewart Living will also develop a range of new and original series andprime time specials that will complement Hallmark Channel’s schedule.  The portion of the agreement that relates to *The Martha Stewart Show* represents a collaborativearrangement.

 

The Company has and will continue to act as principal inthe transactions related to the (i) the sale of most of advertising unitsaired during *The Martha Stewart Show*, (ii) collectionof accounts receivable related to most sales of advertising units and productintegrations, and (iii) the broadcast of *The MarthaStewart Show* and associated advertising units.  Accordingly, the Company is reporting revenuerelated to these transactions on a gross basis. The Company recognized advertising revenue of $1.1 million related tothis transaction for the three and nine months

 

21

----

Table of Contents

 

ended September 30, 2010.

 

The aggregate amount payable to Martha Stewart Livingeach season represents programming expense.  The Company has and will continue to recognize programming expenseusing the percent-of-revenue method. Non-affiliate programming expense relatedto Martha Stewart Living was $1.1 million for the three and nine months ended September 30,2010.

 

22

----

Table of Contents

 

**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 “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations” in the Company’s Annual Report on Form 10-K for the yearended December 31, 2009.

 

**Description of Business and Overview**

 

*CurrentBusiness*

 

Weown and operate the Channels. With 90.2 million subscribers (as provided byNielsen Research) in the United States at September 30, 2010, the HallmarkChannel is the 38th most widely distributed advertising-supportedcable channel in the United States. At December 31, 2009, the HallmarkChannel was the 38th most widely distributed advertising-supportedcable channel in the United States with 88.3 million subscribers (as providedby Nielsen Research). For the third quarter of 2010, the Hallmark Channelfinished the quarter as the 24th highest ratedadvertising-supported cable channel for total day household ratings and the 25th highest rated advertising-supported cablechannel in prime time as measured by Nielsen Research. At October 31,2010, the number of subscribers declined to 87.3 million due to lack of a contractwith AT&T u-Verse (“AT&T”).

 

Welaunched our second 24-hour linear channel, the Hallmark Movie Channel, duringthe first quarter of 2005.  Programmingon the Hallmark Movie Channel consists primarily of movies and mini-series. TheHallmark Movie Channel has generated subscriber fees and advertising revenue since2005. As distribution continues to expand, the financial contribution of theHallmark Movie Channel may grow, including increases in advertising andsubscription revenue. The Hallmark Movie Channel is operated through CrownMedia Holdings’ existing infrastructure at a small incremental cost.  In April 2008, we began distributing theHallmark Movie Channel HD in high definition format, resulting in additionalcosts; however, we expect that this additional format will continue tocontribute to subscriber growth for the Hallmark Movie Channel.  See below for information regarding a highdefinition version of the Hallmark Channel.

 

AtSeptember 30, 2010, the Hallmark Movie Channel was distributed to over38.2 million subscribers, an increase of nearly 9.1 million subscribers from29.1 million at December 31, 2009. The overall increase in distribution,particularly in certain key markets, and a greater number of advertising spotshas contributed to improved Hallmark Movie Channel revenue in 2010 and shouldcontinue to do so through the remainder of the year. In the second quarter of2010, we began selling Hallmark Movie Channel inventory to advertisers based onaudience guarantees, which has increased and will continue to increase ourability to grow revenues from that channel. At October 31, 2010, thenumber of subscribers declined to 36.7 million due to lack of a contract withAT&T.

 

***Current Challenges***

 

TheCompany faces numerous operating challenges. Among them are increasingviewership ratings, maintaining and increasing advertising revenue, maintainingand expanding the distribution of the Channels, broadening viewershipdemographics to meet our target audience, and controlling costs and expenses.

 

*Ratings*

 

Ratingssuccess plays a significant role in our ability to achieve our distribution andadvertising goals.  Our ratings declinedfrom 15th in total day viewership and 12th for prime time in 2009 to 26th in total day viewership and 23rd for prime time in 2010.  We believe our ratings are affected by ourability to (i) acquire and produce series and movies that appeal to ourtarget demographic and (ii) develop a programming schedule that attracts ahigh number of viewers. Original productions are our most high profile programsand generate the Hallmark Channel’s highest ratings. In the past, the Companyhas typically incurred additional marketing and promotional expensessurrounding original productions and certain acquired movies to drive higherratings. Certain acquired series delivered historically strong ratings, butrecently they have been part of the decline experienced in viewer ratings. Inorder to reverse the recent decline in ratings, we plan to continue or increasethe number of our original productions and

 

23

----

Table ofContents

 

developa programming schedule that attracts a greater number of viewers in our targetdemographic, all while controlling the costs and expenses relating to theseactions.

 

Ourrecent agreements with Martha Stewart Living Omnimedia, including theacquisition of exclusive rights to the live daytime lifestyle program *The Martha Stewart Show* and rights to the extensive libraryof Martha Stewart branded lifestyle programming, represent a key part of ourstrategy to attract viewers that appeal to relatively higher CPM (*i.e.,* advertising rates per thousand viewers)advertisers.  We introduced thislifestyle programming in various dayparts in the second quarter of 2010, leadingto the September 2010 premier of *The Martha Stewart Show*on the Hallmark Channel.  Additionally inSeptember, Hallmark Channel premiered several other original lifestyle showsfor the daytime lifestyle block.  Theseprogram changes have resulted and may result at least initially in reductionsin the ratings delivery of the Channel, but our plan is that, over time, thesechanges will increase our revenue through the delivery of a more targeteddemographic and attraction of higher CPM advertisers.

 

Priorto the second quarter of 2010, the Hallmark Movie Channel had not been thesubject of ratings measurement by Nielsen Media Research. Since then, however,the Hallmark Movie Channel has had Nielsen ratings and we have been sellingadvertising inventory for the Hallmark Movie Channel based on a price per unitof audience measurement.

 

*Advertising Revenue*

 

Theoverall improvement in the economy during the first nine months of 2010 had afavorable impact on cable advertising rates, including the rates for ourinventory.  Our third quarter scattermarket inventory was sold at rates 43% above rates in the third quarter 2009scatter market and 110% above the rates for third quarter 2010 inventory soldin the upfront.  Additionally, directresponse rates were down by 27% compared to that inventory sold in the sameperiod of 2009.   Although our CPMs inthe third quarter of 2010 were higher than the same period of 2009, ourdelivery of our key demographic, women 25-54, was substantially lower thanprior periods.  Our demographic deliveryin the third quarter of 2010 was lower than the previous quarter and lower thanthe same period of 2009.  This lowerdemographic delivery more than offset gains in our CPMs resulting in lower advertisingrevenue in the third quarter of 2010 compared to the third quarter of 2009.

 

Inthe 2010/2011 upfront process representing the sale of our inventory for thelast quarter of 2010 and the first three quarters of 2011, we entered intoagreements with major advertising firms representing approximately 41% of ouradvertising inventory.  In the prior year2009/2010 upfront we sold approximately 40% of our inventory.  The 2010/2011 inventory was sold at CPMs over25% higher than the inventory sold in the 2009/2010 upfront, includingsignificant increases in rates related to our new lifestyle programmingblock.  The Company will sell the balanceof the general rate inventory for the 2010/2011 broadcast season to advertisersthat purchase upfront inventory on a calendar year basis, rather than anadvertising year basis, and in the scatter marketplace. Additionally, we soldapproximately 39% of the Hallmark Movie Channel’s available inventory in the2010/2011 upfront.

 

Followingthe upfront period, sales of our general rate, direct response and paid-programminginventory are made closer to the timing of the actual advertisement.  As compared to the upfront sales for the sameperiods, scatters rates in the third quarter of 2010 were 110% higher.

 

Advertiserswith upfront contracts have an option to terminate their contracts, as well asan option to expand the amount of inventory purchased under the contracts. Inprior years, cancellations of upfront contracts were unusual. During the twelvemonths period ended September 2009 comprising the 2008/2009 broadcastseason, advertisers canceled approximately 13% of the inventory covered by suchcontracts.  The Company sold the balanceof the 2008/2009 general rate inventory, including that resulting from thecancellations, in the scatter market. Advertisers cancelled a total of 11% ofthe inventory covered by upfront contracts during the third quarter of 2010 ascompared to 14% during the third quarter of 2009.

 

TheCompany was able to sell the Martha Stewart programming time block at rates117% higher than prior year’s rates during that same time block.

 

*DistributionAgreements*

 

Distributionagreements with multiple systems operators are important because they affectour number of subscribers, which in turn has a major impact on our subscriberfees, the number of persons viewing our programming, and the rates charged foradvertising. Our long-term distribution challenge will be obtaining favorablerenewals of our major distribution agreements as they expire. Our major distribution agreements have terms which expireat various times from September 30, 2010, through December 2023,inclusive of renewal options.

 

24

----

Table of Contents

 

Agreements representing anadditional 5% of subscribers to the Hallmark Channel****will expire prior to December 31, 2010.

 

Our agreement with NationalCable Television Cooperative (“NCTC”),representing approximately 12% of our total Hallmark Channel subscriber base,expired in December 2009.Since then, we entered into a series of extensions with NCTC, the last of whichexpired May 7, 2010. The Company is currently in negotiations with NCTCand anticipates that an agreement will be completed in the fourth quarter of2010. In the mean time, we continue to distribute the Channels to NCTC memberoperators, generally in accordance with the provisions of the most recentlyexpired agreement.  Due to lack of anagreement from May 8, 2010, through September 30, 2010, the Companyrecognized revenue on a cash basis; thus, causing a decrease in advertisingrevenue during that period.

 

The Company’s agreement withAT&T expired on August 31, 2010. On September 1, 2010, theHallmark Channel and the Hallmark Movie Channel were dropped from AT&T’splatform because the parties had not agreed to the terms of a new distributionagreement. As a result, we expect the overall subscriber numbers for theHallmark Channel and the Hallmark Movie Channel to decrease by approximately2.5 million and 1.0 million, respectively. The Company accounted for subscriberrevenue earned through August 31, 2010, on an accrual basis.

 

Theuniverse of cable and satellite TV subscribers in the United States isapproximately 104 million homes.  The top30 cable TV networks in the United States, measured by the number ofsubscribers, have 90 million or more subscribers.  Our goal is for the Hallmark Channel to reach91 million subscribers and the Hallmark Movie Channel to reach 40 millionsubscribers by the end of 2010.

 

*Demographics*

 

Aspay television channels draw audience share, audience demographics (i.e.,viewers categorized by characteristics such as age, gender and income) becomefragmented. As a result, advertisers are able to target the specific groups ofviewers who are most likely to purchase their products by advertising onchannels which attract the desired viewer demographic.

 

Webelieve that the key demographics for the Hallmark Channel are the viewers inthe groups Adults aged 25 to 54 and Women aged 25 to 54.  However, the average median age of a viewerof the Hallmark Channel was 59.5 in 2009. In order to achieve our revenue goals, we need to draw in our targetaudience.  Broadcasts of *The Martha Stewart Show* and other Martha Stewart Living productionson the Hallmark Channel, which commenced in September 2010, are key partsof our efforts to attract our target audience over time.

 

*Launch of High Definition*

 

 

Welaunched a high definition version of the Hallmark Channel in February 2010.  The costs for this launch were approximately$5.0 million, of which a non-cash charge of $4.4 million was recognized in December 2009in connection with the terminations of two existing channel deliveryagreements. The Company may also incur additional costs including the cost ofconverting certain television series to high definition.  The launch of a high definition versionfurthers the Company’s efforts to maintain competitiveness.

 

**Revenue from Continuing Operations**

 

Our revenue consists of subscriber fees and advertising fees.

 

*Subscriber Fees*

 

Subscriber fees are generally payable to us on a per subscriber basisby pay television distributors for the right to carry our Channels. Rates we receive per subscriber vary with changesin the following factors, among others:

 

·              the degree of competition inthe market;

 

·              the relative position in themarket of the distributor and the popularity of the channel;

 

25

----

Table of Contents

 

·              the packaging arrangementsfor the channel; and

 

·              length of the contract termand other commercial terms.

 

We are in continuous negotiations with our existing distributors toincrease our subscriber base in order to enhance our advertising revenue. Wehave been subject to past requests by major distributors to pay subscriberacquisition fees for additional subscribers or to waive or accept lowersubscriber fees if certain numbers of additional subscribers are provided. Wealso may help fund the distributors’ efforts to market our Channels or we maypermit distributors to offer limited promotional periods without payment ofsubscriber fees.

 

In the past, we have generally paid certain television distributorsup-front subscriber acquisition fees to obtain initial carriage on domestic paydistributor systems. Subscriber acquisition fees that we paid in the past werecapitalized and amortized over the contractual term of the applicabledistribution agreement as a reduction in subscriber fee revenue. If theamortization expense exceeds the revenue recognized on a per distributor basis,the excess amortization is included as a component of cost of services. At thetime we sign a distribution agreement and periodically thereafter, we evaluatethe recoverability of the costs we incur against the incremental revenuedirectly and indirectly associated with each agreement.

 

Our Channels are usually offered as one of a number of channels oneither a basic tier or part of other program packages and are not generallyoffered on a stand-alone basis. Thus, while a cable or satellite customer maysubscribe and unsubscribe to the tiers and program packages in which one of ourChannels is placed, these customers do not subscribe and unsubscribe to our Channelsalone.  We are not provided withinformation from the distributors on their overall subscriber churn and in whatmanner their churn rates affect our subscriber counts; instead, we are providedinformation on the total number of subscribers who receive the Channels.

 

Our subscriber count depends on the number of distributors carrying oneof our Channels and the size of such distributors as well as the program tierson which our Channel is carried by these distributors. From time to time, weexperience decreases in the number of subscribers as promotional periods end,or as a distributor arrangement is amended or terminated by us or thedistributor. The level of subscribers could also be affected by a distributorrepositioning our Channels from one tier to another tier. Management analyzesthe estimated effect each new or amended distribution agreement will have onrevenue and costs. Based upon these analyses, if subscriber acquisition feesare needed, management endeavors to achieve a fair combination of subscribercommitments and subscriber acquisition fees.

 

*Advertising*

 

Historically, revenue from advertising aired on our channels hascontributed more than 75% of our total annual revenue.  We earn advertising revenue in the form ofspot or general rate advertising, direct response advertising andpaid-programming (i.e., “infomercials”). Spot advertisements and direct response advertisements are generally 30seconds long and are aired during or between licensed program content.  Spot advertisements are priced at a rate perthousand viewers and almost always bear the Company’s commitment to deliver aspecified number of viewers.  Our revenuefrom direct response advertising varies in proportion to the direct salesachieved by the advertiser.  It is soldwithout ratings or product sales commitments. Paid-programming is sold at fixed rates for 30 minute blocks of time,typically airing in the early morning hours. It requires no licensed program content. Our advertising revenue is affected by the mix of these forms ofadvertising.

 

Our rates for spot advertisements are generally calculated on the basisof an agreed upon price per unit of audience measurement in return for aguaranteed commitment by the advertiser. We commit to provide advertiserscertain rating levels in connection with their advertising. Advertising ratesalso vary by time of year due to seasonal changes in television viewership.Revenue is recorded net of estimated delivery shortfalls (“audience deficiencyunits” or “ADUs”), which are usually settled by providing the advertiseradditional advertising time. The remainder of the revenue is recognized as the “make-good”advertising time is delivered in satisfaction of ADUs. Revenue from directresponse advertising depends largely****upon actionsof viewers.

 

26

----

Table of Contents

 

Whenever spot advertising is aired in programs that do not achievepromised viewership ratings, we issue ADUs which provide the advertiser withadditional spots at no additional cost. We defer a pro rata amount of advertising revenue and recognize a likeamount as a liability for programs that do not achieve promised viewershipratings.  When the make-good spots aresubsequently aired, revenue is recognized and the liability is reduced.  The level of inventory that is utilized forADUs varies over time and is influenced by prior fluctuations in ourunder-delivery, if any, of viewers against promised ratings as well as the rateat which we and our customers mutually agree to utilize the ADUs.

 

Our channels are broadcast 24 hours per day. Our advertising inventorycomprises the commercial load or advertising capacity of the program hours inwhich we intend to broadcast licensed program content.  The volume of inventory that we haveavailable for sale is determined by the number of our channels (*i.e*., two), our chosen commercial load per hour and thenumber of broadcast hours in which we air licensed program content.  Sales of advertising inventory for cash aredecreased by our need to reserve inventory for the use of ADUs.

 

**Cost of Services**

 

Our cost of services consists primarily of the amortization of programlicense fees; the cost of signal distribution; and the cost of promotionalsegments that are aired between programs.

 

**Critical Accounting Policies, Judgments and 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 ofrevenue and expenses during the reporting period. Actual results could differfrom those estimates.

 

For further information regarding our criticalaccounting policies, judgments and estimates, please see Notes to UnauditedCondensed Consolidated Financial Statements contained in Item 1 of this Reportand “Critical Accounting Policies, Judgments and Estimates” in Item 7 of theCompany’s Annual Report on Form 10-K as filed with the SEC for the yearended December 31, 2009.

 

**Effects of Transactions with Related and Certain OtherParties**

 

In2010 and in prior years, we entered into a number of significant transactionswith Hallmark Cards and certain of its subsidiaries. These transactionsinclude, among other things, trademark licenses, an administrative servicesagreement, a tax sharing agreement and the Recapitalization, including theloans under the Credit Agreement, a registration rights agreement and astockholders agreement. For information regarding such transactions andtransactions with other related parties, please see “Effects of Transactionswith Related and Certain Other Parties” in Item 7 of the Company’s AnnualReport on Form 10-K as filed with the SEC for the year ended December 31,2009, and “The Recapitalization” in the Company’s Schedule 14C InformationStatement filed with the SEC on May 21, 2010. Also, please see Notes 1, 5and 6 of Notes to Unaudited Condensed Consolidated Financial Statementscontained in Item 1 of this Report.

 

***Credit Agreement***

 

Pursuantto the Recapitalization, the Company and HCC entered into a Credit Agreementproviding for the restructuring of approximately $315.0 million principalamount of the HCC Debt into new debt instruments on terms including thefollowing:

 

·*Maturity:*  Thematurity of the New Debt is December 31, 2013.

 

·*Tranches:*  TheNew Debt includes two tranches:

 

27

----

Table of Contents

 

· Term A Loan of $200.0 million bears interest payable in cash atthe rate of 9.5% per annum through December 31, 2011, and 12% thereafter.

 

· Term B Loan of $115.0 million bears interest payable in cash atthe rate of 11.5% through December 31, 2011, and 14% thereafter.  At the Company’s option, it may pay-in-kind (“PIK”)interest payable for quarters in 2010. Through September 30, 2010, theCompany has paid interest in cash.

 

TheCompany has the option to PIK up to three additional quarterly cash payments inthe aggregate for the Term A Loan and the Term B Loan. Exercise of the 2010 PIKoption under the Term B Loan will not reduce the number of additional PIKpayments available to the Company. If the Company opts to PIK both the Term ALoan and the Term B Loan cash payments in a single quarter, that will count astwo of the Company’s three additional PIK options.

 

*Default Interest:*    TheCompany will be required to pay interest on its obligations to HCC at aninterest rate equal to the original interest rate applicable to suchobligations plus 2% if: (i) any amount of principal of the New Debt is notpaid when due; (ii) any amount payable under any Fundamental Document (asdefined in the Credit Agreement) is not paid when due; or (iii) an Eventof Default (as described below) exists.

 

*Prepayment:*    TheNew Debt is prepayable at any time at par plus accrued interest.

 

*Mandatory Prepayments:*    Thefollowing amounts must be used to prepay the New Debt. All net cash proceedsfrom asset sales or other dispositions, except to the extent such net cashproceeds are reinvested in productive assets of a kind then used or usable inthe business of the Company or its subsidiaries within 180 days of thesale or other disposition; 100% of net cash proceeds from equity issuances;100% of net cash proceeds from debt issuances (exclusive of the bank creditfacility); 75% of Excess Cash Flow (as defined in the Credit Agreement); andupon the sale of assets in advance of a condemnation proceeding, or followingthe occurrence of a casualty or condemnation for which the Company or itssubsidiaries have received proceeds, any such proceeds in excess of the amountused to replace the subject assets. Prepayments must be applied in thefollowing order (i) first to PIK interest on the Term A Loan(ii) then to principal on the Term A Loan (iii) then to PIK intereston the Term B Loan, and (iv) finally to principal on the Term B Loan.

 

*Acceleration:*    Theprincipal and interest on the New Debt will become immediately due and payableupon a change in control arising from (i) a Premium Transaction (asdescribed below under “Stockholders Agreement”) or (ii) a transactionapproved by the Company’s Board of Directors. Upon an Event of Default, HCC may declare the principal and interest onthe New Debt due and payable, without presentment, demand, protest or othernotice.

 

*Collateral:*   Theobligations under the Credit Agreement are secured by substantially all of theCompany’s assets. This security interest is subordinate to the lender’s securityinterest under the bank credit facility.

 

*Affirmative Covenants:*    Underthe Credit Agreement, the Company and its subsidiary guarantors will, amongother things:

 

(i)      Provide annual and quarterlyfinancial statements and compliance certificates to HCC.

 

(ii)     Maintain their corporate existence and materialrights, licenses and permits and comply in all material respects withapplicable law.

 

(iii)    Keep their tangible properties that are material tothe business in good repair and working condition and their assets of aninsurable character.

 

(iv)    Provide prompt notice to HCC of material eventsincluding any Event of Default, any material adverse change in the party’scondition or operations or any event which could reasonably be expected tomaterially and adversely affect performance of such party’s obligations to HCC,result in a Material Adverse Effect (as defined in the Credit Agreement) orotherwise cause the loss of more than 7.5 million subscribers.

 

28

----

Table of Contents

 

(v)     Provide prompt notice to HCC of the institution ofany action or investigation by any governmental authority or materialdevelopment in any action or investigation, which might, if adverselydetermined, reasonably be expected to have a material adverse effect orotherwise cause the loss of more than 7.5 million subscribers.

 

(vi)    Upon HCC’s request, take all actions necessary toregister copyrights or trademarks.

 

(vii)   Defend the collateral against liens other thanpermitted encumbrances.

 

(viii)  Notify HCC of any potential violation of,non-compliance with or potential liability under, any environmental laws whichcould reasonably be expected to have a material adverse effect.

 

(ix)     Upon HCC’s request, obtain credit ratingsissued by Moody’s or S&P.

 

*Negative Covenants:*    TheCredit Agreement includes restrictions on the ability of the Company and itssubsidiary guarantors (the “Credit Parties”) to, among other things:

 

(i)      Incur additional indebtedness, subject to certainexceptions including, but not limited to, indebtedness in respect of securedpurchase money financings not to exceed $30.0 million at any time,ordinary trade payables, indebtedness to another Credit Party and the$30.0 million revolving credit facility.

 

(ii)     Incur liens on any collateral, subject to certainexceptions including, but not limited to, subordinated liens in favor of guildsas required by collective bargaining agreements and liens incurred in theordinary course of business.

 

(iii)    Incur guaranties, subject tocertain exceptions including, but not limited to, certain guaranties that wouldconstitute investments.

 

(iv)    Make investments orpayments, subject to certain exceptions including investments of less than$5 million in the aggregate to entities that are not wholly-ownedsubsidiaries, intercompany advances, payments to other Credit Parties and toHallmark Cards pursuant to the terms of a service agreement.

 

(v)     Sell, lease, transfer,license, or otherwise dispose of (A) movies or television programs otherthan in the ordinary course of business (provided that the Company will not beentitled to sell, transfer or alienate its entire interest items of suchproducts with an aggregate value in excess of $5 million),(B) channels owned or operated by the Credit Parties or (C) otherproperty except de minims dispositions made in the ordinary course of business.

 

(vi)    Sell, discount or otherwise dispose of notes,accounts receivable, or other obligations owing to HCC except in the ordinarycourse of business.

 

(vii)   Make or incur obligations tomake capital expenditures in excess of $10.0 million for fiscal year 2010,$5.0 million for fiscal year 2011, $5.0 million for fiscal year 2012,and $5.0 million for fiscal year 2013.

 

(viii)  Amend any material agreementin a manner materially disadvantageous to HCC.

 

(ix)     Enter into any agreementprohibiting the creation or assumption of liens upon the properties or assetsof the Credit Parties or requiring an obligation to be secured if some otherobligation is secured.

 

(x)      Enter into any interest rateprotection agreement or currency agreement other than for bona fide hedgingpurposes.

 

(xi)     Permit the Cash InterestCoverage ratio (as defined in the Credit Agreement) of the Company and itsconsolidated subsidiaries, as at the end of each fiscal quarter, to be lessthan 2.0:1.0.

 

29

----

Table of Contents

 

*Events of Default:*    TheCredit Agreement defines “Events of Default” to include the following:

 

(i)      Any representation or warranty made by any CreditParty in the Credit Agreement, other Fundamental Document or in any documentfurnished to HCC pursuant to the Credit Agreement or other FundamentalDocument, is proven to have been false or misleading in any material respect.

 

(ii)     Default in the payment of any principal of orinterest on the New Debt (subject to a five day grace period) or other feespayable by the Company under the Credit Agreement.

 

(iii)    Default by any Credit Party in the performance ofthe covenant requiring notice of material events, any other negative covenantor the requirement to establish the NICC reserve account.

 

(iv)    Default by any Credit Party in the performance ofany other covenant or agreement contained in the Credit Agreement or anyFundamental Document, continuing unremedied for thirty days after thedefaulting party obtains knowledge thereof or receives written notice from HCC.

 

(v)     Default with respect to any indebtedness of anyCredit Party in excess of $1.0 million when due or the performance of anyobligation relating to such indebtedness, if the effect is to accelerate orpermit the acceleration of the maturity of such indebtedness.

 

(vi)    Any Credit Party does not pay its debts as theybecome due or admits in writing its inability to pay its debts, makes a generalassignment for the benefit of creditors or is subject of a voluntary or involuntarybankruptcy or similar proceeding.

 

(vii)   Final judgments for payments in excess of $1.0million are rendered in the aggregate against any Credit Party that is notdischarged or stayed pending appeal within thirty days from the entry of thejudgment.

 

(viii)  The Credit Agreement or other Fundamental Documentceases to be in full force and effect.

 

(ix)     The Credit Parties fail to maintain employee benefitplans in accordance with ERISA.

 

(x)      The Company defaults on the NICC Preferred Interestand such default is not remedied, cured, waived or consented to within thegrace period with respect thereto.

 

(xi)     Any demand for payment is made pursuant to HallmarkCard’s guaranty with respect to the bank credit facility.

 

***Stockholders Agreement***

 

Pursuantto the Recapitalization, the Company, Hallmark Cards and HCC entered into theStockholders Agreement which provides for, among other things, the following.

 

*Standstill Provisions:*    HallmarkCards will not, and will cause its controlled affiliates not to, acquire anyadditional shares of Common Stock (including pursuant to a short form merger)until December 31, 2013 except:

 

(i)      acquisitions that are effected with the priorapproval of a special committee of the Board of Directors comprised solely ofindependent, disinterested directors;

 

(ii)     acquisitions in connection with the conversion ofPreferred Stock;

 

30

----

Table of Contents

 

(iii)     in the event that the Company issues additionalshares of capital stock, such additional shares as are necessary to ensure thatHallmark Cards continues to hold at least the same percentage of the shares ofall classes of the Company’s capital stock as Hallmark Cards owned immediatelyprior to such issuance; and

 

(iv)    acquisitions effected between January 1, 2012and December 31, 2013 and either (x) in connection with certainPremium Transactions (as defined below) or (y) pursuant to a tender offerby Hallmark Cards or its affiliates for all of the outstanding shares of CommonStock, provided the holders of Common Stock not affiliated with Hallmark Cardstender, in the aggregate, at least a majority of the shares of Common Stockheld by all such stockholders at such time.

 

“PremiumTransaction” means a transaction involving the sale or transfer by HCC of itsshares of Common Stock to a third party (by merger or otherwise) in which allstockholders unaffiliated with Hallmark Cards are entitled to participate andare entitled to receive both (i) consideration equivalent in value to thehighest consideration per share of Common Stock received by HCC in connectionwith such transaction, and (ii) a premium of $0.50 per share of CommonStock (subject to adjustment for any stock splits, combinations,reclassifications, adjustments, sale of Common Stock by the Company, or sale ofCommon Stock by HCC pursuant to a public offering or block trade as describedabove, or any similar transaction). For the avoidance of doubt, the aggregatepremium shall not exceed $17,400,880, which is the product of the number ofoutstanding shares owned by minority stockholders as of the date of the MasterRecapitalization Agreement multiplied by $0.50. Also, for the avoidance ofdoubt, HCC may effectuate a Premium Transaction pursuant to a short-form merger(or other merger) between the Company and HCC or any purchaser of its shares,so long as the holders of Class A Common Stock not affiliated with HCCreceive the consideration provided for in this paragraph in connection withsuch merger.

 

*Co-sale Provisions:*    UntilDecember 31, 2013, HCC will not sell or transfer its Common Stock to athird party except:

 

(i)      to an affiliate of Hallmark Cards or pursuant to abona fide pledge of the shares to a lender that is not an affiliate of HallmarkCards (collectively, a “Permitted Transfer”);

 

(ii)     with the prior approval of a special committee ofthe Board of Directors comprised solely of independent disinterested directors;or

 

(iii)    after January 1, 2012 until December 31,2013 (x) in a Premium Transaction or (y) pursuant to a publicoffering or block trade in which to the knowledge of HCC, no purchaser(together with its affiliates and associates) acquires beneficial ownership ofa block of shares of the Company in such transaction in excess of 5% (in thecase of a public offering) or 2% (in the case of any block trade) of theoutstanding Common Stock.

 

Fromand after January 1, 2014 until the earlier of December 31, 2020 andsuch time as Hallmark Cards and its controlled affiliates no longerbeneficially own a majority of the Common Stock, HCC will not sell or transfer,in one or a series of related transactions, a majority of the outstandingshares of Common Stock to a third party, unless (x) in a PermittedTransfer, (y) with the prior approval of a special committee of the Boardof Directors or (z) all stockholders unaffiliated with Hallmark Cards willat Hallmark Card’s option be entitled to either participate in such transactionon the same terms as HCC or receive cash consideration equivalent in value tothe highest consideration per share of Common Stock received by HCC inconnection with such transaction.

 

*Subscription Rights:*    Exceptas otherwise set forth below, any time the Company proposes to issue equitysecurities of any kind, including any warrants, options or other rights toacquire equity securities and debt securities convertible into equitysecurities (“Proposed Securities”), the Company will:

 

(i)      give written notice setting forth in reasonabledetail (w) the designation and all of the terms and provisions of theProposed Securities, including the voting powers, preferences and relativeparticipating, optional or other special rights, and the qualification,limitations or restrictions thereof and interest rate and maturity,(x) the price and other terms of the proposed sale of such securities,(y) the amount of such securities

 

31

----

Table of Contents

 

proposedto be issued, and (z) such other information as HCC reasonably requests inorder to evaluate the proposed issuance; and

 

(ii)     offer to issue to HCC or its affiliate a portion ofthe Proposed Securities equal to a percentage (the “Fully Diluted OwnershipPercentage”) determined by dividing (x) the number of shares owned by HCCand its affiliates immediately prior to the issuance of the Proposed Securitiesby (y) the total number of shares of Common Stock then outstanding,including for purposes of this calculation all shares outstanding on a fullydiluted basis.

 

Ifthe Proposed Securities are to be issued to employees of the Company or itsaffiliates as compensation with the approval of the Board of Directors (the “EmployeeProposed Securities”), the Company must comply with the following:

 

(i)      If the Employee Proposed Securities are shares ofcapital stock, subject to vesting or other similar conditions (“RestrictedStock”), then HCC and, if applicable, its affiliates have the right to purchasecapital stock of the same class as the Restricted Stock but which is notsubject to vesting or other similar conditions. HCC or its affiliates maypurchase up to the number of shares of capital stock equal to the number ofshares of Restricted Stock to be issued multiplied by a fraction, the numeratorof which is the Fully Diluted Ownership Percentage and the denominator of whichis 100% minus the Fully Diluted Ownership Percentage. The purchase price forsuch securities will be the fair market value of the Restricted Stock on thedate of issuance.

 

(ii)      If the Employee Proposed Securities are options toacquire capital stock of the Company, then the issuance of the ProposedSecurities will be deemed to occur upon the exercise of the options and notupon the issuance of the options, and HCC and, if applicable, its affiliates,will have the right to purchase, prior to the expiration of ten(10) business days after receipt of notice of such exercise from the Company,capital stock of the same class as the underlying security. HCC or itsaffiliates may purchase up to the number of shares of capital stock equal tothe number of shares of the underlying security to be issued upon the exerciseof such Employee Proposed Securities multiplied by a fraction, the numerator ofwhich is the Fully Diluted Ownership Percentage and the denominator of which isthe quantity 100% minus the Fully Diluted Ownership Percentage. The issuanceprice will be deemed to be the fair market value of the underlying security onthe date of exercise and not the exercise price of the option or right.

 

Ifthe Proposed Securities are options or rights to acquire capital stock of theCompany but are not Employee Proposed Securities, then the issuance of theProposed Securities will be deemed to occur upon the exercise of the options orrights and not upon the issuance of the options or rights, and HCC and, ifapplicable, its affiliates have the right to purchase capital stock of the sameclass as the underlying security. HCC or its affiliates may purchase up to thenumber of shares of capital stock equal to the number of shares of theunderlying security to be issued upon the exercise of such Proposed Securitiesmultiplied by a fraction, the numerator of which is the Fully Diluted OwnershipPercentage and the denominator of which is the quantity 100% minus the FullyDiluted Ownership Percentage. The issuance price will be deemed to be the sumof the purchase price for such options or rights, plus any additionalconsideration paid upon exercise of such options or rights.

 

HCCand, if applicable, its affiliates, must exercise their purchase rights withinten (10) business days after receipt of such notice from the Company. Uponthe expiration of the offering period, the Company will be free to sell suchProposed Securities that HCC and its affiliates have not elected to purchaseduring the ninety (90) days following such expiration on terms andconditions no more favorable to the purchasers thereof than those offered HCCand its affiliates.

 

Themajority of the obligations of Hallmark Cards set forth in the StockholdersAgreement will terminate upon a payment default on the New Debt, subject to a60-day cure period. The Stockholders Agreement also terminates on the earliestof (i) such time as Hallmark Cards and its controlled affiliates cease tohold a majority of the Common Stock, (ii) such time as Hallmark Cards andits affiliates own all of the outstanding Common Stock and(iii) December 31, 2020.

 

32

----

Table of Contents

 

*Inapplicability of Prior Stockholders Agreement:*    Asa result of the Mergers and the terms of the Stockholders Agreement, HallmarkCards will no longer be subject to the prior stockholders agreement with theCompany. The prior stockholders agreement among the Company and its largeststockholders set forth certain corporate governance rights, and limitations onthe Company’s ability, directly or indirectly, to enter into any materialcontracts or transactions with any affiliate of certain stockholders, includinga wholly-owned subsidiary of Hallmark Cards, unless certain conditions weremet.

 

***Registration Rights Agreement***

 

Inconnection with the Recapitalization, the Company, HCC and any priorstockholders of HEIC that execute a joinder are parties to a RegistrationRights Agreement (the “Registration Rights Agreement”) relating to the sharesof Common Stock (i) issued to HCC or any joined party in connection withthe Mergers, (ii) issuable to HCC upon conversion of the HCC Debt and uponconversion of the Preferred Stock, (iii) acquired by HCC pursuant to itssubscription rights as set forth in the Stockholders Agreement and (iv) issuedas a dividend or other distribution with respect to, or in exchange for or inreplacement of the shares of Common Stock referred to in clauses (i)—(iii) (theshares described in clauses (i)—(iv) collectively, the “RegistrableSecurities”). The Registration Rights Agreement grants (i) three(3) demand registration rights exercisable by the holders of a majority ofthe Registrable Securities, (ii) three (3) resale shelf demand rightsexercisable by holders of a majority of the Registrable Securities and(iii) unlimited piggyback rights. The expenses of any of theseregistrations will be borne by the Company.

 

***Preferred Stock Terms***

 

Inconnection with the Recapitalization, the Company issued to HCC 185,000 sharesof Preferred Stock.  The terms of the PreferredStock include the following:

 

*Dividends:*    Nodividends will accrue or be payable from the date of issue of the PreferredStock through December 31, 2010. Cumulative dividends will accrue from andafter January 1, 2011 through December 31, 2011 at the rate of 14%per annum of the Original Issue Price. The “Original Issue Price” is $1,000 pershare subject to adjustment in the event of any stock dividends, stock splits,stock distributions or combinations and other corporate actions having asimilar effect with respect to the Preferred Stock. Cumulative dividends willaccrue from and after January 1, 2012 at the rate of 16% per annum of theOriginal Issue Price. Until December 31, 2014, dividends are payable incash or in additional shares of Preferred Stock, at the option of the Company.After December 31, 2014, dividends on the Preferred Stock are payable incash only. The Preferred Stock will participate with the Common Stock as to anydeclared dividends on an “as converted” basis.

 

*Optional Conversion:*    Eachshare of Preferred Stock will become and remain convertible at the earlier ofDecember 31, 2013, or upon a payment or refinancing of the New Debt (a “Refinancing”)at the option of the holder into a share of Common Stock at the rate equal to theOriginal Issue Price plus accrued and unpaid cash dividends with respect tosuch shares of Preferred Stock divided by the Preferred Conversion Price. “PreferredConversion Price” was $2.5969 as of the closing of the Recapitalization, whichprice is subject to adjustments for stock splits, combinations, dividends,mergers, recapitalizations and other corporate actions having a similar effectwith respect to the Preferred Stock and other adjustments as provided belowunder “Anti-Dilution Protection.”

 

*Anti-Dilution Protection:*    ThePreferred Conversion Price will be subject to adjustment for stock splits,combinations, dividends, mergers, recapitalizations and other corporate actionshaving a similar effect with respect to the Preferred Stock. The PreferredConversion Price will also be subject to adjustment on a full-ratchet basis inthe event that the Company issues additional shares (other Board approvedemployee options or shares in an acquisition, merger or joint venture) at apurchase price less than the prevailing Preferred Conversion Price.Full-ratchet basis means an adjustment of the Preferred Conversion Price to thelowest consideration paid per share for the additional shares. Shares subjectto options, other rights to acquire and convertible securities are deemedissued at their then exercise or conversion price.

 

*Mandatory Redemption:*    TheCompany must provide written notice (the “Excess Proceeds Notice”) to holdersof Preferred Stock, when and as the Company receives, upon a refinancing of theNew Debt, net proceeds from such refinancing in excess of the aggregateoutstanding principal and interest amounts of New Debt (the “Excess

 

33

----

Table ofContents

 

RefinancingProceeds”). Upon receipt of such notice, the holders of Preferred Stock mayelect to apply such Excess Refinancing Proceeds to redeem (to the extent offunds legally available for such redemption) at the Redemption Price a numberof the outstanding shares of Preferred Stock. The “Redemption Price” means aprice per share equal to the Original Issue Price, plus an amount equal to anyaccrued but unpaid cash dividends with respect to such share, together with anyother dividends declared but unpaid. If the Company receives any such requests,it must redeem on the twentieth day after delivery of the Excess ProceedsNotice, the number of outstanding shares of Preferred Stock set forth in allsuch notices received by the Company within fifteen days after delivery of theExcess Proceeds Notice. If the Excess Refinancing Proceeds are not sufficientto redeem all shares of Preferred Stock to be redeemed, the Company will redeema pro rata portion of redeemable shares based on the holders’ respectiveredemption requests.

 

*Optional Redemption:*    TheCompany will be able to redeem the Preferred Stock at any time, upon 10-dayswritten notice, at the Redemption Price.

 

*Voting Rights:*    ThePreferred Stock will vote together with the Common Stock as a single class,with the Preferred Stock voting on an “as converted” basis.

 

*Protective Provisions:*    Theconsent of holders of more than 50% of the Preferred Stock, voting as aseparate class, will be required to approve certain actions, including withoutlimitation:

 

(i)      Any authorization, offer, sale or issuance of anyequity securities pari passu or senior in right of liquidation, dividends orotherwise to the Preferred Stock or any additional shares of Preferred Stock.

 

(ii)     Repurchase or redemption of equity securities (otherthan from an employee following termination), or declaration or payment of anydividend on the Common Stock.

 

(iii)      Any sale, merger,liquidation or dissolution of the Company.

 

(iv)    Any significant acquisitions involving the payment,contribution or assignment by or to the Company or its subsidiaries of money orassets greater than $5,000,000.

 

(v)     Any action that adversely alters or changes the rights,preferences or privileges of the Preferred Stock.

 

(vi)    The issuance of any additional shares of CommonStock (other than pursuant to options outstanding on the Closing Date) oroptions or rights to acquire Common Stock.

 

(vii)   Except for certain indebtedness, liens andguaranties permitted by the Credit Agreement, authorization or issuance of anydebt security unless the debt security has received the prior approval of theBoard of Directors, or amendment of the terms of any agreement regarding materialindebtedness of the Company, unless the amendment has been approved by theBoard of Directors.

 

*Liquidation Preference:*    Inthe event of any liquidation or winding up of the Company, the holders of thePreferred Stock will be entitled to receive, in preference to the holders ofthe Common Stock, an amount equal to the greater of (x) the Original IssuePrice per share plus accrued but unpaid cash dividends thereon, or(y) that amount that would be received by such holders on an “as converted”basis had all Preferred Stock been converted into Common Stock immediatelyprior to such liquidation or winding up. A consolidation, merger or other formof acquisition of the Company or a sale of all or substantially all of itsassets will be deemed to be a liquidation or winding up for purposes of theliquidation preference.

 

***Tax Sharing Agreement***

 

On March 11, 2003, theCompany became a member of Hallmark Cards consolidated federal tax group andentered into a tax sharing agreement with Hallmark Cards.  HallmarkCards includes the Company in its consolidated federal income taxreturn.  Accordingly, Hallmark Cards has benefited from past taxlosses and may benefit from future tax losses, which may be generated by theCompany.  Based on the tax sharing agreement,

 

34

----

Table of Contents

 

Hallmark Cards pays the Company all of the benefitsrealized by Hallmark Cards as a result of consolidation, 75% in cash on aquarterly basis and the balance when the Company becomes ataxpayer.  Under the tax sharing agreement, at Hallmark Cards’option, this 25% balance may also be applied as an offset against any amountsowed by the Company to any member of the Hallmark Cards consolidated groupunder any loan, line of credit or other payable, subject to any limitationsunder any loan indentures or contracts restricting such offsets.

 

The Company received $21.3million under the tax sharing agreement during 2008, which was offset againstthe tax note. The Company incurred liability under the tax sharing agreement toHallmark Cards in the amount of $8.5 million during 2009.

 

In connection with theRecapitalization, the tax sharing agreement was amended,effective as of January 1, 2010. The amendment provides, among otherthings, that:

 

·      HallmarkCards will not pay any Crown Tax Benefits (defined inthe tax sharing agreement) in cash and instead will carryforward any such amounts to offset future Crown Tax Liability (defined inthe tax sharing agreement);

 

·      theCompany is allowed to deduct both cash-pay and pay-in-kind, or PIK,interest due to Hallmark Cards in calculating tax-sharing payments;

 

·      theconversion of the HCC Debt pursuant to the Recapitalization is not deemedthe payment of interest expense to Hallmark Cards;

 

·      cancellationof indebtedness income resulting from the Recapitalization will be excludedfrom the calculation of tax sharing payments for the 2010 tax year; and

 

·      anyamounts related to taxes owed to Hallmark Cards prior to December 31,2009, was included in the HCC Debt.

 

The first payment by theCompany pursuant to the amended tax sharing agreement is expected to occur on December 15,2010.

 

***“Hallmark Hall of Fame”Programming License Agreement***

 

In2008, Crown Media United States entered into an agreement with Hallmark Cardsto license 58 “Hallmark Hall of Fame” movies, consisting of 16 contemporaryHallmark Hall of Fame titles (i.e., produced from 2003 to 2008) and 42 oldertitles, for exhibition on the Hallmark Channel and Hallmark Movie Channel.  These titles are licensed for ten yearwindows, with windows commencing at various times between 2007 and 2010,depending on availability.  Thisagreement makes the Hallmark Channel and Hallmark Movie Channel the exclusivehome for these movies.  The total licensefee for these movies is $17.2 million and is payable in equal monthlyinstallments over 10 year exhibition windows.

 

***HallmarkAdvertising***

 

Hallmark Cards purchased$429,000 and $775,000 of advertising on the Hallmark Channel in the UnitedStates at negotiated market rates, respectively, during the years ended December 31,2008 and 2009.

 

35

----

Table of Contents

 

During November and December of2009 and February of 2010, Hoops & Yoyo, popular animationcharacters created and owned by Hallmark Cards, hosted certain of our originalmovies airing on Hallmark Channel.  Thecharacters appeared intermittently during the airing of the movies to providecommentaries and narratives pertinent to the movies.  Hallmark Cards provided the content and nolicense fee was paid by the Company to Hallmark Cards for such content.

 

***Intercompany Services Agreement***

 

The Company has anintercompany services agreement with Hallmark Cards, which was entered into in2003 for a term of three years and then extended for additional years through December 31,2010. Under the agreement, Hallmark Cards provides us with the followingservices: tax services; risk management, health, safety and environmentalservices and insurance; legal services; treasury and cash management services;real estate consulting services; human resources services; and other servicesmutually agreed by the parties.

 

We have agreed to pay HallmarkCards $541,000 in 2008 and $455,000 in 2009 per year for these services, plusout-of-pocket expenses and third party fees, payable in arrears on the lastbusiness day of each quarter. The balance of the payable for services, expensesand fees under this and the previous services agreement as of both December 31,2008 and 2009, was approximately $5.5 million. We believe that the servicesbeing provided under the agreement have a value at least equal to the annualfee. For the last three months of 2008, the Company paid the monthly amount dueunder the intercompany service agreement in the amount of approximately$135,000.  The Company made timely paymentsin 2009.

 

***Hallmark Trademark License Agreements***

 

Crown Media United Statesoperates under the benefit of a limited trademark license agreement withHallmark Licensing, Inc., dated March 27, 2001, which has beenextended through September 1, 2011. The amended and restated Crown Media United States trademark agreementpermits Crown Media United States to name its network service as the “HallmarkChannel.”  The agreement contains usagestandards, which limit certain types of programming and programming contentaired on Crown Media United States’ network. Crown Media United States also hasa similar trademark license agreement with Hallmark Licensing, Inc., whichis effective January 1, 2004, and as extended expires September 1,2011, to permit the use of the Hallmark trademark in the name of the “HallmarkMovie Channel.”

 

Under the agreement, ifHallmark Cards notifies us in writing that it has determined that we havefailed to comply with the usage standards set forth in the agreement or haveotherwise breached our obligations under the agreement, we are required to stopany non-complying activity within 10 days of that notice or we may be indefault of the agreement.  We also may bein default if Hallmark Cards delivers such a written notice to us with respectto its standards three or more times in any 12-month period.  In addition, there may be a default under theagreement if we fail to cure any breach of the program agreement with RHIEntertainment Distribution, if we fail to make any payments due under loanagreements within five days of the due date, or if we receive an opinion fromour auditors that shows that we no longer are a going concern. The Companyobtained a waiver for the trademark license agreement dated March 3, 2010,from Hallmark Cards related to its going concern opinion over its 2009financial statements.

 

The license agreements can beterminated immediately and without notice if we transfer in any way our rightsunder the license agreements, if we have an event of default under theagreement or in events of bankruptcy, insolvency or similar proceedings.

 

***LeaseGuarantees with Hallmark Cards***

 

On February 24, 2010, theCompany executed a letter of credit/guaranty commitment with respect to acertain lease agreement with 12700 Investments, Ltd. for the office spaceat 12700 Ventura Boulevard, Studio City, California.   The landlordrequired that Crown Media United States, the entity which executed the lease,provide a letter of credit of $1.6 million securing certain obligations ofCrown Media United States.  Consequently, Hallmark Cards has agreed toguarantee the issuer of such letter of credit against any loss thereon pursuantto the guaranty. As 

 

36

----

Table of Contents

 

an inducement for HallmarkCards to issue the guaranty, Crown Media United States has agreed to payHallmark Cards a fee which equals 0.75% per annum of the outstanding letter ofcredit obligation.  Additionally, in theevent that Hallmark Cards is required to pay any amount under the guaranty,Crown Media United States must reimburse Hallmark Cards for any such amountplus any fees and charges associated with making such payment, any interestapplicable to such amount and any costs and expenses of Hallmark Cards inconnection with protecting its rights under the guaranty.

 

On September 2, 2008,Hallmark Cards issued a guaranty for the benefit of Crown Media United States,which guaranty pertains to a lease agreement with Paramount Group, Inc. forthe office space at 1325 Avenue of the Americas, New York, New York.  As acondition to executing the lease agreement, the landlord required HallmarkCards to guaranty all obligations of Crown Media United States under the leaseagreement.  As an inducement for Hallmark Cards to issue the guaranty,Crown Media United States has paid Hallmark Cards a fee which equals 0.28% perannum of the outstanding obligation under the lease agreement. Additionally, inthe event that Hallmark Cards is required to pay any amount under the guaranty,Crown Media United States must reimburse Hallmark Cards for any such amount plus any fees and charges associatedwith making such payment, any interest applicable to such amount and any costsand expenses of Hallmark Cards in connection with protecting its rights underthe guaranty.

 

***VISN Preferred Interest***

 

VISN, a subsidiary of theNational Interfaith Cable Coalition, Inc. (“NICC”), owns a $25.0 millionpreferred interest in Crown Media United States.  Under the Crown Media United States Amendedand Restated Company Agreement, originally dated November 13, 1998, themembers agreed that if during any year ending after January 1, 2005 andprior to December 31, 2009, Crown Media United States has federal taxableincome (with possible adjustments) in excess of $10.0 million, and thepreferred interest has not been redeemed, Crown Media United States wouldredeem the preferred interest in an amount equal to the lesser of:

 

·      such excess;

·      $5.0 million; or

·      the amount equal to thepreferred liquidation preference on the date of redemption.

 

Crown Media United States didnot have such taxable income in 2009. Crown Media United States may voluntarilyredeem the preferred interest at any time, however, it is obligated to do so onthe date of redemption (December 31, 2010). The preferred interest has aliquidation preference of $25.0 million. See information below on a January 2,2008, agreement under which VISN may request the preferred interest be replacedwith promissory notes of Crown Media Holdings.

 

***Crown Media United StatesProgramming Agreement with NICC***

 

On January 2, 2008, CrownMedia Holdings entered into an agreement with NICC regarding termination of anyright of NICC under the agreement covering the operation of Crown Media UnitedStates (the “Company Agreement”) to compel Crown Media Holdings to buy all ofthe outstanding shares of Class A Common Stock owned by NICC and NICC’ssubsidiary VISN Management Corp. (“VMC”) at the then current market value.  The January 2008 agreement also coversother aspects of Crown Media Holdings’ relationship with NICC.

 

The January 2008agreement provided for the following:

 

37

----

Table of Contents

 

·              The put agreement wasterminated, and the purported exercise of the put was waived.

·              Throughout 2008 and 2009,Crown will provide to NICC the use of a two-hour time period each Sundaymorning for programming by NICC and NICC shall retain any advertising revenuefrom such time period.  Neither NICC norCrown is obligated to make any payment regarding this time period or theprogramming.

·              NICC voluntarily relinquishedits right to designate one director on Crown Media Holdings’ Board ofDirectors, effective with the resignation of its designee on December 19,2007.

·              In settlement of a claim ofNICC for $15,000,000 in the event of a change of control, Crown will pay NICC thetotal amount of $3,750,000 in three installments of $1,250,000 each on January 20,2008, January 20, 2009 and January 20, 2010.  If there would have been a change of controlprior to January 20, 2010, Crown would have paid the remaining unpaidinstallments at that time. The Company has paid the January 20, 2008, 2009and 2010, installments.

·              For so long as the preferredinterest remains outstanding, Crown will remit to NICC payments equivalent to6.0% per annum of outstanding balance of the preferred interest. The 2008 and2009 payments have been made.

·              At the request of VMC, Crownwill replace the preferred interest in Crown Media United States held byNICC/VMC with a promissory note of Crown and, at VMC’s option, a second notepayable to an independent not-for-profit corporation designated by VMC.  Such notes with an aggregate face amount equalto the outstanding preferred interest at the conversion date would bearinterest at 6.0% and a maturity date of December 31, 2010.  If the preferred interest is not exchangedfor notes, Crown will redeem the preferred interest as set forth in the CompanyAgreement of Crown Media United States.

·              To the extent required by theStockholders Agreement of HEIC, Crown will consent, and obtain the consent ofHEIC, for VMC to assign its ownership of HEIC shares to a non-profitcorporation designated by VMC or to NICC. The shares will continue to be subject to the HEIC StockholdersAgreement.  As a result of theRecapitalization, the HEIC Stockholders Agreement is no longer effective.

·              Except as provided orreferenced in the January 2008 Agreement, the term and conditions of thefollowing prior agreements between or among the parties to the January 2008agreements were superseded:  The CompanyAgreement and the December 2005 agreement. The Stockholders Agreement is modified to the extent provided in the January 2008Agreement.  In addition, the partiesprovided mutual releases.

 

During the years ended December 31,2008 and 2009, Crown Media United States paid NICC $6.4 million and $4.6million, respectively, related to the Company Agreement, the December 2005Agreement and the January 2008 Agreement.

 

***DIRECTVAffiliation Agreement***

 

On August 20, 2001, CrownMedia United States entered into an Affiliation Agreement with DIRECTV, Inc.,a wholly owned subsidiary of DIRECTV Enterprises, Inc.  Pursuant to the Affiliation Agreement,DIRECTV distributes the Hallmark Channel on the TOTAL CHOICE ® tier of its DBSdistribution system in the United States and pays us license fees for suchdistribution.  At the same time weentered into a Stock Purchase Agreement with DIRECTV Enterprises whereby weissued 5,360,202 shares of our Class A Common Stock, which shares weresubsequently transferred to its parent company, The DIRECTV Group, Inc. InMarch 2008, we renewed this distribution agreement for a multi-year termand additionally provided DIRECTV with the right to distribute the StandardDefinition and High Definition versions of the Hallmark Movie Channel. As of December 31,2009, DIRECTV accounted for 17.7 million of our subscribers.  Upon completion of the Recapitalization, TheDIRECTV Group, Inc.’s ownership percentage of our Class A CommonStock was reduced from approximately 7.2% to approximately 1.5%.

 

***Bank Credit Facility***

 

In 2001, the Company enteredinto a credit agreement (which agreement has been amended subsequently, with

 

38

----

Table of Contents

 

the most recent amendment dated June 29, 2010) witha syndicate of banks, led by JP Morgan Chase Bank, N.A. as Administrative Agentand Issuing Bank.  In March 2008, JPMorgan Chase Bank became the sole lender under the bank credit facility byacquiring the interests of all other lending banks.  The facility isguaranteed by the Company’s subsidiaries, is secured by all tangible andintangible property of the Company and its subsidiaries, and is guaranteed byHallmark Cards.  Interest on the credit facility is the Eurodollarrate plus 2.25% or the alternate base rate plus 1.25%.

 

As a result of the most recentamendment executed in June 2010 (Amendment No. 17), the bank creditfacility is a revolving line of credit in the amount of $30.0 million due on June 30,2011.   Simultaneously with executingAmendment No. 17, Hallmark Cards Subordination and Support Agreement wasterminated and an intercreditor agreement among HCC, JP Morgan Chase Bank andthe Company was entered into, which among other things defines the lienpriorities and allows for payments to HCC pursuant to the Recapitalization.

 

Each loan under the bankcredit facility bears interest at a Eurodollar rate or an alternate base rateas we may request at the time of borrowing.  The Eurodollar rate isbased on the London interbank market for Eurodollars, and remains in effect forthe time period of the loan ranging from one, two, three, six or twelvemonths.  The alternate rate is based upon the prime rate of JP MorganChase Bank, a certificate of deposit rate or the Federal Funds effective rate,which is adjusted whenever the rates change.  We were required to paya commitment fee of 0.15% per annum of the committed, but not outstanding,amounts under the revolving credit facility, payable in quarterly installments.Pursuant to Amendment No. 15, the commitment fee of 0.15% per annum wasincreased to 0.375% per annum, which results in no increase to us because thedifference was previously paid by us to Hallmark Cards.

 

The credit agreement, asamended, contains a number of affirmative and negative covenants.   Affirmative covenants include, without limitation,the following: (1) (a) within 90 days after the end of each fiscalyear, submit to the banks audited consolidated financial statements of theCompany required to be submitted to the S.E.C., and (b) within 45 daysafter the end of each of the first three fiscal quarters, submit to the banksunaudited consolidated financial statements of the Company required to besubmitted to the S.E.C.; (2) cause the Company’s corporate existence to beeffective; (3) keep tangible properties material to the Company’s businessin good condition; (4) provide notice of the following material events: (a) anyevent of default, (b) material adverse change in the condition oroperations of any credit party, (c) any action which could affect theperformance of the credit parties’ obligations under the Credit Agreement, (d) anyother event which could result in a material adverse effect, (e) openingor change of any executive office, (f) change in the name of the creditparties, (g) any event which affects the collectibility of receivables ordecrease the value of the collateral, (h) proposed material amendment toany material agreement that are part of the collateral and (i) any noticewhich a credit party received with respect to a claimed default; (5) (a) insureits assets adequately, (b) insure against other hazards and risks, (c) maintaindistributor’s “errors and omissions” insurance, (d) maintain broadcaster’s“errors and omissions” insurance, (e) cause all insurance to provide tothe Lender a written notice of any termination or material change of coverageand (f) upon request, provide to the Lender a statement of insurancecoverage; (6) maintain true and complete books and records of financialoperations and provide the Agent access to such books and records; (7) observeand perform all material agreements with respect to thedistribution/exploitation of the Products (as defined in the Credit Agreement);(8) pay all taxes and other governmental charges and indebtedness in theordinary course of business of the credit parties; (9) defend thecollateral against all liens, other than permitted encumbrances; (10) uponreceipt of any (a) payment from any obligor which should be remitted tothe Agent or (b) the proceeds of any sale of Product, remit such paymentor proceeds to the Agent; (11) comply with all applicable environmental laws,notify the Agent of any material violation of any applicable environmental lawsand indemnify the Agent and the Issuing Bank against any environmentallaw-related claims; and, (12) (a) upon request, execute and deliver allnecessary documents to perfect the liens on the collateral and to carry out thepurpose of the Credit Agreement and its ancillary documents and (b) clarify,if necessary, the chain of title for any item of the Products.

 

Negative covenants includelimitations on (1) indebtedness, (2) liens, (3) guaranties, (4) investments,(5) making “Restricted Payments,” (Restricted Payments include anydistribution on our equity, any redemption or other acquisition of our equityincluding redemption of the company obligated mandatorily redeemable preferredinterest, any payment on debt of the Company which is subordinated to the bankloans, and any other payment to Hallmark Cards or any of itsaffiliates).  The credit agreement, however, permits the Company tomake payments to Hallmark Cards or an affiliate in payment of a validoutstanding obligation with respect to certain payments related

 

39

----

Table of Contents

 

to the Recapitalization or any commercially reasonablefees in consideration for Hallmark Cards having extended its guarantee for thebank credit facility under Amendment No. 15, (6) sale of assets, (7) saleof receivables, (8) entering into any sale and leaseback transactions, (9) enteringinto transactions with affiliates, (10) amending any material agreementwith a credit party, (11) creating negative pledge, (12) mergers oracquisitions, (13) production of any item of Product in any fiscal year havingan aggregate budgeted negative cost in excess of $5.0 million, (14) changingour business activities, (15) entering into certain transactions that areprohibited under ERISA, (16) entering into any interest rate protectionagreement or currency agreement, (17) acquiring or creating any new subsidiary,(18) using or storing hazardous materials on our premises, (19) creatingany first tier subsidiary other than CM Intermediary or have any asset relatedto the Channel at a level above CM Intermediary and (20) creating any newliens.

 

Events of default under theamended credit agreement include, among other things,  (1) thefailure to pay principal or interest, with the default continuing unremediedfor five days after receipt of a remittance advice, (2) a failure toobserve covenants, (3) a change in control, (4) the Hallmark Cards’guarantee of the credit facility shall have expired or otherwise terminated orHallmark Cards shall have disavowed its obligations under the guarantee ordefault shall otherwise have occurred in accordance with the terms of theguarantee, (5) a termination by Hallmark Cards or any of its affiliates ofthe right of the Company or its subsidiaries to use the names “Hallmark” or “Crown”in their television services or any Channels owned or operated bythem.  For purposes of the credit facility, a change in control meansthat (a)  HCC ceases to have sufficient voting power to elect a majorityof the Company’s board of directors or beneficial ownership of over a majorityof the outstanding equity interest of the Company having voting power,(b) the majority of the Board is not comprised of individuals who wereeither in office or who were nominated by a two-third’s vote of individuals inoffice or so nominated as at December 17, 2001, or (c) theconsummation by the Company of a Rule 13e-3 transaction (or a “going-private”transaction) as defined in the Securities Exchange Act.

 

***Certain Business Relationships and Conflicts of Interest***

 

HCC holds approximately 90.3%of our outstanding shares of Class A Common Stock and 100% of PreferredStock.  HCC’s control could discourageothers from initiating potential merger, takeover or other change of controltransactions that may otherwise be beneficial to our businesses or holders of Class ACommon Stock.  As a result, the marketprice of our Class A Common Stock or our business could suffer.

 

HCC’s control relationshipwith us also could give rise to conflicts of interest, including:

 

·      conflictsbetween HCC, as our controlling stockholder, and our other stockholders, whoseinterests may differ with respect to, among other things, our strategicdirection or significant corporate transactions;

·      conflictsrelated to corporate opportunities that could be pursued by us, on the onehand, or by HCC or its other affiliates, on the other hand; or

·      conflictsrelated to existing or new contractual relationships between us, on the onehand, and HCC and its affiliates, on the other hand.

 

In addition, our directors,who may also be officers or directors of HCC or its affiliates, will havefiduciary duties, including duties of loyalty, to both companies and may haveconflicts of interest with respect to matters potentially involving oraffecting us.

 

Our certificate ofincorporation provides that Hallmark Cards will have no duty to refrain fromengaging in activities or lines of business that are the same as or similar tothe activities or lines of business in which we engage, and neither Hallmark Cardsnor any officer or director of Hallmark Cards, except as provided below, willbe liable to us or to our stockholders for breach of any fiduciary duty byreason of any such activities of Hallmark Cards.  In the event that Hallmark Cards acquiresknowledge of a potential transaction or matter which may be a corporateopportunity for both Hallmark Cards and us, Hallmark Cards will have no duty tocommunicate or offer that corporate opportunity to us and will not be liable tous or our stockholders for breach of any fiduciary duty as a stockholder byreason of the fact that Hallmark Cards pursues or acquires that corporateopportunity for itself, directs that corporate opportunity to another person,or does not communicate information regarding that corporate

 

40

----

Table of Contents

 

opportunity to us.

 

In the event that one of ourdirectors or officers who is also a director or officer of Hallmark Cardsacquires knowledge of a potential transaction or matter which may be acorporate opportunity for both us and Hallmark Cards, that director or officerwill have fully satisfied his or her fiduciary duty to us and our stockholderswith respect to that corporate opportunity if that director or officer acts ina manner consistent with the following policy:

 

·      abusiness opportunity offered to any person who is one of our officers, and whois also a director but not an officer of Hallmark Cards, will belong to us;

·      abusiness opportunity offered to any person who is one of our directors but notone of our officers, and who is also a director or officer of Hallmark Cards,will belong to us if that opportunity is expressly offered to that person inhis or her capacity as one of our directors, and otherwise will belong toHallmark Cards;

·      abusiness opportunity offered to any person who is one of our officers and anofficer of Hallmark Cards will belong to us if that opportunity is expresslyoffered to that person in his or her capacity as one of our officers, andotherwise will belong to Hallmark Cards; and

·      a corporatetransaction opportunity will belong to Hallmark cards and any person who is anofficer or director of us and an officer or director of Hallmark Cards shallhave no duty to communicate such corporate transaction opportunity to us.

 

For purposes of the policy:

 

·      a “businessopportunity” is any corporate opportunity relating to the operation of amultichannel video programming provider, other than a corporate transactionopportunity;

·      a “corporatetransaction opportunity” is any corporate opportunity relating to theacquisition by a third party unaffiliated with Hallmark Cards of the Company orof all or a material portion of its equity, debt, assets or voting power;

·      adirector who is our Chairman of the Board or Chairman of a committee of theBoard will not be deemed to be one of our officers by reason of holding thatposition, unless that person is one of our full-time employees;

·      referencesto us shall mean us and all corporations, partnerships, joint ventures,associations and other entities in which we beneficially own, directly orindirectly, 50% or more of the outstanding voting stock, voting power,partnership interests or similar voting interests; and

·      theterm “Hallmark Cards” means Hallmark Cards and all corporations, partnerships,joint ventures, associations and other entities, other than us, as we aredefined in this paragraph, in which Hallmark Cards beneficially owns, directlyor indirectly, 50% or more of the outstanding voting stock, voting power,partnership interests or similar voting interests.

 

The foregoing provisions ofour certificate of incorporation will expire on the date that Hallmark Cardsceases to own beneficially common stock representing at least 20% of the totalvoting power of all of our classes of outstanding capital stock and no personwho is one of our directors or officers is also a director or officer ofHallmark Cards or any of its subsidiaries.

 

We expect conflicts to beresolved on a case-by-case basis, and in a manner consistent with applicablelaw.

 

41

----

Table ofContents

 

**Selected Historical ConsolidatedFinancial Data of Crown Media Holdings**

 

In the table below, we provide selected historicalcondensed consolidated financial and other data of Crown Media Holdings and itssubsidiaries. The following selected condensed consolidated statement ofoperations data and selected cash flow information for three and nine monthsended September 30, 2009 and 2010, are derived from the unauditedfinancial statements of Crown Media Holdings and its subsidiaries. This datashould be read together with the condensed consolidated financial statementsand related notes included elsewhere in this Form 10-Q. Ratings andsubscriber information also are unaudited but are not derived from suchfinancial statements and notes thereto.

 
| ** **                                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Percent** | ** ** | **Nine Months Ended  September 30,** | ** ** | **Percent** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------------|------------|-------------|------------|-----------------------------------------------------|------------|-------------|------------|
| ** **                                        | ** ** | **2009**                                             | ** ** | **2010**    | ** ** | **Change**                                          | ** ** | **2009**    | ** ** | **2010** | ** ** | **Change** | ** ** |
| Revenues:                                         |       |                                                 |       |        |       |                                                |       |        |       |   |   |   |   |
| Subscriber fees                                   |       | $                                                    | 15,998     |        | $          | 13,973                                              |       | -13         | %          | $ | 47,153 |   | $ | 46,839 |   | -1 | % |
| Advertising                                       |       | 46,487                                               |       | 48,499      |       | 4                                                   | %          | 153,702     |       | 149,635 |   | -3 | % |
| Sublicense fees and other revenue                 |       | 334                                                  |       | 48          |       | -86                                                 | %          | 1,098       |       | 133 |   | -88 | % |
| Total revenues                                    |       | 62,819                                               |       | 62,520      |       | 0                                                   | %          | 201,953     |       | 196,607 |   | -3 | % |
| Cost of Services:                                 |       |                                                 |       |        |       |                                                |       |        |       |   |   |   |   |
| Programming costs                                 |       | 31,680                                               |       | 31,246      |       | -1                                                  | %          | 95,196      |       | 90,617 |   | -5 | % |
| Operating costs                                   |       | 3,405                                                |       | 3,092       |       | -9                                                  | %          | 11,905      |       | 8,502 |   | -29 | % |
| Total cost of services                            |       | 35,085                                               |       | 34,338      |       | -2                                                  | %          | 107,101     |       | 99,119 |   | -7 | % |
| Selling, general and administrative expense       |       | 12,703                                               |       | 12,641      |       | 0                                                   | %          | 36,462      |       | 37,694 |   | 3 | % |
| Marketing expense                                 |       | 339                                                  |       | 7,114       |       | 1999                                                | %          | 5,956       |       | 8,551 |   | 44 | % |
| Loss from sale of film assets                     |       | —                                               |       | —      |       | 0                                                   | %          | —      |       | 155 |   | 100 | % |
| Income before interest and income tax expense     |       | 14,692                                               |       | 8,427       |       | -43                                                 | %          | 52,434      |       | 51,088 |   | -3 | % |
| Interest expense                                  |       | (24,884                                              | )          | (2,509      | )          | -90                                                 | %          | (75,399     | )          | (53,579 | ) | -29 | % |
| Income tax expense                                |       | —                                               |       | —      |       | 0                                                   | %          | —      |       | (2,897 | ) | 100 | % |
| Net (loss) income                                 |       | $                                                    | (10,192    | )           | $          | 5,918                                               |       | -158        | %          | $ | (22,965 | ) | $ | (5,388 | ) | -77 | % |
|                                              |       |                                                 |       |        |       |                                                |       |        |       |   |   |   |   |
| **Other Data:**                                   |       |                                                 |       |        |       |                                                |       |        |       |   |   |   |   |
| Net cash provided by operating activities         |       | $                                                    | 1,998      |        | $          | 22,727                                              |       | 1037        | %          | $ | 33,367 |   | $ | 51,515 |   | 54 | % |
| Net cash used in investing activities             |       | $                                                    | (414       | )           | $          | (303                                                | )          | -27         | %          | $ | (1,062 | ) | $ | (1,415 | ) | 33 | % |
| Net cash used in financing activities             |       | $                                                    | (18,016    | )           | $          | (4,466                                              | )          | -75         | %          | $ | (26,660 | ) | $ | (24,406 | ) | -8 | % |
| Total domestic day household ratings (1)(3)       |       | 0.537                                                |       | 0.409       |       | -24                                                 | %          | 0.571       |       | 0.433 |   | -24 | % |
| Total domestic primetime household ratings (2)(3) |       | 0.899                                                |       | 0.657       |       | -27                                                 | %          | 0.976       |       | 0.711 |   | -27 | % |
| Subscribers at period end                         |       | 87,717                                               |       | 90,218      |       | 3                                                   | %          | 87,717      |       | 90,218 |   | 3 | % |

 

----

(1)  Total day is the time periodmeasured from the time each day the broadcast of commercially sponsoredprogramming commences to the time such commercially sponsored programming ends.

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

(3)  These Nielsen ratings are for thetime period July 1 through September 30 and January 1 throughSeptember 30.

 

42

----

Table of Contents

 

***Results of Operations***

 

*Three Months Ended September 30,2009, Compared to Three Months Ended September 30, 2010*

 

*Revenue. *Our revenue, comprised primarily of subscriber andadvertising fees, decreased $299,000 or less than 1% in 2010 over 2009. Our subscriber fee revenue remained constant.  The amount of subscriber acquisition fees that was recorded as a reduction ofsubscriber fee revenue was approximately $651,000 and $485,000 for 2009 and2010, respectively. The increase in subscriber revenue due to smallcontractual rate increases and significant growth in Hallmark Movie Channelsubscribers was offset by the accountingtreatment of subscriber revenue for one multiple systems operator and the lackof a month of  revenue for anothermultiple systems operator.

 

Due to the lack of distribution agreements with twomultiple system operators, the Company’s subscriber revenue has and willcontinue to decline until new agreements are executed.

 

Advertising revenue increased $2.0 million or 4% in 2010over 2009 due to higher CPM rates offset by declines in viewer ratingsacross demographic categories for 2010 compared to 2009. The ratings declinereduced the revenue from all inventory, including inventory used to satisfydeficiencies in audience delivery.  Audiencedeficiency unit revenue decreased $1.2 million from contra-revenue of $894,000for 2009, to contra-revenue of $2.1 million for the same period in 2010 as aresult of such ratings declines, leading to a corresponding decrease in revenuerecognized by the Company. CPM rates in the third quarter of 2010 increased byapproximately 11% over the same period of 2009, thereby increasingrevenues.  However, the increase in CPMrates was more than offset by the decline in ratings which reduced the value ofthe Company’s inventory.

 

Webelieve that changes to our program schedule in 2009 and through the thirdquarter of 2010, along with increased competition (including the availabilityof high definition distribution by competitors), contributed to a decline inratings on the Hallmark Channel. From 2005 until early 2009, our programmingschedule did not change significantly. Beginning in 2008, a number of programsthat had previously received strong ratings began to experience ratingsdeclines, and we placed television series in certain timeslots instead ofmovies or original productions.  Also, anumber of programs in the schedule provided strong household ratingsperformance but less effective delivery of our key demographic, women age 25-54.  In 2009, we began to introduce new contentinto the schedule with the objective of increasing the delivery of women25-54.  The schedule changes likelyresulted in some viewer confusion, resulting in lower ratings.  We will continue to focus on programacquisitions, original program production and schedule changes that areintended to improve both the viewer ratings and the demographic delivery of theHallmark Channel.

 

Thefact that Hallmark Channel was not broadcast in high definition may have had anegative impact on ratings in 2009.  Of thetop 44 advertising supported cable networks with a 0.4 household rating orhigher in prime time, only six of those networks (including Hallmark Channel)were not offered in high definition.  Ofthose six networks, three experienced double-digit ratings decreases in 2009compared to 2008 and three experienced single digit increases.  In 2009, 33% of viewers with access to highdefinition programming services tuned to those high definition services first.  The growth in popularity of high definitionprogramming is expected to continue in 2010 and beyond, and these highdefinition trends were part of our decision to launch Hallmark Channel in highdefinition in February 2010.

 

In2009, competition within the cable television industry increased significantly.  The number of cable networks investing inoriginal programming increased 74% in 2009 compared to 2008, and, for the fullyear 2009, acquired (non-original) programming represented only 33% of primetime cable programming. The increase in cable networks’ investment in originalprogramming continues in 2010, and we believe it continues to negatively impactour ratings.  Although Hallmark Channelcontinues to invest in original programming, our increase in investment fororiginal content did not match the growth of the market or many of ourcompetitors.  The impact of theprogramming competition is heightened by the continued growth of time-shiftingdigital video recording devices, or DVR’s. With the proliferation of thesedevices, viewers are able to increase their access to the new, compellingcontent.

 

43

----

Table of Contents

 

Forthe three months ended September 30, 2010, Nielsen ranked the HallmarkChannel 24th in total dayviewership with a 0.409 household rating and 25th in primetimewith a 0.657 household rating among the 78 cable channels in the United Statesmarket.

 

Advertisingrevenue from the Hallmark Movie Channel increased from $2.4 million for thethree months ended September 30, 2009, to $4.6 million for the threemonths ended September 30, 2010. This is due to the increase in the numberof subscribers as the Company continues to expand distribution of this channel.

 

*Cost of services.*Cost of services as a percent of revenue decreased to 55% in 2010 ascompared to 56% in 2009. This decrease results primarily from the effects ofthe 9% decrease in operating costs, discussed below, offset in part by the 4%decrease in advertising revenue discussed above.

 

Programmingcosts decreased $434,000 or 1% from 2009. During 2009 and through the thirdquarter of 2010, except for Martha Stewart programming, we did not enter intoany significant new third party license agreements. As a result, expiringprogram rights and the related amortization were not replaced in full withassets and amortization from newer license agreements. At this time, we do notexpect significant program acquisitions for the rest of 2010, other than thepotential additional costs to obtain high definition version of certain of ourprogramming.

 

Operatingcosts for 2010 decreased$313,000 over 2009. The Company’s bad debt expense was $235,000 for 2009, ascompared to $12,000 for 2010.  Thedecrease in bad debt expense is primarily due to certain advertising customersexperiencing cash flow problems under generally poor economic conditions during2009 and being unable to make timely payments. Customer cash flow problemsdeclined in 2010 and, therefore, payments were received on a timelier basis.

 

*Selling, general andadministrative expense.* Ourselling, general and administrative expense for 2010 remained constant.

 

*Marketing expense*.  Ourmarketing expense increased $6.8 million or approximately 2,000% in the thirdquarter of 2010 versus the third quarter of 2009. The Company allocatedsignificant marketing resources towards the third quarter launch of the MarthaStewart programming in 2010.

 

*Interest expense. *Interest expense decreased$22.4 million due to the Recapitalization.

 

*Nine Months Ended September 30,2009, Compared to Nine Months Ended September 30, 2010*

 

*Revenue. *Our revenue, comprised primarily of subscriber andadvertising fees, decreased $5.3 million or 3% in 2010 over 2009. Our subscriber fee revenue decreased $314,000 or 1% due to on-goingnegotiations with two distributors.  The amount of subscriber acquisition fees that was recorded as a reduction ofsubscriber fee revenue was approximately $2.0 million and $1.5 million for 2009and 2010, respectively.

 

Due to the lack of distribution agreements with twomultiple system operators, the Company’s subscriber revenue has and willcontinue to decline until new agreements are executed.

 

The $4.1 million or 3% decrease in advertising revenueis primarily due to declines in viewer ratings across demographiccategories for 2010 compared to 2009. For the nine months ended September 30,2010, Nielsen ranked the Hallmark Channel 26th in total dayviewership with a 0.433 household rating and 23rd in primetimewith a 0.711 household rating among the 78 cable channels in the United Statesmarket. The ratings decline reduced the revenue from all inventory, includinginventory used to satisfy deficiencies in audience delivery.  Audience deficiency unit revenue decreased$7.5 million from contra-revenue of $5.8 million for 2009, to contra-revenue of$13.3 million for the same period in 2010 as a result of such ratings declines,leading to a corresponding decrease in revenue recognized by the Company.

 

44

----

Table of Contents

 

Advertisingrevenue from the Hallmark Movie Channel increased from $7.5 million for thenine months ended September 30, 2009, to $12.6 million for the nine monthsended September 30, 2010. This is due to the increase in the number ofsubscribers as the Company continues to expand distribution of this channel.

 

*Cost of services.*Cost of services as a percent of revenue decreased to 50% in 2010 ascompared to 53% in 2009. This decrease results primarily from the effects ofthe $4.6 million or 5% decrease in programming costs, discussed below, offsetin part by the 3% decrease in advertising revenue discussed above. We may,however, incur additional programming related costs in the future to obtainhigh definition versions of certain of our programming.

 

Operatingcosts for 2010 decreased $3.4million over 2009 due in part to the $1.1 million decrease in bad debt expense.The Company’s bad debt expense was $1.1 million for 2009, as compared to$44,000 for 2010.  The decrease in baddebt expense is primarily due to certain advertising customers experiencingcash flow problems under generally poor economic conditions during 2009 andbeing unable to make timely payments. Customer cash flow problems declined in2010 and, therefore, payments were received on a timelier basis. Additionally,salary and termination expense decreased $1.4 million and playback andtransponder expense decreased $1.0 million due to terminations of employmentduring second quarter of 2009 and standard definition provider contracts in thefourth quarter of 2009.

 

*Selling, general andadministrative expense.* Ourselling, general and administrative expense for 2010 increased $1.6 millionover 2009.  Salary and severance expensedecreased $5.2 million primarily due to terminations of employment in 2009.Additionally, commission expense increased $785,000 due to meeting quarterlyadvertising revenue expectations. Research expense increased $1.3 million dueto the receipt of ratings for the Hallmark Movie Channel. Benefits and bonusexpense increased $3.3 million due to an increase in bonus expense based uponassumptions that certain performance metrics will be met and an increase ininsurance premiums.   Additionally, theCompany recorded $1.0 million of debt issuance costs in conjunction with theRecapitalization.

 

*Marketing expense*.  Ourmarketing expense increased $2.6 million or 44% in 2010 versus 2009. TheCompany allocated significant marketing resources towards the third quarterlaunch of the Martha Stewart programming in 2010. During 2009, the Company hadone significant marketing promotion in January 2009 centered on theoriginal movie, “Taking a Chance on Love.” The Company did not have asignificant marketing promotion in the first quarter of 2010.

 

*Loss from sale of film assets*. In June 2010, the Company concluded that payments for residualsand participations, which are liabilities from the Company’s December 2006sale of its film assets, would occur generally sooner than originally estimatedin December 2006 and December 2009 based upon a request for paymentreceived in July 2010.  Accordingly,in the second quarter of 2010, the Company increased the carrying amount of theliability by $155,000 and recognized a corresponding loss from sale of filmassets in the accompanying statement of operations.

 

*Interest expense. *Interest expense decreased$21.8 million due to the Recapitalization.

 

*Income tax expense*. For tax purposes, theRecapitalization generated cancellation of debt income which is currentlyestimated at approximately $200.0 million, which was offset by net operatinglosses.  Accordingly, the Company isexpected to generate federal and state taxable income for both regular tax andalternative minimum tax (“AMT”) purposes. For regular tax purposes, this income will be fully offset by netoperating loss carryforwards.  However,for federal AMT purposes, loss carryforwards can be used against AMT income butare limited to 90% of AMT income.  As aresult, the Company has recorded an income tax expense of $2.9 million for theestimated AMT in its consolidated statements of operations as it is not likelythat any benefit of this AMT as a credit carryforward will be realized.

 

**Liquidity and Capital Resources**

 

During the nine months ended September 30, 2009,our cash provided by operating activities was $33.4 million as compared to$51.5 million for the nine months ended September 30, 2010.**The Company’s net loss for the nine months ended September 30,2010, decreased $17.6 million to $5.4 million from $23.0 million for the ninemonths 

 

45

----

Table of Contents

 

ended September 30, 2009. Our depreciation andamortization expense for the nine months ended September 30, 2010decreased $6.1 million to $93.2 million from $99.3 million in 2009.  The Company made programmingpayments of $96.5 million and $94.1 million during the nine months ended September 30,2009 and 2010, respectively.

 

Cash used in investing activities was $1.1 million and$1.4 million during the nine months ended September 30, 2009 and 2010,respectively. During the nine months ended September 30, 2009 and 2010, wepurchased property and equipment of $371,000 and $729,000, respectively. Duringthe nine months ended September 30, 2009 and 2010, the Company paid$691,000 and $686,000, respectively, to the buyer of the international businessfor amounts due under the terms of the sale agreement, primarily forreimbursement of transponder lease payments. The related liability wasrecognized in 2005 as part of the sale of our international business.

 

Cash used in financing activities was $26.7 million and$24.4 million for the nine months ended September 30, 2009 and 2010. Weborrowed $18.1 million and $0 under our credit facility to supplement the cashrequirements of our operating and investing activities during the nine monthsended September 30, 2009 and 2010, respectively. We repaid principal of$44.1 million and $1.0 million under our bank credit facility during the ninemonths ended September 30, 2009 and 2010, respectively.  Also, during 2010, pursuantto provisions of the Recapitalization, the Company sequestered $20.0 million,which is now restricted to the payment of the NICC preferred interest on orbefore December 31, 2010.

 

TheCompany expects to make its first cash payment through the fourth quarter of2010 prior to December 31, 2010, for tax liabilities incurred under thetax sharing agreement as amended. The Company may also have to make cashpayments to Hallmark Cards during 2011 under the amended tax sharing agreement.

 

Additionally,the Company may make a principal payment on its Term A loan of approximately$8.6 million during the next 12 months.

 

*Cash Flows*

 

Asof September 30, 2010, the Company had $36.2 million in cash and cashequivalents on hand.  Also available tothe Company was the full $30.0 million bank credit facility which expires June 30,2011.  Day-to-day cash disbursementrequirements have typically been satisfied with cash on hand and operating cashreceipts supplemented with the borrowing capacity available under the bankcredit facility and, prior to the Recapitalization, forbearance by HallmarkCards and its affiliates.

 

TheCompany’s management anticipates that the principal uses of cash during thetwelve month period ending September 30, 2011, will include the payment ofoperating expenses, accounts payable and accrued expenses, programming costs,and nominal interest of approximately $30.0 million to $45.0 million due underthe New Debt issued in the Recapitalization. Subject to the legal availability of funds and approval by the Company’sboard of directors, the Company may also pay approximately $19.5 million forcash dividends on Preferred Stock during the nine months ending September 30,2011; at the option of the Company’s board of directors, such dividends, ifany, may be paid in the form of additional shares of Preferred Stock.

 

AtSeptember 30, 2010, the Company also had an additional $20.0 million ofcash, the use of which is restricted to payment of the $25.0 million companyobligated, mandatorily redeemable preferred interest payable to VISN ManagementCorp. on December 31, 2010.  TheCompany believes that it will be able to fund all, or substantially all, of theremaining $5.0 million with cash provided by operating activities.

 

Increasesin the Company’s audience deficiency liability during the nine month periodsended September 30, 2009, and 2010, contributed $5.8 million and $13.3million, respectively, to cash flows from operating activities (reflected aspart of the changes in accounts payable, accrued and other liabilities in theaccompanying condensed consolidated statements of cash flows included in Part Iof this report).  At September 30,2010, the Company’s audience deficiency liability was $31.1 million, an amountequivalent to approximately 14% of advertising revenue for the year ended December 31,2009.  Settlement of any portion of thisliability will not require the direct use of cash because it is the Company’spolicy to settle in kind.  However, suchsettlement requires the use of advertising 

 

46

----

Table of Contents

 

spotsthat otherwise may be sold for cash. Accordingly, any decrease in this liability will indirectly require theuse of cash with little or no corresponding effect on reported advertisingrevenue.

 

**RiskFactors and Forward-Looking Statements**

 

The discussion set forth inthis Form 10-Q contains statements concerning potential future events.Such forward-looking statements are based on assumptions by Crown MediaHoldings management, as of the date of this Form 10-Q includingassumptions about risks and uncertainties faced by Crown Media Holdings.Readers can identify these forward-looking statements by their use of suchverbs as “expects,” “anticipates,” “believes,” or similar verbs or conjugationsof such verbs. If any of management’s assumptions prove incorrect or shouldunanticipated circumstances arise, Crown Media Holdings’ actual results, levelsof activity, performance, or achievements could differ materially from thoseanticipated by such forward-looking statements.

 

Among the factors that couldcause actual results to differ materially are those discussed in this Reportbelow and in the Company’s filings with the Securities and Exchange Commission,including the Risk Factors stated in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2009, and the Quarterly Report on Form 10-Qfor the quarter ended June 30, 2010. Such Risk Factors include, but arenot limited to, the following: competition for distribution of channels, viewers, advertisers and theacquisition of programming; fluctuations in the availability of programming;fluctuations in demand for programming which we air on our channels; ourability to address our liquidity needs; our incurrence of losses; and oursubstantial indebtedness affecting our financial condition and results.

 

**Available Information**

 

**We will make available free of chargethrough our website, www.hallmarkchannel.com, the 2009 Annual Report on Form 10-K,our quarterly reports on Form 10-Q, our current reports on Form 8-K,and amendments to such reports, as soon as reasonably practicable after weelectronically file or furnish such material with the Securities and ExchangeCommission.**

 

**Additionally, we will make available,free of charge upon request, a copy of our Code of Business Conduct and Ethics,which is applicable to all of our employees, including our senior financialofficers. Requests for a copy of this code should be addressed to the GeneralCounsel 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 interest ratesincrease. If market interest rates were to increase immediately and uniformlyby 10% from levels as of September 30, 2010, the decline of the fair valueof the fixed income portfolio would not be material.

 

As of September 30, 2010, our cash, cashequivalents and short-term investments had a fair value of $56.2 million(including restricted cash) and were invested in cash and short-term commercialpaper. The primary purpose of these investing activities has been to preserveprincipal until the cash is required to fund operations and to fund the $25.0mandatorily redeemable preferred interest amount payable in December 2010.Consequently, the size of this portfolio fluctuates significantly as cash isprovided 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. For the three and nine  months ended September 30, 2010, theimpact of interest rate fluctuations, changed business prospects and all otherfactors did not have a material impact on the fair value of this portfolio, oron our income derived from this portfolio.

 

47

----

Table of Contents

 

We have not used derivative financial instruments forspeculative purposes. As of September 30, 2010, we are not hedged orotherwise protected against risks associated with any of our investing orfinancing activities.

 

***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 used derivatives forspeculative purposes.

 

If we use risk management control policies, there willbe inherent risks that may only be partially offset by our hedging programsshould there be any unfavorable movements in interest rates or equityinvestment prices.

 

Theestimated exposure discussed below is intended to measure the maximum amount wecould lose from adverse market movements in interest rates and equityinvestment prices, given a specified confidence level, over a given period oftime.  Loss is defined in the value atrisk estimation as fair market value loss.

 

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

 

***a.  Disclosure Controls andProcedures***

 

Our management evaluated, with the participation of our Chief ExecutiveOfficer and our Chief Financial Officer, the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this QuarterlyReport on Form 10-Q. Based on this evaluation, our Chief Executive Officerand our Chief Financial Officer have concluded that our disclosure controls andprocedures were effective as of the end of the period covered by this QuarterlyReport on Form 10-Q.

 

***b.  Changes in Internal Controlover Financial Reporting***

 

Therewas no change in the Company’s internal control over financial reporting thatoccurred during the quarter ended September 30, 2010, that materiallyaffected, or was reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

**PART II.  OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

For information regarding a lawsuit concerning theCompany’s proposed Recapitalization, please see Note 11 to the UnauditedCondensed Consolidated Financial Statements contained in Item 1 of this Report.

 

48

----

Table of Contents

 

**Item 6.  *Exhibits***

 

**INDEX TO EXHIBITS**

 
| **Exhibit Number** | ** ** | **Exhibit Title**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|-------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.4                     |       | Agreement  and Plan of Merger of Crown Media Holdings, Inc. and Hallmark  Entertainment Investments Co., dated as of February 26, 2010 (previously  filed as an exhibit to our Schedule 14C Information Statement filed on  May 21, 2010 and incorporated herein by reference).                                                                                                                                                                                                             |
| 2.5                     |       | Agreement  and Plan of Merger of Crown Media Holdings, Inc. and Hallmark  Entertainment Holdings, Inc., dated as of February 26, 2010  (previously filed as an exhibit to our Schedule 14C Information Statement  filed on May 21, 2010 and incorporated herein by reference).                                                                                                                                                                                                         |
| 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 (File No. 000-30700; Film  No. 1693331) 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).                                                                                                                                                                                                                                                                                  |
| 3.4                     |       | Second  Amended and Restated Certificate of Incorporation of Crown Media Holdings  (previously filed as an exhibit to our Schedule 14C Information Statement  filed on May 21, 2010 and incorporated herein by reference).                                                                                                                                                                                                                                                                            |
| 3.5                     |       | Certificate  of Designation, Powers, Preferences, Qualifications, Limitations,  Restrictions and Relative Rights of Series A Convertible Preferred Stock  of Crown Media Holdings, Inc. (previously filed as an exhibit to our  Schedule 14C Information Statement filed on May 21, 2010 and  incorporated herein by reference).                                                                                                                                                            |
| 3.6                     |       | Proposed  form of Third Amended and Restated Certificate of Incorporation of Crown  Media Holdings, Inc. (previously filed as Exhibit 3.3 to our  Current Report on Form 8-K filed on March 1, 2010 and incorporated  herein by reference).                                                                                                                                                                                                                                            |
| 10.1                    |       | Amendment No. 16, dated as of March 2,  2010, 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, and JP Morgan Chase Bank as Administrative Agent  and as Issuing Bank (previously filed as Exhibit 10.26 to our  Annual Report on Form 10-K filed on March 4, 2010 and incorporated  herein by reference).                                         |
| 10.2                    |       | Amendment No. 17, dated as of June 29,  2010, 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, and JP Morgan Chase Bank as Administrative Agent  and as Issuing Bank (previously filed as Exhibit 10.1 to our Current Report  on Form 8-K filed on June 29, 2010 and incorporated herein by reference).                                                          |
| 10.3                    |       | Waiver to the Trademark License Extension Agreement  (Hallmark Channel and Hallmark Movie Channel) dated March 3, 2010, by  and between Hallmark Licensing Inc. and Crown Media United States, LLC (previously  filed as Exhibit 10.46 to our Annual Report on Form 10-K filed on  March 4, 2010 and incorporated herein by reference).                                                                                                                                                |
| 10.4                    |       | Intercompany Services Extension Agreement, dated as of  January 1, 2010, by and between Hallmark Cards, Incorporated and  Crown Media Holdings, Inc. (previously filed as  Exhibit 10.58 to our Annual Report on Form 10-K filed on March 4,  2010 and incorporated herein by reference).                                                                                                                                                                                    |
| 10.5                    |       | Master Recapitalization Agreement by and among Hallmark  Cards, Incorporated, H C Crown Corp., Hallmark Entertainment  Holdings, Inc., Crown Media Holdings, Inc., Crown Media United  States, LLC, and The Subsidiaries of Crown Media Holdings, Inc. Listed  as Guarantors on the Credit Facility, dated as of February 26, 2010  (previously filed as an exhibit to our Schedule 14C Information  Statement filed on May 21, 2010 and  incorporated herein by reference). |
| 10.6                    |       | Credit Agreement, dated June 29, 2010, Among Crown  Media Holdings, Inc. as Borrower and HC Crown Corp., as Lender and Each  of the Credit Parties Identified on the Signature Pages                                                                                                                                                                                                                                                                                                        |

 

49

----

Table of Contents

 
|   |   | Hereto (previously filed as an exhibit to our Schedule  14C Information Statement filed on May 21, 2010 and incorporated herein by reference).                                                                                                                                                                         |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.7   |   | Stockholders Agreement, dated June 29, 2010, by  and among H C Crown Corp., Hallmark Cards, Incorporated and Crown Media  Holdings, Inc. (previously filed as an exhibit to our Schedule  14C Information Statement filed on May 21, 2010 and incorporated herein by reference).                        |
| 10.8   |   | Registration Rights Agreement, dated June 29,  2010, among H C Crown Corp., any Other HEIC Stockholder and Crown Media  Holdings, Inc. (previously filed as an exhibit to our Schedule  14C Information Statement filed on May 21, 2010 and incorporated herein by reference).                               |
| 10.9   |   | Amendment No. 2 to Federal Income Tax Sharing  Agreement, dated June 29, 2010, between Hallmark  Cards, Incorporated and Crown Media Holdings, Inc. (previously  filed as an exhibit to our Schedule 14C Information Statement filed on  May 21, 2010 and incorporated herein by  reference).      |
| 10.10  |   | Amendment by letter dated March 19, 2010 to Master  Recapitalization Agreement (previously filed as Exhibit 10.10 to our  Quarter Report on Form 10-Q filed on August 12, 2010, and  incorporated herein by reference).                                                                                 |
| 10.11  |   | Security Agreement, dated June 29, 2010, between  the Company and HCC (previously filed as  Exhibit 10.11 to our Quarter Report on Form 10-Q filed on  August 12, 2010, and incorporated herein by reference).                                                                                          |
| 10.12  |   | Pledge Agreement, dated June 29, 2010, between  the Company and HCC (previously filed as  Exhibit 10.12 to our Quarter Report on Form 10-Q filed on  August 12, 2010, and incorporated herein by reference).                                                                                            |
| 10.13  |   | Trademark  License Extension Agreement (Hallmark Channel) dated June 29, 2010 by  and between Hallmark Licensing Inc. and Crown Media United States, LLC (previously filed as Exhibit 10.13 to our Quarter Report on  Form 10-Q filed on August 12, 2010, and incorporated herein by  reference).       |
| 10.14  |   | Trademark  License Extension Agreement (Hallmark Movie Channel) dated June 29, 2010  by and between Hallmark Licensing Inc. and Crown Media United States, LLC (previously filed as Exhibit 10.14 to our Quarter Report on  Form 10-Q filed on August 12, 2010, and incorporated herein by  reference). |
| 31.1   |   | Rule 13a-14(a) Certification  executed by the Company’s 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.                                                                                                                                                                                                                                                                                          |

 

----

*Management contract or compensating plan orarrangement.

 

50

----

Table of Contents

 

**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.

 

CROWN MEDIA HOLDINGS, INC.

 

| **Signature**             | ** ** | **Title**           | ** ** | **Date**              |
|---------------------------|------------|---------------------|------------|-----------------------|
|                      |       |                |       |                  |
| By: /s/ WILLIAM J. ABBOTT |       | Principal Executive |       | November 9, 2010 |
|                      |       | Officer             |       |                  |
| William J. Abbott         |       |                |       |                  |
|                      |       |                |       |                  |
| By: /s/ MICHAEL J. HARMON |       | Principal           |       | November 9, 2010 |
|                      |       | Financial and       |       |                  |
| Michael J. Harmon         |       | Accounting Officer  |       |                  |

 

51

----