**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

**Form 10-Q**

 

**(Mark One)**

| **x**                                                   | ** ** | ** QUARTERLY REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**   |
|---------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|
|                                                    |       |                                                                                                      |
| **For the quarterly period ended  March 31, 2008** |
|                                                    |       |                                                                                                      |
| **or**                                                  |
|                                                    |       |                                                                                                      |
| **o**                                                   | ** ** | ** TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |

 

**For the transition period from                      to                      .**

 

**Commission File Number: 000-30700**

 

**Crown MediaHoldings, 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, Including AreaCode)

 

 

(Former Name, Former Address, and Former FiscalYear,

if Changed Since Last Report.)

 

Indicate by check markwhether the registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes  x   Noo

 

Indicate by check mark whether the registrant isa large accelerated filer, an accelerated filer, a non-accelerated filer or asmaller reporting company.  Seedefinition of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 ofthe Exchange Act. (Check one):

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

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

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). Yes o   No x

 

As of May 5, 2008,the number of shares of Class A Common Stock, $.01 par value outstandingwas 74,117,654, and the number of shares of Class B Common Stock, $.01 parvalue, outstanding was 30,670,422.

 

 

----

 

**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, 2007 and March 31, 2008 (Unaudited)                          | 3          |
|             | Condensed Consolidated Statements of Operations and  Comprehensive Loss (Unaudited)  - Three Months Ended March 31, 2007 and 2008 | 5          |
|             | Condensed Consolidated Statements of Cash Flows  (Unaudited)  - Three Months Ended March 31, 2007 and 2008                        | 6          |
|             | Notes to Unaudited Condensed Consolidated Financial  Statements                                                                   | 7          |
|             |                                                                                                                              |       |
| Item 2           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                       | 22         |
|             |                                                                                                                              |       |
| Item 3           | Quantitative  and Qualitative Disclosures About Market Risk                                                                       | 30         |
|             |                                                                                                                              |       |
| Item 4           | Controls and  Procedures                                                                                                          | 31         |
|             |                                                                                                                              |       |
| **PART II** | **Other Information**                                                                                                             | 31         |
|             |                                                                                                                              |       |
| Item 6           | Exhibits                                                                                                                          | 31         |
|             |                                                                                                                              |       |
| Signatures       | 32                                                                                                                                |

 

2

----

 

*In this Form 10-Q theterms “Crown Media Holdings”and the “Company” refer to Crown Media Holdings, Inc.and, unless the context requires otherwise, subsidiaries of Crown MediaHoldings that 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.*

* *

*The name Hallmark and other product or servicenames are trademarks or registered trademarks of their owners.*

* *

**PART I. FINANCIALINFORMATION**

** **

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

 

**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED BALANCE SHEETS**

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

** **
| ** **                                                                                  | ** ** | **As of December 31,** | ** ** | **As of March 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                  | ** ** | **2007**                              | ** ** | **2008**                           | ** ** |
| ASSETS                                                                                      |       |                                  |       |                               |       |
|                                                                                        |       |                                  |       |                               |       |
| Cash and cash equivalents                                                                   |       | $                                     | 1,974      |                               | $          | 3,046 |   |
| Accounts receivable, less  allowance for doubtful accounts of  $242  and $208, respectively |       | 68,603                                |       | 68,010                             |       |
| Program license fees — affiliates                                                      |       | 166                                   |       | 400                                |       |
| Program license fees —  non-affiliates                                                 |       | 119,523                               |       | 112,273                            |       |
| Prepaid and other assets                                                                    |       | 4,478                                 |       | 4,297                              |       |
| Prepaid program license fee  assets                                                         |       | 8,361                                 |       | 14,935                             |       |
| Total current assets                                                                        |       | 203,105                               |       | 202,961                            |       |
|                                                                                        |       |                                  |       |                               |       |
| Program license fees — affiliates                                                      |       | 653                                   |       | 2,670                              |       |
| Program license fees —  non-affiliates                                                 |       | 129,268                               |       | 119,096                            |       |
| Subscriber acquisition fees,  net                                                           |       | 3,333                                 |       | 4,419                              |       |
| Property and equipment, net                                                                 |       | 15,962                                |       | 15,597                             |       |
| Goodwill                                                                                    |       | 314,033                               |       | 314,033                            |       |
| Prepaid and other assets                                                                    |       | 9,887                                 |       | 9,081                              |       |
| Total assets                                                                                |       | $                                     | 676,241    |                               | $          | 667,857 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

3

----

 
| ** **                                                                                                                                                                                                                                                                       | ** ** | **As of December 31,** | ** ** | **As of March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                       | ** ** | **2007**                              | ** ** | **2008**                           | ** ** |
|                                                                                                                                                                                                                                                                             |       |                                  |       |                               |       |
| LIABILITIES AND STOCKHOLDERS’  DEFICIT                                                                                                                                                                                                                                      |       |                                  |       |                               |       |
|                                                                                                                                                                                                                                                                             |       |                                  |       |                               |       |
| LIABILITIES:                                                                                                                                                                                                                                                                     |       |                                  |       |                               |       |
| Accounts payable and accrued  liabilities                                                                                                                                                                                                                                        |       | $                                     | 25,255     |                               | $          | 23,530 |   |
| Audience deficiency reserve  liability                                                                                                                                                                                                                                           |       | 15,620                                |       | 15,451                             |       |
| Accrued restricted stock units                                                                                                                                                                                                                                                   |       | 4,609                                 |       | 5,978                              |       |
| License fees payable to affiliates                                                                                                                                                                                                                                               |       | 1,628                                 |       | 3,258                              |       |
| License fees payable to  non-affiliates                                                                                                                                                                                                                                          |       | 107,749                               |       | 101,979                            |       |
| Payables to affiliates                                                                                                                                                                                                                                                           |       | 18,951                                |       | 16,720                             |       |
| Credit facility and interest  payable                                                                                                                                                                                                                                            |       | 19,583                                |       | 26,794                             |       |
| Company obligated mandatorily  redeemable preferred  interest                                                                                                                                                                                                                    |       | —                                |       | 5,000                              |       |
| Other current liabilities                                                                                                                                                                                                                                                        |       | 5,979                                 |       | 4,891                              |       |
| Total current liabilities                                                                                                                                                                                                                                                        |       | 199,374                               |       | 203,601                            |       |
| Accrued liabilities                                                                                                                                                                                                                                                              |       | 18,056                                |       | 16,581                             |       |
| License fees payable to  non-affiliates                                                                                                                                                                                                                                          |       | 56,521                                |       | 48,963                             |       |
| Payables to affiliates                                                                                                                                                                                                                                                           |       | 4,041                                 |       | 2,556                              |       |
| Credit facility                                                                                                                                                                                                                                                                  |       | 50,000                                |       | 45,000                             |       |
| Note and interest payable to  HC Crown                                                                                                                                                                                                                                           |       | 101,360                               |       | 103,456                            |       |
| Note and interest payable to  Hallmark Cards affiliate                                                                                                                                                                                                                           |       | 57,868                                |       | 59,062                             |       |
| Senior secured note to HC  Crown, including accrued interest                                                                                                                                                                                                                     |       | 621,266                               |       | 637,033                            |       |
| Note and interest payable to  Hallmark Cards affiliate                                                                                                                                                                                                                           |       | 158,753                               |       | 162,030                            |       |
| Note and interest payable to  Hallmark Cards                                                                                                                                                                                                                                     |       | 22,075                                |       | 17,429                             |       |
| Company obligated mandatorily  redeemable preferred  interest                                                                                                                                                                                                                    |       | 18,690                                |       | 14,315                             |       |
| Other liabilities                                                                                                                                                                                                                                                                |       | 19,232                                |       | 18,467                             |       |
| Obligation to NICC for the repurchase of  Class A common stock, extinguished without cash on January 2, 2008,  per the agreement, $.01 par value;  4,357,066 and 0 shares issued and  outstanding  as of December 31, 2007 and March 31, 2008,  respectively |       | 32,765                                |       | —                             |       |
| Total liabilities                                                                                                                                                                                                                                                                |       | 1,360,001                             |       | 1,328,493                          |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                                                                                                                                    |       |                                  |       |                               |       |
| STOCKHOLDERS’ DEFICIT:                                                                                                                                                                                                                                                      |       |                                  |       |                               |       |
| Class A common stock,  $.01 par value; 200,000,000 shares authorized; 69,760,588 and 74,117,654  shares issued and outstanding as of December 31, 2007 and March 31,  2008,  respectively                                                                         |       | 698                                   |       | 741                                |       |
| Class B common stock,  $.01 par value; 120,000,000 shares  authorized;  30,670,422 shares issued and outstanding as of December 31, 2007 and  March 31, 2008                                                                                                      |       | 307                                   |       | 307                                |       |
| Paid-in capital                                                                                                                                                                                                                                                                  |       | 1,411,291                             |       | 1,449,087                          |       |
| Accumulated deficit                                                                                                                                                                                                                                                              |       | (2,096,056                            | )          | (2,110,771                         | )          |
| Total stockholders’ deficit                                                                                                                                                                                                                                                 |       | (683,760                              | )          | (660,636                           | )          |
| Total liabilities and  stockholders’ deficit                                                                                                                                                                                                                                |       | $                                     | 676,241    |                               | $          | 667,857 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

4

----

 

**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS ANDCOMPREHENSIVE LOSS**

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

** **
| ** **                                                                                       | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2007**                                             | ** ** | **2008** | ** ** |
| Revenue:                                                                                         |       |                                                 |       |   |   |
| Subscriber fees                                                                                  |       | $                                                    | 7,495      |   | $ | 13,853 |   |
| Advertising                                                                                      |       | 45,850                                               |       | 56,348 |   |
| Advertising by Hallmark Cards                                                                    |       | 148                                                  |       | 75 |   |
| Other revenue                                                                                    |       | 79                                                   |       | 288 |   |
| Total revenue, net                                                                               |       | 53,572                                               |       | 70,564 |   |
| Cost of Services:                                                                                |       |                                                 |       |   |   |
| Programming costs                                                                                |       |                                                 |       |   |   |
| Affiliates                                                                                       |       | 5,562                                                |       | 394 |   |
| Non-affiliates                                                                                   |       | 34,130                                               |       | 35,011 |   |
| Subscriber acquisition fee  amortization expense                                                 |       | 7,848                                                |       | — |   |
| Amortization of capital lease                                                                    |       | 289                                                  |       | 289 |   |
| Other costs of services                                                                          |       | 2,948                                                |       | 3,180 |   |
| Total cost of services                                                                           |       | 50,777                                               |       | 38,874 |   |
| Selling, general and  administrative expense                                                     |       | 14,193                                               |       | 13,461 |   |
| Marketing expense                                                                                |       | 4,212                                                |       | 6,398 |   |
| Depreciation and amortization  expense                                                           |       | 497                                                  |       | 432 |   |
| (Loss) income from operations  before interest expense                                           |       | (16,107                                              | )          | 11,399 |   |
| Interest income                                                                                  |       | 388                                                  |       | 190 |   |
| Interest expense                                                                                 |       | (24,489                                              | )          | (26,304 | ) |
| Net loss and comprehensive  loss                                                                 |       | $                                                    | (40,208    | ) | $ | (14,715 | ) |
| Weighted average number of  Class A and Class B shares  outstanding, basic and diluted |       | 104,788                                              |       | 104,740 |   |
| Net loss per share, basic and  diluted                                                           |       | $                                                    | (0.38      | ) | $ | (0.14 | ) |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

5

----

 

**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

** **
| ** **                                                                             | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2007**                                             | ** ** | **2008** | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                                 | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Net loss                                                                               |       | $                                                    | (40,208    | ) | $ | (14,715 | ) |
| Adjustments to reconcile net  loss to net cash used in operating activities:           |       |                                                 |       |   |   |
| Depreciation and amortization                                                          |       | 48,977                                               |       | 36,552 |   |
| Accretion on company obligated  mandatorily redeemable preferred interest              |       | 552                                                  |       | 626 |   |
| Provision for allowance for  doubtful accounts                                         |       | 330                                                  |       | (34 | ) |
| Residuals and participations                                                           |       | —                                               |       | 96 |   |
| Impairment of film asset                                                               |       | —                                               |       | 176 |   |
| Loss on sale of property and  equipment                                                |       | 39                                                   |       | — |   |
| Stock-based compensation                                                               |       | 1,596                                                |       | 834 |   |
| Changes in operating assets  and liabilities:                                          |       |                                                 |       |   |   |
| (Increase) decrease in  accounts receivable                                            |       | 5,037                                                |       | 627 |   |
| Additions to program license  fees                                                     |       | (43,766                                              | )          | (20,234 | ) |
| (Additions) deletions to subscriber  acquisition fees                                  |       | 176                                                  |       | (1,750 | ) |
| (Increase) decrease in prepaid  and other assets                                       |       | (10,163                                              | )          | (6,116 | ) |
| Increase (decrease) in  accounts payable, accrued and other liabilities                |       | (4,160                                               | )          | (4,636 | ) |
| Increase in interest payable                                                           |       | 19,377                                               |       | 22,729 |   |
| Increase (decrease) in  subscriber acquisition fees payable                            |       | (233                                                 | )          | 1,721 |   |
| Increase (decrease) in license  fees payable to affiliates                             |       | 1,430                                                |       | 1,630 |   |
| Increase (decrease) in license  fees payable to non-affiliates                         |       | 7,813                                                |       | (13,329 | ) |
| Increase (decrease) in payables  to affiliates                                         |       | 369                                                  |       | (3,716 | ) |
| Increase (decrease) in  deferred revenue                                               |       | —                                               |       | (155 | ) |
| Net cash (used in) provided by  operating activities                                   |       | (12,834                                              | )          | 306 |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                                 |       |                                                 |       |   |   |
| Purchases of property and  equipment                                                   |       | (206                                                 | )          | (180 | ) |
| Payments to buyer of  international business                                           |       | (977                                                 | )          | (1,107 | ) |
| Net cash used in investing  activities.                                                |       | (1,183                                               | )          | (1,287 | ) |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                                 |       |                                                 |       |   |   |
| Borrowings under the credit  facility                                                  |       | 6,000                                                |       | 18,761 |   |
| Principal payments on the  credit facility                                             |       | —                                               |       | (16,530 | ) |
| Principal payments on capital  lease obligations                                       |       | (162                                                 | )          | (178 | ) |
| Net cash provided by financing  activities                                             |       | 5,838                                                |       | 2,053 |   |
| Net (decrease) increase in  cash and cash equivalents                                  |       | (8,179                                               | )          | 1,072 |   |
| Cash and cash equivalents,  beginning of period                                        |       | 13,965                                               |       | 1,974 |   |
| Cash and cash equivalents, end  of period                                              |       | $                                                    | 5,786      |   | $ | 3,046 |   |
|                                                                                   |       |                                                 |       |   |   |
| Supplemental disclosure of  cash and non-cash activities:                              |       |                                                 |       |   |   |
| Interest paid                                                                          |       | $                                                    | 2,206      |   | $ | 1,666 |   |
| Tax sharing payment from  Hallmark Cards applied to  note  payable to Hallmark Cards   |       | $                                                    | —     |   | $ | 5,075 |   |
| Reclassification of Redeemable  Common Stock to common stock  and  paid-in capital to  |       | $                                                    | —     |   | $ | 32,765 |   |
| Interest payable converted to  principal on note payable  to  Hallmark Card affiliates |       | $                                                    | 18,778     |   | $ | 24,747 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

6

----

 

**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**For the Three Months Ended March 31,2007 and 2008**

 

**1. Business and Organization**

 

***Organization***

 

Crown Media Holdings, Inc.(“Crown Media Holdings,” “Crown Media” or the “Company”), through itswholly-owned subsidiary, Crown Media United States, LLC (“Crown Media UnitedStates”), owns and operates pay television channels (collectively the “HallmarkChannel” or the “channel”) dedicated to high quality, entertainment programmingfor adults and families, in the United States. Significant investors in CrownMedia Holdings include Hallmark Entertainment Investments Co. (“HallmarkEntertainment Investments”), a subsidiary of Hallmark Cards, Incorporated (“HallmarkCards”), the National Interfaith Cable Coalition, Inc. (“NICC”), and,indirectly through their investments in Hallmark Entertainment Investments,Liberty Media Corporation (“Liberty Media”) and J.P. Morgan Partners (BHCA), L.P. (“J.P. Morgan”).

 

The Company’s continuing operations are currentlyorganized into one operating segment, the domestic channels.

 

***Liquidity***

*** ***

Asof March 31, 2008, the Company had $3.0 million in cash and cashequivalents on hand. As of March 31, 2008, the Company had borrowed $71.7million from the $90.0 million revolving bank credit facility.  In March 2008, the bank credit facilitywas extended until May 31, 2009, and the committed amount of the facilitywas reduced to $90.0 million.  Thiscommitment will decrease to $60.0 million on June 30, 2008, andthereafter, to $50.0 million on September 30, 2008, and $45.0 million on March 31,2009.  The Company will use cash flowsfrom operations to reduce outstanding borrowings under the facility and expectsthese reductions to be sufficient to maintain outstanding borrowings below thecommitment levels throughout the term of the facility. See Note 5.

 

The Company’s principal sources of funds are cash onhand, cash generated by operations and amounts available under the Company’srevolving bank credit facility through May 31, 2009.  In addition, in March 2008, the Companyand Hallmark Cards entered into an Amended and Restated Waiver Agreement whichchanges the maturity date of three obligations and defers payments undercertain obligations.  See Note 6.  Previously, the Company’s tax sharingagreement with Hallmark Cards has also been a source of cash. However, we donot expect to receive or pay any cash related to this agreement in the nexttwelve months.

 

TheCompany expects to continue making investments in programming, marketing anddistribution during 2008. However, the Company’s recurring loss situation hasdemanded that all areas of expenses, including programming, marketing anddistribution be closely monitored and controlled.

 

TheCompany believes that cash on hand, cash generated by operations, and borrowingavailability under its bank credit facility through May 31, 2009, whencombined with the deferral of any required payments on related-party debt andrelated interest mentioned below, will be sufficient to fund the Company’soperations and meet its liquidity needs through March 31, 2009.  The Company anticipates that its principaluses of cash during the next twelve months will continue to include the paymentof operating expenses, accounts payable and accrued expenses, license fees forprogramming, interest and repayment of principal under its bank credit facilityand interest under certain notes payable to Hallmark Cards affiliates.

 

Thesufficiency of the existing sources of liquidity to fund the Company’soperations is dependent upon maintaining subscriber revenue at or above theamount of such revenue for the quarter ended March 31, 2008, andcontinuing growth in advertising revenue. A significant decline in thepopularity of the Hallmark

 

7

----

 

Channel,an adverse modification to any of the Company’s distribution agreements, aneconomic decline in the advertising market, an increase in program acquisitioncosts, an increase in competition or other adverse changes in operatingconditions could negatively impact the Company’s liquidity and its ability tofund the current level of operations.

 

TheCompany will endeavor to extend or refinance the bank credit facility prior toor upon its maturity.  Any such extensionor refinancing could require a continuation of a letter of credit from HallmarkCards in support of the bank credit facility or other steps by the Company and,thus, is not assured.  If the Company isnot able to arrange for the extension, refinancing or replacement of the bankcredit facility prior to its maturity and either (1) the bank draws downon Hallmark Cards’ irrevocable letter of credit or (2) Hallmark Cardspurchases the interests of the lending bank, Hallmark Cards would have allobligations and rights of the lending banks under the bank credit facility. Inthat event, Hallmark Cards could demand payment of outstanding amounts at anytime after March 31, 2009, under the terms of the Waiver Agreementdescribed below.

 

Upon maturity of the creditfacility on May 31, 2009, without renewal or replacement, JP Morgan ChaseBank, N.A., will have the right to forego a call on Hallmark Cards’ irrevocableletter of credit and instead initiate foreclosure against the Company’s assets. Suchforeclosure proceedings would adversely affect our ability to continue ouroperations. However, prior to any such possible foreclosure, if the Company hadnot secured a refunding of the credit facility or alternative financing, theCompany would require Hallmark Cards to exercise its option, pursuant to theterms of the Waiver Agreement, to purchase all of the outstanding indebtednessunder the credit facility. The credit facility would then be subject to termsof the Waiver Agreement.

 

Becauseof the Company’s possible inability to meet its obligations when they come dueon March 31, 2009 and later dates in 2009 through December 31, 2009,the Company anticipates that prior to March 2009, it will be necessary toeither extend or refinance (i) the bank credit facility and (ii) thepromissory notes payable to affiliates of Hallmark Cards described in the Notesbelow. As part of a combination of actions and in order to obtain additionalfunding, the Company may consider various alternatives, including refinancingthe bank credit facility, raising additional capital through the issuance ofequity or debt securities, or other strategic alternatives.

 

***Transactions with NICC***

 

On October 28, 2007, NICCpurportedly exercised the Put Right, described below in Note 8, by makingformal demand that the Company purchase all of the 4,357,066 shares of Class Acommon stock owned by NICC.  The Companysubsequently informed NICC that exercise of the Put Right constituted a breachof a binding agreement in September 2007 whereby NICC agreed not toexercise the Put Right.

 

NICC proposed that its purchasedemand be settled on January 4, 2008. If the Company repurchased the shares as requested, the settlementamount would have been $32.8 million, based on the 30-day average closing pricefrom October 8, 2007 through November 16, 2007, inclusive.

 

As more fully described below in Note 8, the Company and NICC signedthe Modification Agreement on January 2, 2008 whereby the Company’sobligation under the Put Right was immediately extinguished.  The Modification Agreement also resolved arelated dispute with respect to expiration or survival of a prior provisionwhich would have required the Company to pay NICC $15.0 million upon a changein control of the Company.  Pursuant tothe Modification Agreement, the Company will pay NICC a total of $3.8 millionin equal installments of $1.3 million on each January 20 of 2008, 2009 and2010.  In addition, the Company willprovide NICC with two-hours of broadcast time each Sunday morning during 2008and 2009 at no cost to NICC. We estimate the value of the broadcast time to be$1.5 million.  Its discounted value isreflected as deferred revenue as of December 31, 2007 and will beamortized to revenue ratably over NICC’s two year use. The Company is alsoobligated to pay NICC an estimated $3.7 million in quarterly installments atthe rate of 6% of the outstanding liquidation preference of the CMUS preferredinterest owned by VISN Management Corp. (“VISN”), a wholly-owned subsidiary ofNICC.

 

8

----

 

***Classification of Redeemable Common Stock***

*** ***

AtDecember 31, 2007, the Company classified 4,357,066 shares of Class Acommon stock and $32.8 million associated with the purported exercise of the PutRight referred to above as redeemable common stock. The shares and relatedamount were reclassified to common stock and paid-in capital on January 2,2008, in connection with the NICC Modification Agreement discussed above and inNote 8.

 

**2. Summary of SignificantAccounting Policies and Estimates**

 

***InterimFinancial Statements***

 

In the opinion ofmanagement, the accompanying condensed consolidated balance sheets and relatedinterim condensed consolidated statements of operations and cash flows includeall adjustments, consisting of normal recurring items necessary for their fairpresentation in conformity with accounting principles generally accepted in theUnited States. Interim results are not necessarily indicative of results for afull year. These condensed consolidated financial statements should be read inconjunction with the audited consolidated financial statements and the notes tothose statements for the year ended December 31, 2007, included in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2007.

 

***Basis of Presentation***

*** ***

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

 

***Net Loss per Share***

 

Basic net loss per share is computed by dividing the netloss for the period by the weighted average number of common shares outstandingduring the period. Diluted net loss per share is computed based on the weightedaverage number of common shares and potentially dilutive common sharesoutstanding. The calculation of diluted net loss per share excludes potentialcommon shares if the effect would be antidilutive. Potential common shares consistof incremental common shares issuable upon the exercise of stock options.Approximately 360,000, and 341,000 stock options for the three months ended March 31,2007 and 2008, respectively, have been excluded from the calculations of lossper share because their effect would have been anti-dilutive.

 

The 4,357,066 shares related toNICC’s purported exercise of the Put Right have been excluded from thedetermination of weighted average shares outstanding through January 1,2008.

 

***Concentration of Credit Risk***

*** ***

Financial instruments, which potentially subject Crown Media Holdingsto a concentration of credit risk, consist primarily of cash, cash equivalentsand accounts receivable. Generally, Crown Media Holdings does not requirecollateral to secure receivables. Crown Media Holdings has no significantoff-balance sheet financial instruments with risk of accounting losses.

 

Five of our distributors each accounted for more than10% of our condensed consolidated subscriber revenue for both the three monthsended March 31, 2007 and 2008, and together accounted for a total of 92%and 80% of consolidated subscriber revenue for those periods,respectively.  Three and four of ourdistributors each accounted for more than 15% of our consolidated subscribersfor the three months ended March 31, 2007 and 2008, and together accountedfor 66% and 76% of our subscribers on those dates, respectively.

 

9

----

 

***Reclassifications***

 

Certain reclassifications have been made toconform the prior period’s financial information to the current presentation.

 

In December 2007, the Company classified “TheNote” as a $2.4 million program license fee – affiliate and the related onemonth amortization of $40,000 as programming costs – affiliate.  The Company is a co-owner of this film. TheCompany has reclassified $2.0 million as a film asset and $362,000 as anaccounts receivable in the accompanying December 31, 2007, balance sheet.

 

***Recently Issued Accounting Pronouncements***

*** ***

In September 2006, the FASB issued Statement ofFinancial Accounting Standards No. 157 (“SFAS 157”), *Fair Value Measurements,* in order toestablish a single definition of fair value and a framework for measuring fairvalue in generally accepted accounting principles that is intended to result inincreased consistency and comparability in fair value measurements.SFAS 157 also expands disclosures about fair value measurements, with theintention of improving the quality of information provided to users offinancial statements. The standard applies whenever other authoritativeliterature requires (or permits) certain assets or liabilities to be measuredat fair value, but does not expand the use of fair value.

 

SFAS 157 was originally effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those years with early adoption permitted. In early2008, the FASB issued Staff Position (FSP) FAS-157-2, which delays by one year,the effective date of SFAS 157 for all non-financial assets andnon-financial liabilities, except those that are recognized or disclosed atfair value in the financial statements on a recurring basis (at leastannually). The delay pertains to items including, but not limited to,non-financial assets and non-financial liabilities initially measured at fairvalue in a business combination, reporting units measured at fair value in thefirst step of evaluating goodwill for impairment under SFAS 142, *Goodwill and Other Intangible Assets*, indefinite-lived intangibleassets measured at fair value for impairment assessment under SFAS 142, andlong-lived assets measured at fair value for impairment assessment underSFAS 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*. The Company adopted the portion of SFAS 157that has not been delayed by FSP FAS-157-2 as of January 1, 2008, andplans to adopt the balance of its provisions as of January 1, 2009.

 

The Company does not have balance sheet items carriedat fair value on a recurring basis (to which SFAS 157 applies in 2008) such asderivative financial instruments which are valued primarily based on quotedprices in active or brokered markets for identical as well as similar assetsand liabilities. Balance sheet items carried at fair value on a non-recurringbasis (to which SFAS 157 will apply in 2009) consist of goodwill,property and equipment, subscriber acquisition fees and the film asset. Theadoption of SFAS 157 in 2008 has had no effect on the measurement of theCompany’s financial assets and liabilities. The Company is continuing toevaluate the impact the standard will have on the determination of fair valuerelated to non-financial assets and non-financial liabilities inpost-2008 years.

 

In February 2007, the FASB issued Statement ofFinancial Accounting Standards No. 159 (“SFAS 159”), *Establishing the Fair Value Option for FinancialAssets and Liabilities*. The FASB has issued SFAS 159 to permitall entities to elect, at specified election dates, to measure eligiblefinancial instruments at fair value. An entity shall report unrealized gainsand losses on items for which the fair value option has been elected inearnings at each subsequent reporting date, and recognize upfront costs andfees related to those items in earnings as incurred and not deferred.SFAS 159 applies to fiscal years beginning after November 15, 2007,with early adoption permitted for an entity that has also elected to apply theprovisions of SFAS 157. An entity is prohibited from retrospectivelyapplying SFAS 159, unless it chooses early adoption. SFAS 159 alsoapplies to eligible items existing at November 15, 2007 (or early adoptiondate). The Company adopted SFAS 159 effective January 1, 2008.  The Company has not elected to measureeligible financial instruments at fair value. Accordingly, SFAS 159 hashad no effect on the Company’s condensed consolidated balance sheets or resultsof operations.

 

10

----

 

**3. Subscriber Acquisition Fees**

 

Subscriber acquisition fees are comprised of thefollowing:

 
| ** **                            | ** ** | **As of December 31,** | ** ** | **As of March 31,** | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|
| ** **                            | ** ** | **2007**                              | ** ** | **2008**                           | ** ** |
| ** **                            | ** ** | **(In thousands)**               | ** ** |
| Subscriber acquisition fees,  at cost |       | $                                     | 9,837      |                               | $          | 10,837 |   |
| Accumulated amortization              |       | (6,504                                | )          | (6,418                             | )          |
| Subscriber acquisition fees,  net     |       | $                                     | 3,333      |                               | $          | 4,419 |   |

 

*Of thenet balance at March 31, 2008, the Company expects $4.4 million will berecognized as a reduction of subscriber fee revenue in future periods.*

* *

Asof December 31, 2007, and March 31, 2008, the condensed consolidatedbalance sheets also reflect subscriber acquisition fees payable of $29,000 and$1.8 million, respectively. For the three months ended March 31, 2007 and2008, the Company made cash payments of $57,000 and $29,000, respectively,relating to current subscriber acquisition fee obligations.

 

**4. Program License Fees**

 

Program license fees are comprised of the following:

 
| ** **                                                 | ** ** | **As of December 31,** | ** ** | **As of March 31,** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                              | ** ** | **2008**                           | ** ** |
| ** **                                                 | ** ** | **(In thousands)**               | ** ** |
| Program license fees—RHI  Entertainment  Distribution |       | $                                     | 244,920    |                               | $          | 242,135 |   |
| Program license fees—NICC                             |       | 197                                   |       | 180                                |       |
| Program license fees—other  affiliates                |       | 918                                   |       | 3,267                              |       |
| Program license fees—other  non-affiliates            |       | 297,816                               |       | 310,326                            |       |
| Program license fees, at cost                              |       | 543,851                               |       | 555,908                            |       |
| Accumulated amortization                                   |       | (294,241                              | )          | (321,469                           | )          |
| Program license fees, net                                  |       | $                                     | 249,610    |                               | $          | 234,439 |   |

 

AtDecember 31, 2007, and March 31, 2008, $8.4 million and $14.9 millionof program license fees were included in prepaid program license fee assets onthe accompanying condensed consolidated balance sheets as the Company made paymentsfor the program license fees prior to commencement of the license period.

 

License fees payable are comprised of the following:

 
| ** **                                                 | ** ** | **As of December 31,** | ** ** | **As of March 31,** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                              | ** ** | **2008**                           | ** ** |
| ** **                                                 | ** ** | **(In thousands)**               | ** ** |
| License fees payable—RHI  Entertainment  Distribution |       | $                                     | 21,427     |                               | $          | 15,665 |   |
| License fees payable—NICC                             |       | 1,078                                 |       | 358                                |       |
| License fees payable—other  affiliates                |       | 550                                   |       | 2,900                              |       |
| License fees  payable—non-affiliates                  |       | 142,843                               |       | 135,277                            |       |
| Total license fees payable                                 |       | 165,898                               |       | 154,200                            |       |
| Less current maturities                                    |       | (109,377                              | )          | (105,237                           | )          |
| Long-term license fees payable                             |       | $                                     | 56,521     |                               | $          | 48,963 |   |

 

**5. Credit Facility**

 

ByAmendment No. 14 in March 2008, the maturity date of the bank creditfacility was extended to May 31, 2009. Under this Amendment, the amounts available under this facility havebeen, and will continue to be, reduced from $130.0 million as follows:

 

11

----

 
| **Date**                | ** ** | **Revolving Credit Commitment** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|
| March 10, 2008     |       | $                                         | 90,000,000 |   |
| June 30, 2008      |       | $                                         | 60,000,000 |   |
| September 30, 2008 |       | $                                         | 50,000,000 |   |
| March 31, 2009     |       | $                                         | 45,000,000 |   |

 

Inconnection with Amendment No. 14, JP Morgan Chase Bank became the solelender under the bank credit facility by acquiring the interests of all otherlending banks. Concurrent with the execution of Amendment No. 14, theexisting Hallmark Cards’ support letter of credit was reissued by JPMorgan inthe face amount of $90.0 million, with an expiration date of June 10,2009.

 

TheCompany had at March 31, 2008, $18.3 million of unused revolving creditcapacity. Other than with respect to the scheduled decreases in borrowingcapacity described above, the Company’s ability to borrow additional amountsunder the credit facility is not limited or restricted.  The Company and the lending banks originallyentered into the facility in 2001 and have subsequently amended the terms ofthis facility, with the most recent amendment dated as of March 10,2008.  The facility is guaranteed by theCompany’s subsidiaries and is secured by all tangible and intangible propertyof Crown Media Holdings and its subsidiaries.

 

Eachborrowing under the bank credit facility bears interest at a Eurodollar rate oran alternate base rate as the Company may request at the time ofborrowing.  The Eurodollar rate is basedon the London interbank market for Eurodollars, and remains in effect for thetime period of the loan ranging from one, two, three, six or twelvemonths.  The alternate rate is based uponthe prime rate of JP Morgan Chase Bank, a certificate of deposit rate or the FederalFunds effective rate, which is adjusted whenever the rates change.  The Company is required to pay a commitmentfee of 0.15% per annum of the committed, but not outstanding, amounts under therevolving credit facility, payable in quarterly installments.

 

At December 31, 2007, and March 31, 2008,the Company had outstanding borrowings of $69.5 million and $71.7 million,respectively, under the credit facility and there were no letters of creditoutstanding. At December 31, 2007, $69.5 million of the outstandingbalance bore interest at the Eurodollar rate (5.60% at December 31, 2007)and $0 bore interest at the JP Morgan Chase Bank prime rate. At March 31,2008, $71.7 million of the outstanding balance bore interest at the Eurodollarrate (3.45% at March 31, 2008) and $0 bore interest at the JP Morgan ChaseBank prime rate. Under the credit facility, $1.3 million bore interest at theJP Morgan Chase Bank prime rate (7.25%) for five days during January 2008,$5.8 million bore interest at 7.25% for four days in January 2008, $2.6million bore interest at 6.50% for six days in January 2008, $362,000 boreinterest at 6.00% for six days in January and February 2008, $387,000bore interest at 6.00% for six days in January and February 2008,$6.8 million bore interest at 6.00% for six days in February 2008, and$1.6 million bore interest at 6.00% for four days in February 2008. Interest expense on borrowings under the creditfacility for each of the three months ended March 31, 2007 and 2008, was$1.4 million and $895,000, respectively.

 

***Covenants***

 

The credit facility, as amended, contains affirmativeand negative covenants.  The Company’sAnnual Report on Form 10-K contains a detailed description of thesecovenants. The Company was in compliance with these covenants at March 31,2008.

 

**6. Related Party Long-TermObligations**

 

***Waiver and Standby Purchase Agreement***

 

On March 10, 2008, the Company, Hallmark Cardsand affiliates of Hallmark Cards who hold obligations of the Company enteredinto an Amended and Restated Waiver and Standby Purchase Agreement (the “WaiverAgreement”).  The Waiver Agreementreplaces a previous version of the Waiver and Standby Purchase Agreement dated March 21,2006 as amended through October 2007. The Waiver Agreement extended to March 31, 2009 the period duringwhich the Hallmark parties will defer the payment of obligations listedbelow.  The Waiver Agreement from March 2008also included the following changes:  Theannual addition of interest to principal on 

 

12

----

 

the obligations describedbelow (except the 10.25% Note continues to add interests semi-annually to theprincipal); the extension of the maturity dates of three notes (the 2001, 2005and 2006 notes mentioned below) to December 31, 2009; fixing the interestrate of these three notes to a rate of LIBOR plus 5%, adjusted quarterly; theaccrual and addition to principal of interest through November 15, 2008 onthese three notes; a requirement to pay interest on these three notes in cash,quarterly commencing November 16, 2008; and a change to the definition ofExcess Cash Flow.  As revised, the WaiverAgreement defers all payments due on any of the following obligations and,except as noted above, payment of interest thereon until March 31, 2009,or an earlier date as described below as the waiver termination date, whereuponall of these amounts become immediately due and payable (the “Waiver Period”):

 

·                                          Noteand interest payable to HC Crown, dated December 14, 2001, in the originalprincipal amount of $75.0 million, payable to HC Crown. (Total amountoutstanding at December 31, 2007, and March 31, 2008, includingaccrued interest was $101.4 million and $103.4 million, respectively. See *Note and Interest Payable to HC Crown*below.)

 

·                                          $70.0 million note and interest payableto Hallmark Cards affiliate arising out of the sale toCrown Media Holdings of the Hallmark Entertainment film library. (Total amount outstanding at December 31,2007, and March 31, 2008, including accrued interest was $57.9 million and$59.1 million, respectively. See *Note and Interest Payableto Hallmark Cards Affiliate*below.)

 

·                                          10.25%senior secured note, dated August 5,2003, in the initial accreted value of $400.0 million, payable to HCCrown.  (Total amount outstanding at December 31,2007, and March 31, 2008, including accrued interest was $621.3 millionand $637.0 million, respectively. See *Senior Secured Note*below.)

 

·                                          Note andinterest payable to Hallmark Cards affiliate, dated as of October 1, 2005,in the principal amount of $132.8 million. (Total amount outstanding at December 31,2007, and March 31, 2008, including accrued interest was $158.8 millionand $162.0 million, respectively. See *Note and Interest Payableto Hallmark Cards Affiliate*below.)

 

·                                          Note andinterest payable to Hallmark Cards in the amount of $33.1 million, dated as of July 27,2007. (Total amount outstanding at December 31, 2007, and March 31,2008, including accrued interest was $22.1 million and $17.4 million,respectively. See *Tax Note*below.)

 

·                                          Allobligations of the Company under the bank credit facility by virtue of HallmarkCards’ deemed purchase of participations in all of the obligations under aletter of credit which Hallmark Cards has given in support of the facility orthe purchase by Hallmark Cards of all these obligations pursuant to the bankcredit facility.

 

Hallmark Cards has agreed that it will not accelerate the maturity ofany of the foregoing obligations or initiate collection proceedings during theWaiver Period. Interest will continue to accrue on these obligations during theWaiver Period and will be payable as indicated above. The Company will continueto pay interest on the bank credit facility during the Waiver Period.

 

The waiver termination date is March 31, 2009, or earlier uponoccurrence of any of the following events: (a) the Company fails to pay any principal or interest, regardlessof amount, due on any indebtedness to unrelated parties with an aggregateprincipal amount in excess of $5.0 million or any other event or conditionoccurs that results in any such indebtedness becoming due prior to itsscheduled maturity, provided that the waiver will not terminate if the Companyreduces the principal amount of such indebtedness to $5.0 million or lesswithin five business days of a written notice of termination from HallmarkCards; (b) certain bankruptcy events occur; (c) the Company defaultsin its payment of licensing fees under the Second Amended and Restated ProgramLicense Agreement with RHI Entertainment Distribution (formerly known asHallmark Entertainment Distribution at which time it was a wholly-ownedsubsidiary of Hallmark Cards); (d) a representation and warranty of theCompany in the Waiver Agreement is false or misleading in any material respect;(e) the Company fails to pay interest on the bank 

 

13

----

 

credit facility describedabove to the extent that Hallmark Cards has purchased all or a portion of theindebtedness thereunder or to perform any covenants in the Waiver Agreement; or(f) the security agreements granted to the Hallmark parties shall notremain perfected.

 

Under the Waiver Agreement, if the bank lender under the bank creditfacility accelerates any of the indebtedness under the bank credit facility orseeks to collect any indebtedness under it, the Company may elect to exerciseits right to require that Hallmark Cards or its designated subsidiary exercisean option to purchase all the outstanding indebtedness under the bank creditfacility as provided in the bank credit facility.  All expenses and fees in connection with thispurchase would be added to the principal amount of the credit facilityobligations.

 

The Waiver Agreement does not limit any existing rights of HallmarkCards or its affiliates to offset amounts owed to us under the Hallmark TaxSharing Agreement or as otherwise agreed by us against these obligations.  Additionally, during the Waiver Period,Hallmark Cards is permitted to offset future tax benefits it realizes pursuantto the Tax Sharing Agreement, first against accrued and unpaid interest andthen to the unpaid principal balance of the Tax Note until the earlier of suchtime as the balance reaches zero or the maturity date of the Tax Note.

 

Pursuant to the Waiver Agreement, the Company must make prepayments onthe outstanding debt from 100% of any “Excess Cash Flow” during the WaiverPeriod.   “Excess Cash Flow” is definedas 1) the net proceeds of any debt or equity financings; 2) the net cashproceeds from the sale, transfer or release by the Company of assets outsidethe ordinary course of business; and 3) if positive, the consolidated net cashflow from operations calculated in the same manner (and subject to the samerestrictions on selling, general and administrative expenses, capitalexpenditures and similar items) as “Cash Flow Before Interest, Taxes (includingtax sharing payments) and Principal” as set forth in the Crown Media Holdings2008 budget as approved by the Board of Directors of Crown Media Holdings andprovided to the Hallmark parties.  For2009, the restrictions will be those contained in the 2009 budget to be approvedby the Board of Directors of Crown Media Holdings and reasonably acceptable tothe Hallmark parties.

 

Additionally, the Waiver Agreement contains thefollowing covenants:  (1) compliancewith obligations in the loan documents for the bank credit facility; (2) executionof additional documents as necessary to implement the waiver agreement; (3) commerciallyreasonable efforts to refinance the obligations subject to the Waiver Period aslisted above; and (4) ratification of the security interests granted tothe Hallmark affiliates in personal property of the Company.

 

***Hallmark Letterof Credit***

 

Concurrentwith the execution of Amendment No. 14, the existing Hallmark Cards’support letter of credit was reissued by JPMorgan in the face amount of $90.0million and with an expiration date of June 10, 2009.

 

***Senior SecuredNote***

 

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

 

Inaccordance with the Waiver Agreement, cash payments are not required until March 31,2009. The principal amount of the senior secured note accretes at 10.25% perannum, compounding semi-annually, to $596.6 million at August 5,2007.  From that date, interest at 10.25%per annum was scheduled to be payable semi-annually on the accreted value of thesenior note to HC Crown, but now interest accrued after March 31, 2009,will be payable semi-annually in arrears on August 5 and February 5of each year until maturity.  The notematures on August 5, 2011, and is pre-payable without penalty. At December 31,2007, and March 31, 2008, $621.3 million and $637.0 million, respectively,of principal and interest were included in the senior note payable in theaccompanying consolidated balance sheets. The note purchase agreement for thesenior note contains certain restrictive covenants which, among other things,prevent the Company from incurring any additional indebtedness, purchasing orotherwise acquiring shares of the Company’s stock, investing in other partiesand incurring liens on the Company’s assets.  As a fee for the issuance of the notes, theCompany paid $3.0 million to HC Crown, which was initially capitalized and isbeing amortized as additional interest expense over the term of the notepayable.

 

14

----

 

***Noteand Interest Payable to HC Crown***

 

On December 14,2001, the Company executed a $75.0 million promissory note with HC Crown.  Due to the Waiver Agreement, the note andrelated interest are not due until December 31, 2009. This note issubordinate to the bank credit facility. The rate of interest under this notewas equal to LIBOR plus three percent and is currently LIBOR plus 5% per annumpursuant to the March 2008 amendment to the Waiver Agreement. At December 31,2007, and March 31, 2008, borrowings under the note were $93.5 million and$101.3 million, respectively. Accrued interest on the note of $7.9 million and$2.1 million are included in note and interest payable to HC Crown on theaccompanying consolidated balance sheets as of December 31, 2007, and March 31,2008, respectively. At December 31, 2007, $93.5 million of the outstandingbalance bore interest at the Eurodollar rates of 8.23%. At March 31, 2008,$101.3 million of the outstanding balance bore interest at the Eurodollar ratesof 9.68%. At December 31, 2007, and March 31, 2008, $101.4 millionand $103.4 million, respectively, are each reported as note and interestpayable to HC Crown on the accompanying consolidated balance sheets.

 

***Noteand Interest Payable to Hallmark Cards Affiliate***

 

On October 1, 2005, the Company convertedapproximately $132.8 million of its license fees payable to Hallmark affiliatesto a promissory note.  The rate ofinterest under this note was equal to LIBOR plus three percent and is currentlyLIBOR plus 5% per annum pursuant to the March 2008 amendment to the WaiverAgreement. Pursuant to the Waiver Agreement, the promissory note is payable infull on December 31, 2009.  At December 31,2007, and March 31, 2008, borrowings under the note were $146.4 millionand $158.7 million, respectively. Accrued interest on the note of $12.4 millionand $3.3 million is included in note and interest payable to Hallmark Cardsaffiliate on the accompanying consolidated balance sheets as of December 31,2007, and March 31, 2008, respectively. At December 31, 2007, $146.4million of the outstanding balance bore interest at the Eurodollar rates of8.23%. At March 31, 2008, $158.7 million of the outstanding balance boreinterest at the Eurodollar rates of 9.68%. At December 31, 2007, and March 31,2008, $158.8 million and $162.0 million, respectively, are each reported asnote and interest payable to Hallmark Cards affiliate in the accompanyingconsolidated balance sheets.

 

***Noteand Interest Payable to Hallmark Cards Affiliate***

 

On March 21,2006, the Company converted approximately $70.4 million of its payable to aHallmark Cards affiliate to a promissory note. The rate of interest under thisnote was equal to LIBOR plus three percent and is currently LIBOR plus 5% perannum pursuant to the March 2008 amendment to the Waiver Agreement.Pursuant to the Waiver Agreement, the promissory note is payable in full on December 31,2009. At December 31, 2007, and March 31, 2008, borrowings under thenote were $53.4 million and $57.9 million, respectively. Accrued interest onthe note of $4.5 million and $1.2 million is included in note and interestpayable to Hallmark Cards affiliate on the accompanying consolidated balancesheet as of December 31, 2007, and March 31, 2008, respectively. At December 31,2007, $53.4 million of the outstanding balance bore interest at the Eurodollarrates of 8.23%.  At March 31, 2008,$57.9 million of the outstanding balance bore interest at the Eurodollar ratesof 9.68%.  At December 31, 2007, andMarch 31, 2008, $57.9 million and $59.1 million, respectively, are eachreported as note and interest payable to Hallmark Cards affiliate in theaccompanying consolidated balance sheet.

 

***Note and Interest Payable to Hallmark Cards***

 

On July 27, 2007, the Company replaced a payableto Hallmark Cards under the Tax Sharing Agreement with a $33.1 millionpromissory note payable to Hallmark Cards due in July 2009 with interestat LIBOR plus 3% per annum (the “Tax Note”). The Tax Note may be prepaid in whole or in part with no penalty.  The Company is not required to make any cashpayments prior to maturity. Until the Tax Note and related interest is paid infull, Hallmark Cards will offset any future tax benefits it realizes pursuantto the Tax Sharing Agreement, first against accrued and unpaid interest andthen against the unpaid principal balance. In September 2007, HallmarkCards offset $6.5 million against $508,000 of accrued and unpaid interest and$6.0 million of unpaid principal. Additionally, in September 2007, theCompany recorded an additional $85,000 charge to interest expense related tothe receipt of an invoice for the actual amount owed in regard to the return oftax benefits under the Tax Sharing Agreement as described above. In December 2007,Hallmark Cards offset $5.7 million against $571,000 of accrued and unpaidinterest and $5.1 million of unpaid principal. In March 2008, HallmarkCards offset $5.1 million against $429,000 of 

 

15

----

 

accrued and unpaid interest and $4.6 million of unpaid principal.

 

At December 31,2007, and March 31, 2008, interest was paid to the respective balancesheet dates. At December 31, 2007, $22.1 million of the outstandingbalance bore interest at the Eurodollar rates of 8.23%.  At March 31, 2008, $17.4 million of theoutstanding balance bore interest at the Eurodollar rates of 7.68%.  At December 31, 2007, and March 31,2008, borrowings under the note were $22.1 million and $17.4 million,respectively, and are each reported as note and interest payable to HallmarkCards in the accompanying consolidated balance sheets.

 

The Tax Note and any payment thereunder aresubordinated to the bank credit facility extended to the Company by JP MorganChase Bank.

 

***Interest Paid to HC Crown***

 

Interestexpense paid to HC Crown was $453,000 for the three months ended March 31,2007, and $390,000 for the three months ended March 31, 2008. Prior toAmendments No. 8 and No. 10 to the Company’s credit facility, suchamounts would have been paid to the bank syndicate.

 

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

 

Theaggregate maturies of related party long-term debt for each of the five yearssubsequent to March 31, 2008, are as follows:

** **
| ** **                                                                                       | ** ** | **Payments Due by Period** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                       | ** ** | **Total**                                 | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** |
| ** **                                                                                       | ** ** | **(In thousands)**                   | ** ** |
| Note and interest payable to HC Crown, with  principal due December 31, 2009                |       | $                                         | 103,456    |   | $ | — |   | $ | 103,456 |   | $ | — |   | $ | — |   | $ | — |   |
| 10.25 % Senior secured note to HC Crown, including  accrued interest, due August 5, 2011    |       | 637,033                                   |       | — |   | — |   | — |   | 637,033 |   | — |   |
| Note and interest payable to Hallmark Cards  affiliate with principal due December 31, 2009 |       | 162,030                                   |       | — |   | 162,030 |   | — |   | — |   | — |   |
| Note and interest payable to Hallmark Cards  affiliate with principal due December 31, 2009 |       | 59,062                                    |       | — |   | 59,062 |   | — |   | — |   | — |   |
| Note and interest payable to Hallmark Cards due  July 27, 2009                              |       | 17,429                                    |       | — |   | 17,429 |   | — |   | — |   | — |   |
|                                                                                             |       | $                                         | 979,010    |   | $ | — |   | $ | 341,977 |   | $ | — |   | $ | 637,033 |   | $ | — |   |

 

**7. Related Party Transactions**

 

***Tax Sharing Agreement***

 

*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 past tax losses and may benefit from future federal tax losses, which maybe generated by Crown Media Holdings. Based on the tax sharing agreement, Hallmark Cards has agreed to payCrown Media Holdings all of the benefits realized by Hallmark Cards as a resultof including Crown Media Holdings in its consolidated income tax return.  These benefits are estimated and paid 75% incash on a quarterly basis and the balance when Crown Media Holdings becomes afederal taxpayer.  A final true-upcalculation is completed within 15 days after Hallmark Cards files itsconsolidated federal income tax return for the year.  Pursuant to the true-up calculation, CrownMedia Holdings is 

 

16

----

 

obligatedto reimburse Hallmark Cards the amount that any estimated payments haveexceeded the actual benefit realized by Hallmark Cards and Hallmark Cards isobligated to pay Crown Media Holdings the amount that any actual benefitexceeds the estimated payments.  Underthe tax sharing agreement, at Hallmark Cards’ option, the non-interest bearingbalance of the 25% in federal tax benefits may be applied as an offset againstany amounts owed by Crown Media Holdings to any member of the Hallmark Cardsconsolidated group under any loan, line of credit or other payable, subject tolimitations under any loan indentures or contracts restricting such offsets.

 

The Company received $0 and $5.1 million (includingthe $5.1 million offset against the Tax Note during the first quarter of 2008)under the Tax Sharing Agreement during three months ended March 31, 2007and 2008, respectively. Any payments received from Hallmark Cards or creditedagainst amounts owed by Crown Media Holdings to any member of the HallmarkCards consolidated group under the tax sharing agreements are recorded as anaddition to paid-in capital in the accompanying consolidated statements ofstockholders’ equity (deficit).

 

*Accounting for Uncertainty inIncome Taxes*

 

Under FASB Interpretation No. 48, *Accounting for Uncertainty in Income Taxes* (“FIN 48”), ifthe probability for sustaining a tax position is at least more likely than not,then the tax position is warranted and recognition should be at the highestamount which is greater than 50% likely of being realized upon ultimatesettlement. At March 31, 2008, the total amount of unrecognized taxbenefits for uncertain tax positions was $0. The Company recognizes interestand penalties related to uncertain tax positions in income tax expense.  As of the date of adoption and on March 31,2008, we have no accrued interest related to uncertain tax positions.

 

By virtue of its inclusion in Hallmark Cardsconsolidated tax returns, the Company is subject to examination by the InternalRevenue Service for periods subsequent to March 10, 2003. Further, netoperating loss carryforwards (“NOL’s”) are subject to examination in the yearthey are utilized regardless of whether the tax year in which they weregenerated has been closed by statute.  Theamount subject to disallowance is limited to the NOL utilized.  Accordingly, the Company is subject toexamination for NOL’s generated prior to March 11, 2003 if and when suchNOL’s are utilized in future tax returns.

 

The Company  files  state tax  returns  in major  jurisdictions such asCalifornia,  Colorado  and New  York,  and has  also been included in thecombined state tax returns of Hallmark or Hallmark Entertainment Holdings, Inc.The state returns are generally subject to examination for years after 2002.

 

***Services Agreement with Hallmark Cards***

 

The Company has an intercompany services agreementwith Hallmark Cards, which was entered into in 2003 for a term of three yearsand then extended for additional years through January 1, 2009.  Under the agreement, Hallmark Cards providesCrown Media Holdings with tax, risk management, health safety, environmental,insurance, legal, treasury and cash management services and real estateconsulting services.  Under theagreement, the Company agreed to pay Hallmark Cards $546,000 in 2007 and$541,000 in 2008 for these services, plus out-of-pocket expenses and thirdparty fees, payable in arrears on the last business day of each quarter. However, the Company has not paid these amountswith concurrence of Hallmark Cards.

 

For the year ended December 31,2007, Crown Media Holdings had accrued $546,000 under the agreement. For thethree months ended March 31, 2008, the Company has accrued $135,000 underthe agreement. At December 31, 2007, and March 31, 2008, non-interestbearing unpaid accrued service fees and unreimbursed expenses of $13.3 millionand $13.6 million, respectively, were included in payable to affiliates on theaccompanying consolidated balance sheets. At December 31, 2007, and March 31,2008, out-of-pocket expenses and third party fees were $1.2 million and$175,000, respectively.

 

17

----

 

***“Hallmark Hallof Fame” Programming License Agreement***

 

In 2008, Crown Media United States entered into anagreement with Hallmark Hall of Fame Productions, Inc. to license 58 “HallmarkHall of Fame” movies, consisting of 16 contemporary Hallmark Hall of Fametitles (i.e., produced from 2003 to 2008) and 42 older titles, for exhibitionon 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 its 10 year exhibition window.

 

The Company aired one title during 2007 and hasrecorded $550,000 as a license fee payable to affiliate related to this title.Windows opened for additional titles in the amount of $2.4 million during thethree months ending March 31, 2008.

 

**8. Company Obligated MandatorilyRedeemable Preferred Interest and NICC License Agreements**

 

VISN owns a $25.0 million company obligated mandatorily redeemablepreferred membership interest in Crown Media United States (the “preferredinterest”) issued in connection with an investment by the Company in CrownMedia United States. On November 13, 1998, the Company, Vision Group, VISNand Henson Cable Networks, Inc. signed an amended and restated companyagreement governing the operation of Crown Media United States (the “companyagreement”), 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 Settlement Agreement”).

 

Under the company agreement, the members agreed that if during any yearending after January 1, 2005 and on or prior to December 31, 2009,Crown Media United States has Federal taxable income (with possibleadjustments) in excess of $10.0 million, and the preferred interest has notbeen redeemed, Crown Media United States will redeem the preferred interest inan amount equal to the lesser of: (i) such excess Federal taxable income; (ii) $5.0million; or (iii) the amount equal to the preferred liquidation preferenceon the date of redemption.  Crown MediaUnited States may voluntarily redeem the preferred interest at any time;however, it is obligated to do so no later than December 31, 2010. Due tothe mandatory redemption provision of the preferred interest, on July 1,2003, the preferred interest was remeasured at fair value and reclassified tonon-current liabilities in accordance with the provisions of *Statement of Financial Accounting Standards  No. 150: Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity (asamended)* (“*SFAS 150*”). TheCompany has classified $5.0 million as a current liability in the condensedconsolidated balance sheet, as management believes that Crown Media UnitedStates will have Federal taxable income for the year ended December 31,2008.

 

TheDecember 2005 NICC Settlement Agreement provided that in the event therewas a change in control of Crown Media Holdings prior to the December 31,2007, expiration of the NICC Agreement, the Company was required to immediatelypay NICC (1) $15.0 million (the “Termination Payment”) (2) anyremaining portions of the payments for the non-dramatic specials and the “madefor television” movie development and (3) the deferred payments. Also, itprovided that the Hallmark Channel would be obligated to continue to broadcastand pay for the Sunday “New Morning with Naomi Judd” and weekday “New Morning”series and the Sunday morning programming block for an additional six monthsfollowing the change in control, after which all funding and broadcastobligations to NICC would cease. Also, under the December 2005 NICCSettlement Agreement, Crown Media Holdings would be required to redeem thePreferred Interest for $25.0 million plus accrued interest at LIBOR from November 27,2005.  In September 2007 NICCadvised the Company that it believed that, if there were no prior sale of theChannel, the Termination Payment provision would survive the December 31,2007 expiration of the December 2005 NICC Settlement Agreement.  The Company believed that the TerminationPayment provision expired on December 31, 2007.

 

TheDecember 2005 NICC Settlement Agreement also granted NICC a conditionalright to require the Company to repurchase all of the shares of the Company’s Class Acommon stock then owned by NICC (the “Put Right”).  There having been no change in control of theCompany, on July 1, 2007, NICC and the Company 

 

18

----

 

commenceda required 60-day negotiating period regarding continuation of the programmingcommitments.  This 60-day period expired August 29,2007, without agreement between the parties. As a result, the Put Right becamecontractually exercisable on August 30, 2007, with a November 1,2007, expiration. However, the Company believes that in September 2007 itreached a binding agreement with NICC, under which NICC agreed it would notexercise the Put Right.

 

NICCpurportedly exercised the Put Right by written notice on October 28, 2007and proposed that the purchase be settled on January 4, 2008.  The determination or resolution of whethercash would be used to satisfy the Put Right was beyond the sole control of theCompany.  Therefore, in accordance with *SFAS 150*, the accompanying consolidated balance sheet as of December 31,2007 reflects a liability of $32.8 million for the pending repurchase ofCompany shares owned by NICC.  Suchamount reflects the 30-day average closing price of the Company’s Class Acommon stock from October 8, 2007 through November 16, 2007,inclusive, as specified in the NICC Agreement with respect to exercise of thePut Right.

 

On January 2, 2008, the Company and NICC resolved the disputesdiscussed above and signed an agreement (the “Modification Agreement”) which,among other things, immediately extinguished the Put Right and the Company’spending obligation.  In addition, theModification Agreement also settled the dispute with respect to whether theTermination Payment provision expired with, or survived, the December 31,2007 expiration of the December 2005 NICC Settlement Agreement. We agreedto pay NICC $3.8 million in three equal installments payable each January 20of 2008, 2009 and 2010.  We also agreedto provide NICC a two-hour broadcast period granted each Sunday morning duringthe two year period ending December 31, 2009.  The discounted value of the broadcast period,estimated to be $1.4 million, is reflected as deferred revenue as of December 31,2007. We are also obligated to pay NICC an estimated $3.7 million in quarterlyinstallments at the rate of 6% of the outstanding liquidation preference of thepreferred interest.  These costs arereflected on the accompanying consolidated statement of operations andcomprehensive loss for the year ended December 31, 2007 as a charge toselling, general and administrative expense at a discounted amount of $8.2million.  The deferred revenue will beamortized to revenue ratably over NICC’s two-year use of the broadcastcommitment.

 

Duringthe three months ended March 31, 2007, and 2008, Crown Media United Statespaid NICC $7.3 million and $4.9 million, respectively, related to the companyagreement as amended.

 

**9.  RHI Entertainment**

 

***Program License Agreements with RHI EntertainmentDistribution***

*** ***

Crown Media United States haslicensed programming for distribution in the United States from RHIEntertainment Distribution, since 1998, most recently under a Second Amended and Restated ProgramLicense Agreement dated as of January 1, 2005 (“Second Restated Agreement”).  A special committee of the Board of Directorsand the entire Board of Directors (with directors affiliated with HallmarkCards and J.P. Morgan Partners abstaining from the vote) approved the SecondRestated Agreement. This Second Restated Agreement expires on December 31,2008.

 

Programmingcosts related to the RHI Entertainment Distribution program agreements were$14.8 million and $17.2 million for the three months ended March 31, 2007and 2008, respectively. As of December 31, 2007, and March 31, 2008,$21.4 million and $15.7 million, respectively, are included in license feespayable to non-affiliates on the accompanying consolidated balance sheets.Crown Media Holdings paid RHI Entertainment $21.1 million and $6.9 million forlicense fees during the three months ended March 31, 2007 and 2008,respectively.

 

**10. Share-Based Compensation**

 

The Company recorded $1.4 million of compensation expense associatedwith the Employment and Performance RSUs during each of the three month periodsended March 31, 2007 and 2008, and has included such amounts in selling,general and administrative expense on the accompanying consolidated statementsof operations

 

19

----

 

The Company issued cash settlements of $1.5million during the year ended December 31, 2007. Additionally,following the December 2007 death of one of the members of the Company’sBoard of Directors, the Company settled 5,820 vested RSUs for approximately$35,000 in cash in January 2008.

 

Sixty-five percent of the Achieved Performance RSUs(that portion of the Performance RSUs that were earned based on meeting theplan’s performance criteria – “Achieved Performance RSUs”) granted in 2006became fully vested in March 2008 after all major distribution agreementswere renewed. In a second vesting, 65% to 135% (“the Modifier”) of the AchievedPerformance RSUs (less the Achieved Performance RSUs previously vested) willvest on December 31, 2008, based upon a formula using subscriber revenueachieved for a specified time period.

 

 TheCompensation Committee of the Board of Directors has the discretion to increaseor decrease the Modifier by 20% and also may extend the deadlines forsatisfaction of the vesting conditions. In order to be eligible for vesting and settlement of the AchievedPerformance RSUs, the individual holding them must either be employed at thetime of the first vesting or have been terminated without cause within 90 daysof a vesting date.

 

The Company originally intended to complete thesigning of the renewal agreements by November 2007, but did not.  Since the original performance condition wasnot achieved in November 2007, the cumulative compensation cost related tothe modified award of $2.7 million (assuming vesting will occur under themodified performance condition (all agreements were signed by April 2008)),represented the modified award’s fair value in November 2007. The Companyhas and will continue to adjust the fair value of this award at each quarterlyreporting period until vesting and settlement occurs.

 

On March 13, 2008, theCompensation Committee determined that the first vesting of the 2006Performance RSUs would be paid out in accordance with the vesting criteria asif all the major distribution agreements had been renewed prior to eachagreement’s expiration date, and accordingly, 100% of the first vesting of thePerformance RSUs were deemed Achieved Performance RSUs.  The Company adjusted its liability to theactual settlement amount during the three months ended March 31, 2008. Thesettlement of 571,578 vested units valued at approximately $3.2 million waspaid on April 4, 2008.

 

At December 31,2007, the CEO’s SARs were valued at $4.6 million using the closing price of ashare of our common stock on December 31, 2007, of $6.50. At March 31,2008, the CEO’s SARs were valued at $2.3 million using the closing price of ashare of our common stock on March 31, 2008, of $5.17. The Companyrecorded $236,000 in compensation expense and $570,000 in compensation benefitrelated to SARs for the three months ended March 31, 2007 and 2008,respectively, on our consolidated statement of operations as a component ofselling, general and administrative expense. The SARs have been recorded in accounts payable and accrued liabilitieson the accompanying consolidated balance sheets at December 31, 2007, and March 31,2008, respectively.

 

**11. Commitments and Contingencies**

 

In thenormal course of business, the Company has entered into agreements that commitit to make cash payments in future periods with respect to non-cancelableleases and programming contracts.

 

In accordance with the Purchaseand Sale Agreement dated February 23, 2005, Sparrowhawk Media Limited hasmade several warranty and indemnity claims against the Company of approximately$2.0 million. At both December 31, 2007, and March 31, 2008, accountspayable and accrued liabilities include an accrual commensurate with theCompany estimate that it may be liable within the range of $250,000 to$750,000.

 

On July 27, 2007, a lawsuit was brought againstCrown Media Holdings, Inc. and our former Chief Financial Officer, WilliamAliber, in the U.S. District Court for the Northern District of Illinois.  The plaintiff, Robert Lieblang, claims tohave purchased our common shares on the market from August 31, 2005 to April 13,2006 and to have sold those shares in April 2006 and in August 2006.  The plaintiff alleges that he relied to hisdetriment on 

 

20

----

 

allegedly false and misleading statements by the defendants regardingthe possible sale of Crown Media Holdings. We announced the exploration of strategic alternatives including thepossibility of selling the Company in August 2005; in April 2006, weannounced the termination of an extensive review of strategic alternativesincluding a possible sale.  Plaintiffalleges claims under Section 10(b) of the Securities Exchange Act(and Rule 10b-5), the Illinois Consumer Fraud Act and common lawfraud.  The complaint seeks compensatorydamages of approximately $2.0 million plus interest and $6.0 million inpunitive damages.  The Company hasretained counsel to defend Mr. Aliber and the Company and has submittedthe claims to an insurer under an insurance policy. The insurer is paying costsof this lawsuit, subject to certain reservations or exclusions. Through December 31,2007, the Company has incurred legal expense equal to its deductible of$500,000 under its insurance policy. In January 2008, the court ruledagainst the defendant’s motion to dismiss the lawsuit, although the court’sruling also narrowed the securities law claims to purchases after a certaindate in 2006.

 

On January 2, 2008, the Company and NICC signedan agreement which immediately extinguished the Put Right and covered otheraspects of the Company’s relationship with NICC.  See Note 8.

 

21

----

 

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

 

The following discussion and analysis of theCompany’s financial condition and results of operations should be read inconjunction with “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2007.

 

**Description of Business andOverview**

 

*CurrentBusiness*

 

Crown Media Holdings, Inc. (“Crown MediaHoldings,” “Crown Media” or the “Company”), through its subsidiary, owns andoperates pay television channels (the “Hallmark Channel” and the “Hallmark Movie Channel,” each singularlythe “channel” or collectively the “Channels”) dedicated to high-qualityentertainment programming for adults and families, in the United States.

 

With 84.2 million subscribers (as provided by Nielsen Research) in theUnited States at March 31, 2008, the Hallmark Channel is the 38thmost widely distributed advertising-supported cable channel in the UnitedStates. For the first quarter of 2008, the Hallmark Channel finished thequarter as the tenth highest rated advertising-supported cable channel fortotal day ratings and the seventh highest rated advertising-supported cablechannel in prime time as measured by Nielsen Research.

 

We launched our second 24-hour linear channel, the Hallmark MovieChannel, during the first quarter of 2005. Programming on the Hallmark Movie Channel consists of movies andmini-series. The Hallmark Movie Channel generated advertising revenue in 2007,and 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, which has resulted inadditional costs, but is expected to result in incremental subscriber growth.

 

*Current Challenges and Developments*

 

The Hallmark Channel faces numerous operating challenges. Among themare maintaining and expanding the distribution of the Channels, broadeningviewership demographics, increasing viewership ratings, and increasingadvertising sales revenue.

 

Distribution agreements are important because they affect our number ofsubscribers, which in turn has a major impact on our subscriber fees, thenumber of persons viewing our programming, and the rates charged for advertising.The current and long-term distribution challenges are renewing our distributionarrangements with the multiple system operators as they expire on favorableterms. Our major distribution agreements have terms which expire atvarious times from December 31, 2008, through, with options to renew, December 2023.

 

Since January 1, 2007, through the date of this Report, the Companyhas renewed its agreements with six major distributors, accounting for87% of our subscriber base at March 31, 2008.  Each renewal agreement has a multi-year term. The March 2007 agreement withEchoStar Communication Corporation provided for a repositioning of the HallmarkChannel on the DISH Network, resulting in an addition of approximately 6.4million Nielsen subscribers in May 2007. It further provided for carryingthe Hallmark Movie Channel on a package of the DISH Network, increasingdistribution of that Channel by more than 4.0 million subscribers. In May 2007,we executed a renewal of our distribution agreement with the NationalCable Television Cooperative (“NCTC”). Under the terms of the renewal, wecontinue to be available to NCTC’s 1,100 member companies. In November 2007,we executed a renewal agreement with Comcast Corporation, providing Comcastwith rights to distribute the Hallmark Channel, the Hallmark Movie Channel andthe Hallmark Movie Channel HD.  In thefirst 

 

22

----

 

quarter of 2008, werenewed distribution agreements with Time Warner Cable and DirecTV for multi-yeardistribution of the Hallmark Channel. In April 2008, we renewed ourdistribution agreement with Cablevision Systems, which was the final majordistribution agreement which originally expired in 2007. The renewal agreementcovers the Hallmark Channel as well as the Standard Definition and HighDefinition versions of the Hallmark Movie Channel.

 

Our agreements with major distributors contain “most favored nations”clauses.  These clauses typically providethat, in the event we enter into an agreement with another distributor on morefavorable terms, these terms must be offered to the distributor, subject tovarious exceptions and conditions.  Theseclauses cover matters such as subscriber fees, launch support, localadvertising time and other financial and operating provisions.  We take these provisions into account whenrenewing agreements.

 

Domestic telephone companies have entered the business of distributingtelevision channels to households through their wire-lines. We have agreementswith several telephone companies and cooperatives of telephone companies, whichpermit the carriage of the Hallmark Channel and the Hallmark Movie Channel andHallmark Movie Channel HD, and are negotiating with others.

 

The universe of cable TV subscribers in the United States isapproximately 100 million homes.  The top30 cable TV networks in the United States have 90 million or moresubscribers.  Our goal is to reach 90million subscribers in the next one to two years.

 

Three factors have contributed to the ratings of the Hallmark Channel:acquired series and movies, original productions and marketing and promotionalefforts. Certain acquired series have consistently delivered strong ratingsacross all day-parts. Original productions are our most high profile programsand generate the Hallmark Channel’s highest ratings. Their ratings success isof significant help to our distribution and advertising sales teams in sellingthe Hallmark Channel. Prior to 2007, substantially all of our originalprogramming was provided by RHI Entertainment. In 2007, we began acquiringoriginal programming from a broad range of producers and expect to continuethese third party acquisitions in the future. The Company typically incursadditional marketing and promotional expenses surrounding original productionsand certain acquired movies.

 

We sold approximately 50% of the advertising inventory on our Channelsin the upfront market (generally sales in June, July and August forthe last quarter of 2007 and the first three quarters of 2008), compared to46%  sold in the 2006 upfront market. Wewere able to achieve significant increases in our CPMs in the 2007 upfrontmarket compared to the 2006 upfront market. The balance of advertisinginventory has been made available in the scatter market, which in the past andin 2007 has yielded higher advertising rates than the upfront market.

 

Historically, Nielsen cable television ratings were based on viewing ofnetworks’ programming content.  Beginningin the fourth quarter of 2007, Nielsen began measuring and providingperformance data based on viewing of commercial content as well as programmingcontent.  The new ratings informationalso includes data on viewing of program content through digital recordingdevices (*i.e.,* DVR’s), if that viewing occurswithin three days of the program’s air date. From the beginning of the fourth quarter of 2007 through the firstquarter of 2008, we experienced a decrease in viewers of approximately 5% underthe new ratings measurement system. We have factored the new rating informationinto our advertising rates, and at this time we do not expect a significantimpact from the new rating information on our net advertising rates.

 

At March 31, 2008, the Hallmark Movie Channel was distributed toover 5.0 million subscribers, an increase of nearly 174,000 subscribers from December 31,2007.  This increase in distribution hasand will continue to improve the Company’s ability to generate advertisingrevenue from the Hallmark Movie Channel in 2008, thus, enabling the channel tobecome a more significant component of the Company’s advertising revenue in2008.

 

23

----

 

**Revenue from ContinuingOperations**

 

*Our revenue consists of subscriberfees and advertising.*

* *

*Subscriber Fees*

* *

Subscriber feesare generally payable to us on a per subscriber basis by pay televisiondistributors for the right to carry our Channels. In the past, we have paidcertain television distributors up-front subscriber acquisition fees to carryour Channel. Subscriber acquisition fees that we pay are capitalized andamortized over the contractual term of the applicable distribution agreement asa reduction in subscriber fee revenue. If the amortization expense exceeds therevenue recognized on a per distributor basis, the excess amortization isincluded as a component of cost of services. At the time we sign a distributionagreement, we evaluate the recoverability of the costs we incur against theincremental revenue directly and indirectly associated with each agreement.

 

Rates we receive per subscriber vary with changes in the following factors, amongothers:

 

·              Thelevel of sophistication and degree of competition in the market;

 

·              Therelative position in the market of the distributor and the popularity of thechannel;

 

·              Thepackaging arrangements for the channel; and

 

·              Othercommercial terms and length of the contract term.

 

We are in continuous negotiations with ourexisting distributors to increase our subscriber base in order to enhance ouradvertising results. We have been subject in the past to requests by majordistributors to pay subscriber acquisition fees for additional subscribers orto waive or accept lower subscriber fees if certain numbers of additionalsubscribers are provided. We also may help fund the distributors’ efforts tomarket our Channels or we may permitdistributors to offer limited promotional periods without payment of subscriberfees

 

Our Channels are usually offered as one of anumber of channels on either a basic tier or part of other program packages andare not generally offered on a stand-alone basis. Thus, while a cable orsatellite customer may subscribe and unsubscribe to the tiers and programpackages in which one of our Channels is placed, these customers do notsubscribe and unsubscribe to our Channels alone.  We are not provided with information from thedistributors on their overall subscriber churn and in what manner their churnrates affect our subscriber counts; instead, we are provided information on thetotal number of subscribers who receive the Channels.

 

Our subscriber count depends on the number of distributors carrying one of ourChannels and the size of such distributors as well as the program tiers onwhich 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 adistributor repositioning our Channels from one tier to another tier. Management analyzes the estimated effect each newor amended distribution agreement will have on revenue and costs. Based uponthese analyses, if subscriber acquisition fees are needed, management endeavorsto achieve a fair combination of subscriber commitments and subscriberacquisition fees.

 

#### *Advertising*

 

Our advertising rates are generally calculated onthe basis of an agreed upon price per unit of audience measurement in returnfor a guaranteed commitment by the advertiser. We commit to provide advertiserscertain rating levels in connection with their advertising. Advertising ratesmay vary by time of year due to seasonal changes in television viewership.Revenue is recorded net of estimated delivery shortfalls, which are usuallysettled by providing the advertiser additional advertising time. The remainderof the revenue is recognized as the “make-good” advertising time is consumed.

 

24

----

 

**Cost of Services**

 

Our cost of servicesconsists primarily of the amortization of program license fees; subscriberacquisition fee expense; the cost of signal distribution; administration,distribution and, until we sold our film assets, amortization of and otherexploitation of our film assets; and the cost of promotional segments that areaired between programs. We expect cost of services to continue to increase inthe future due to the amortization of programming to support our advertisingstrategy. We expect this increase to be offset in part by a decrease insubscriber acquisition fee expense to zero in 2008, based primarily upondistribution agreements renewed in 2007 and to date in 2008.

* *

**Critical Accounting Policies,Judgments and Estimates**

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires Crown MediaHoldings to make estimates and assumptions that affect the reported amounts ofassets and liabilities and disclosure of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenue andexpenses during the reporting period. Actual results could differ from thoseestimates.

 

For further information regarding our criticalaccounting policies, judgments and estimates, please see the 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, 2007.

 

**Effects of Transactions withRelated and Certain Other Parties**

 

In 2008 and in prior years, we entered into anumber of significant transactions with Hallmark Cards and its subsidiaries.These transactions include, amongother things, programming, trademark licenses, administrative services, a lineof credit, a tax sharing agreement, the issuance of four promissory notes and awaiver agreement. For information regardingsuch transactions and transactions with other related parties, please see “Effectsof Transactions with Related and Certain Other Parties” in Item 7 of theCompany’s Annual Report on Form 10-K as filed with the SEC for the yearended December 31, 2007. Also, please see Notes 6, 7 and 8 of Notesto Unaudited Condensed Consolidated Financial Statements contained in Item 1 ofthis Report.

 

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

##  

In the table below, we provide selected historical condensed consolidated financial andother data of Crown Media Holdings and its subsidiaries. The following selectedcondensed consolidated statement of operations data for three months ended March 31,2007 and 2008, are derived from the unaudited financial statements of CrownMedia Holdings and its subsidiaries (except ratings and subscriberinformation). This data should be read together with the condensed consolidatedfinancial statements and related notes included elsewhere in this Form 10-Q.

 

25

----

 
| ** **                                               | ** ** | ** **                                           | ** ** | ** **        | ** ** | **Percent Change** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|-------------------|------------|-------------------------|------------|
| ** **                                               | ** ** | **Three Months Ended March 31,** | ** ** | **2008 vs.** | ** ** |
| ** **                                               | ** ** | **2007**                                             | ** ** | **2008**          | ** ** | **2007**                | ** ** |
| Revenue:                                                 |       |                                                 |       |              |       |                    |       |
| Subscriber fees                                          |       | $                                                    | 7,495      |              | $          | 13,853                  |       | 85 | % |
| Advertising                                              |       | 45,998                                               |       | 56,423            |       | 23                      | %          |
| Other revenue                                            |       | 79                                                   |       | 288               |       | 265                     | %          |
| Total revenue                                            |       | 53,572                                               |       | 70,564            |       | 32                      | %          |
| Cost of Services:                                        |       |                                                 |       |              |       |                    |       |
| Programming costs                                        |       | 39,692                                               |       | 35,405            |       | -11                     | %          |
| Subscriber acquisition fee amortization                  |       | 7,848                                                |       | 0                 |       | -100                    | %          |
| Operating costs                                          |       | 3,237                                                |       | 3,469             |       | 7                       | %          |
| Total cost of services                                   |       | 50,777                                               |       | 38,874            |       | -23                     | %          |
| Selling, general and administrative expense              |       | 14,690                                               |       | 13,893            |       | -5                      | %          |
| Marketing expense                                        |       | 4,212                                                |       | 6,398             |       | 52                      | %          |
| Loss from continuing operations before interest  expense |       | (16,107                                              | )          | 11,399            |       | -171                    | %          |
| Interest expense                                         |       | (24,101                                              | )          | (26,114           | )          | 8                       | %          |
| Net loss                                                 |       | $                                                    | (40,208    | )                 | $          | (14,715                 | )          | -63 | % |
|                                                     |       |                                                 |       |              |       |                    |       |
| **Other Data:**                                          |       |                                                 |       |              |       |                    |       |
| Net cash (used in) provided by operating activities      |       | $                                                    | (12,834    | )                 | $          | 306                     |       | -102 | % |
| Capital expenditures                                     |       | $                                                    | (206       | )                 | $          | (180                    | )          | -13 | % |
| Net cash provided by (used in) investing activities      |       | $                                                    | (1,183     | )                 | $          | (1,287                  | )          | 9 | % |
| Net cash provided by (used in) financing activities      |       | $                                                    | 5,838      |              | $          | 2,053                   |       | -65 | % |
| Total domestic day household ratings (1)(3)              |       | 0.732                                                |       | 0.731             |       | 0                       | %          |
| Total domestic primetime household ratings (2)(3)        |       | 1.159                                                |       | 1.193             |       | 3                       | %          |
| Subscribers at period end                                |       | 76,240                                               |       | 84,215            |       | 10                      | %          |

 

----

(1)  Total day isthe time period measured from the time each day the broadcast of commerciallysponsored programming commences to the time such commercially sponsoredprogramming ends.

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

(3)  These Nielsen ratings are for the timeperiod January 1 through March 31.

 

### ***Results of Operations***

### ** **

#### *ThreeMonths Ended March 31, 2007 Compared to Three Months Ended March 31,2008*

####  

*Revenue. *Our revenue from continuing operations,comprised of subscriber fees and advertising, increased 32% to $70.6 millionfor the three months ended March 31, 2008. Our 85% increase to $13.9 million in subscriber fee revenue for the threemonths ended March 31, 2008, was a result of contractual rateincreases in renewed distribution agreements and reductions in subscriberacquisition fees netted from gross subscriber revenue.  We anticipate that these same factors willresult in substantial increases in subscriber fees during the remainder of 2008,compared to the corresponding periods in 2007; subscriber revenue growth beyond2008 will be limited. Subscriberacquisition fee expense recorded as a reduction of revenue was $982,000 for thethree months ended March 31, 2007, and $664,000 for the comparable periodin 2008. The number of paying subscribers has increased as a result ofpreviously amended distribution agreements in the United States, which providedfor incentives for growth in distribution.

 

26

----

 

The increase in advertisingrevenue to $56.4 million for the three months ended March 31, 2008,compared to $46.0 million for the three months ended March 31, 2007,reflects the growth in domestic subscribers and an increase in advertisingrates. Generally, as we have expanded our domestic subscribers and providedhigher rated programming, our advertising revenue has increased. The number ofadvertisers was 438 at March 31, 2008, as compared to 439 at March 31,2007.

 

Among the 73ad-supported cable channels in the United States market, the Hallmark Channelranked tenth in total day with a 0.731 household rating for the three monthsending March 31, 2008 and seventh for primetime with a 1.193 householdrating for the same period based on Nielsen ratings.

 

*Cost of services. *Cost of services as a percent of revenue decreased to55% in 2008, as compared to 95% in 2007. This decrease results from thecombined effects of the 32% increase in revenue, discussed above, and a 23%decrease in related costs which is discussed below.

 

Total programming costs for the three months ended March 31,2008, decreased 11% following the December 31, 2007, expiration of ourprogramming agreement with NICC. This was offset in part by the Companylicensing Hallmark Hall of Fame movies under an agreement which we and HallmarkCards entered into during 2008 and which covers a 10-year exhibition window.

 

The Company’s negative bad debtexpense was $34,000 for the three months ended March 31, 2008, as comparedto the Company’s bad debt expense of $330,000 for the three months ended March 31,2007.

 

Subscriber acquisitionfee amortization expense results from subscriber acquisition costs incurredpreviously by us and amortized over the remaining life of the relevantdistribution agreement. Subscriber acquisition fee amortization expensedecreased 100% as all of the expense was net against revenue during threemonths ended March 31, 2008. The Company’s three largest affiliationagreements became fully amortized during the fourth quarter of 2007.

 

*Selling, general and administrative expense.* Our selling, general and administrativeexpense decreased 5% quarter over quarter. This decrease is primarily due to the $806,000 decrease of our expenserelated to the SAR liability.

 

*Marketing expense*.  Our marketing expense increased 52%. TheCompany had one marketing promotion for “Love is a Four Letter Word” in February 2007.The Company had two marketing promotions for “The Good Witch” in January 2008and “Bridal Fever” in February 2008

 

*Interestexpense. *Interest expense for the three months ended March 31,2008, increased $2.0 million compared to the three months ended March 31,2007.  This increase was due to the $1.5million increase in interest on our $637.0 million senior secured note, the$404,000 increase in interest on our $162.0 million note payable to HallmarkCards affiliates, the $164,000 increase in interest on our $59.1 million notepayable to Hallmark Cards affiliates commencing March 21, 2006, the$138,000 increase in interest on our $103.4 million note payable to HallmarkCards affiliates, the $429,000 increase in interest on our $17.4 million notepayable to Hallmark Cards affiliates, and an offset in part by the $518,000decrease in interest on our bank credit facility due to a lower principalbalance.  The majority of theaforementioned increases occurred due to increases in principal balances andincreases in interest rates.

 

## **Liquidityand Capital Resources**

##  

During the three months ended March 31,2008 our operating activities provided $306,000 of cash.  During the comparable period in 2007, ouroperating activities consumed $12.8 million of cash.** The most significant contributions to thisfavorable change of $13.1 million are (1) a $13.1 million increase in ourearnings before depreciation and amortization, (2) a $23.5 millionreduction in our acquisition of program licenses, and (3) a $20.9 millionreduction of our liabilities for program license fees. The Company has cash receipts of $61.8 million and 

 

27

----

 

$71.8 million for the three months ended March 31,2007 and 2008, respectively.

 

Cash used in investingactivities was $1.2 million and $1.3 million for the three months ended March 31,2007 and 2008, respectively. During the three months ended March 31, 2007,the Company made payments to the buyer of the international business of$977,000. During the three months ended March 31, 2008, the Company madepayments to the buyer of the international business of $1.1 million.

 

Cash provided by financingactivities was $5.8 million and $2.1 million for the three months ended March 31,2007 and 2008, respectively. We borrowed $6.0 million and $18.8 million underour credit facility to supplement the cash requirements of our operating andinvesting activities during the three months ended March 31, 2007 and2008, respectively. We repaid principal of $0 and $16.5 million under ourcredit facility during the three months ended March 31, 2007 and 2008,respectively.

 

*Cash Flows*

 

Asof March 31, 2008, the Company had $3.0 million in cash and cashequivalents on hand. As of March 31, 2008, the Company had borrowed $71.7million from the $90.0 million revolving bank credit facility.  In March 2008, the bank credit facilitywas extended until May 31, 2009, and the committed amount of the facilitywas reduced to $90.0 million.  Thiscommitment will decrease to $60.0 million on June 30, 2008, andthereafter, to $50.0 million on September 30, 2008, and $45.0 million on March 31,2009.  The Company will use cash flowsfrom operations to reduce outstanding borrowings under the facility and expectsthese reductions to be sufficient to maintain outstanding borrowings below thecommitment levels throughout the term of the facility.

 

The Company’s principal sources of funds are cash onhand, cash generated by operations and amounts available under the Company’srevolving bank credit facility through May 31, 2009.  In addition, in March 2008, the Companyand Hallmark Cards entered into an Amended and Restated Waiver Agreement whichchanges the maturity date of three obligations and defers payments undercertain obligations.  Previously, theCompany’s tax sharing agreement with Hallmark Cards has also been a source ofcash. However, we do not expect to receive or pay any cash related to thisagreement in the next twelve months.

 

The Company expects tocontinue making investments in programming, marketing and distribution during2008. However, the Company’s recurring loss situation has demanded that allareas of expenses, including programming, marketing and distribution be closelymonitored and controlled.

 

The Company believesthat cash on hand, cash generated by operations, and borrowing availabilityunder its bank credit facility through May 31, 2009, when combined withthe deferral of any required payments on related-party debt and relatedinterest mentioned below, will be sufficient to fund the Company’s operationsand meet its liquidity needs through March 31, 2009.  The Company anticipates that its principaluses of cash during the next twelve months will continue to include the paymentof operating expenses, accounts payable and accrued expenses, license fees forprogramming, interest and repayment of principal under its bank credit facilityand interest under certain notes payable to Hallmark Cards affiliates.

 

The sufficiency of theexisting sources of liquidity to fund the Company’s operations is dependentupon maintaining subscriber revenue at or above the amount of such revenue forthe quarter ended March 31, 2008, and continuing growth in advertisingrevenue. A significant decline in the popularity of the Hallmark Channel, anadverse modification to any of the Company’s distribution agreements, aneconomic decline in the advertising market, an increase in program acquisitioncosts, an increase in competition or other adverse changes in operatingconditions could negatively impact the Company’s liquidity and its ability tofund the current level of operations.

 

The Company willendeavor to extend or refinance the bank credit facility prior to or upon itsmaturity.  Any such extension orrefinancing could require a continuation of a letter of credit from HallmarkCards in support of the bank credit facility or other steps by the Company and,thus, is not assured.  If the Company is 

 

28

----

 

not able to arrange forthe extension, refinancing or replacement of the bank credit facility prior toits maturity and either (1) the bank draws down on Hallmark Cards’irrevocable letter of credit or (2) Hallmark Cards purchases the interestsof the lending bank, Hallmark Cards would have all obligations and rights ofthe lending banks under the bank credit facility. In that event, Hallmark Cardscould demand payment of outstanding amounts at any time after March 31,2009, under the terms of the Waiver Agreement described below.

 

Upon maturity of the creditfacility on May 31, 2009, without renewal or replacement, JP Morgan ChaseBank, N.A., will have the right to forego a call on Hallmark Cards’ irrevocableletter of credit and instead initiate foreclosure against the Company’s assets. Suchforeclosure proceedings would adversely affect our ability to continue ouroperations. However, prior to any such possible foreclosure, if the Company hadnot secured a refunding of the credit facility or alternative financing, theCompany would require Hallmark Cards to exercise its option, pursuant to theterms of the Waiver Agreement, to purchase all of the outstanding indebtednessunder the credit facility. The credit facility would then be subject to termsof the Waiver Agreement.

 

Becauseof the Company’s possible inability to meet its obligations when they come dueon March 31, 2009 and later dates in 2009 through December 31, 2009,the Company anticipates that prior to March 2009, it will be necessary toeither extend or refinance (i) the bank credit facility and (ii) thepromissory notes payable to affiliates of Hallmark Cards described in the Notesbelow. As part of a combination of actions and in order to obtain additionalfunding, the Company may consider various alternatives, including refinancingthe bank credit facility, raising additional capital through the issuance ofequity or debt securities, or other strategic alternatives.

 

***Bank Credit Facility, Hallmark Notes, andTax Sharing Agreement***

 

For informationregarding our Bank Credit Facility, Hallmark Notes and Tax Sharing Agreement,please see “Bank Credit Facility, Hallmark Notes, and Tax Sharing Agreement” ofthe Company’s Annual Report on Form 10-K as filed with the SEC for theyear ended December 31, 2007. Also, please see Notes 5, 6 and 7 ofNotes to Unaudited Condensed Consolidated Financial Statements contained inItem 1 of this Report.

 

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

##  

Thediscussion set forth in this Form 10-Q contains statements concerningpotential future events. Such forward-looking statements are based onassumptions by Crown Media Holdings management, as of the date of this Form 10-Qincluding assumptions about risks and uncertainties faced by Crown MediaHoldings. Readers can identify these forward-looking statements by their use ofsuch verbs as “expects,” “anticipates,” “believes,” or similar verbs orconjugations of such verbs. If any of management’s assumptions prove incorrector should unanticipated circumstances arise, Crown Media Holdings’ actualresults, levels of activity, performance, or achievements could materiallydiffer from those anticipated by such forward-looking statements.

 

Amongthe factors that could cause actual results to differ materially are thosediscussed in this Report below and in the Company’s filings with the Securitiesand Exchange Commission, including the Risk Factors stated in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2007. SuchRisk Factors include, but are not limited to, the following:  competition for distribution of channels,viewers, advertisers and the acquisition of programming; fluctuations in theavailability of programming; fluctuations in demand for programming which weair on our channels; our ability to address our liquidity needs; our incurrenceof losses; and our substantial indebtedness affecting our financial conditionand results.

 

### **Available Information**

 

**We will makeavailable free of charge through our website, www.hallmarkchannel.com, theAnnual**

 

29

----

 

**Report, our quarterly reports on Form 10-Q, our currentreports on Form 8-K, and amendments to such reports, as soon as reasonablypracticable after we electronically file or furnish such material with theSecurities and Exchange Commission.**

 

**Additionally,we will make available, free of charge upon request, a copy of our Code ofBusiness Conduct and Ethics, which is applicable to all of our employees,including our senior financial officers. Requests for a copy of this codeshould be addressed to the General Counsel at 12700 Ventura Boulevard, StudioCity, California  91604.**

 

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

 

We only invest in instrumentsthat meet high credit and quality standards, as specified in our investmentpolicy guidelines. These instruments, like all fixed income instruments, aresubject to interest rate risk. The fixed income portfolio will decline in valueif interest rates increase. If market interest rates were to increaseimmediately and uniformly by 10% from levels as of March 31, 2008, thedecline of the fair value of the fixed income portfolio would not be material.

 

As of March 31, 2008, ourcash, cash equivalents and short-term investments had a fair value of $3.0million and were invested in cash and short-term commercial paper. The primarypurpose of these investing activities has been to preserve principal until thecash is required to fund operations. Consequently, the size of this portfoliofluctuates significantly as cash is provided by and used in our business.

 

The value of certain investmentsin this portfolio can be impacted by the risk of adverse changes in securitiesand economic markets and interest rate fluctuations. For the three months endedMarch 31, 2008, the impact of interest rate fluctuations, changed businessprospects and all other factors did not have a material impact on the fairvalue of this portfolio, or on our income derived from this portfolio.

 

We have not used derivativefinancial instruments for speculative purposes. As of March 31, 2008, weare not hedged or otherwise protected against risks associated with any of ourinvesting or financing activities.

 

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

 

We are exposed to market risk,including changes to interest rates. To reduce the volatility relating to theseexposures, we may enter into various derivative investment transactions in thenear term pursuant to our investment and risk management policies andprocedures in areas such as hedging and counterparty exposure practices. Wehave not and will not use derivatives for speculative purposes.

 

If we use risk managementcontrol policies, there will be inherent risks that may only be partiallyoffset by our hedging programs should there be any unfavorable movements ininterest rates or equity investment prices.

 

The estimated exposure discussed below is intended tomeasure the maximum amount we could lose from adverse market movements ininterest rates and equity investment prices, given a specified confidencelevel, over a given period of time.  Lossis defined in the value at risk estimation as fair market value loss.

 

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

 

Our material interest bearing assets consisted of cashequivalents and short-term investments. The balance of our interest bearingassets was $3.0 million, or less than 1% of total assets, as of March 31,2008. Our material liabilities subject to interest rate risk consisted of ourbank credit facility, our note and interest payable to HC Crown, and our notesand interest payable to Hallmark Cards affiliates. The balance of thoseliabilities was $413.8 million, or 31% of total liabilities, as of March 31,2008. Net interest expense for the three months ended March 31, 2008, was$26.1 million, 37%, of our total revenue. Our net interest expense of theseliabilities is sensitive to changes in the general level of interest rates,primarily U.S. and LIBOR interest 

 

30

----

 

rates.In this regard, changes in U.S. and LIBOR (“Eurodollar”) interest rates affectthe fair value of interest bearing liabilities.

 

If market interest rates were to increase or decrease by1% from levels as of March 31, 2008, our interest expense for the quarterwould change correspondingly by $1.1 million.

 

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

 

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

 

Our management evaluated, with the participation of our Chief Executive Officer and ourChief Financial Officer, the effectiveness of our disclosure controls andprocedures as of the end of the period covered by this Quarterly Report on Form 10-Q.Based on this evaluation, our Chief Executive Officer and our Chief FinancialOfficer have concluded that our disclosure controls and procedures wereeffective as of the end of the period covered by this Quarterly Report on Form 10-Q.

 

***b.     Changes in Internal Control over Financial Reporting***

 

There was no change in the Company’s internal control over financialreporting that occurred during the quarter ended March 31, 2008, thatmaterially affected, or was reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

**PART II.  OTHER INFORMATION**

 

**Item 6.  *Exhibits***

 

**INDEX TO EXHIBITS**

 
| **Exhibit Number** | ** ** | **Exhibit Title**                                                                                                                                                                                                                                                     |
|-------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                                                                                                                                                                                       |
| 3.1                     |       | Amended and Restated  Certificate of Incorporation (previously filed as Exhibit 3.1 to our  Registration Statement on Form S-1/A (Amendment No. 2), Commission  File No. 333-95573, and incorporated herein by reference).                             |
| 3.2                     |       | Amendment to the Amended and  Restated Certificate of Incorporation (previously filed as Exhibit 3.2  to our Quarterly Report on Form 10-Q filed on July 31, 2001 (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).                                                  |
| 31.1                    |       | Rule 13a-14(a) Certification executed by  the Company’s Acting 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.                                                                                                                                                                                                                                          |

 

31

----

 

**SIGNATURES**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on thedates indicated.

 

CROWN MEDIA HOLDINGS, INC.

 
| **Signature**                                                            | ** ** | **Title**           | ** ** | **Date**         |
|--------------------------------------------------------------------------|------------|---------------------|------------|------------------|
|                                                                     |       |                |       |             |
| By:       /s/  HENRY S. SCHLEIFF      |       | Principal Executive |       | May 7, 2008 |
|                                                                     |       | Officer             |       |             |
|        Henry  S. Schleiff             |       |                |       |             |
|                                                                     |       |                |       |             |
| By:        /s/  BRIAN C. STEWART |       | Principal           |       | May 7, 2008 |
|                                                                     |       | Financial and       |       |             |
|        Brian  C. Stewart              |       | Accounting Officer  |       |             |

 

32

----