**UNITED STATES SECURITIES ANDEXCHANGE 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 June 30, 2007**                                                                                                                                                                                                                                                  |
| ** **     |       | ** **                                                                                                                                                                                                                                                                                        |
| **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 Media Holdings, Inc.**

(Exact Name of Registrant asSpecified in Its Charter)

| **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 ExecutiveOffices and Zip Code)

**(818) 755-2400**

(Registrant’s Telephone Number,Including Area Code)

(Former Name, Former Address,and Former Fiscal Year,if Changed Since Last Report.)

Indicate by checkmark whether the registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes  x     No o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check one):

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o   No x

As of August 3, 2007, thenumber of shares of Class A Common Stock, $.01 par value outstanding was74,117,654, and the number of shares of Class B Common Stock, $.01 par value,outstanding was 30,670,422.

 

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**TABLE OF CONTENTS**
| **PART I**  | ** ** | **Financial Information**                                                                                                                |   |   |
|-------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|        |       |                                                                                                                                     |   |   |
| Item 1      |       | Financial  Statements (Unaudited)                                                                                                        |   |   |
|        |       | CROWN MEDIA HOLDINGS, INC. AND  SUBSIDIARIES                                                                                             |   |   |
|        |       | Condensed  Consolidated Balance Sheets – December 31, 2006 andJune 30, 2007 (Unaudited)                                             |   |   |
|        |       | Condensed  Consolidated Statements of Operations and Comprehensive Loss (Unaudited)  - Three and Six Months Ended June 30, 2006 and 2007 |   |   |
|        |       | Condensed  Consolidated Statements of Cash Flows (Unaudited)  - Six Months Ended June 30, 2006 and 2007                                  |   |   |
|        |       | Notes to  Unaudited Condensed Consolidated Financial Statements                                                                          |   |   |
|        |       |                                                                                                                                     |   |   |
| Item 2      |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                              |   |   |
|        |       |                                                                                                                                     |   |   |
| Item 3      |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                              |   |   |
|        |       |                                                                                                                                     |   |   |
| Item 4      |       | Controls and  Procedures                                                                                                                 |   |   |
|        |       |                                                                                                                                     |   |   |
| **PART II** | ** ** | **Other Information**                                                                                                                    |   |   |
|        |       |                                                                                                                                     |   |   |
| Item I      |       | Legal Proceedings                                                                                                                        |   |   |
|        |       |                                                                                                                                     |   |   |
| Item 1A     |       | Risk Factors                                                                                                                             |   |   |
|        |       |                                                                                                                                     |   |   |
| Item 4      |       | Submission of  Matters to a Vote of Security Holders                                                                                     |   |   |
|        |       |                                                                                                                                     |   |   |
| Item 6      |       | Exhibits                                                                                                                                 |   |   |
|        |       |                                                                                                                                     |   |   |
| Signatures  |       |                                                                                                                                     |

 

2

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*In this Form 10-Q theterms “Crown Media Holdings” and the “Company” refer to Crown MediaHoldings, Inc. and, unless the context requires otherwise, subsidiaries ofCrown Media Holdings that operate or have operated our businesses, Crown MediaUnited States, LLC (“Crown Media United States”), and until the completion ofthe sale of our film library in December 2006, Crown Media Distribution,LLC (“Crown Media Distribution”). The term “common stock” refers to ourClass A common stock and Class B common stock, unless the contextrequires otherwise.*

*The names Hallmark, TOTAL CHOICE and other product orservice names are trademarks or registered trademarks of their owners.*

**PART I. FINANCIAL INFORMATION**

**Item 1.  *Financial Statements (Unaudited)***

**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATEDBALANCE SHEETS**

**(In thousands, except par valueand number of shares)**
| ** **                                                                                 | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                 | ** ** | **2006**                              | ** ** | **2007**                          | ** ** |
| ASSETS                                                                                     |       |                                  |       |                              |       |
| Cash  and cash equivalents                                                                 |       | $                                     | 13,965     |                              | $          | 6,933 |   |
| Accounts  receivable, less allowance for doubtful accounts of  $246 and $191, respectively |       | 57,079                                |       | 59,390                            |       |
| Program  license fees—affiliates                                                      |       | 115                                   |       | 114                               |       |
| Program  license fees—non-affiliates                                                  |       | 111,909                               |       | 126,113                           |       |
| Receivable  from buyer of international business                                           |       | 24                                    |       | 9                                 |       |
| Prepaid  and other assets                                                                  |       | 4,202                                 |       | 6,296                             |       |
| Prepaid  program license fee assets                                                        |       | 10,271                                |       | 18,045                            |       |
| Total current assets                                                                       |       | 197,565                               |       | 216,900                           |       |
|                                                                                       |       |                                  |       |                              |       |
| Accounts  receivable                                                                       |       | 850                                   |       | 424                               |       |
| Program  license fees—affiliates                                                      |       | 274                                   |       | 217                               |       |
| Program  license fees—non-affiliates                                                  |       | 185,620                               |       | 170,041                           |       |
| Subscriber  acquisition fees, net                                                          |       | 41,665                                |       | 22,960                            |       |
| Property  and equipment, net                                                               |       | 16,313                                |       | 15,870                            |       |
| Goodwill                                                                                   |       | 314,033                               |       | 314,033                           |       |
| Prepaid  and other assets                                                                  |       | 11,463                                |       | 9,002                             |       |
| Total  assets                                                                              |       | $                                     | 767,783    |                              | $          | 749,447 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

3

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| ** **                                                                                                                                                          | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                                          | ** ** | **2006**                              | ** ** | **2007**                          | ** ** |
| LIABILITIES AND STOCKHOLDERS’  DEFICIT                                                                                                                         |       |                                  |       |                              |       |
| LIABILITIES:                                                                                                                                                        |       |                                  |       |                              |       |
| Accounts payable and accrued liabilities                                                                                                                            |       | $                                     | 26,588     |                              | $          | 29,591 |   |
| Accrued restricted stock units                                                                                                                                      |       | 1,513                                 |       | 4,241                             |       |
| Subscriber acquisition fees payable                                                                                                                                 |       | 2,071                                 |       | 1,854                             |       |
| License fees payable to affiliates                                                                                                                                  |       | 2,275                                 |       | 3,806                             |       |
| License fees payable to non-affiliates                                                                                                                              |       | 96,085                                |       | 92,111                            |       |
| Payables to RHI and related companies                                                                                                                               |       | 168                                   |       | —                            |       |
| Payables to affiliates                                                                                                                                              |       | 13,777                                |       | 15,162                            |       |
| Payable to buyer of international business                                                                                                                          |       | 5,098                                 |       | 4,929                             |       |
| Interest payable                                                                                                                                                    |       | 59                                    |       | 91                                |       |
| Capital lease obligations                                                                                                                                           |       | 672                                   |       | 705                               |       |
| Deferred credit from technical services agreement                                                                                                                   |       | 1,213                                 |       | 927                               |       |
| Total current liabilities                                                                                                                                           |       | 149,519                               |       | 153,417                           |       |
|                                                                                                                                                                |       |                                  |       |                              |       |
| Accrued liabilities                                                                                                                                                 |       | 25,291                                |       | 22,842                            |       |
| License fees payable to non-affiliates                                                                                                                              |       | 88,951                                |       | 101,737                           |       |
| Line of credit and interest payable to HC Crown                                                                                                                     |       | 93,465                                |       | 97,434                            |       |
| Line of credit and interest payable to Hallmark Cards affiliate                                                                                                     |       | 53,364                                |       | 55,605                            |       |
| Payable to buyer of international business                                                                                                                          |       | 4,771                                 |       | 2,956                             |       |
| Senior unsecured note to HC Crown, including accrued interest                                                                                                       |       | 562,167                               |       | 590,978                           |       |
| Credit facility                                                                                                                                                     |       | 87,633                                |       | 91,633                            |       |
| Note and interest payable to Hallmark Cards affiliate                                                                                                               |       | 146,397                               |       | 152,547                           |       |
| Payable to Hallmark Cards under the Tax Sharing Agreement                                                                                                           |       | —                                |       | 33,082                            |       |
| Capital lease obligations                                                                                                                                           |       | 15,498                                |       | 15,137                            |       |
| Company obligated mandatorily redeemable preferred  interest                                                                                                        |       | 16,483                                |       | 17,587                            |       |
| Deferred credit from technical services agreement                                                                                                                   |       | 3,188                                 |       | 2,498                             |       |
| Total liabilities                                                                                                                                                   |       | 1,246,727                             |       | 1,337,453                         |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                       |       |                                  |       |                              |       |
| STOCKHOLDERS’ DEFICIT:                                                                                                                                         |       |                                  |       |                              |       |
| Class A common stock, $.01 par value; 200,000,000 shares  authorized; 74,117,654 shares issued and outstanding as of December 31,  2006 and June 30, 2007 |       | 741                                   |       | 741                               |       |
| Class B common stock, $.01 par value; 120,000,000 shares  authorized; 30,670,422 shares issued and  outstanding as of December 31, 2006 and June 30, 2007 |       | 307                                   |       | 307                               |       |
| Paid-in capital                                                                                                                                                     |       | 1,457,032                             |       | 1,431,840                         |       |
| Accumulated deficit                                                                                                                                                 |       | (1,937,024                            | )          | (2,020,894                        | )          |
| Total stockholders’ deficit                                                                                                                                    |       | (478,944                              | )          | (588,006                          | )          |
| Total liabilities and stockholders’ deficit                                                                                                                    |       | $                                     | 767,783    |                              | $          | 749,447 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

4

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

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS**

**(In thousands, except per sharedata)**
| ** **                                                                                                                  | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **2006**                                        | ** ** | **2007**                                      | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenue:                                                                                                                    |       |                                            |       |                                          |       |   |   |   |   |
| Subscriber fees                                                                                                             |       | $                                               | 6,379      |                                          | $          | 6,507 |   | $ | 12,611 |   | $ | 14,002 |   |
| Advertising                                                                                                                 |       | 43,086                                          |       | 49,081                                        |       | 80,999 |   | 94,931 |   |
| Advertising by Hallmark Cards                                                                                               |       | 463                                             |       | 242                                           |       | 943 |   | 390 |   |
| Film asset license fees                                                                                                     |       | 518                                             |       | —                                        |       | 788 |   | — |   |
| Sublicense fees and other  revenue                                                                                          |       | 76                                              |       | 77                                            |       | 154 |   | 156 |   |
| Total revenue, net                                                                                                          |       | 50,522                                          |       | 55,907                                        |       | 95,495 |   | 109,479 |   |
| Cost of Services:                                                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| Programming costs                                                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| Affiliates                                                                                                                  |       | 2,846                                           |       | 4,340                                         |       | 5,502 |   | 9,902 |   |
| Non-affiliates                                                                                                              |       | 31,121                                          |       | 34,049                                        |       | 62,058 |   | 68,179 |   |
| Amortization of film assets                                                                                                 |       | 8,279                                           |       | —                                        |       | 17,143 |   | — |   |
| Impairment of film assets                                                                                                   |       | 184,886                                         |       | —                                        |       | 184,886 |   | — |   |
| Subscriber acquisition fee  amortization expense                                                                            |       | 7,723                                           |       | 7,832                                         |       | 15,513 |   | 15,680 |   |
| Amortization of capital lease  obligation                                                                                   |       | 290                                             |       | 290                                           |       | 579 |   | 579 |   |
| Other costs of services                                                                                                     |       | 3,211                                           |       | 2,312                                         |       | 7,052 |   | 5,260 |   |
| Total cost of services                                                                                                      |       | 238,356                                         |       | 48,823                                        |       | 292,733 |   | 99,600 |   |
| Selling, general and administrative expense                                                                                 |       | 12,777                                          |       | 14,057                                        |       | 21,807 |   | 28,250 |   |
| Marketing expense                                                                                                           |       | 1,111                                           |       | 4,073                                         |       | 5,368 |   | 8,285 |   |
| Depreciation and amortization expense                                                                                       |       | 803                                             |       | 396                                           |       | 1,682 |   | 893 |   |
| Gain from sale of film assets                                                                                               |       | —                                          |       | (521                                          | )          | — |   | (521 | ) |
| Loss from operations                                                                                                        |       | (202,525                                        | )          | (10,921                                       | )          | (226,095 | ) | (27,028 | ) |
| Interest income                                                                                                             |       | 812                                             |       | 356                                           |       | 1,669 |   | 744 |   |
| Interest expense                                                                                                            |       | (25,725                                         | )          | (33,097                                       | )          | (48,285 | ) | (57,586 | ) |
| Loss before discontinued  operations and cumulative effect of change in accounting principle                                |       | (227,438                                        | )          | (43,662                                       | )          | (272,711 | ) | (83,870 | ) |
| (Loss) gain from sale of discontinued operations, net of tax                                                                |       | (8                                              | )          | —                                        |       | 154 |   | — |   |
| Loss before cumulative effect  of change in accounting principle                                                            |       | (227,446                                        | )          | (43,662                                       | )          | (272,557 | ) | (83,870 | ) |
| Cumulative effect of change in accounting principle                                                                         |       | —                                          |       | —                                        |       | (2,099 | ) | — |   |
| Net loss and comprehensive  loss                                                                                            |       | $                                               | (227,446   | )                                             | $          | (43,662 | ) | $ | (274,656 | ) | $ | (83,870 | ) |
| Weighted average number of  Class A and Class B shares  outstanding, basic and diluted                            |       | 104,788                                         |       | 104,788                                       |       | 104,788 |   | 104,788 |   |
| Loss per share before discontinued  operations and cumulative  effect  of change in accounting principle, basic and diluted |       | $                                               | (2.17      | )                                             | $          | (0.42 | ) | $ | (2.60 | ) | $ | (0.80 | ) |
| (Loss) gain per share from  discontinued operations,  basic and  diluted                                                    |       | (0.00                                           | )          | —                                        |       | (0.00 | ) | — |   |
| Cumulative effect of change in  accounting principle,  basic and  diluted                                                   |       | —                                          |       | —                                        |       | (0.02 | ) | — |   |
| Net  loss per share, basic and diluted                                                                                      |       | $                                               | (2.17      | )                                             | $          | (0.42 | ) | $ | (2.62 | ) | $ | (0.80 | ) |

 

See accompanying notes tounaudited condensed consolidated financial statements.

5

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

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**
| ** **                                                                                                                                          | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                                          | ** ** | **2006**                                          | ** ** | **2007** | ** ** |
| CASH  FLOWS FROM OPERATING ACTIVITIES:                                                                                                              |       |                                              |       |   |   |
| Net loss                                                                                                                                            |       | $                                                 | (274,656   | ) | $ | (83,870 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities:                                                                        |       |                                              |       |   |   |
| Gain from sale of discontinued operations                                                                                                           |       | (154                                              | )          | — |   |
| Gain from sale of film assets                                                                                                                       |       | —                                            |       | (521 | ) |
| Impairment of film assets                                                                                                                           |       | 184,886                                           |       | — |   |
| Depreciation and amortization                                                                                                                       |       | 106,318                                           |       | 97,474 |   |
| Accretion on company obligated mandatorily redeemable preferred  interest                                                                           |       | 973                                               |       | 1,103 |   |
| Provision for allowance for doubtful accounts                                                                                                       |       | 1,271                                             |       | (13 | ) |
| Cumulative effect of change in accounting principle                                                                                                 |       | 2,099                                             |       | — |   |
| Loss on sale of property and equipment                                                                                                              |       | —                                            |       | 39 |   |
| Stock-based compensation                                                                                                                            |       | (3,810                                            | )          | 4,530 |   |
| Changes in operating assets and liabilities:                                                                                                        |       |                                              |       |   |   |
| (Increase) decrease in accounts receivable                                                                                                          |       | 9,648                                             |       | (1,872 | ) |
| Decrease in receivable from buyer of international business                                                                                         |       | 378                                               |       | 15 |   |
| Additions to program license fees                                                                                                                   |       | (49,756                                           | )          | (76,648 | ) |
| (Additions) deletions to subscriber acquisition fees                                                                                                |       | (331                                              | )          | 120 |   |
| Decrease in prepaid and other assets                                                                                                                |       | (2,969                                            | )          | (8,206 | ) |
| Decrease in accounts payable, accrued and other liabilities                                                                                         |       | (7,641                                            | )          | (893 | ) |
| Increase in interest payable                                                                                                                        |       | 35,438                                            |       | 41,203 |   |
| Decrease in subscriber acquisition fees payable                                                                                                     |       | (9,979                                            | )          | (218 | ) |
| Increase (decrease) in license fees payable to non-affiliates                                                                                       |       | (16,870                                           | )          | 8,813 |   |
| Increase in license fees payable to affiliates                                                                                                      |       | 5,398                                             |       | 1,531 |   |
| Increase in payables to affiliates                                                                                                                  |       | 1,018                                             |       | 9,276 |   |
| Increase in deferred revenues                                                                                                                       |       | 349                                               |       | — |   |
| Net cash used in operating activities                                                                                                               |       | (18,390                                           | )          | (8,137 | ) |
| CASH  FLOWS FROM INVESTING ACTIVITIES:                                                                                                              |       |                                              |       |   |   |
| Purchases of property and equipment                                                                                                                 |       | (27                                               | )          | (583 | ) |
| Payments to buyer of international business                                                                                                         |       | (6,501                                            | )          | (1,984 | ) |
| Net cash used in investing activities                                                                                                               |       | (6,528                                            | )          | (2,567 | ) |
| CASH  FLOWS FROM FINANCING ACTIVITIES:                                                                                                              |       |                                              |       |   |   |
| Proceeds from the issuance of common stock upon exercise of stock  options                                                                          |       | 114                                               |       | — |   |
| Proceeds from tax sharing agreement with Hallmark Cards                                                                                             |       | 5,000                                             |       | — |   |
| Borrowings under the credit facility                                                                                                                |       | 15,000                                            |       | 6,000 |   |
| Payments on the credit facility                                                                                                                     |       | —                                            |       | (2,000 | ) |
| Principal payments on capital lease obligations                                                                                                     |       | (299                                              | )          | (328 | ) |
| Net cash provided by financing activities                                                                                                           |       | 19,815                                            |       | 3,672 |   |
| Net decrease in cash and cash equivalents                                                                                                           |       | (5,103                                            | )          | (7,032 | ) |
| Cash  and cash equivalents, beginning of period                                                                                                     |       | 15,926                                            |       | 13,965 |   |
| Cash  and cash equivalents, end of period                                                                                                           |       | $                                                 | 10,823     |   | $ | 6,933 |   |
|                                                                                                                                                |       |                                              |       |   |   |
| Supplemental  disclosure of cash and non-cash activities:                                                                                           |       |                                              |       |   |   |
| Interest  paid                                                                                                                                      |       | $                                                 | 9,234      |   | $ | 4,494 |   |
| Income  taxes paid                                                                                                                                  |       | $                                                 | 3          |   | $ | — |   |
| Reduction of additional paid-in capital for  obligation to return amounts previously received as capital contributions  under tax sharing agreement |       | $                                                 | —     |   | $ | 25,192 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

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

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**For the Three and Six MonthsEnded June 30, 2006 and 2007**

**1. Business and Organization**

***Organization***

CrownMedia Holdings, Inc. (“Crown Media Holdings,” “Crown Media” or the “Company”),through its wholly-owned subsidiary, Crown Media United States, LLC (“CrownMedia United States”), owns and operates pay television channels (collectivelythe “Hallmark Channel” or the “Channel”) dedicated to high quality,entertainment programming for adults and families in the United States.Significant investors in Crown Media Holdings include Hallmark EntertainmentInvestments Co. (“Hallmark Entertainment Investments”), a subsidiary ofHallmark Cards, Incorporated (“Hallmark Cards”), the National Interfaith CableCoalition, Inc. (“NICC”), and, indirectly through their investments inHallmark Entertainment Investments, Liberty Media Corporation (“Liberty Media”)and J.P. Morgan Partners (BHCA), L. P. (“J.P. Morgan”).

***Liquidity***

As of June 30, 2007, theCompany had $6.9 million in cash and cash equivalents on hand. As of June 30,2007, the Company had borrowed $91.6 million from a $130.0 million revolvingbank credit facility, which matures May 31, 2008.

TheCompany’s principal sources of funds are cash on hand, cash generated byoperations and amounts available under the Company’s revolving bank creditfacility. The Company’s tax sharing agreement with Hallmark Cards haspreviously also been a source of cash. However, we do not expect to receive orpay any cash related to this agreement in the next twelve months.

As of the date of thisreport, we believe that it is reasonably possible that the Put Right describedin Note 11 below regarding shares of our Class A common stock owned by NationalInterfaith Cable Coalition, Inc. (“NICC”) will be exercisable between August30, 2007, and November 1, 2007.  In such event, we also believe that itwould be reasonably possible that NICC would exercise the Put Right upon whichwe would be required to buy all such shares (4.4 million shares as ofJune 30, 2007) at the then current market value.  NICC’s exercise ofthe Put Right would cost the Company approximately $28.8 million, based on theclosing stock price of Class A common stock on August 3, 2007, of $6.61. We likely would need to finance such a redemption using funds obtained fromoutside sources.  It is also possible that NICC and its affiliates mightsell our shares on the open market or otherwise decide not to exercise the PutRight.  Our liquidity during the remainder of 2007 and our discussions andexpectations regarding liquidity through August 15, 2008, are highlydependent upon our ability to raise capital through external sources in theevent NICC exercises the Put Right.

The Company believesthat, under the Put Right, NICC could not require us to buy approximately634,000 additional Crown shares that NICC invested in HEIC to facilitate theCompany’s participation in the tax sharing agreement.  However, if the Company negotiated aredemption of such shares, the Company would require an additional $4.2 millionof funding, based on the August 3, 2007 price.

There is no certaintythat the Put Right will be exercised.  However, the Company has commenceda preliminary analysis of funding alternatives.  Among the Company’sconsiderations is the effect, if any, that a funding alternative may have onthe Company’s ability to continue participation in the tax sharing agreementwith Hallmark Cards.  If the Company is unable to continue participationin the tax sharing agreement, the Company would not receive any benefit fromtax operating loss carryforwards until such time as the Company reports taxableincome.

TheCompany currently has $38.4 million of unused revolving credit capacity. TheCompany’s ability to borrow additional amounts under the current creditfacility is not limited or restricted as long as no covenants, representationsor warranties are violated. The Company was in compliance with these covenantsat June 30, 2007.

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The sufficiency of theexisting sources of liquidity to fund the Company’s operations is dependentupon continued growth in subscriber revenue and advertising revenue. Anydecline in the popularity of the Hallmark Channel, any significant futureadverse modifications to the Company’s distribution agreements, an economicdecline in the advertising market, an increase in program acquisition costs, anincrease in competition or other adverse operating conditions would negativelyimpact the Company’s liquidity and its ability to fund the current level ofoperations

The Company expects tocontinue making investments in programming, marketing and distribution.However, the Company’s recurring loss situation has demanded that all areas ofexpenses, including programming, marketing and distribution be closelymonitored and controlled.

The Company anticipatesthat its principal uses of funds for 2007 will continue to include the paymentof operating expenses, accounts payable and accrued expenses, license fees forprogramming, and interest under its bank credit facility.

The Company currentlybelieves that cash on hand, cash generated by operations and borrowingavailability under its bank credit facility, when combined with the deferral ofany required payments on related-party debt and related interest mentionedbelow, will be sufficient to fund the Company’s operations and meet itsliquidity needs through August 15, 2008. This statement is qualified with respect to the possible exercise of thePut Right described above.

The Company intends toextend or refinance the Bank credit facility prior to or upon its maturity. Anysuch extension or refinancing might require a continuation of a letter ofcredit from Hallmark Cards or other steps by the Company and, thus, is not assured.If the Company is not able to arrange for the extension, refinancing orreplacement of the bank credit facility prior to its maturity and either (1)the bank draws down on the irrevocable letter of credit provided by HallmarkCards in support of the bank credit facility or (2) Hallmark Cards purchasesthe interests of the lending banks, Hallmark Cards would have all obligationsand rights of the lending banks under the bank credit facility. In that event,Hallmark Cards could demand payment of outstanding amounts at any time afterAugust 15, 2008, under the terms of the waiver and standby purchase agreement (“WaiverAgreement”) described below.

Upon maturity of the credit facility on May 31, 2008,the lending group led by JP Morgan Chase has the right to elect to forego thereceipt of cash to pay the principal amount of the credit facility in full,which is provided for under the terms of an irrevocable letter of creditprovided by Hallmark Cards, and instead may elect to initiate a process to foreclose onthe Company’s assets. Such foreclosure proceedings, would adverselyaffect our ability to continue our operations. Prior to any such possibleforeclosure proceedings, however, the Company, if it has not secured anextension of the credit facility or alternative financing, would cause HallmarkCards pursuant to the terms of the Waiver Agreement to exercise its option topurchase all of the outstanding indebtedness under the credit facility and thecredit facility would then be subject to terms of the Waiver Agreement.

Due to the Company’spossible inability to meet its obligations when they come due in August 2008,the Company anticipates that prior to August 15, 2008, 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, a sale of certain assets or other strategicalternatives.

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

***Interim Financial Statements***

In the opinion of management, the accompanying condensed consolidatedbalance sheets and related interim condensed consolidated statements ofoperations and cash flows include all adjustments, consisting of normalrecurring items necessary for their fair presentation in conformity withaccounting principles generally accepted in the United States. Interim resultsare not necessarily indicative of results for a full year. Thesecondensed consolidated financial statements should be read in conjunction withthe audited consolidated financial statements and the notes to those statementsfor the year ended December 31, 2006, included in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2006.

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***Basis of Presentation***

Thecondensed consolidated financial statements include the consolidated accountsof Crown Media Holdings, including those of its wholly owned subsidiaries. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

InDecember 2006, the Company completed the sale of the domestic rights toits film library assets. The accompanying condensed consolidated statements ofoperations and cash flows do not reflect associated revenue and expenses asdiscontinued operations because the portions of advertising revenue and relatedcash collections that were derived from the Company’s use of the film libraryassets to meet programming requirements of the Channel could not be clearlydistinguished from advertising revenue and cash collections derived from theuse of programming licensed from third parties.

***Use of Estimates***

The Company’s condensedconsolidated financial statements are prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”). Theseaccounting principles require the Company to make certain estimates, judgmentsand assumptions. The Company believes that the estimates, judgments andassumptions made when accounting for items and matters such as customerretention patterns, allowance for bad debts, useful lives of assets, cash flowprojections used in various asset valuations, income taxes, reserves and otherprovisions for contingencies are reasonable, based on information available atthe time they are made. These estimates, judgments and assumptions can affectthe reported amounts of assets and liabilities as of the date of the condensedconsolidated financial statements, as well as the reported amounts of revenueand expenses during the periods presented. Actual results could differ fromthese estimates.

***Allowance for Doubtful Accounts***

Theallowance for doubtful accounts is based upon the Company’s assessment ofprobable loss related to uncollectible accounts receivable. The Company uses anumber of factors in determining the allowance, including, among other things,collection trends. The Company’s bad debt expense was $355,000 for the threemonths ended June 30, 2006.  The Company’snegative bad debt expense was $344,000 for the three months ended June 30,2007. The Company’s bad debt expense was $1.3 million for the six months endedJune 30, 2006. The Company’s negative bad debt expense was $13,000 for the sixmonths ended June 30, 2007

***Taxes on Income***

Pursuantto the tax sharing agreement entered into with Hallmark Cards inMarch 2003, the Company’s results of operations for tax purposes became apart of the Hallmark Cards consolidated federal tax return as of and subsequentto March 2003. However, the Company continues to account for income taxeson a separate return basis. Accordingly, the Company accounts for income taxesusing an asset and liability method which requires the recognition of deferredtax assets and liabilities for the expected future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases and netoperating loss and tax credit carryforwards. Deferred tax assets andliabilities are measured using enacted tax rates expected to be applied totaxable income in the years in which those temporary differences are expectedto be recovered or settled. The Company reduces deferred tax assets by avaluation allowance if it is more likely than not that some portion or all ofthe deferred tax assets will not be realized. Any payments received fromHallmark Cards under the tax sharing agreement are recorded as an increase inadditional paid-in capital. Based on thetax sharing agreement, the Company may ultimately owe Hallmark Cards for itsshare of the consolidated federal tax liability caused by the inclusion of theCompany in the consolidated group. Such payments would be treated as areduction to paid-in capital to the extent of amounts previously received underthe tax sharing agreement.

***Stock-Based Compensation***

Duringthe first quarter of fiscal 2006, we adopted the provisions of, and account forstock-based compensation in accordance with, the Financial Accounting StandardsBoard’s (“FASB”) Statement of Financial Accounting StandardsNo. 123—revised 2004 (“SFAS 123R”), *Share-Based Payment,*which replaced Statement of Financial Accounting Standards No. 123 (“SFAS123”), *Accounting for Stock-Based Compensation,*and supersedes APB 

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Opinion No. 25 (“APB25”), *Accounting for Stock Issued to Employees*.Under the fair value recognition provisions of this statement, stock-basedcompensation cost is measured at the grant date based on the fair value of theaward and is recognized as expense on a straight-line basis over the periodduring which the holder is required to provide services in exchange for theaward, i.e., usually the vesting period. We elected the modified-prospectivemethod, under which prior periods are not revised for comparative purposes. Thevaluation provisions of SFAS 123R apply to new grants and to grants that wereoutstanding as of the effective date and are subsequently modified. Estimatedcompensation for grants that were outstanding as of the effective date isrecognized over the remaining service period using the compensation costestimated for the SFAS 123 pro forma disclosures.

***Net Loss per Share***

Basicnet loss per share is computed by dividing the net loss for the period by theweighted average number of common shares outstanding during the period. Dilutednet loss per share is computed based on the weighted average number of commonshares and potentially dilutive common shares outstanding. The calculation ofdiluted net loss per share excludes potential common shares if the effect wouldbe anti-dilutive. Potential common shares consist of incremental common sharesissuable upon the exercise of stock options. Approximately 855,000, and 360,000stock options for the three and six months ended June 30, 2006 and 2007,respectively, have been excluded from the calculations of loss per sharebecause their effect would have been anti-dilutive.

***Concentration of Credit Risk***

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

***Reclassifications***

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

***Recently Issued AccountingPronouncements***

InSeptember 2006, the FASB issued SFAS No. 157, *Fair Value Measurements* (“SFAS No. 157”). SFASNo. 157 defines fair value, establishes a framework for measuring fairvalue and expands disclosures about fair value measurements. SFAS No. 157is effective for the Company as of January 1, 2008. The Company iscurrently evaluating the potential impact of adopting SFAS No. 157.

InFebruary 2007, the FASB issued SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities*,including an amendment of SFAS No. 115 (“SFAS No. 159”). SFASNo. 159 permits entities to choose, at specified election dates, tomeasure eligible items at fair value (the “fair value option”). A businessentity shall report unrealized gains and losses on items for which the fairvalue option has been elected in earnings at each subsequent reporting period.This accounting standard is effective as of the beginning of an entity’s firstfiscal year that begins after November 15, 2007. The effect, if any, ofadopting SFAS No. 159 on the Company’s financial position and results ofoperations is currently being evaluated.

**3. Film Library Impairment**

In thesecond quarter of 2006, the Company retained an investment banking firm tosolicit expressions of interest from third parties for the potential purchaseof the Company’s film library. As a result of non-binding bids received fromthird party organizations, management deemed it necessary to review its filmasset titles for impairment in the second quarter of 2006.  Management completed a valuation analysis ofthe film library as of June 30, 2006. The fair value was derived by management from taking into account thefollowing:  (1) an implied purchaseprice from third parties (including the impact of a possible retention by theCompany of residual and participation liabilities); (2) the fair value ofrights to the non-exclusive internal use of certain films by the Hallmark MovieChannel; and 

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(3) the amount ofaccounts receivable related to the film library, which were part of the assetsto be sold. The resulting non-cash impairment charge of $184.9 million isincluded in impairment of film assets on the accompanying statement ofoperations for the three and six months ended June 30, 2006.

The bids used in management’s valuation of the filmassets involve lump sum amounts with no values applied to individual films orgroups of films.  However, it wasnecessary under applicable accounting requirements to allocate the fair valueof the film library as a whole to each individual film.  Based upon the conclusion that individualfilms had retained their relative value within the film library taken as awhole, management elected to allocate the bid values on a relative sales valuebasis.  The non-cash impairment chargeswere recorded at June 30, 2006, for each film where the estimated fair valuewas less than its carrying value.

**4. Residual and Participation Liabilities**

OnDecember 15, 2006, we completed the sale of domestic rights and certaininternational ancillary rights to our library of approximately 620 televisionmovies, mini-series and series (the “Crown Library”) to RHI Entertainment LLC (“RHI”).  Included in accounts payable and accruedliabilities is $11.4 million at June 30, 2007, related to residuals andparticipations that RHI would otherwise be obligated to pay to third parties inconnection with domestic film library sales between the December 2006 sale andDecember 2016. The Company’s actual cost of this obligation will depend on theactual sales of these films by RHI but, in no event, will exceed $22.5 million.Any revisions to these estimated liabilities will be reflected as gain (loss)from the sale of the film assets and reflected in continuing operations infuture periods.

Duringthe second quarter of 2007, the Company settled a residual and participationliability related to the Company’s use of the film assets prior to the sale toRHI for $521,000 less than it had originally accrued.  Therefore, the Company recognized a gain inthis amount on the sale of its film assets during this time period.

Also,included in accounts payable and accrued liabilities as of June 30, 2007, is$4.8 million for the estimated cost of residuals and participations that thebuyer of our international business (which included the international rights toour film library) would otherwise be obligated to pay to third parties inconnection with international film library sales between the April 2005 saleand April 2015.  The Company’s actual cost of this obligation will dependon the actual internal usage or sales of these films by the buyer. Anyrevisions to these estimated liabilities will be reflected as gain (loss) fromthe sale of discontinued operations in future periods.

**5. Subscriber Acquisition Fees**

Subscriberacquisition fees are comprised of the following:
|                                      | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|
| ** **                           | ** ** | **2006**                              | ** ** | **2007**                          | ** ** |
| ** **                           | ** ** | **(In thousands)**               | ** ** |
| Subscriber acquisition fees, at cost |       | $                                     | 189,391    |                              | $          | 182,830 |   |
| Accumulated amortization             |       | (147,726                              | )          | (159,870                          | )          |
| Subscriber  acquisition fees, net    |       | $                                     | 41,665     |                              | $          | 22,960 |   |

 

*Of the net balance at June 30, 2007, the Company expects$9.8 million will be recognized as a reduction of subscriber fee revenue and$13.2 million will be recognized as subscriber acquisition fee expense infuture periods.*

As of December 31,2006, and June 30, 2007, the condensed consolidated balance sheets also reflectsubscriber acquisition fees payable of $2.1 million and $1.9 million,respectively. For the three months ended June 30, 2006 and 2007, the Companymade cash payments of $2.3 million and $39,000, respectively, relating tocurrent subscriber acquisition fee obligations. For the six months ended June 30, 2006 and 2007, the Company made cashpayments of $10.3 million and $96,000, respectively, relating to currentsubscriber acquisition fee obligations.

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**6. Program License Fees**

Programlicense fees are comprised of the following:
|                                                           | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|
| ** **                                                | ** ** | **2006**                              | ** ** | **2007**                          | ** ** |
| ** **                                                | ** ** | **(In thousands)**               | ** ** |
| Program license fees—RHI Entertainment  Distribution |       | $                                     | 212,143    |                              | $          | 220,348 |   |
| Program license fees—NICC                            |       | 197                                   |       | 197                               |       |
| Program license fees—other affiliates                |       | 368                                   |       | 368                               |       |
| Program license fees—other non-affiliates            |       | 326,552                               |       | 325,853                           |       |
| Program license fees, at cost                             |       | 539,260                               |       | 546,766                           |       |
| Accumulated amortization                                  |       | (241,342                              | )          | (250,281                          | )          |
| Program license fees, net                                 |       | $                                     | 297,918    |                              | $          | 296,485 |   |

 

Programming costs for thethree months ended June 30, 2006 and 2007, were $34.0 million and $38.4million, respectively.  Programming costsfor the six months ended June 30, 2006 and 2007, were $67.6 million and $78.1million, respectively.

At December 31,2006, and June 30, 2007, $10.3 million and $18.0 million of program licensefees were included in prepaid program license fee assets on the accompanyingcondensed consolidated balance sheets as the Company made payments for theprogram license fees prior to commencement of the license period.

Licensefees payable are comprised of the following:
|                                                           | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|
| ** **                                                | ** ** | **2006**                              | ** ** | **2007**                          | ** ** |
| ** **                                                | ** ** | **(In thousands)**               | ** ** |
| License fees payable—RHI Entertainment  Distribution |       | $                                     | 18,439     |                              | $          | 10,097 |   |
| License fees payable—NICC                            |       | 2,275                                 |       | 3,806                             |       |
| License fees payable—non-affiliates                  |       | 166,597                               |       | 183,751                           |       |
| Total license fees payable                                |       | 187,311                               |       | 197,654                           |       |
| Less current maturities                                   |       | (98,360                               | )          | (95,917                           | )          |
| Long-term license fees payable                            |       | $                                     | 88,951     |                              | $          | 101,737 |   |

 

**7. Property and Equipment**

Propertyand equipment are comprised of the following:
| ** **                        | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** | ** **                 | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|----------------------------|------------|
| ** **                        | ** ** | **2006**                              | ** ** | **2007**                          | ** ** | **Depreciable Lives** | ** ** |
| ** **                        | ** ** | **(In thousands)**               | ** ** | **(In years)**               | ** ** |
| Technical equipment and computers |       | $                                     | 15,083     |                              | $          | 8,005                      |       | 3-5 |   |
| Leased assets                     |       | 17,363                                |       | 17,363                            |       | 15                         |       |
| Furniture, fixtures and equipment |       | 1,241                                 |       | 1,287                             |       | 5                          |       |
| Leasehold improvements            |       | 2,853                                 |       | 1,681                             |       | 3-7                        |       |
| Construction-in-progress          |       | 273                                   |       | 95                                |       |                       |       |
| Property and equipment, at  cost  |       | 36,813                                |       | 28,431                            |       |                       |       |
| Accumulated depreciation          |       | (20,500                               | )          | (12,561                           | )          |                       |       |
| Property and equipment, net       |       | $                                     | 16,313     |                              | $          | 15,870                     |       |   |   |

 

Depreciationexpense related to property and equipment was $740,000 and $465,000, for thethree months ended June 30, 2006 and 2007, respectively. Depreciation expenserelated to property and equipment was $1.5 million and $987,000, for the sixmonths ended June 30, 2006 and 2007, respectively.

Softwareand other intangible assets of $1.0 million and $816,000 as ofDecember 31, 2006, and June 30, 2007, respectively, have been included inprepaid and other assets in the accompanying condensed consolidated balancesheets.

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**8. Credit Facility**

At June 30, 2007, theCompany had an amended credit agreement with a syndicate of banks, led by JPMorgan Chase Bank, under which the banks have extended to the Company a securedrevolving credit facility with availability of up to $130.0 million. At June30, 2007, the outstanding balance under the credit facility was $91.6 million,and the Company had at that date $38.4 million of unused revolving creditcapacity. The Company’s ability to borrow additional amounts under the creditfacility is not limited or restricted, so long as no covenants, representationsor warranties are violated. 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 July 27, 2007. Thefacility is guaranteed by the Company’s subsidiaries and is secured by alltangible and intangible property of Crown Media Holdings and its subsidiaries.

Each borrowing under thebank credit facility bears interest at a Eurodollar rate or an alternate baserate as the Company may request at the time of borrowing in accordance with thecredit agreement. The Eurodollar rate is based on the London interbank marketfor Eurodollars, and remains in effect for the time period of the loan rangingfrom one, two, three, six or twelve months. The alternate rate is based uponthe prime rate of JP Morgan Chase Bank, a certificate of deposit rate or theFederal Funds effective rate, which is adjusted whenever the rates change. TheCompany is required to pay a commitment fee of 0.15% per annum of thecommitted, but not outstanding, amounts under the revolving credit facility,payable in quarterly installments.

At December 31,2006, and June 30, 2007, the Company had outstanding borrowings of $87.6million and $91.6 million, respectively, under the credit facility and therewere no letters of credit outstanding. At December 31, 2006, $87.6 millionof the outstanding balance bore interest at the Eurodollar rate (6.10% atDecember 31, 2006) and $0 bore interest at the JP Morgan Chase Bank primerate. At June 30, 2007, $91.6 million of the outstanding balance bore interestat the Eurodollar rate (6.07% at June 30, 2007) and $0 bore interest at the JPMorgan Chase Bank prime rate. Interestexpense on borrowings under the credit facility for each of the three monthsended June 30, 2006 and 2007, was $3.3 million and $1.4 million,respectively.  Interest expense onborrowings under the credit facility for each of the six months ended June 30,2006 and 2007, was $6.2 million and $2.8 million, respectively.

***Covenants***

Thecredit facility, as amended, contains affirmative and negative covenants.  The Company’s Annual Report on Form 10-Kcontains a detailed description of these covenants. The Company was incompliance with these covenants at June 30, 2007.

Amendment No. 12,dated as of March 2, 2007, extended the maturity date of the revolvingcredit facility to May 31, 2008. Additionally, the amendment provided forthe Hallmark Cards letter of credit to be replaced by a JP Morgan Bank letterof credit for the $130.0 million, with an expiration date of June 10,2008.

AmendmentNo. 13, dated as of July 27, 2007, permitted the Company to issue apromissory note in favor of Hallmark Cards in the principal amount of $33.1million regarding the tax sharing agreement (the “Tax Note”).   Additional information regarding the Tax Noteis described below under Note 10 - Related Party Transactions - Tax SharingAgreement.

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

***Waiver and Standby Purchase Agreement***

Under the Waiver andStandby Purchase Agreement dated March 21, 2006, as last amended on August3, 2007, Hallmark Cards agreed to defer all payments due on any of thefollowing obligations and, except where noted, payment of interest thereonuntil August 15, 2008, or an earlier date as described below as the waivertermination date, whereupon all of these amounts become immediately due andpayable (the “Waiver Period”):

·                 Line of creditand interest payable to HC Crown, dated December 14, 2001, in the originalprincipal amount of $75.0 million, payable to HC Crown. (Total amountoutstanding at June 30, 2007, including accrued interest was $97.4 million. See*Line of Credit and Interest Payable to HC Crown*below.)

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·                 $70.0million line of credit and interest payable to Hallmark Cards affiliate arising out of the Company’s purchase of the HallmarkEntertainment film library. (Totalamount outstanding at June 30, 2007, including accrued interest was $55.6million. See *Line of Credit and Interest Payable toHallmark Cards Affiliate*below.)

·                 10.25% seniorunsecured note, dated August 5, 2003, in the initial accreted value of$400.0 million, payable to HC Crown. (Total amount outstanding at June30, 2007, including accrued interest was $591.0 million. See *Senior Unsecured Note*below.)

·                 Note and interest payable to Hallmark Cards affiliate, dated as of October 1, 2005, inthe principal amount of $132.8 million, payable to HallmarkEntertainment Holdings. (Total amount outstanding at June 30, 2007, includingaccrued interest was $152.5 million. See *Note and Interest Payableto Hallmark Cards Affiliate*below.)

·                 Notein the amount of $33.1 million payable to Hallmark Cards, dated as of July 27,2007, bearing interest at LIBOR plus 3% per annum, to return previous capitalcontributions to Hallmark Cards for changes to Hallmark Card’s previously filedtax returns pursuant to the Tax Sharing Agreement. (Total amount outstanding atJune 30, 2007, was classified as Payable to Hallmark Cards under Tax SharingAgreement in the accompanying condensed consolidated balance sheet. See *Amounts Payable to Hallmark Cards under Tax Sharing Agreement in Note10* below.)

·                 All obligationsof the Company under the bank credit facility by virtue of Hallmark Cards’deemed purchase of participations in all of the obligations under a letter ofcredit which Hallmark Cards has given in support of the facility or thepurchase by Hallmark Cards of all these obligations pursuant to the bank creditfacility.

Hallmark Cards has agreedthat it will not accelerate the maturity of any of the foregoing obligations orinitiate collection proceedings during the Waiver Period. Interest willcontinue to accrue on these obligations during the Waiver Period. The Companywill continue to pay interest on the credit facility during the Waiver Period.

The waiver terminationdate is August 15, 2008, or earlier upon occurrence of any of the followingevents:  (a) the Company fails topay any principal or interest, regardless of amount, due on any indebtedness tounrelated parties with an aggregate principal amount in excess of $5.0 millionor any other event or condition occurs that results in any such indebtednessbecoming due prior to its scheduled maturity, provided that the waiver will notterminate if the Company reduces the principal amount of such indebtedness to$5.0 million or less within five business days of a written notice oftermination from Hallmark Cards; (b) certain bankruptcy events occur;(c) the Company defaults in its payment of licensing fees under the SecondAmended and Restated Program License Agreement with RHI EntertainmentDistribution (formerly known as Hallmark Entertainment Distribution at whichtime it was a wholly-owned subsidiary of Hallmark Cards); (d) arepresentation and warranty of the Company in the Waiver Agreement is false ormisleading in any material respect; or (e) the Company fails to payinterest on the bank credit facility described above to the extent thatHallmark Cards has purchased all or a portion of the indebtedness thereunder orto perform any covenants in the Waiver Agreement.

Under the WaiverAgreement, if the lenders under the bank credit facility accelerate or seek tocollect any of the indebtedness under the bank credit facility, then theCompany may require that Hallmark Cards or its designated subsidiary exercisean option to purchase such indebtedness. All expenses and fees incurred inconnection with such a purchase would be added to the principal amount of thecredit facility obligations.

The Waiver Agreement doesnot limit any existing rights of Hallmark Cards or its affiliates to offsetamounts owed to us under the Hallmark Tax Sharing Agreement and Hallmark Cards’share of the amounts payable under the December 1, 2005, agreement withNICC (described below) against these obligations. Additionally, during theWaiver Period, Hallmark Cards is permitted to offset future tax benefits itrealizes pursuant to the Tax Sharing Agreement, first against accrued andunpaid interest and then to the unpaid principal balance of the Tax Note untilthe earlier of such time as the balance equals zero or the maturity date of theTax Note.

Pursuant to the WaiverAgreement, the Company must make prepayments on the outstanding debt from 100%of any “Excess Cash Flow” during the Waiver Period.  “Excess Cash Flow” is defined as 1) the netproceeds of any debt or equity financings or sale of assets; 2) the netcash proceeds from the incurrence by the Company of indebtedness; 3) the netcash proceeds from the sale, transfer or release by the Company of assetsoutside the ordinary course of business; and 4) if positive, the consolidated net cash flow from operations ofCrown Holdings 

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for any calendar quarter as shown in an SEC report, lesscash funds used to pay current operating expenses and to pay or establishreasonable reserves for future expenses, indebtedness payments, and capitalimprovements and replacements as determined by the Board of Directors of theCompany.

***Hallmark Letter of Credit***

Pursuant to AmendmentNo. 12 to the bank credit facility, Hallmark Cards has provided anirrevocable letter of credit issued by JP Morgan Chase Bank in the amount of$130.0 million, as credit support for our obligations under the credit facilitywith an expiration date of June 10, 2008.

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

Theaggregate maturities of related party long-term debt for each of the five yearssubsequent to June 30, 2007, are as follows:
| ** **                                                                                                                                                                     | ** ** | **Payments Due by Period** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                                                     | ** ** | **Total**                                 | ** ** | **1 year** | ** ** | **2 years** | ** ** | **3 years** | ** ** | **4 years** | ** ** | **5 years** | ** ** |
| ** **                                                                                                                                                                     | ** ** | **(In thousands)**                   | ** ** |
| Line of credit  and interest payable to HC Crown, with principal due August 15, 2008 (8.37%  Eurodollar rate at December 31, 2006 and 8.35% Eurodollar rate at June 30,  2007) |       | $                                         | 97,434     |   | $ | — |   | $ | 97,434 |   | $ | — |   | $ | — |   | $ | — |   |
| Note payable to  Hallmark Cards, with principal due July 27, 2009                                                                                                              |       | 33,082                                    |       | — |   | — |   | 33,082 |   | — |   | — |   |
| 10.25 % Senior  unsecured note to HC Crown, including accrued interest, due August 5, 2011                                                                                     |       | 590,978                                   |       | — |   | — |   | — |   | — |   | 590,978 |   |
| Note and  interest payable to Hallmark Entertainment Holdings due August 15, 2008  (8.37% Eurodollar rate at December 31, 2006 and 8.35% Eurodollar rate at June  30, 2007)    |       | 152,547                                   |       | — |   | 152,547 |   | — |   | — |   | — |   |
| Note and  interest payable to Hallmark Entertainment Holdings due August 15, 2008  (8.37% Eurodollar rate at December 31, 2006 and 8.35% Eurodollar rate at June  30, 2007)    |       | 55,605                                    |       | — |   | 55,605 |   | — |   | — |   | — |   |
|                                                                                                                                                                           |       | $                                         | 929,646    |   | $ | — |   | $ | 305,586 |   | $ | 33,082 |   | $ | — |   | $ | 590,978 |   |

 

***Interest Paid to HC Crown***

Interest expense paid toHC Crown was $1.1 million for the three months ended June 30, 2006, and$474,000 for the three months ended June 30, 2007.  Interest expense paid to HC Crown was $2.2million for the six months ended June 30, 2006, and $927,000 for the six monthsended June 30, 2007.

**10. Related Party Transactions**

***Tax Sharing Agreement***

***Overview***

On March 11, 2003,Crown Media Holdings became a member of Hallmark Cards consolidated federal taxgroup and entered into a federal tax sharing agreement with Hallmark Cards (the“tax sharing agreement”). Hallmark Cards includes Crown Media Holdings in itsconsolidated federal income tax return. Accordingly, Hallmark Cards hasbenefited from past tax losses of Crown Media Holdings and may benefit fromfuture federal tax losses, which may be generated by Crown Media Holdings.Based on the tax sharing agreement, Hallmark Cards has agreed to pay CrownMedia Holdings all of the benefits realized by Hallmark Cards as a result ofincluding Crown Media Holdings in its consolidated income tax return. Thesebenefits are estimated and paid 75% in cash or can be netted against theamounts payable under the Note Payable to Hallmark Cards on a quarterly basisand the balance when Crown Media Holdings becomes a federal taxpayer. Under thetax sharing agreement, at Hallmark 

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Cards’option, this 25% balance may also be applied as an offset against any amountsowed by Crown Media Holdings to any member of the Hallmark Cards consolidatedgroup under any loan, line of credit or other payable, subject to limitationsunder any loan indentures or contracts restricting such offsets.

The Company did notreceive any amounts under the tax sharing agreement during the three monthsended June 30, 2006 and 2007. The Company received $5.0 million and $0 underthe Tax Sharing Agreement during and the six months ended June 30, 2006 and2007, 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 condensed consolidated balancesheets.

*AmountsPayable to Hallmark Cards under Tax Sharing Agreement*

TheInternal Revenue Service has examined Hallmark Cards’ consolidated tax returnsfiled for fiscal years 2003 and 2004 andhas determined that, with respect to a portion of the losses attributable tothe Company for fiscal years 2003 and 2004, Hallmark Cards should not havecarried back such losses to its consolidated federal tax returns filed forfiscal years 2001 and 2002.  These lossesare now available as carry-forwards in the consolidated federal tax returnbeginning in 2005 and later years.  Furthermore, the examination changed the amount of foreign tax creditsthat had previously been conveyed to the Company under the Tax SharingAgreement. Because the Company’s share of the tax benefits realized from suchlosses and credits ($25.2 million) were either contributed to the Company incash or applied as an offset against amounts owed by the Company to othermembers of the consolidated group, the Company is now obligated to return thisamount to Hallmark Cards plus interest related thereto in the amount of $7.9million.  As a result, the Companyrecorded $25.2 million as a distribution of capital and a payable to HallmarkCards in the accompanying condensed consolidated balance sheets. In addition,the Company recorded $7.9 million as an addition to interest expense in theaccompanying condensed consolidated statements of operations for the three andsix months ended June 30, 2007.

OnJuly 27, 2007, the Company executed a $33.1 million promissory note payable toHallmark Cards due in July 2009, bearing interest at LIBOR plus 3% per annum(the “Note”).  The Note may be prepaid inwhole or in part with no penalty.  TheCompany is not required to make any cash payments prior to maturity. HallmarkCards will offset any future tax benefits it realizes pursuant to the TaxSharing Agreement, first against accrued and unpaid interest and then againstthe unpaid principal balance.

TheNote and any payment thereunder are subordinated to the bank credit facilityextended to the Company by JP Morgan Chase Bank.

*Accounting for Uncertainty in Income Taxes*

TheCompany adopted Financial Accounting Standards Board (“FASB”) InterpretationNo. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), on January 1,2007. FIN 48 requires a new evaluation process for all tax positions taken. Ifthe probability for sustaining a tax position is greater than 50%, then the taxposition is warranted and recognition should be at the highest amount which wouldbe expected to be realized upon ultimate settlement. As of the date of adoptionof FIN 48, the total amount of unrecognized tax benefits for uncertain taxpositions was $0. As a result of the implementation of FIN 48, the Companyrecognized no increase or decrease in the amount of unrecognized tax benefitsfor uncertain tax positions.

TheCompany recognizes interest and penalties related to uncertain tax positions inincome tax expense.  As of the date ofadoption and on June 30, 2007, we have no accrued interest related to uncertaintax positions.

Byvirtue of its inclusion in Hallmark Cards consolidated tax returns, the Companyis subject to examination by the Internal Revenue Service for periodssubsequent to March 10, 2003. Further, net operating loss carryforwards (“NOL’s”)are subject to examination in the year they are utilized regardless of whether thetax year in which they were generated has been closed by statute.  The amount subject to disallowance is limitedto the NOL utilized.  

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Accordingly, the Company is subject to examination forNOL’s generated prior to March 11, 2003 if and when such NOL’s are utilized infuture tax returns.

TheCompany files state tax returns in major jurisdictions such as California, Coloradoand New York, and has also been included in the combined state tax returns ofHallmark or Hallmark Entertainment Holdings, Inc. The state returns aregenerally subject to examination for years after 2001.

***Services Agreement with HallmarkCards***

Foreach of the three months ended June 30, 2006 and 2007, Crown Media Holdings hadaccrued $133,000 and $137,000, respectively, under the intercompany servicesagreement with Hallmark Cards. For each of the six months ended June 30, 2006and 2007, Crown Media Holdings had accrued $265,000 and $273,000, respectively,under the agreement. At December 31, 2006, and June 30, 2007, non-interestbearing unpaid accrued service fees and unreimbursed expenses of $11.5 millionand $12.8 million, respectively, were included in payable to affiliates in theaccompanying condensed consolidated balance sheets. At December 31, 2006,and June 30, 2007, out-of-pocket expenses and third party fees were $914,000and $976,000, respectively.

**11. Company Obligated Mandatorily Redeemable Preferred Interest andNICC License Agreements**

VISN (a subsidiary ofNICC) owns a $25.0 million company obligated mandatorily redeemable preferredinterest in Crown Media United States (the “preferred interest”) issued inconnection with an investment by the Company in Crown Media United States. OnNovember 13, 1998, the Company, Vision Group, VISN and Henson CableNetworks, Inc. signed an amended and restated agreement governing theoperation of Crown Media United States, as amended at various times throughDecember 1, 2005 (the “company agreement”).

In the event there is achange of control of Crown Media Holdings prior to the expiration of theDecember 1, 2005, agreement (i.e., December 31, 2007), NICC willimmediately receive a $15.0 million “termination payment,” any remaining portionsof the payments for the non-dramatic specials and the “made for television”movie development and the deferred payments. The Hallmark Channel will beobligated to continue to broadcast and pay for the Sunday “New Morning withNaomi Judd” and weekday “New Morning” series and the Sunday morning programmingblock for an additional six months following the change in control, after whichall funding and broadcast obligations to NICC will cease. Also, under existingobligations, Crown Media Holdings would be required to redeem the $25.0 millionpreferred interest of NICC in Crown Media United States, LLC, for that amountplus accrued interest at LIBOR from November 27, 2005.

If there has not been achange of control of the Company, then on or about June 30, 2007 theCompany is required to commence negotiations with NICC for a period of 60 daysregarding continuation of the programming commitments. If at the end of thenegotiating period the parties have not reached agreement and the Company isnot willing to continue the programming commitments at the same levels, NICCmay exercise the Put Right by written notice given no later thanNovember 1, 2007.  The Company wouldthen be compelled to buy all of the shares of the Company’s Class A commonstock owned by NICC at a price per share that reflects the average of pricesfor a period that encompasses the 15 days before and the 15 days after the dateof notice.

If at any time NICC hassold more than 50% of the shares of the Company’s Class A common stock which itowned as of February 22, 2001, except as part of a sale or merger of theCompany, substantially all of the Company’s programming commitments andobligations will cease, at the option of Crown Media United States, at the endof the then current broadcast season (approximately August 31).  The Put Right would continue subject to thetime constraints described above.  As ofthe date of this memorandum, NICC’s ownership remains above the 50% level.

The Company has been innegotiations with NICC regarding the continuation of the programmingcommitments. In the event a new agreement is not reached or other resolution isnot reached and NICC seeks to exercise its Put Right, the Company will endeavorto finance the purchase of the NICC stock through outside sources rather thanfrom funds from operations.

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Duringthe three months ended June 30, 2006, and 2007, Crown Media United States paidNICC $3.9 million and $4.0 million, respectively, related to the companyagreement as amended. During the six months ended June 30, 2006, and 2007,Crown Media United States paid NICC $11.3 million and $11.3 million,respectively, related to the company agreement as amended.

**12.  RHI Entertainment**

OnJanuary 12, 2006, Hallmark Cards sold the equity interests in HallmarkEntertainment, LLC, and, thus indirectly, Hallmark Entertainment Distributionto the management of Hallmark Entertainment, LLC and affiliates ofKelso & Company. Since 1995, Hallmark Entertainment Distribution hadbeen a subsidiary of Hallmark Entertainment, LLC, which in turn was awholly-owned subsidiary of Hallmark Cards. Following Hallmark Cards sale of the companies, Hallmark Entertainment,LLC and Hallmark Entertainment Distribution were renamed RHI Entertainment, LLCand RHI Entertainment Distribution, LLC, respectively.

Untilthe December 15, 2006 sale of the film library assets, Crown MediaHoldings had agreements with RHI Entertainment Distribution (or HallmarkEntertainment Distribution) for services in connection with the operation ofthe film library assets and the licensing of programming produced ordistributed by RHI Entertainment Distribution. Crown Media Holdings continuesto license programming from RHI Entertainment Distribution.

***ProgramLicense Agreements with RHI Entertainment Distribution***

Crown Media United States has licensed programming fordistribution in the United States from Hallmark Entertainment Distribution, nowRHI Entertainment Distribution, since 1998. It currently licenses thisprogramming under a Second Amended and Restated Program LicenseAgreement dated as of January 1, 2005 (“Second Restated Agreement”). ThisSecond Restated Agreement expires on December 31, 2008.

Underboth the current and previous agreements with RHI Entertainment Distribution,if Crown Media United States sub-licenses any licensed program to a third party,it must equally share with RHI Entertainment Distribution the excess, if any,of the sublicensing fee over the initial program license fee paid by the CrownMedia United States. Crown Media United States did not sub-license any licensedprogram to a third party during either of the three months ended June 30, 2006or 2007. Crown Media United States did not sub-license any licensed program toa third party during either of the six months ended June 30, 2006 or 2007. 

Programmingcosts related to the RHI Entertainment Distribution program agreements were$10.7 million and $15.2 million for the three months ended June 30, 2006, and2007, respectively. Programming costs related to the RHI EntertainmentDistribution program agreements were $20.5 million and $30.0 million for thesix months ended June 30, 2006, and 2007, respectively. As of December 31,2006, and June 30, 2007, $18.4 million and $10.1 million, respectively, areincluded in license fees payable to non-affiliates in the accompanying condensedconsolidated balance sheets. Crown Media Holdings paid RHI EntertainmentDistribution $12.7 million and $8.5 million for license fees during the threemonths ended June 30, 2006 and 2007, respectively. Crown Media Holdings paidRHI Entertainment Distribution $20.1 million and $29.6 million for license feesduring the six months ended June 30, 2006 and 2007, respectively.

**13. Share-Based Compensation**

Crown Media Holdings has one stock option plan, theAmended and Restated Crown Media Holdings, Inc. 2000 Long Term IncentivePlan (the “Plan”). The Plan covers three types of share-based compensation:Stock Options, Restricted Stock Units (“RSU”) and Share Appreciation Rights (“SAR”)that are subject to SFAS 123R. Compensation cost for stock options issued toemployees represented the excess of the quoted market price of the Company’sstock at the measurement date of the grant over the exercise price of theoption.

***Stock-Based Compensation***

Wecurrently use the Black-Scholes option pricing model to determine the fairvalue of stock options. The determination of the fair value of stock-basedpayment awards on the date of grant using an option-pricing model is affectedby our stock price as well as assumptions regarding a number of complex andsubjective variables. These 

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variables include our expected stock price volatilityover the term of the awards, actual and projected employee stock optionexercise behaviors, risk-free interest rate and expected dividends.

TheCompany recorded a $1.9 million compensation credit related to restricted stockunits and $3,000 compensation expense related to stock options for the threemonths ended June 30, 2006, on our condensed consolidated statement ofoperations as a component of selling, general and administrative expense. TheCompany recorded a $3.8 million compensation credit related to restricted stockunits and $10,000 compensation expense related to stock options for the sixmonths ended June 30, 2006, on our condensed consolidated statement ofoperations as a component of selling, general and administrative expense.  

TheCompany recorded $2.1 million compensation expense related to restricted stockunits for the three months ended June 30, 2007, on our condensed consolidatedstatement of operations as a component of selling, general and administrativeexpense. The Company recorded $3.5 million compensation expense related torestricted stock units for the six months ended June 30, 2007, on our condensedconsolidated statement of operations as a component of selling, general andadministrative expense.  

As ofJune 30, 2007, there was no unrecognized compensation cost, adjusted forestimated forfeitures, related to non-vested stock options granted to ouremployees. Total unrecognized compensation cost will be adjusted for future changesin estimated forfeitures.

***Stock Option Information***

A summary of the status of Crown Media Holdings, Inc.Stock Option Plan at June 30, 2007, and changes during the period then ended ispresented below:
| ** **                      | ** ** | **Shares**              | ** ** | **Exercise  Price  Per Option** | ** ** | **Weighted-   Average  Exercise  Price  Per Option** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------|------------|-------------------------|------------|--------------------------------------|------------|----------------------------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| ** **                      | ** ** | **(in thousands)** | ** ** | ** **                           | ** ** | ** **                                                     | ** ** | ** **                                           | ** ** | ** **                      | ** ** |
| Balance, December 31, 2006 |       | 810                     |       |                                 |       | $                                                              | 10.24      |                                                 | 2.09       |                            | $          | 0.00 |   |
| Options forfeited               |       | (450                    | )          | $                                    | 9.10       |                                                           | $          | 9.10                                                 |       |                            |       |   |   |
| Balance, June 30, 2007          |       | 360                     |       |                                 |       | $                                                              | 11.67      |                                                 | 3.96       |                            | $          | 0.00 |   |
| Exercisable                     |       | 360                     |       |                                 |       | $                                                              | 11.67      |                                                 | 3.96       |                            | $          | 0.00 |   |
|                                 |            |                         |            |                                      |            |                                                                |            |                                                      |            |                                 |            |  |  |  |

 
| ** **                                                       | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                                | ** ** |
|------------------------------------------------------------------|------------|------------------------------|------------|-------------------------------------------------------------|------------|
| **Range of Exercise Prices Per Option** | ** ** | **Shares  Outstanding**      | ** ** | **Weighted Average  Remaining  Contractual Life** | ** ** | **Weighted Average  Exercise Price  Per Option** | ** ** | **Exercisable  Shares** | ** ** | **Weighted Average  Exercise Price  Per Option** | ** ** |
| ** **                                                       | ** ** | **(In thousands)**      | ** ** | **(In years)**                                         | ** ** | ** ** | ** ** | **(In thousands)** | ** ** | ** ** | ** ** |
| $ 6.30 - 10.50                                    |       | 67                           |       | 2.5                                                         |       | $ | 9.09 |   | 67 |   | $ | 9.09 |   |
| $10.51 - 12.60                                         |       | 235                          |       | 4.5                                                         |       | $ | 11.47 |   | 235 |   | $ | 11.47 |   |
| $12.61 - 14.70                                         |       | 24                           |       | 2.8                                                         |       | $ | 14.00 |   | 24 |   | $ | 14.00 |   |
| $14.71 - 21.00                                         |       | 34                           |       | 3.7                                                         |       | $ | 16.52 |   | 34 |   | $ | 16.52 |   |
|                                                             |       | 360                          |       |                                                        |       |   |   | 360 |   |   |   |

 

***Restricted Stock Unit Information***

TheCompany’s RSUs are settled in either common stock or cash as determined by theCompany’s Board of Directors. The Company has historically settled the RSUs incash, and considering such past practices, has classified its RSUs as liabilityawards for accounting purposes.

In January 2006, the Companysettled vested Employment RSUs to one executive for approximately $4.4 million.In June 2006, the Company settled vested 2003 and 2004 EmploymentRSUs for approximately $1.5 million in cash. In June 2006, the Company settled vested 2003and 2004 Board of Director RSUs for approximately $80,000 in cash. InAugust 2006, the Company settled vested 2005 Employment RSUs forapproximately $442,000 in cash. The Company settled the CEO’s RSUs for $203,000in November 2005, $165,000 in February 2006 and 

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$76,000 in May 2006. The CEO’s Performance RSUslapsed without vesting. In August 2006, the Company settled vested 2005 Boardof Director RSUs for approximately $34,000 in cash. Additionally, inAugust 2006, one executive retired, and the Company settled vestedEmployment RSUs for approximately $16,000 in cash. In June 2007, the Companysettled vested 2004 Employment RSUs for approximately $704,000 in cash.  It also settled vested 2004 Board of DirectorRSUs for approximately $29,000 in cash.

UnderSFAS 123R, the fair value of the 2004 and 2005 Employment RSU grants areestimated using a Black-Scholes option pricing model. The fair value of the2004 and 2005 Performance RSU grants are estimated at each reporting date usinga Monte Carlo Lattice option pricing model. The Company applies a forfeiturerate to the RSUs as required by SFAS No. 123R.
|                                           | ** ** | ** ** | ** ** | **Weighted-  Average  Remaining** | ** ** |
|-------------------------------------------|------------|------------|------------|-----------------------------------|------------|
| **Employment RSUs**                  | ** ** | **Units**  | ** ** | **Contractual Term**         | ** ** |
| Nonvested Balance, December 31, 2006 |       | 814,967    |       | 2.27                              |       |
| Units settled in cash                     |       | (105,000   | )          |                              |       |
| Nonvested Balance, June 30, 2007          |       | 709,967    |       | 2.04                              |       |

 

The closing price of a share of our common stock was$4.12 on June 30, 2006, and was $3.63 on December 31, 2006. The closingprice of a share of our common stock was $7.20 on June 30, 2007.
|                                           | ** ** | ** ** | ** ** | **Weighted-  Average  Remaining** | ** ** |
|-------------------------------------------|------------|------------|------------|-----------------------------------|------------|
| **Performance RSUs**                 | ** ** | **Units**  | ** ** | **Contractual Term**         | ** ** |
| Nonvested Balance, December 31, 2006 |       | 1,304,700  |       | 1.25                              |       |
| Units forfeited                           |       | (135,000   | )          |                              |       |
| Nonvested Balance, June 30, 2007          |       | 1,169,700  |       | 0.86                              |       |

 

At December 31, 2006, the 2004 Performance RSUswere valued at $0.00 per unit and the 2005 Performance RSUs were valued at$0.12 per unit. At June 30, 2007, the 2005 Performance RSUs were valued at$1.32 per unit. The 2004 Performance RSUs expired in May 2007. The chiefexecutive officer Performance grant expired in May 2006. Valuation of thesePerformance RSU grants is based upon market conditions. 

The following table includes assumptions used to valuethe Performance RSUs at December 31, 2006.
|                          | ** ** | **2004 Grant** | ** ** | **2005 Grant** | ** ** |
|--------------------------|------------|---------------------|------------|---------------------|------------|
| Expected volatility      |       | 40.80               | %          | 47.20               | %          |
| Expected dividends       |       | 0                   |       | 0                   |       |
| Expected Term (in years) |       | 0.41                |       | 1.63                |       |
| Risk-free rate           |       | 5.09                | %          | 4.82                | %          |

 

The following table includes assumptions used to valuethe Performance RSUs at June 30, 2007.
|                          | ** ** | **2005 Grant** | ** ** |
|--------------------------|------------|---------------------|------------|
| Expected volatility      |       | 48.94               | %          |
| Expected dividends       |       | 0                   |       |
| Expected Term (in years) |       | 1.13                |       |
| Risk-free rate           |       | 4.91                | %          |

 

UnderSFAS 123R, the fair value at December 31, 2006, of each 2006 Employment andPerformance RSU grant is estimated at $3.63 based upon the closing price of a share of our common stock asof the December 31, 2006, reporting date. Under SFAS 123R, the fairvalue at June 30, 2007, of each 2006 Employment and Performance RSU grant isestimated at $7.20 based upon the closingprice of a share of our common stock as of the June 30, 2007, reporting date.Valuation of the 2006 Employment RSUs is based solely on a service condition.Valuation of the 2006 Performance RSUs is based upon a service condition and aperformance condition.

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|                                            | ** ** | ** ** | ** ** | **Weighted-  Average  Remaining** | ** ** |
|--------------------------------------------|------------|------------|------------|-----------------------------------|------------|
| **Board of Directors RSUs** | ** ** | **Units**  | ** ** | **Contractual Term**         | ** ** |
| Nonvested Balance, December 31, 2006  |       | 81,150     |       | 2.32                              |       |
| Units settled in cash                      |       | (4,420     | )          |                              |       |
| Nonvested Balance, June 30, 2007           |       | 76,730     |       | 1.94                              |       |

 

***Chief Executive Officer (“CEO”) Share AppreciationRights Agreement***

Thefair value of the CEO’s SAR grant under an agreement dated October 3, 2006, isestimated at each reporting date using a Monte Carlo Lattice option pricingmodel. At December 31, 2006, the CEO’sSARs were valued at $872,616 using the closing price of a share of our commonstock on December 31, 2006, of $3.63. At June 30, 2007, the CEO’s SARswere valued at $4.5 million using the closing price of a share of our commonstock on June 30, 2007, of $7.20. Valuation of this SAR grant is based uponmarket and service conditions. The Company recorded $59,000 incompensation expense related to SARs for the year ended December 31, 2006,on our condensed consolidated statement of operations as a component ofselling, general and administrative expense. The Company recorded $832,000 incompensation expense related to SARs for the three months ended June 30, 2007,on our condensed consolidated statement of operations as a component ofselling, general and administrative expense. The Company recorded $1.1 millionin compensation expense related to SARs for the six months ended June 30, 2007,on our condensed consolidated statement of operations as a component ofselling, general and administrative expense. The SARs have been recorded inaccounts payable and accrued liabilities in the accompanying condensedconsolidated balance sheets for the year ended December 31, 2006, and thesix months ended June 30, 2007.

The following table includes assumptions used to valuethe SARs at December 31, 2006.
| Expected volatility            |   | 46.91   | %      |
|--------------------------------|--------|---------|--------|
| Expected dividends             |   | 0       |   |
| Expected Term (in years)       |   | 3.56    |   |
| Risk-free rate                 |   | 4.72    | %      |
| Average Number of SARs granted |   | 240,390 |   |

 

The following table includesassumptions used to value the SARs at June 30, 2007.
| Expected volatility            |   | 43.40   | %      |
|--------------------------------|--------|---------|--------|
| Expected dividends             |   | 0       |   |
| Expected Term (in years)       |   | 2.97    |   |
| Risk-free rate                 |   | 4.89    | %      |
| Average Number of SARs granted |   | 631,622 |   |

 

**14. Employee Benefits**

***DeferredCompensation Plans***

TheCompany sponsors a deferred compensation plan for its management. Participantsin this plan earn interest on their deferred compensation. Related liabilitiesof $3.3 million and $2.4 million at December 31, 2006, and June 30, 2007,respectively, are included in the accompanying condensed consolidated balancesheets among short and long-term accrued liabilities. The Company suspendedthis plan for 2006, and no deferral of employee compensation earned was allowedin 2006. The Company continued to pay interest on amounts deferred in previousyears and paid out these amounts in accordance with the terms of the plan. TheCompany reactivated the plan in 2007.

TheCompany also sponsors a deferred compensation plan for its Board of Directors.Participants in this plan earn interest on their deferred compensation. Relatedliabilities of $589,000 and $299,000 at December 31, 2006, and June 30,2007, respectively, are included in the accompanying condensed consolidatedbalance sheets among 

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short and long-term accrued liabilities. The Companysuspended this plan for 2006, and no deferral of director compensation earnedwas allowed in 2006. The Company continued to pay interest on amounts deferredin previous years and paid out these amounts in accordance with the terms ofthe plan. The Company reactivated this plan in 2007.

**15. Customer and Segment Information**

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

Five of our distributors each accounted for more than10% of our consolidated subscriber revenue for both the three months ended June30, 2006 and 2007, and together accounted for a total of 90% and 91% ofconsolidated subscriber revenue for those periods, respectively.  Three and four of our distributors each accountedfor more than 15% of our subscribers for the three months ended June 30, 2006and 2007, and together accounted for 61% and 77% of our subscribers on thosedates, respectively. 

Five of our distributors each accounted for more than10% of our consolidated subscriber revenue for both the six months ended June30, 2006 and 2007, and together accounted for a total of 90% and 92% ofconsolidated subscriber revenue for those periods, respectively.  Three and four of our distributors eachaccounted for more than 15% of our subscribers for the six months ended June30, 2006 and 2007, and together accounted for 61% and 77% of our subscribers onthose dates, respectively.

**16. Commitments and Contingencies**

In the normal course of business, the Company hasentered into agreements that commit it to make cash payments in future periodswith respect to non-cancelable leases 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. The Company recorded an accrual related to this claim during theyear ended December 31, 2006, which is included in accounts payable and accruedliabilities in the accompanying condensed consolidated balance sheets. TheCompany estimated that it may be liable within the range of $500,000 to $1.0million related to these claims at both December 31, 2006, and June 30, 2007.****

On July 27, 2007, a lawsuit was brought against CrownMedia Holdings, Inc. and our former Chief Financial Officer, William Aliber, inthe 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 April13, 2006 and to have sold those shares in April 2006 and in August 2006.  The plaintiff alleges that he relied to hisdetriment on allegedly false and misleading statements by the defendantsregarding the possible sale of Crown Media Holdings.  We announced a possible sale in August 2005;in April 2006 we announced the termination of an extensive review of strategicalternatives including a possible sale. Plaintiff alleges claims under Section 10(b) of the Securities ExchangeAct (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.  We are reviewing theallegations and have submitted the claims to an insurer under an insurancepolicy.  We expect that we willvigorously defend ourselves against these claims.

**17. Subsequent Events**

On July 27, 2007, the Company issued a promissory notein favor of Hallmark Cards in the principal amount of $33.1 million.  Because payment under the note is notrequired until July 2009, the related payable to Hallmark Cards has beenclassified as non-current in the accompanying balance sheet as of June 30,2007.  Additional information regarding this Tax Note is described above underNote 10 - Related Party Transactions - Tax Sharing Agreement.

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On August 1, 2007, Hallmark Licensing, Inc. extendedthe trademark agreements to September 1, 2008. Such trademark agreements allow Crown Media United States to name itsnetwork services “Hallmark Channel” and “Hallmark Movie Channel.” 

In consideration for Hallmark Cards to executeAmendment No. 4 to the Waiver Agreement, on July 27, 2007, the Company executedCopyright Security Agreement and Security and Pledge Agreement for the benefitof Hallmark Cards.  Under the agreements,the Company and its subsidiaries grant security interests to Hallmark Cards inany copyright license and program license agreements and all other personalproperty. 

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**ITEM 2.  *Management’s Discussion and Analysis of FinancialCondition and Results of Operations***

The following discussion andanalysis of the Company’s financial condition and results of operations shouldbe read in conjunction with “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” in the Company’s Annual Report on Form10-K for the year ended December 31, 2006.

**Description of Business and Overview**

*Current Business*

Crown Media Holdings, Inc. (“Crown Media Holdings,”“Crown Media” or the “Company”), through its subsidiary, owns and operates paytelevision channels (collectively the “Hallmark Channel,” the “Hallmark MovieChannel,” the “channel” or collectively the “channels”) dedicated tohigh-quality entertainment programming for adults and families, in the UnitedStates.

With82.6 million subscribers (as provided by Nielsen Research) in the United Statesat June 30, 2007, the Hallmark Channel is the 38th most widely distributed advertising-supportedcable channel in the United States. For the second quarter of 2007, theHallmark Channel finished the quarter as the 11th highest rated advertising-supported cablechannel for total day ratings and the11th highest rated advertising-supported cablechannel in prime time as measured by Nielsen Research.

TheHallmark Movie Channel focuses on movies and mini-series. It will generateadvertising revenue in 2007, and as distribution continues to expand, thefinancial contribution of the Hallmark Movie Channel may grow. The HallmarkMovie Channel is operated through Crown Media Holdings existing infrastructureat a small incremental cost, which has and will continue to increase since thesale of our domestic film library, and we have and will continue to acquiremore third-party programming for the Hallmark Movie Channel.

*Current Challenges*

TheHallmark Channel faces numerous operating challenges. Among them aremaintaining and expanding the distribution of the channels, broadeningviewership demographics and improving viewership ratings, and increasingadvertising sales revenue. 

Distributionagreements are important because they affect our number of subscribers, whichin turn has a major impact on our subscriber fees, the number of personsviewing our programming, and the rates charged for advertising. The current andlong-term distribution challenges are renewing our distribution arrangementswith the multiple system operators as they expire. Our majordistribution agreements have terms which expire at various times throughMarch 2012. Agreements which provide approximately two-thirds of oursubscriber base at June 30, 2007, will expire and be the subject of renewalnegotiations on or prior to December 31, 2007.****Whilethe economics of the renewals and potential cash incentive payments are unknownand could have a significant impact on our business, we believe that the ratingssuccess of the Hallmark Channel and the positive family-friendly environment wehave created with our programming schedule will assist us in our renewaldiscussions. Any renewals of these distribution agreements may also besignificant as to whether we are able to maintain or increase our subscriberfees. Since January 1, 2007, the Company has renewed its agreements with three majordistributors, accounting for 24% of our subscriber base at June 30,2007.  One of those renewal agreementswas a multi-year agreement in March 2007 with EchoStar CommunicationCorporation that provided for a repositioning of the Hallmark Channel on theDISH Network, resulting in an addition of approximately 6.4 million Nielsensubscribers in May 2007, and for carrying the Hallmark Movie Channel on apackage of the DISH Network, increasing distribution of that Channel by morethan 4.0 million subscribers. Also as previously announced, the Company executed in May2007, a multi-year renewal of its distribution agreement with the NationalCable Television Cooperative (“NCTC”). Under the terms of the renewal, theCompany will continue to be available to NCTC’s 1,100 member companies. 

Ouragreements with major distributors contain “most favored nations” clauses.  These clauses typically provide that, in theevent we enter into an agreement with another distributor on more favorableterms, these terms must be offered to the distributor, subject to variousexceptions and conditions.  These clausescover matters such as 

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subscriberfees, launch support, local advertising time and other financial and operatingprovisions.  We take these provisionsinto account when renewing agreements.

Domestictelephone companies are entering the business of distributing televisionchannels to households through their wire-lines. We have reached agreementswith several telephone companies and cooperatives of telephone companies, whichpermit the carriage of the Hallmark Channel and the Hallmark Movie Channel, andare negotiating with others. We expect that subscribers to these telephoneservices will in large part be customers previously served by cable andsatellite television companies, which continue to carry our programming. Todate, subscribers and revenues through telephone companies have not been significant.

Theuniverse of cable TV subscribers in the United States is approximately 100million homes.  The top 30 cable TVnetworks in the United States have at or above 90 million subscribers.  Our goal is to reach 90 million subscribersin the next one to two years.  

Threefactors have contributed to the ratings of the Hallmark Channel: acquiredseries and movies, original productions and marketing. Certain acquired serieshave consistently delivered strong ratings across all day-parts. Originalproductions are our most high profile programs and generate the channel’shighest ratings. Original productions are significant in helping ourdistribution and advertising sales teams sell the channel. Substantially all ofour original programming has in the past been provided by RHI Entertainment,but we are now acquiring some of this programming from other producers. TheCompany typically incurs additional marketing expenses surrounding originalproductions and certain acquired movies.

Wesold approximately 50% of our inventory for advertising on our Channels in theupfront market (generally sales in June, July and August for the lastquarter of 2007 and the first three quarters of 2008), compared to 46%  sold in the 2006 upfront market. We were ableto achieve significant increases in our CPMs in the 2007 upfront marketcompared to the 2006 upfront market. The balance of advertising inventory hasbeen made available in the scatter market, which in the past and in the firsttwo quarters of 2007 has yielded higher advertising rates than the upfrontmarket. 

**Critical Accounting Policies, Judgmentsand Estimates**

The preparation of consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States requires Crown Media Holdings to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during the reportingperiod. Actual results could differ from those estimates.

TheCompany believes that the estimates, judgments and assumptions made whenaccounting for items and matters such as customer retention patterns, allowancefor bad debts, useful lives of assets, cash flow projections used in variousasset valuations, income taxes, reserves and other provisions for contingenciesare reasonable, based on information available at the time they are made. Theseestimates, judgments and assumptions can affect the reported amounts of assetsand liabilities as of the date of the condensed consolidated financialstatements, as well as the reported amounts of revenue and expenses during theperiods presented. Actual results could differ from these estimates.

For further informationregarding our critical accounting policies, judgments and estimates, please seethe Notes to Unaudited Condensed Consolidated Financial Statements contained inItem 1 of this Report and “Critical Accounting Policies, Judgments andEstimates” in Item 7 of the Company’s Annual Report on Form 10-K for the yearended December 31, 2006, as filed with the SEC. These policies, judgments andestimates concern, among other things, allowance for doubtful accounts, programlicense fees, subscriber acquisition fees, long-lived assets, residual andparticipation liabilities, revenue recognition and stock-based compensation.

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

In 2007 and in prior years, weentered into a number of significant transactions with Hallmark Cards and itssubsidiaries. These transactions include, among other things, programming,trademark licenses, administrative services, a line of credit, a tax sharingagreement, the issuance of five promissory notes and a Waiver Agreement.For 

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information regarding such transactions and transactions with otherrelated parties, please see “Effects of Transactions with Related and CertainOther Parties” in Item 7 of the Company’s Annual Report on Form 10-K for theyear ended December 31, 2006, filed with the SEC and Notes 8, 9, 10 and11 of Notes to Unaudited Condensed Consolidated Financial Statements containedin Item 1 of this Report. 

On August 1, 2007, Hallmark Licensing, Inc. extendedthe trademark agreements to September 1, 2008. Such trademark agreements allow Crown Media United States to name itsnetwork services “Hallmark Channel” and “Hallmark Movie Channel.” 

In consideration for Hallmark Cards to executeAmendment No. 4 to the Waiver Agreement, on July 27, 2007, the Company executedCopyright Security Agreement and Security and Pledge Agreement for the benefitof Hallmark Cards.  Under the agreements,the Company and its subsidiaries grant security interests to Hallmark Cards inany copyright license and program license agreements and all other personalproperty. 

***Recently Issued Accounting Pronouncements***

InSeptember 2006, the FASB issued SFAS No. 157, *Fair Value Measurements* (“SFAS No. 157”). SFASNo. 157 defines fair value, establishes a framework for measuring fairvalue and expands disclosures about fair value measurements. SFAS No. 157is effective for the Company as of January 1, 2008. The Company iscurrently evaluating the potential impact of adopting SFAS No. 157. 

In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*,including an amendment of SFAS No. 115 (“SFAS No. 159”). SFASNo. 159 permits entities to choose, at specified election dates, tomeasure eligible items at fair value (the “fair value option”). A businessentity shall report unrealized gains and losses on items for which the fairvalue option has been elected in earnings at each subsequent reporting period.This accounting standard is effective as of the beginning of an entity’s firstfiscal year that begins after November 15, 2007. The effect, if any, ofadopting SFAS No. 159 on the Company’s financial position and results ofoperations is currently being evaluated. 

## **Selected Historical Consolidated FinancialData of Crown Media Holdings**

In the table below, we provideselected historical condensed consolidated financial and other data of CrownMedia Holdings and its subsidiaries. The following selected condensedconsolidated statements of operations data for three and six months ended June 30,2006 and 2007, 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.
| ** **                                               | ** ** | ** **                                          | ** ** | ** **        | ** ** | **Percent %**                                | ** ** | ** **        | ** ** | ** ** | ** ** | **Percent %** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------|------------|---------------------------------------------------|------------|-------------------|------------|------------|------------|--------------------|------------|
| ** **                                               | ** ** | **Three Months Ended June 30,** | ** ** | **2007 vs.** | ** ** | **Six Months Ended June 30,** | ** ** | **2007 vs.** | ** ** |
| ** **                                               | ** ** | **2006**                                            | ** ** | **2007**          | ** ** | **2006**                                          | ** ** | **2006**          | ** ** | **2007**   | ** ** | **2006**           | ** ** |
| Revenues:                                                |       |                                                |       |              |       |                                              |       |              |       |       |       |               |       |
| Subscriber fees                                          |       | $                                                   | 6,379      |              | $          | 6,507                                             |       | 2                 | %          | $          | 12,611     |               | $          | 14,002 |   | 11 | % |
| Advertising                                              |       | 43,549                                              |       | 49,323            |       | 13                                                | %          | 81,942            |       | 95,321     |       | 16                 | %          |
| Film asset  license fees                                 |       | 518                                                 |       | —            |       | -100                                              | %          | 788               |       | —     |       | -100               | %          |
| Sublicense fees  and other revenue                       |       | 76                                                  |       | 77                |       | 1                                                 | %          | 154               |       | 156        |       | 1                  | %          |
| Total revenues                                           |       | 50,522                                              |       | 55,907            |       | 11                                                | %          | 95,495            |       | 109,479    |       | 15                 | %          |
| Cost of Services:                                        |       |                                                |       |              |       |                                              |       |              |       |       |       |               |       |
| Programming  costs                                       |       | 33,967                                              |       | 38,389            |       | 13                                                | %          | 67,560            |       | 78,081     |       | 16                 | %          |
| Amortization of  film assets                             |       | 8,279                                               |       | —            |       | -100                                              | %          | 17,143            |       | —     |       | -100               | %          |
| Impairment of  film assets                               |       | 184,886                                             |       | —            |       | -100                                              | %          | 184,886           |       | —     |       | -100               | %          |
| Subscriber  acquisition fee amortization                 |       | 7,723                                               |       | 7,832             |       | 1                                                 | %          | 15,513            |       | 15,680     |       | 1                  | %          |
| Operating costs                                          |       | 3,501                                               |       | 2,602             |       | -26                                               | %          | 7,631             |       | 5,839      |       | -23                | %          |
| Total cost of services                                   |       | 238,356                                             |       | 48,823            |       | -80                                               | %          | 292,733           |       | 99,600     |       | -66                | %          |
| Selling, general and  administrative expense             |       | 13,580                                              |       | 14,453            |       | 6                                                 | %          | 23,489            |       | 29,143     |       | 24                 | %          |
| Marketing expense                                        |       | 1,111                                               |       | 4,073             |       | 267                                               | %          | 5,368             |       | 8,285      |       | 54                 | %          |
| Gain on sale of film  assets                             |       | 0                                                   |       | (521              | )          | 100                                               | %          | 0                 |       | (521       | )          | 100                | %          |
| Loss from continuing  operations before interest expense |       | (202,525                                            | )          | (10,921           | )          | -95                                               | %          | (226,095          | )          | (27,028    | )          | -88                | %          |
| Interest expense                                         |       | (24,913                                             | )          | (32,741           | )          | 31                                                | %          | (46,616           | )          | (56,842    | )          | 22                 | %          |
| Loss from continuing  operations                         |       | (227,438                                            | )          | (43,662           | )          | -81                                               | %          | (272,711          | )          | (83,870    | )          | -69                | %          |
| Gain (loss) on sale of  discontinued operations          |       | (8                                                  | )          | —            |       | -100                                              | %          | 154               |       | —     |       | -100               | %          |
| Cumulative effect of  change in accounting principal     |       | —                                              |       | —            |       |                                              |       | (2,099            | )          | —     |       | 100                | %          |
| Net loss                                                 |       | $                                                   | (227,446   | )                 | $          | (43,662                                           | )          | -81               | %          | $          | (274,656   | )                  | $          | (83,870 | ) | -69 | % |
|                                                     |       |                                                |       |              |       |                                              |       |              |       |       |       |               |       |
| **Other Data:**                                          |       |                                                |       |              |       |                                              |       |              |       |       |       |               |       |
| Net cash (used in)  provided by operating activities     |       | $                                                   | 1,970      |              | $          | 4,697                                             |       | 138               | %          | $          | (18,390    | )                  | $          | (8,137 | ) | -56 | % |
| Capital expenditures                                     |       | $                                                   | (24        | )                 | $          | (377                                              | )          | 1471              | %          | $          | (27        | )                  | $          | (583 | ) | 2059 | % |
| Net cash provided by  (used in) financing activities     |       | $                                                   | 4,849      |              | $          | (2,166                                            | )          | -145              | %          | $          | 19,815     |               | $          | 3,672 |   | -81 | % |
| Total domestic day  household ratings (1)(3)             |       | 0.717                                               |       | 0.644             |       | -10                                               | %          | 0.730             |       | 0.687      |       | -6                 | %          |
| Total domestic  primetime household ratings (2)(3)       |       | 1.140                                               |       | 1.045             |       | -8                                                | %          | 1.127             |       | 1.100      |       | -2                 | %          |
| Subscribers at period  end                               |       | 73,274                                              |       | 82,600            |       | 13                                                | %          | 73,274            |       | 82,600     |       | 13                 | %          |

 

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

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

(3)  These Nielsen ratings are for the time periodJanuary 1 through June 30.

### ***Results ofOperations***

#### *Three Months Ended June 30, 2006 Compared to Three Months Ended June30, 2007*

*Revenue. *Our revenue from continuing operations, whichis comprised of subscriber fees and advertising, increased 11% to $55.9 millionfor the three months ended June 30, 2007. Our 2% increase to $6.5 million in subscriber fee revenue for the threemonths ended June 30, 2007, was a result of a net effective rate that washigher on average and increases in the number of subscribers under certain newand existing agreements. A key aspect of the change in net subscriber rates waslower subscriber acquisition fees recorded as a reduction of revenues.Subscriber acquisition fee expense recorded as a reduction of revenue was $1.9million for the three months ended June 30, 2007, and $2.2 million for thecomparable period in 2006. Subscribers have increased as a result of theEchoStar distribution agreement signed in March 2007 and as a result ofinternal growth pursuant to previously amended distribution agreements in theUnited States, which provided for incentives for growth in distribution. 

The increase in advertisingrevenue to $49.3 million for the three months ended June 30, 2007, compared to$43.5 million for the three months ended June 30, 2006, reflects the growth indomestic subscribers and an increase in advertising rates, offset in part by agrowth in our audience deficiency reserve. Generally, as we have expanded ourdomestic subscribers and provided higher rated programming, our advertising revenuehas increased. The number of advertisers was 439 at both March 31 and June 30,2007, as compared to 427 at June 30, 2006. 

Among the 69 ad-supported cable channels in the UnitedStates market, the Hallmark Channel ranked 11th intotal day with a 0.644 household rating for the three months ending June 30,2007 and 11th for primetime with a 1.045 household ratingfor the same period based on Nielsen ratings. This ratings performance issignificant, particularly because the Hallmark Channel is not a fullydistributed network. Most of the channels that rate above the Hallmark Channelhave higher levels of distribution. Domesticday household and primetime household ratings 

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decreased in the second quarter of 2007 compared to the second quarter of2006 due to the loss of *M*A*S*H* inprimetime and changes to our programming schedule to incorporate freshprogramming. 

Revenue from our film assets totaled $0 for the three months endedJune 30, 2007, compared with $518,000 for the comparable period in2006.  The Company sold its film assets in December 2006.

*Cost of services. *Cost of services as a percent of revenue decreased to87% in 2007, as compared to 472% in 2006. This decrease was primarily due tothe sale of the film assets in December 2006. 

Total programming costs for the three months endedJune 30, 2007, increased 13% due directlyto the expensing (instead of amortizing over a period of time) of certain NICCprogramming and higher amortization of more original programs produced to airon the Hallmark Channel in the current period as compared to the prior period.We expect continued increases in programming costs in 2007 compared to 2006,because of the sale of our film assets in December 2006 and in order tomaintain or improve ratings and enhance our demographics. The $8.3million decrease in amortization of film assets and $184.9 million decrease inimpairment of film assets were primarily due to the sale of our film assets inDecember 2006. 

The Company’s bad debt expensewas $355,000 for the three months ended June 30, 2006, as compared to theCompany’s negative bad debt expense (meaning a credit) of $343,000 for thethree months ended June 30, 2007. This decrease in bad debt expense was due tothe Company’s increased collection efforts in 2007 and a reduction in theallowance for doubtful accounts.

Subscriber acquisition fee amortization expenseresults from subscriber acquisition costs incurred previously by us andamortized over the remaining life of the relevant distribution agreement.

*Selling, general and administrative expense.* Our selling, general and administrativeexpense increased 6% due to a $4.0 million increase and a $832,000 increase incompensation expense related to the obligations of restricted stock units andstock appreciation rights, respectively, offset in part by a $407,000 decreasein depreciation and amortization expense primarily related to assets becomingfully depreciated, a $3.0 million decrease in severance expense, a $519,000decrease in accounting fees and a $945,000 decrease in legal fees. Our closingstock price was $6.34 at March 31, 2006, and $5.33 at March 31, 2007. Ourclosing stock price was $4.12 at June 30, 2006, and $7.20 at June 30, 2007. Theclosing stock prices are used to value both our restricted stock units and ourstock appreciation rights. Any increases/decreases in our closing stock pricecauses increases/decreases in our compensation expense. 

*Marketing expense. *Our marketing expense increased 267% primarily due tothe Company’s marketing promotion surrounding Mother’s Day during the secondquarter of 2007. During the same period in 2006, the Company did not hold anypromotions.  

*Gain on sale of film assets. *During the second quarterof 2007, the Company settled a residual and participation liability for$521,000 less than it had originally accrued for it in conjunction with thesale of its film library.  Therefore, theCompany recognized a gain on the sale of its film assets during this timeperiod.

*Interest expense.*The interestexpense for the second quarter of 2007 includes a portion of a $33.1 millionnote provided under the tax sharing agreement by us to Hallmark Cards in July2007 and the related payable on our balance sheet. See Note 10 to the UnauditedCondensed Consolidated Financial Statements in this Report.  Of the total amount payable to HallmarkCards, $7.9 million represents interest expense payable pursuant to the TaxSharing Agreement.

*Loss from ContinuingOperations. *Loss fromoperations for the three months ended June 30, 2007, was $43.7 million. Lossfrom continuing operations for the three months ended June 30, 2006, was $227.4million. Our loss from continuing operations decreased primarily due theelimination of film assets amortization and the impairment of our film assets. 

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#### *Six Months Ended June 30, 2006 Compared to Six Months Ended June 30,2007*

*Revenue. *Our revenue from continuing operations, whichis comprised of subscriber fees and advertising, increased 15% to $109.5million for the six months ended June 30, 2007. Our 11% increase to $14.0 million in subscriber fee revenue for the sixmonths ended June 30, 2007, was a result of higher net effective rates onaverage, primarily due to a decrease in subscriber acquisition fees appliedagainst revenue, and increase in the number of subscribers. Subscriberacquisition fee expense recorded as a reduction of revenue was $2.9 million forthe six months ended June 30, 2007, and $4.3 million for the comparable periodin 2006, primarily due to the renewal of distribution agreements and theresulting reversal of certain subscriber acquisition fees associated with theprevious agreements during the first quarter of 2007. Subscribers were alsopositively impacted by the expiration of free carriage periods during 2006 and2007. Subscribers have increased as a result of the EchoStar distributionagreement signed in March 2007 and as a result of internal growth pursuant topreviously amended distribution agreements in the United States, which providedfor incentives for growth in distribution. 

The increase in advertisingrevenue to $95.3 million for the six months ended June 30, 2007, compared to$81.9 million for the six months ended June 30, 2006, reflects the growth indomestic subscribers and an increase in advertising rates for the reasonsindicated above for the second quarter. 

Among the 69 ad-supported cable channels in theUnited States market, the Hallmark Channel ranked11th in total day with a 0.687household rating for the six months ending June 30, 2007 and 10th forprimetime with a 1.100 household rating for the same period based on Nielsenratings. This ratings performance is significant, particularly because theHallmark Channel is not a fully distributed network. Most of the channels thatrate above the Hallmark Channel have higher levels of distribution. 

Revenue from our film assets totaled $0 for the six months endedJune 30, 2007, compared with $788,000 for the comparable period in2006.  The Company sold its film assets in December 2006.

*Cost of services. *Cost of services as a percent of revenue decreased to91% in 2007, as compared to 307% in 2006. This decrease was primarily due tothe sale of our film assets in December 2006. 

Total programming costs for the six months ended June30, 2007, increased 16% due directly to theexpensing (instead of amortizing over a period of time) of certain NICCprogramming and higher amortization of more original programs produced to airon the Hallmark Channel in the current period as compared to the prior period.In addition, in the first quarter of 2007, we had $1.7 million in write-offs ofcertain programming. The $17.1 million decrease in amortization of filmassets and the $184.9 million decrease in impairment of film assets wereprimarily due to the sale of our film assets in December 2006. 

The Company’s bad debt expensewas $1.3 million for the six months ended June 30, 2006, as compared to theCompany’s negative bad debt expense of $13,000 for the six months ended June30, 2007. This decrease in bad debt expense was due to the Company’s increasedcollection efforts in 2007.

Subscriber acquisition fee amortization expenseresults from subscriber acquisition costs incurred previously by us andamortized over the remaining life of the relevant distribution agreement.

*Selling, general and administrative expense.* Our selling, general and administrativeexpense increased 24% due to a $7.3 million increase and a $1.1 millionincrease in compensation expense related to the obligations of restricted stockunits and stock appreciation rights, respectively, offset in part by a $789,000decrease in depreciation and amortization expense primarily related to assetsbecoming fully depreciated, a $ 3.0 million decrease in severance expense, a$943,000 decrease in accounting fees and a $964,000 decrease in legal fees. 

*Marketing expense. *Our marketing expense increased 54% primarily due tothe Company’s marketing promotions surrounding Valentine’s Day and Mother’s Dayduring 2007. During the same period in 2006, the Company held one promotionduring January. 

*Gain on sale of film assets. *The Company settled aresidual and participation liability for $521,000 less than it 

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had originallyaccrued for it in conjunction with the sale of its film library.  Therefore, the Company recognized a gain onthe sale of its film assets during this time period.

*Interest expense. *Interestexpense increased for the six months ended June 30, 2007, compared to June 30,2006, by $10.2 million.  This increasewas due to the $3.4 million increase in interest on our $400.0 million seniorunsecured note, the $960,000 increase in interest on our $132.8 million notepayable to Hallmark Cards affiliates, the $655,000 increase in interest on our$70.4 million note payable to Hallmark Cards affiliates commencing March 21,2006, the $554,000 increase in interest on our $86.3 million note payable toHallmark Cards affiliates, and offset in part by the $3.3 million decrease ininterest on our bank credit facility due to a lower principal balance.  The majority of the aforementioned increasesoccurred due to increases in principal balances.

Additionally, interest expense for the six monthsended June 30, 2007, includes a portion of a $33.1 million note provided underthe tax sharing agreement by us to Hallmark Cards in July 2007 and the relatedpayable in our balance sheet as indicated above.

*Loss from ContinuingOperations. *Loss fromoperations for the six months ended June 30, 2007, was $83.9 million. Loss fromcontinuing operations for the six months ended June 30, 2006, was $272.7 million.Our loss from continuing operations decreased primarily due to the eliminationof film assets amortization and the elimination of the impairment of filmassets. 

*Cumulative effect of change inaccounting principle.  *OnJanuary 1, 2006, we adopted SFAS 123R. Thetotal compensation cost related to 2004 and 2005 performance RSUs granted underthe Plan net of estimated forfeitures was $2.1 million, which was recorded as acumulative catch-up adjustment during the six months ended June 30, 2006. Underprior accounting treatment, the performance RSUs were not classified as aliability as it was deemed improbable that these RSUs would settle based uponthe performance of our Class A common stock.

## **Liquidity and Capital Resources**

Cash used in operating activitiesfrom continuing operations was $18.4 million and $8.1 million for the sixmonths ended June 30, 2006 and 2007.**Lossfrom continuing operations for the six months ended June 30, 2006 and 2007, was$272.7 million and $83.9 million, respectively. During the six months ended June 30, 2006, the Company made payments of$10.3 million for subscriber acquisition fees. During the six months ended June30, 2007, the Company made payments of $96,000 for subscriber acquisition fees.

Cash used in investing activitieswas $6.5 million and $2.6 million for the six months ended June 30, 2006 and2007, respectively. During the six months ended June 30, 2006, the Company madepayments to the buyer of the international business of $6.5 million. During thesix months ended June 30, 2007, the Company made payments to the buyer of theinternational business of $2.0 million.

Cash provided by financingactivities was $19.8 million and $3.7 million for the six months ended June 30,2006 and 2007, respectively. During the six months ended June 30, 2006 and2007, we received proceeds of $5.0 million and $0, respectively, from our taxsharing agreement with Hallmark Cards. We borrowed $15.0 million and $6.0million under our credit facility to cover the cash we used in operating andinvesting activities during the six months ended June 30, 2006 and 2007,respectively. We made $2.0 million of payments on the credit facility duringthe six months ended June 30, 2007.

The aggregate maturity of a new related partylong-term debt for each of the five years subsequent to June 30, 2007, is asfollows:
| ** **                                                        | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                        | ** ** | **Total**                                 | ** ** | **1 year** | ** ** | **2 years** | ** ** | **3 years** | ** ** | **4 years** | ** ** | **5 years** | ** ** |
| ** **                                                        | ** ** | **(In thousands)**                   | ** ** |
| Note payable to  Hallmark Cards, with principal due July 27, 2009 |       | 33,082                                    |       | — |   | — |   | 33,082 |   | — |   | — |   |

 

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*Cash Flows*

As of June 30, 2007, the Company had $6.9 million incash and cash equivalents on hand. As of June 30, 2007, the Company hadborrowed $91.6 million from a $130.0 million revolving bank credit facility,which matures May 31, 2008.

The Company’s principalsources of funds are cash on hand, cash generated by operations and amountsavailable under the Company’s revolving bank credit facility. The Company’s taxsharing agreement with Hallmark Cards has previously also been a source ofcash. However, we do not expect to receive or pay any cash related to thisagreement in the next twelve months.

As of the date of this report, we believe thatit is reasonably possible that the Put Right described in Note 11 belowregarding shares of our Class A common stock owned by National Interfaith CableCoalition, Inc. (“NICC”) will be exercisable between August 30, 2007, andNovember 1, 2007.  In such event, we also believe that it would bereasonably possible that NICC would exercise the Put Right upon which we wouldbe required to buy all such shares (4.4 million shares as of June 30,2007) at the then current market value.  NICC’s exercise of the Put Rightwould cost the Company approximately $28.8 million, based on the closing stockprice of Class A common stock on August 3, 2007, of $6.61.  We likelywould need to finance such a redemption using funds obtained from outsidesources.  It is also possible that NICC and its affiliates might sell ourshares on the open market or otherwise decide not to exercise the PutRight.  Our liquidity during the remainder of 2007 and our discussions andexpectations regarding liquidity through August 15, 2008, are highlydependent upon our ability to raise capital through external sources in theevent NICC exercises the Put Right.

The Company believes that, under the Put Right,NICC could not require us to buy approximately 634,000 additional Crown sharesthat NICC invested in HEIC to facilitate the Company’s participation in the taxsharing agreement.  However, if theCompany negotiated a redemption of such shares, the Company would require anadditional $4.2 million of funding, based on the August 3, 2007 price.

There is no certainty that the Put Right will beexercised.  However, the Company has commenced a preliminary analysis offunding alternatives.  Among the Company’s considerations is the effect,if any, that a funding alternative may have on the Company’s ability tocontinue participation in the tax sharing agreement with Hallmark Cards. If the Company is unable to continue participation in the tax sharingagreement, the Company would not receive any benefit from tax operating losscarryforwards until such time as the Company reports taxable income.

The Company currently has $38.4 million of unusedrevolving credit capacity. The Company’s ability to borrow additional amountsunder the current credit facility is not limited or restricted as long as nocovenants, representations or warranties are violated.

The sufficiency of the existing sources of liquidityto fund the Company’s operations is dependent upon continued growth insubscriber revenue and advertising revenue. Any decline in the popularity ofthe Hallmark Channel, any significant future adverse modifications to theCompany’s distribution agreements, an economic decline in the advertisingmarket, an increase in program acquisition costs, an increase in competition orother adverse operating conditions would negatively impact the Company’sliquidity and its ability to fund the current level of operations

The Company expects to continue making investments inprogramming, marketing and distribution. However, the Company’s recurring losssituation has demanded that all areas of expenses, including programming,marketing and distribution be closely monitored and controlled.

The Company anticipates that its principal uses offunds for 2007 will continue to include the payment of operating expenses,accounts payable and accrued expenses, license fees for programming, andinterest under its bank credit facility.

The Company currently believes that cash on hand, cashgenerated by operations and borrowing availability under its bank creditfacility, when combined with the deferral of any required payments onrelated-party debt and related interest mentioned below, will be sufficient tofund the Company’s operations and meet its liquidity needs

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throughAugust 15, 2008.  This statement isqualified with respect to the possible exercise of the Put Right describedabove.

The Company intends to extend or refinance the Bankcredit facility prior to or upon its maturity. Any such extension orrefinancing might require a continuation of a letter of credit from HallmarkCards or other steps by the Company and, thus, is not assured. If the Companyis not able to arrange for the extension, refinancing or replacement of thebank credit facility prior to its maturity and either (1) the bank draws downon the irrevocable letter of credit provided by Hallmark Cards in support ofthe bank credit facility or (2) Hallmark Cards purchases the interests of thelending banks, Hallmark Cards would have all obligations and rights of thelending banks under the bank credit facility. In that event, Hallmark Cardscould demand payment of outstanding amounts at any time after August 15, 2008,under the terms of the waiver and standby purchase agreement (“Waiver Agreement”)described below.

Uponmaturity of the credit facility on May 31, 2008, the lending group led byJP Morgan Chase has the right to elect to forego the receipt of cash to pay theprincipal amount of the credit facility in full, which is provided for underthe terms of an irrevocable letter of credit provided by Hallmark Cards,and instead mayelect to initiate a process to foreclose on the Company’s assets. Suchforeclosure proceedings, would adversely affect our ability to continue ouroperations. Prior to any such possible foreclosure proceedings, however, theCompany, if it has not secured an extension of the credit facility oralternative financing, would cause Hallmark Cards pursuant to the terms of theWaiver Agreement to exercise its option to purchase all of the outstandingindebtedness under the credit facility and the credit facility would then besubject to terms of the Waiver Agreement.

Due to the Company’s possible inability to meet itsobligations when they come due in August 2008, the Company anticipates thatprior to August 15, 2008, it will be necessary to either extend or refinance(i) the bank credit facility and (ii) the promissory notes payable toaffiliates of Hallmark Cards described in the Notes below. As part of acombination of actions and in order to obtain additional funding, the Companymay consider various alternatives, including refinancing the bank creditfacility, raising additional capital through the issuance of equity or debtsecurities, a sale of certain assets or other strategic alternatives.

***Bank Credit Facility, HC Crown Loans, and Tax Sharing Agreement***

For information regarding our Bank CreditFacility, HC Crown Loans and Tax Sharing Agreement, please see “Bank CreditFacility, HC Crown Loans, and Tax Sharing Agreement” of the Company’s AnnualReport on Form 10-K for the year ended December 31, 2006, as filed with the SECand Notes 8 and 9 of Notes to Unaudited Condensed Consolidated FinancialStatements contained in Item 1 of this Report.

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

The discussion set forth inthis Form 10-Q contains statements concerning potential future events. Suchforward-looking statements are based on assumptions by Crown Media Holdings management,as of the date of this Form 10-Q including assumptions about risks anduncertainties faced by Crown Media Holdings. Readers can identify theseforward-looking statements by their use of such verbs as “expects,” “anticipates,”“believes,” or similar verbs or conjugations of such verbs. If any ofmanagement’s assumptions prove incorrect or should unanticipated circumstancesarise, Crown Media Holdings’ actual results, levels of activity, performance,or achievements could materially differ from those anticipated by suchforward-looking statements.

Among the factors thatcould cause actual results to differ materially are those discussed in thisReport below and in the Company’s filings with the Securities and ExchangeCommission, including the Risk Factors stated in the Company’s Annual Report onForm 10-K for the year ended December 31, 2006. Such Risk Factors include, butare not limited to, the following: competition for distribution of channels, viewers, advertisers and theacquisition of programming; fluctuations in the availability of programming;fluctuations in demand for programming which we air on our channels; ourability to address our liquidity needs; our incurrence of losses; and oursubstantial indebtedness affecting our financial condition and results.

Stated below are certainRisk Factors which contain significant changes from those stated in the Company’s

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Annual Report on Form 10-K for the year ended December 31, 2006. CrownMedia Holdings will not update any forward-looking statements contained in thatForm 10-K to reflect future events or developments.

If we do not successfully address the risks describedbelow and in our prior Reports mentioned above, our business, prospects,financial condition, results of operations or cash flow could be materiallyadversely affected. The trading price of our Class A common stock could declinebecause of any of these risks.

**Risks Relating to Our Business**

***Our liquidity is dependent on external funds.***

Because we currently operate at a loss, we may have a negative cash flowand any unanticipated significant expense or any development that hampers ourgrowth in revenue or decreases any of our revenue would result in the need foradditional external funds in order to continue operations. We have no arrangementsfor any such additional external financings, whether debt or equity, and arenot certain whether any such new external financing would be available onacceptable terms. Any new debt financing would require the cooperation andagreement of existing lenders.

Further, as discussed in this Report under “Liquidity and CapitalResources” above, we need to (1) extend, refinance or replace our bank line ofcredit on or prior to May 31, 2008, or to extend or replace borrowings fromHallmark Cards by August 15, 2008, that would result from the banks drawingupon the irrevocable letter of credit supporting the bank credit facility, (2)extend or refinance outstanding notes payables to Hallmark Cards and itssubsidiaries on or prior to August 15, 2008, and (3) if the Put Right of NICCbecomes exercisable and is exercised, obtain outside financing to cover therepurchase of common stock under the Put Right.

Upon maturity of the credit facility onMay 31, 2008, the lending group led by JP Morgan Chase has the right to electto forego the receipt of cash to pay the principal amount of the creditfacility in full, which is provided for under the terms of an irrevocableletter of credit provided by Hallmark Cards, but instead can elect to initiatea process to foreclose on the Company’s assets. Such foreclosure proceedings, whichwe view as a remote possibility, could affect our ability to continue ouroperations. Prior to any such possible foreclosure proceedings, the Companywould consider various alternatives as indicated above.  The Company could also cause Hallmark Cards,pursuant to the terms of the Waiver Agreement, to exercise its option topurchase all of the outstanding indebtedness under the credit agreement. Thecredit facility would then be subject to Hallmark Cards agreement not to demandpayment prior to August 15, 2008.

### **AvailableInformation**

**We will make available free of charge through ourwebsite, www.hallmarkchannel.com, the Annual Report, our quarterly reports onForm 10-Q, our current reports on Form 8-K, and amendments to such reports, assoon as reasonably practicable after we electronically file or furnish suchmaterial with the Securities and Exchange Commission.**

**Additionally, we will make available, free of chargeupon request, a copy of our Code of Business Conduct and Ethics, which isapplicable to all of our employees, including our senior financial officers.Requests for a copy of this code should be addressed to the General Counsel atCrown Media Holdings, Inc., 12700 Ventura Boulevard, Studio City, California 91604.**

**Item 3.  *Quantitativeand Qualitative Disclosures About Market Risk***

We only invest in instruments that meet high credit and qualitystandards, as specified in our investment policy guidelines. These instruments,like all fixed income instruments, are subject to interest rate risk. The fixedincome portfolio will decline in value if interest rates increase. If marketinterest rates were to increase immediately and uniformly by 10% from levels asof June 30, 2007, the decline of the fair value of the fixed income portfoliowould not be material.

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As of June 30, 2007, our cash, cash equivalents and short-terminvestments had a fair value of $6.9 million, which were invested in cash andshort-term commercial paper. The primary purpose of these investing activitieshas been to preserve principal until the cash is required to fund operations.Consequently, the size of this portfolio fluctuates significantly as cash isprovided by and used in our business.

The value of certain investments in this portfolio can be impacted by therisk of adverse changes in securities and economic markets and interest ratefluctuations. At June 30, 2007, all of our investments in this category were infixed rate instruments or money market type accounts. A decrease in interestrates has the effect of reducing our future annual interest income from thisportfolio, since funds would be reinvested at lower rates as the instrumentsmature. Over time, any net percentage decrease in our interest rates could bereflected in a corresponding net percentage decrease in our interest income.For the three and six months ended June 30, 2007, the impact of interest ratefluctuations, changed business prospects and all other factors did not have amaterial impact on the fair value of this portfolio, or on our income derivedfrom this portfolio.

We have not used derivative financial instruments for speculativepurposes. As of June 30, 2007, we are not hedged or otherwise protected againstrisks associated with any of our investing or financing activities.

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

We are exposed to market risk, including changes to interest rates. Toreduce the volatility relating to these exposures, we may enter into variousderivative investment transactions in the near term pursuant to our investmentand risk management policies and procedures in areas such as hedging andcounterparty exposure practices. We have not and will not use derivatives forspeculative purposes.

Though we intend to use risk management control policies, there will beinherent risks that may only be partially offset by our hedging programs shouldthere be any unfavorable movements in interest rates or equity investmentprices.

***Our interest income and expense is subject to fluctuations in interestrates.***

Our material interest bearingassets consisted of cash equivalents and short-term investments. The balance ofour interest bearing assets was $6.9 million, or less than 1% of total assets,as of June 30, 2007. Our material liabilities subject to interest rate riskconsisted of our bank credit facility, our line of credit and interest payableto HC Crown, our line of credit and interest payable to Hallmark Cardsaffiliate, and our note and interest payable to Hallmark Cards affiliate. Thebalance of those liabilities was $499.0 million, or 37% of total liabilities,as of June 30, 2007. Net interest expense for the three months ended June 30,2007, was $32.7 million, 59%, of our total revenue. Net interest expense forthe six months ended June 30, 2007, was $56.8 million, 52%, of our totalrevenue. Our net interest expense of these liabilities is sensitive to changesin the general level of interest rates, primarily U.S. and LIBOR interestrates. In this regard, changes in U.S. and LIBOR interest rates affect the fairvalue of interest bearing liabilities.

If market interest rates were toincrease or decrease by 1% from levels as of June 30, 2007, our interestexpense for the quarter would change correspondingly by $705,000 and $1.9million for each of the three and six months.

**Item 4.  *Controls andProcedures.***

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

Ourmanagement evaluated, with the participation of our Chief Executive Officer andour Chief Financial Officer, the effectiveness of our disclosure controls andprocedures as of the end of the period covered by this Quarterly Report on Form10-Q. Based on this evaluation, our Chief Executive Officer and our ChiefFinancial Officer have concluded that our disclosure controls and procedureswere effective as of the end of the period covered by this Quarterly Report onForm 10-Q.

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

There was nochange in the Company’s internal control over financial reporting that occurredduring the quarter ended June 30, 2007, that materially affected, or wasreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

**PART II.  OTHER INFORMATION**

**Item I.  *LegalProceedings***

On July 27, 2007,a lawsuit was brought against Crown Media Holdings, Inc. and our former ChiefFinancial Officer, William Aliber, in the U.S. District Court for the NorthernDistrict of Illinois.  The plaintiff,Robert Lieblang, claims to have purchased our common shares on the market fromAugust 31, 2005 to April 13, 2006 and to have sold those shares in April 2006and in August 2006.  The plaintiffalleges that he relied to his detriment on allegedly false and misleadingstatements by the defendants regarding the possible sale of Crown MediaHoldings.  We announced a possible salein August 2005; in April 2006 we announced the termination of an extensivereview of strategic alternatives including a possible sale.  Plaintiff alleges claims under Section 10(b)of the Securities Exchange Act (and Rule 10b-5), the Illinois Consumer FraudAct and common law fraud.  The complaintseeks compensatory damages of approximately $2.0 million plus interest and $6.0million in punitive damages.  We arereviewing the allegations and have submitted the claims to an insurer under aninsurance policy.  We expect that we willvigorously defend ourselves against these claims.

**Item1A.  *Risk Factors***

See “RisksRelating to Our Business” in Part I, Item 2 above for information on changes torisk factors.

**Item4.  *Submission of Matters to aVote of Security Holders***

Our 2007 annual meeting of stockholders was held onJune 28, 2007.  The following proposalswere voted upon at the meeting, with the following number of votes cast for,against or withheld:

# **Proposal 1:Election of Directors**

| Name                     | ** ** | **Number of Votes  For** | ** ** | **Votes Withheld** | ** ** | **Abstentions and  Broker Non-Votes** | ** ** |
|--------------------------|------------|------------------------------------|------------|-------------------------|------------|-------------------------------------------------|------------|
|                     |       |                               |       |                    |       |                                            |       |
| Wilford V. Bane,  Jr.    |       | 373,639,847                        |       | 749,703                 |       | -0-                                             |       |
| Glenn Curtis             |       | 373,804,632                        |       | 584,918                 |       | -0-                                             |       |
| Fred Dressler            |       | 374,262,269                        |       | 127,281                 |       | -0-                                             |       |
| Brian E. Gardner         |       | 373,685,591                        |       | 703,959                 |       | -0-                                             |       |
| Herbert Granath          |       | 374,229,291                        |       | 160,259                 |       | -0-                                             |       |
| David E. Hall            |       | 373,574,519                        |       | 815,031                 |       | -0-                                             |       |
| Donald J. Hall,  Jr.     |       | 373,798,086                        |       | 591,464                 |       | -0-                                             |       |
| Irvine O.  Hockaday, Jr. |       | 373,426,297                        |       | 963,253                 |       | -0-                                             |       |
| Anil Jagtiani            |       | 373,778,360                        |       | 611,190                 |       | -0-                                             |       |
| A. Drue Jennings         |       | 374,073,976                        |       | 315,574                 |       | -0-                                             |       |
| Peter A. Lund            |       | 373,477,333                        |       | 912,217                 |       | -0-                                             |       |
| Henry Schleiff           |       | 373,971,491                        |       | 418,059                 |       | -0-                                             |       |
| Deanne R. Stedem         |       | 373,585,064                        |       | 678,976                 |       | -0-                                             |       |

 

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# **Proposal 2:**

|                                                                                                                                                             | ** ** | **Number of Votes  For** | ** ** | **Votes Against** | ** ** | **Abstentions and  Broker Non-Votes** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|------------------------|------------|-------------------------------------------------|------------|
| Consider and  approve the performance based compensation payable to the Company’s President  and Chief Executive Officer and other executive officers. |       | 369,157,856                        |       | 1,094,921              |       | 5,174,736                                       |       |

 

**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). |
|           | 10.1       |              | Amendment No. 4 to Waiver and Standby Purchase  Agreement dated August 3, 2007, by and between Hallmark Cards Incorporated  and Crown Media Holdings, Inc. |
|           | 10.2*      |              | Crown Media Holdings, Inc. 2007 Annual Advertising  Sales Commission Plan** |
|           | 10.3       |              | Promissory Note in the amount of $33,082,019, dated  July 27, 2007, issued by Crown Media Holdings, Inc. in favor of Hallmark  Cards, Incorporated. |
|           | 10.4       |              | Amendment No. 13, dated as of July 27, 2007, to the  Credit, Security, Guaranty and Pledge Agreement, dated as of August 31, 2001  among Crown Media Holdings, Inc. as Borrower, the Guarantors named therein,  the Lenders named therein and JP Morgan Chase Bank  as Administrative Agent and as Issuing Bank. |
|           | 10.5       |              | Amended and Restated  Subordination and Support Agreement, dated as of July 27, 2007, among Crown  Media Holdings, Inc., Hallmark Cards, Incorporated and The Chase Manhattan  Bank (now known as JP Morgan Chase Bank) as agent for the Lenders and the Issuing  Bank referred to in the Credit Agreement |
|           | 10.6       |              | Copyright Security Agreement,  dated July 27, 2007, executed by Crown Media Holdings, Inc. and its  subsidiaries for the benefit of Hallmark Cards, Incorporated. |
|           | 10.7       |              | Security and Pledge Agreement,  dated July 27, 2007, by and among Crown Media Holdings, Inc., its  subsidiaries and Hallmark Cards, Incorporated. |
|           | 10.8*      |              | Amendment to Employment Agreement, dated as of May  22, 2007, by and between William Abbott and Crown Media Holdings, Inc.  (previously filed as Exhibit 10.1 to our Current Report on Form 8-K filed on  June 1, 2007 and incorporated herein by reference). |
|           | 10.9*      |              | Third Amendment to Employment Agreement, dated as of  June 13, 2007, by and between David Kenin and Crown Media Holdings, Inc. (previously  filed as Exhibit 10.1 to our Current Report on Form 8-K filed on June 26,  2007 and incorporated herein by reference). |

 

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| 10.10 |   | Trademark License Extension Agreement (Hallmark  Movie Channel), dated August 1, 2007, by and between Hallmark Licensing, Inc.  and Crown Media United States, LLC. |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.11 |   | Trademark License Extension Agreement (Hallmark  Channel), dated August 1, 2007, by and between Hallmark Licensing, Inc. and  Crown Media United States, LLC.       |
| 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.                                                                                                                                        |

 

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* Management contract or compensating plan or arrangement.** Portions of this exhibit have been omitted pursuant to a confidentialtreatment request filed with the Commission.

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**SIGNATURES**

Pursuant to the requirements of the Securities ExchangeAct of 1934, this report has been signed below by the following persons onbehalf of the registrant and in the capacities and on the dates indicated.
| CROWN MEDIA HOLDINGS, INC. |
|----------------------------|
|                       |
| Signature                  | ** ** | **Title** | ** ** | **Date** |
|                       |   |   |   |   |   |
| By:                        | /s/ HENRY S. SCHLEIFF |   | Principal Executive |   | August 8, 2007 |
|                       |   |   | Officer |   |   |
|                       | Henry S. Schleiff |   |   |   |   |
|                       |   |   |   |   |   |
| By:                        | /s/ BRIAN C. STEWART |   | Principal |   | August 8, 2007 |
|                       |   |   | Financial and |   |   |
|                       | Brian C. Stewart |   | Accounting Officer |   |   |

 

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