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**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 thequarterly period ended March 31, 2010**

 

**or**

 
| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|----------------------------------------------------------------------------------------------------|

** **

**For the transition periodfrom                    to                    .**

 

**Commission File Number: 000-30700**

 

**Crown Media Holdings, Inc.**

(Exact Name of Registrant as Specified in ItsCharter)

 

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

 

**12700 Ventura Boulevard,**

**Suite 200**

**Studio City, California 91604**

(Address of Principal Executive Offices and ZipCode)

 

**(818) 755-2400**

(Registrant’s Telephone Number, Including AreaCode)

 

(Former Name, Former Address, and Former FiscalYear,

if Changed Since Last Report.)

 

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

 

Indicate by checkmark whether the registrant has submitted electronically and posted on itscorporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes oNo o

 

Indicate by check mark whetherthe registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company.  See definition of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 ofthe Exchange Act. (Check one):

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

(do not check if  a smaller reporting company) | Smaller  reporting company o |

 

Indicate by check mark whetherthe registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes oNo x

 

As of May 3, 2010, the number of shares of Class A CommonStock, $.01 par value outstanding was 74,117,654, and the number of shares of Class BCommon Stock, $.01 par value, outstanding was 30,670,422.

 

 

 

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**TABLE OF CONTENTS**

** **
| ** **       | ** **                                                                                                      | ** ** | **Page** |
|------------------|-----------------------------------------------------------------------------------------------------------------|------------|----------|
| **PART I**  | **Financial Information**                                                                                       |       |     |
|             |                                                                                                            |       |     |
| Item 1           | Financial Statements  (Unaudited)                                                                               |       | 3        |
|             | CROWN  MEDIA HOLDINGS, INC. AND SUBSIDIARIES                                                                    |       |     |
|             | Condensed  Consolidated Balance Sheets — December 31, 2009 andMarch 31, 2010 (Unaudited)         |       | 3        |
|             | Condensed  Consolidated Statements of Operations (Unaudited) - Three Months Ended  March 31, 2009 and 2010 |       | 5        |
|             | Condensed  Consolidated Statements of Cash Flows (Unaudited) - Three Months Ended  March 31, 2009 and 2010 |       | 6        |
|             | Notes  to Unaudited Condensed Consolidated Financial Statements                                                 |       | 7        |
|             |                                                                                                            |       |     |
| Item 2           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                     |       | 24       |
|             |                                                                                                            |       |     |
| Item 3           | Quantitative  and Qualitative Disclosures About Market Risk                                                     |       | 33       |
|             |                                                                                                            |       |     |
| Item 4           | Controls and  Procedures                                                                                        |       | 34       |
|             |                                                                                                            |       |     |
| **PART II** | **Other Information**                                                                                           |       | 35       |
|             |                                                                                                            |       |     |
| Item 1           | Legal Proceedings                                                                                               |       | 35       |
|             |                                                                                                            |       |     |
| Item 1A          | Risk Factors                                                                                                    |       | 35       |
|             |                                                                                                            |       |     |
| Item 6           | Exhibits                                                                                                        |       | 36       |
|             |                                                                                                            |       |     |
| Signatures       |                                                                                                            |       | 38       |

 

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*In this Form 10-Q the terms “Crown Media Holdings”and the “Company” refer to Crown Media Holdings, Inc. and, unless thecontext requires otherwise, subsidiaries of Crown Media Holdings that operateor have operated our businesses including Crown Media United States, LLC (“CrownMedia United States”). The term “common stock” refers to our Class Acommon stock and Class B common stock, unless the context requiresotherwise.*

* *

*Thename Hallmark and other product or service names are trademarks or registeredtrademarks of their owners.*

* *

**PART I. FINANCIALINFORMATION**

** **

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

 

**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED BALANCE SHEETS**

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

** **
| ** **                                                                                  | ** ** | **As of  December 31,** | ** ** | **As of  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------------------|------------|
| ** **                                                                                  | ** ** | **2009**                     | ** ** | **2010**                  | ** ** |
|                                                                                        |       |                         |       |                      |       |
| ASSETS                                                                                      |       |                         |       |                      |       |
|                                                                                        |       |                         |       |                      |       |
| Cash  and cash equivalents                                                                  |       | $                            | 10,456     |                      | $          | 16,615 |   |
| Accounts  receivable, less allowance for doubtful accounts of  $476  and $229, respectively |       | 68,817                       |       | 64,040                    |       |
| Program  license fees                                                                       |       | 106,825                      |       | 104,258                   |       |
| Prepaid  program license fees                                                               |       | 1,778                        |       | 12,974                    |       |
| Prepaid  and other assets                                                                   |       | 2,271                        |       | 2,238                     |       |
| Total  current assets                                                                       |       | 190,147                      |       | 200,125                   |       |
|                                                                                        |       |                         |       |                      |       |
| Program  license fees                                                                       |       | 178,332                      |       | 168,643                   |       |
| Property  and equipment, net                                                                |       | 13,176                       |       | 13,261                    |       |
| Goodwill                                                                                    |       | 314,033                      |       | 314,033                   |       |
| Prepaid  and other assets                                                                   |       | 2,373                        |       | 4,510                     |       |
| Total  assets                                                                               |       | $                            | 698,061    |                      | $          | 700,572 |   |

** **

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATEDBALANCE SHEETS**

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

**(continued)**

 
| ** **                                                                                                                                                                                 | ** ** | **As of  December 31,** | ** ** | **As of  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                                                                 | ** ** | **2009**                     | ** ** | **2010**                  | ** ** |
|                                                                                                                                                                                       |       |                         |       |                      |       |
| LIABILITIES  AND STOCKHOLDERS’ DEFICIT                                                                                                                                                |       |                         |       |                      |       |
|                                                                                                                                                                                       |       |                         |       |                      |       |
| LIABILITIES:                                                                                                                                                                               |       |                         |       |                      |       |
| Accounts  payable and accrued liabilities                                                                                                                                                  |       | $                            | 19,642     |                      | $          | 18,102 |   |
| Audience  deficiency reserve liability                                                                                                                                                     |       | 17,872                       |       | 22,130                    |       |
| License  fees payable                                                                                                                                                                      |       | 99,494                       |       | 93,594                    |       |
| Payables  to Hallmark Cards affiliates                                                                                                                                                     |       | 23,745                       |       | 28,499                    |       |
| Credit  facility and interest payable                                                                                                                                                      |       | 1,002                        |       | —                    |       |
| Notes  and interest payable to Hallmark Cards affiliates                                                                                                                                   |       | 345,314                      |       | 345,184                   |       |
| Company  obligated mandatorily redeemable preferred  interest                                                                                                                              |       | 22,902                       |       | 23,474                    |       |
| Total  current liabilities                                                                                                                                                                 |       | 529,971                      |       | 530,983                   |       |
|                                                                                                                                                                                       |       |                         |       |                      |       |
| Accrued  liabilities                                                                                                                                                                       |       | 24,484                       |       | 22,978                    |       |
| License  fees payable                                                                                                                                                                      |       | 82,881                       |       | 73,652                    |       |
| Senior  secured note to HC Crown, including accrued interest                                                                                                                               |       | 758,755                      |       | 778,012                   |       |
| Total  liabilities                                                                                                                                                                         |       | 1,396,091                    |       | 1,405,625                 |       |
| 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, 2009, and  March 31, 2010, respectively  |       | 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, 2009, and  March 31, 2010, respectively |       | 307                          |       | 307                       |       |
| Paid-in  capital                                                                                                                                                                           |       | 1,456,788                    |       | 1,452,089                 |       |
| Accumulated  deficit                                                                                                                                                                       |       | (2,155,866                   | )          | (2,158,190                | )          |
| Total  stockholders’ deficit                                                                                                                                                          |       | (698,030                     | )          | (705,053                  | )          |
| Total  liabilities and stockholders’ deficit                                                                                                                                          |       | $                            | 698,061    |                      | $          | 700,572 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                                                                                                | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                | ** ** | **2009**                               | ** ** | **2010** | ** ** |
| Revenue:                                                                                                                  |       |                                   |       |   |   |
| Subscriber fees                                                                                                           |       | $                                      | 15,295     |   | $ | 16,994 |   |
| Advertising                                                                                                               |       | 55,125                                 |       | 51,246 |   |
| Advertising by Hallmark Cards                                                                                             |       | 169                                    |       | 64 |   |
| Other revenue                                                                                                             |       | 363                                    |       | 74 |   |
| Total revenue, net                                                                                                        |       | 70,952                                 |       | 68,378 |   |
| Cost of Services:                                                                                                         |       |                                   |       |   |   |
| Programming costs                                                                                                         |       |                                   |       |   |   |
| Hallmark affiliates                                                                                                       |       | 293                                    |       | 427 |   |
| Non-affiliates                                                                                                            |       | 31,922                                 |       | 28,730 |   |
| Contract termination                                                                                                      |       | —                                 |       | 103 |   |
| Other costs of services                                                                                                   |       | 4,012                                  |       | 2,594 |   |
| Total cost of services                                                                                                    |       | 36,227                                 |       | 31,854 |   |
| Selling, general and  administrative expense (exclusive of depreciation and amortization expense  shown separately below) |       | 12,081                                 |       | 12,028 |   |
| Marketing expense                                                                                                         |       | 4,775                                  |       | 973 |   |
| Depreciation and amortization  expense                                                                                    |       | 483                                    |       | 383 |   |
| Income from operations                                                                                                    |       | 17,386                                 |       | 23,140 |   |
| Interest income                                                                                                           |       | 137                                    |       | 18 |   |
| Interest expense                                                                                                          |       | (24,974                                | )          | (25,482 | ) |
| Net loss and comprehensive  loss                                                                                          |       | $                                      | (7,451     | ) | $ | (2,324 | ) |
| Weighted average number of  Class A and Class B shares  outstanding,  basic and diluted                         |       | 104,788                                |       | 104,788 |   |
| Net loss per share, basic and  diluted                                                                                    |       | $                                      | (0.07      | ) | $ | (0.02 | ) |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

 
| ** **                                                                                | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                | ** ** | **2009**                               | ** ** | **2010** | ** ** |
| CASH  FLOWS FROM OPERATING ACTIVITIES:                                                    | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Net  loss                                                                                 |       | $                                      | (7,451     | ) | $ | (2,324 | ) |
| Adjustments  to reconcile net loss to net cash (used in)provided by operating activities: |       |                                   |       |   |   |
| Depreciation  and amortization                                                            |       | 33,576                                 |       | 30,441 |   |
| Accretion  on company obligated mandatorily redeemable preferred interest                 |       | 520                                    |       | 572 |   |
| Provision  for allowance for doubtful accounts                                            |       | 622                                    |       | 26 |   |
| Loss  on sale of fixed asset                                                              |       | —                                 |       | 2 |   |
| Stock-based  compensation (benefit)                                                       |       | (287                                   | )          | 76 |   |
| Changes  in operating assets and liabilities:                                             |       |                                   |       |   |   |
| (Increase)  decrease in accounts receivable                                               |       | (3,452                                 | )          | 4,751 |   |
| Additions  to program license fees                                                        |       | (54,228                                | )          | (16,902 | ) |
| Increase  in prepaid and other assets                                                     |       | (2,735                                 | )          | (14,058 | ) |
| Increase  (decrease) in accounts payable, accrued and other liabilities                   |       | (3,675                                 | )          | 1,347 |   |
| Increase  in interest payable                                                             |       | 18,960                                 |       | 18,921 |   |
| Increase  (decrease) in license fees payable                                              |       | 17,699                                 |       | (15,131 | ) |
| Increase  in payables to affiliates                                                       |       | 66                                     |       | 50 |   |
| Net  cash (used in) provided by operating activities                                      |       | (385                                   | )          | 7,771 |   |
| CASH  FLOWS FROM INVESTING ACTIVITIES:                                                    |       |                                   |       |   |   |
| Purchases  of property and equipment                                                      |       | (81                                    | )          | (426 | ) |
| (Payments  to) accretion on buyer of international business                               |       | (223                                   | )          | 29 |   |
| Net  cash used in investing activities                                                    |       | (304                                   | )          | (397 | ) |
| CASH  FLOWS FROM FINANCING ACTIVITIES:                                                    |       |                                   |       |   |   |
| Borrowings  under the credit facility                                                     |       | 12,391                                 |       | — |   |
| Principal  payments on the credit facility                                                |       | (8,934                                 | )          | (1,000 | ) |
| Principal  payments on capital lease obligations                                          |       | (196                                   | )          | (215 | ) |
| Net  cash provided by (used in) financing activities                                      |       | 3,261                                  |       | (1,215 | ) |
| Net  increase in cash and cash equivalents                                                |       | 2,572                                  |       | 6,159 |   |
| Cash  and cash equivalents, beginning of period                                           |       | 2,714                                  |       | 10,456 |   |
| Cash  and cash equivalents, end of period                                                 |       | $                                      | 5,286      |   | $ | 16,615 |   |
|                                                                                      |       |                                   |       |   |   |
| Supplemental  disclosure of cash and non-cash activities:                                 |       |                                   |       |   |   |
| Interest  paid                                                                            |       | $                                      | 4,717      |   | $ | 5,354 |   |
| Reduction  of additional paid-in capital for obligation undertax sharing agreement        |       | $                                      | 2,800      |   | $ | 4,699 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**For the Three Months Ended March 31,2009 and 2010**

 

**1. Business and Organization**

 

***Organization***

 

Crown Media Holdings, Inc.(“Crown Media Holdings” or the “Company”), through its wholly-owned subsidiary,Crown Media United States, LLC (“Crown Media United States”), owns and operatespay television channels (collectively the “Channels” or the “channels”)dedicated to high quality, entertainment programming for adults and families,in the United States. Significant investors in Crown Media Holdings includeHallmark Entertainment Investments Co. (“Hallmark Entertainment Investments”),a subsidiary of Hallmark Cards, Incorporated (“Hallmark Cards”), the NationalInterfaith Cable Coalition, Inc. (“NICC”), the DIRECTV Group, Inc.and, indirectly through their investments in Hallmark EntertainmentInvestments, Liberty Media Corporation (“Liberty Media”) and J.P. MorganPartners (BHCA), L. P. (“J.P. Morgan”).

 

The Company’s continuing operations are currently organized into oneoperating segment, the channels.

 

***Recent Developments***

 

*Recapitalization of the Company*

 

In thesecond quarter of 2009, the Company’s Board of Directors formed a SpecialCommittee of three independent directors to review and consider a May 28,2009 proposal from H C Crown Corp. (“HC Crown”) regarding a recapitalization ofthe amounts owed by the Company to HC Crown and its affiliates.  HC Crown is a wholly-owned subsidiary ofHallmark Cards.  On February 9,2010, the Special Committee of the Board and HC Crown approved and executed aRecapitalization Term Sheet, representing non-binding terms of recapitalizationtransactions for the Company.  On February 26,2010, the Company entered into the Master Recapitalization Agreement withHallmark Cards, HC Crown and related entities that provides for therecapitalization transactions and the agreements described below (the “Recapitalization”).  The summary of the terms of theRecapitalization transactions is qualified entirely by reference to theagreements to which each summary description relates, each of which we havefiled with the Securities and Exchange Commission (the “SEC”).

 

TheRecapitalization transactions include, among other things, $315.0 millionprincipal amount of the HC Crown Debt (as defined below) being restructuredinto new debt instruments, $185.0 million principal amount of the HC Crown Debtbeing converted into convertible preferred stock of the Company, Class BCommon Stock being converted into Class A Common Stock with Class ACommon Stock becoming the only authorized and outstanding common stock of theCompany (the “Class A Common Stock”), and the balance of the HC Crown Debtbeing converted into shares of Class A Common Stock.  Upon execution of the Master RecapitalizationAgreement, the automatic termination of the waiver under the existing Amendedand Restated Waiver and Standby Purchase Agreement (the “Waiver Agreement”)with Hallmark Cards and HC Crown was extended until August 31, 2010; theWaiver Agreement defers payment dates on HC Crown Debt (excluding accountspayable).

 

“HC Crown Debt”means (i) the aggregate principal amount of all indebtednessowed to Hallmark Cards, HC Crown and their controlled affiliates, includingaccrued and unpaid interest thereon through the closing date, but excludingaccrued but unpaid interest with respect to the 2001 Note, the 2005 Note andthe 2006 Note; (b) all accounts payable and open intercompany accounts ofthe Company and its subsidiaries owed to HC Crown and Hallmark Cards and theircontrolled affiliates (other than the Company and its subsidiaries); and (c) anyamounts due to Hallmark Cards or its affiliates under the Tax SharingAgreement (as described below) through December 31, 2009; provided thatfor the avoidance of doubt the following shall not constitute HC CrownDebt:  (i) Reimbursement Obligations(as defined in the Master Recapitalization Agreement), (ii) OrdinaryCourse of Business Obligations (as defined in the Master RecapitalizationAgreement), and (iii) any amounts due to Hallmark Cards or its affiliatesunder the Tax Sharing Agreement accruing on or after January 1, 2010.  “2001Note” means the 

 

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Promissory Note, dated asof December 14, 2001, of the Company in the original principal amount of$75.0 million payable to HC Crown; “2005 Note” means the Promissory Note, datedas of October 1, 2005, of a wholly-owned subsidiary of the Company in theoriginal principal amount of $132.8 million payable to HC Crown; and “2006 Note”means the Promissory Note, dated as of March 21, 2006, of the Company inthe original principal amount of $70.4 million payable to HC Crown.

 

The Company estimates that the “Conversion Price” (as defined in theMaster Recapitalization Agreement) will be $2.5969, and that if theRecapitalization transactions were to close on May 31, 2010, the Companywould issue Preferred Stock and Class A Common Stock as follows:

 

· to HC Crown 185,000 shares of Preferred Stock with aliquidation preference of $1,000 per share and an initial estimated conversionprice of $2.5969 (which is subject to future adjustments as provided in theCertificate of Designation), which shares would be convertible into anestimated 71,238,785 shares of Class A Common Stock at such ConversionPrice;

· to HC Crown a number of shares of Class A CommonStock equal to the HC Crown Debt on the closing of the Recapitalization (the “ClosingDate”) (which is expected to be approximately $1.2 billion) less $500.0 milliondivided by the estimated Conversion Price, or an estimated 252,451,757 sharesof Class A Common Stock; and

· as a result of the mergers of each of Hallmark Entertainment Investments Co. andHallmark Entertainment Holdings (“HEIC” and “HEH”) with and into theCompany, to HC Crown, Liberty Crown, Inc., VISN Management Corp. and JPMorgan Partners (BHCA), L.P., in the aggregate, 83,817,071 shares of Class ACommon Stock and will cancel 83,817,071 shares of the Company’s Class Aand Class B Common Stock owned currently by HEIC.

 

The actualConversion Price may differ from $2.5969 per share as a result of a number offactors, including the final determination of HC Crown Debt as of March 31,2010. The actual number of shares of Class A Common Stock issued inexchange for HC Crown Debt may differ from the number stated above as a resultof (a) an actual closing date other than May 31, 2010, (b) thefinal determination of HC Crown Debt as of the actual closing date, and (c) thedifference, if any, in the actual Conversion Price and the estimated ConversionPrice of $2.5969 per share.

 

Immediately following the Recapitalization transactions, assuming aclosing date of May 31, 2010, and based on the assumptions set forthabove, HC Crown will hold an estimated 322,449,413 shares of Class ACommon Stock (including shares of Class A Common Stock currently helddirectly by HC Crown, but excluding shares of Class A Common Stockissuable upon conversion of the Preferred Stock).

 

Otheraspects of the Recapitalization concern: a credit agreement for the new debt;an amendment to the Tax Sharing Agreement with Hallmark Cards; a registrationrights agreement; efforts to extend or replace the Company’s revolving line ofcredit; Hallmark Cards’ willingness to guarantee $30.0 million of a revolvingline of credit; a standstill agreement of Hallmark entities pursuant to whichsuch entities agree not to acquire, through December 31, 2013, additionalshares of Class A Common Stock of the Company, subject to certainexceptions, and agree to certain restrictions on their ability to sell ortransfer shares of Class A Common Stock of the Company until December 31,2013 and, subject to lesser restrictions, until December 31, 2020; andauthority to implement a reverse stock split if recommended by a committee ofdisinterested, independent directors.

 

Eachof the Company (subject to approval by the Special Committee) and HC Crown hasthe right to terminate the Master Recapitalization Agreement at any time afterthe later of (x) June 30, 2010 and (y) 45 days following receiptof notice that the information statement filed by the Company will not bereviewed by the SEC or that the SEC staff has no further comments thereon, ifthe Recapitalization has not been consummated prior to that date.  Even if there were such a termination, theWaiver Agreement will continue to provide that the automatic termination dateof the waiver will extend to August 31, 2010.  The closing of the Recapitalization issubject to a number of conditions, including, among other things, (a) representationsand warranties of the Company being accurate, (b) there being noinjunction or action by any court or other governmental entity preventing theconsummation of the Recapitalization transactions which has not been vacated,dismissed or withdrawn prior to the completion of the Recapitalizationtransactions, (c) the Company’s obtaining a revolving credit agreement ofat least $30.0 million and a term of at least 360 days from theclosing, (d) Hallmark Cards not having delivered a notice that HallmarkCards, in its sole discretion (but after consultation with legal counsel),shall have determined that the status of any pending or threatened litigation(including, without limitation, the action styled *S. Muoio &Co. LLC v. Abbott et al*, C.A. No. 4729-CC (Del. Ch.)) or regulatoryproceeding relating to the Recapitalization transactions is unsatisfactory toHallmark Cards and (e) the satisfaction or waiver of the conditions to theeffectiveness of the new credit agreement.

 

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If theRecapitalization has not been consummated by August 31, 2010, the WaiverAgreement would terminate automatically with the effect that approximately $1.2billion of the HC Crown Debt which would be otherwise restructured in theRecapitalization would become due and payable.

 

HallmarkCards and the Company are working with a major bank on the extension of theCompany’s revolving credit facility. However, there can be no assurance thatthe Company will obtain such an extension or a new revolving credit facility,either in a form satisfactory for the requirements of the MasterRecapitalization Agreement or prior to the dates on which the MasterRecapitalization Agreement can be terminated by a party. See Note 11 forinformation regarding a pending lawsuit on the Recapitalization in which theplaintiff objects to the Recapitalization. So long as any litigation or regulatory proceeding is threatened orpending, Hallmark can unilaterally prevent the consummation of theRecapitalization by virtue of the closing conditions in the MasterRecapitalization Agreement.

 

Fromthe date of the Master Recapitalization Agreement to the Closing Date, theCompany will be subject to various affirmative covenants (including covenantsto operate in the ordinary course of business and to keep available theservices of its officers and employees and preserve the present relationshipswith persons doing business with it) as well as various negative covenants(including, among others, with respect to sales, leases or transfers outsidethe ordinary course of business and acquisitions of material assets other thanin accordance with past practices).

 

If theRecapitalization is consummated, the Hallmark parties will own, excluding theshares of Class A Common Stock that would be received upon conversion ofthe preferred stock, at least 90.1% of the sum of the outstanding common stockof the Company and shares subject to outstanding options (there beingoutstanding options for the issuance of up to 85,813 shares of Class ACommon Stock as of March 31, 2010). Certain aspects of the Recapitalization require stockholderapproval.  Hallmark EntertainmentHoldings, Inc. (“HEH”) and certain Hallmark Cards affiliates as direct orindirect owners of a more than a majority of the Company’s voting stock have providedin the Master Recapitalization Agreement, or will provide, their writtenconsents as stockholders to these matters in lieu of holding a meeting of theCompany’s stockholders.  No vote of otherstockholders will be requested or required. The closing of the Recapitalization cannot occur until 20 calendar daysafter an information statement required by regulations of the SEC is sent tothe stockholders of the Company, or if such information statement is furnishedby sending a Notice of Internet Availability, until 40 calendar days after suchnotice is sent to the stockholders of the Company.   Pursuant to the Master RecapitalizationAgreement, the Company filed the preliminary information statement with the SECon March 29, 2010.

 

Additional information about the Recapitalization is set forth in theCompany’s Annual Report on Form 10-K for the year ended December 31,2009, including in Note 1 to the Consolidated Financial Statements in thatReport.

 

***Martha Stewart Agreement***

 

In January 2010, CrownMedia United States, LLC entered into a multi-year agreement with MarthaStewart Living Omnimedia, Inc. (“Martha Stewart Living”) to exclusivelytelevise original episodes of the popular daytime home and lifestyle series *The Martha Stewart Show* on Hallmark Channel beginning September 2010.As part of the agreement, Martha Stewart Living will also develop a range ofnew and original series and prime time specials that will complement HallmarkChannel’s schedule.  Beginning in thefall of 2010, Mondays through Fridays, *The Martha Stewart Show*,will be presented 10 a.m. to 11 a.m. (ET/PT), kicking off atwo-and-half-hour block of original Martha Stewart programming.  Following *The Martha Stewart Show*,from 11 a.m. to 12:30 p.m. (ET/PT) each weekday, the Hallmark Channelwill present exclusive original programming currently in development at MarthaStewart Living that will feature a portfolio of creative content for which theMartha Stewart brand is known and which will showcase experts and personalitiesfrom within Martha Stewart Living. Additionally, Martha Stewart Living will develop numerous holiday andinterview specials for prime time on the network.

 

With respect to *The Martha StewartShow*, the agreement constitutes a collaborative arrangement foraccounting purposes.  The Company will provide broadcast time and beresponsible for most advertising sales activities except product integration. Martha Stewart Living will produce the program content at its sole expense forwhich it will be entitled to receive 100% of all related advertising revenueuntil it has recovered its direct production, delivery and reasonably allocatedoverhead costs, the sum of which shall not exceed $25.0 million, representingits production, delivery and allocated overhead costs per broadcast season,subject to 10% escalations per season.  Martha Stewart Living may thenadditionally recover certain equipment acquisition costs not to exceed $750,000per season.  Subsequent advertisingrevenue, if any, in the same season will be allocated 90%/10% in favor of the

 

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Company until theCompany has recovered $10.0 million, subject to 8% escalations perseason.  Thereafter, in the same season, advertising revenue, if any, willbe allocated 50%/50%.  After the initial broadcast season, renewals for upto two additional seasons are generally at the option of Martha Stewart Living.The Company’s commitments for the other program content require the payment ofprogram license fees and, in some cases, equal sharing of advertising revenueonly after the Company has recovered such costs along with a reasonable valuefor airtime.

 

In March 2010, the Company acquired an exclusive license fordomestic television rights to extensive lifestyle programming from the libraryof Martha Stewart Living. The content will be used in various dayparts tointroduce home and lifestyle programming to Hallmark Channel viewers.  Hallmark Channel’s lineup with thisprogramming includes episodes from the library programs “From Martha’s Kitchen,”“From Martha’s Home” and “From Martha’s Garden.”  Other titles in the library, but not yetscheduled, are “Petkeeping with Marc Morrone,” early seasons of “Everyday Food,”“Martha Stewart Living” and assorted specials.

 

***Liquidity***

*** ***

As of March 31,2010, the Company had $16.6 million in cash and cash equivalents on hand and$30.0 million of borrowing capacity under the bank credit facility.  Day-to-day cash disbursement requirementshave typically been satisfied with cash on hand and operating cash receiptssupplemented with the borrowing capacity available under the bank creditfacility and forbearance by Hallmark Cards and its affiliates.  The Company’s management anticipates that theprincipal uses of cash up to August 31, 2010, will include the payment ofoperating expenses, accounts payable and accrued expenses, programming costs,costs incurred in connection with the Recapitalization, interest and repaymentof principal under the bank credit facility and interest of approximately $15.0million to $18.0 million due under certain notes to Hallmark Cards affiliatesfrom January 1 through August 31, 2010.  The amounts outstanding under the bank creditagreement and those notes to Hallmark affiliates are due August 31, 2010, asdiscussed below.

 

The Company generatedpositive cash flows from operating activities for the year ended December 31,2009, and the three months ended March 31, 2010.  As indicated below, there can be no assurancethat the Company’s operating activities will generate positive cash flow infuture periods.

 

Another significantaspect of the Company’s liquidity is the deferral of payments on obligationsowed to Hallmark Cards and its subsidiaries. Under the Waiver Agreement, thedeferred payments under such obligations are extended to August 31,2010.  These obligations comprised $345.2million at March 31, 2010.  Anadditional $778.0 million (10.25% Senior Secured Note) of principal andinterest outstanding at March 31, 2010, payable to a Hallmark Cards’ affiliatein August 2011, is also subject to the Waiver Agreement until August 31,2010.  Interest amounts related to the10.25% note will be added to principal through August 5, 2010.  The deferral of payments under the WaiverAgreement terminates on August 31, 2010. Hallmark Cards and its affiliates have no obligation, and have stated anintention not to extend this waiver termination date. The note purchaseagreement for the senior note provides that if there is an event of defaultwith respect to any other indebtedness in excess of $5.0 million, the accretedvalue and any accrued and unpaid interest on the senior note would become dueand payable.

 

At March 31, 2010,the Company had no liability under the credit facility. The Company’s abilityto pay amounts outstanding under the bank credit facility on the maturity dateis highly dependent upon its ability to generate sufficient, timely cash flowfrom operations between January 1 and the earlier of August 31, 2010,or the date on which the Recapitalization is consummated.  There is uncertainty regarding the Company’sfuture advertising revenues, so it is possible that cash flows may be less thanthe expectations of the Company’s management.

 

Upon maturity of thecredit facility on August 31, 2010, to the extent the facility has notbeen paid in full, renewed or replaced, the Company could exercise its optionunder the Waiver Agreement and require Hallmark Cards to purchase the interestof the lending bank in the facility.  Inthat case, Hallmark Cards would have all the obligations and rights of thelending bank under the bank credit facility and could demand payment ofoutstanding amounts at any time after August 31, 2010, under the terms ofthe Waiver Agreement.

 

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The Company believesthat cash on hand, cash generated by operations, and borrowing availabilityunder its bank credit facility through August 31, 2010, when combined with(1) the deferral of otherwise required payments under the 10.25% SeniorSecured Note related-party debt and the tax sharing agreement, and (2) ifnecessary, Hallmark Cards’ purchase of any outstanding indebtedness under thebank credit facility on August 31, 2010 will be sufficient to fund theCompany’s operations and enable the Company to meet its liquidity needs untilthe earlier of August 31, 2010 or the closing of the Recapitalizationdescribed above in this Note 1.

 

As discussed above, theCompany has entered into the Master Recapitalization Agreement for theRecapitalization transactions, including the exchange of existing debt owed toH C Crown Corp. for new debt, preferred stock and common stock.  It is a condition of the Recapitalizationthat the Company have obtained a revolving credit facility from a third-partylender, guaranteed by Hallmark Cards or one of its affiliates, with a term ofnot less than 360 days of the closing date of the Recapitalization, with theavailability of at least $30.0 million and on other terms and conditionsreasonably acceptable to the Company.  Ifthe Recapitalization is closed as contemplated at this time, the Companybelieves that cash on hand, cash generated by operations and borrowingavailability under the contemplated revolving credit facility will besufficient to fund the Company’s operations and enable the Company to meet itsliquidity needs until at least March 31, 2011.

 

Also, as discussedabove, the form of credit agreement with HC Crown and other Hallmark Cardaffiliates in the Recapitalization requires that, prior to closing of thecredit agreement, the Company establish the NICC Reserve Account in the Company’sname for amounts that the Company may choose as a sinking fund with respect tothe $25.0 million payable by December 31, 2010, for the redemption of thepreferred interest in Crown Media United States.  The preferred interestis held by VISN Management Corp. (“VISN”), a wholly-owned subsidiary ofNICC.  At no time may the amounts in the NICC Reserve Account exceed $25.0million.  In order to redeem the preferred interest, the Company may needto borrow up to $25.0 million under the bank credit facility.

 

The sufficiency of theexisting sources of liquidity to fund the Company’s operations is dependentupon maintaining subscriber and advertising revenue at or near the amount ofsuch revenue for the year ended December 31, 2009, and consummation of theRecapitalization. A significant decline in the popularity of the Channels, aneconomic decline in the advertising market, an increase in program acquisitioncosts, an increase in competition or other adverse changes in operatingconditions could negatively impact the Company’s liquidity and its ability tofund the current level of operations.

 

The closing of the Recapitalization is subject to anumber of conditions, including, among other things, (a) representationsand warranties of the Company being accurate, (b) there being noinjunction or action by any court or other governmental entity preventing theconsummation of the Recapitalization transactions which has not been vacated,dismissed or withdrawn prior to the completion of the Recapitalizationtransactions, (c) the Company’s obtaining a revolving credit agreement ofat least $30.0 million and a term of at least 360 days from theclosing, (d) Hallmark Cards not having delivered a notice that HallmarkCards, in its sole discretion (but after consultation with legal counsel),shall have determined that the status of any pending or threatened litigation(including, without limitation, the action styled *S. Muoio &Co. LLC v. Abbott et al*, C.A. No. 4729-CC (Del. Ch.)) orregulatory proceeding relating to the Recapitalization transactions isunsatisfactory to Hallmark Cards and (e) the satisfaction or waiver of theconditions to the effectiveness of the new credit agreement.  If for any reason the Recapitalization is notconsummated, the Company would be unable to meet its obligations which becomedue on August 31, 2010, which provides substantial doubt about the Company’sability to continue as a going concern. In addition, it is unlikely that the Company could obtain, without aguarantee or other support of Hallmark Cards, other equity or debt financingprior to August 31, 2010 in order to replace or refinance obligationsbecoming due on that date.  This is theview of the special committee which considered and negotiated theRecapitalization.  Accordingly, the Companybelieves the ability of the Company to continue its operations depends uponcompletion of the Recapitalization.

 

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

 

***InterimFinancial Statements***

 

In the opinion ofmanagement, the accompanying condensed consolidated balance sheets and relatedinterim condensed consolidated statements of operations and cash flows includeall adjustments, consisting of normal recurring items necessary for their fairpresentation in conformity with accounting principles generally accepted in theUnited States. Interim results are not necessarily indicative of results for afull year. These condensed consolidated financial statements should be read inconjunction with the audited consolidated financial statements and the notes tothose statements for the year ended December 31, 2009, included in theCompany’s Annual Report

 

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on Form 10-K for the year ended December 31, 2009.

 

***Basis of Presentation***

 

The condensed consolidatedfinancial statements include the accounts of Crown Media Holdings and itswholly-owned subsidiaries. All significant intercompany balances andtransactions have been eliminated in consolidation.

 

The preparation of financial statements in accordance with generallyaccepted accounting principles requires the consideration of events ortransactions that occur after the balance sheet date but before the financialstatements are issued. Depending on the nature of the subsequent event, financialstatement recognition or disclosure of the subsequent event is required.  Subsequent events have been evaluated.

 

***Use of Estimates***

 

The preparation of the accompanying consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions about future events. These estimates and the underlying assumptionsaffect the amounts of assets and liabilities reported, disclosures aboutcontingent assets and liabilities, and reported amounts of revenues andexpenses. Such estimates include the collectability of accounts receivable, thevaluation of goodwill, intangible assets, and other long-lived assets, legalcontingencies, indemnifications, and assumptions used in the calculation ofincome taxes, among others. These estimates and assumptions are based onmanagement’s best estimates and judgment. Management evaluates its estimatesand assumptions on an ongoing basis using historical experience and otherfactors, including the current economic environment, which management believesto be reasonable under the circumstances. Management adjusts such estimates andassumptions when facts and circumstances dictate. Illiquid credit markets,volatile equity, foreign currency, and energy markets, and declines in consumerspending have combined to increase the uncertainty inherent in such estimatesand assumptions. As future events and their effects cannot be determined withprecision, actual results could differ significantly from these estimates.Changes in those estimates resulting from continuing changes in the economicenvironment will be reflected in the financial statements in future periods.

 

***Allowance for Doubtful Accounts***

 

The allowance for doubtfulaccounts is based upon the Company’s assessment of probable loss related touncollectible accounts receivable.  TheCompany uses a number of factors in determining the allowance, including, amongother things, collection trends. The Company’s bad debt expense was $622,000and $26,000 for the three months ended March 31, 2009 and 2010,respectively.

 

***Fair Value ofFinancial Instruments***

 

Financial Accounting Standards Board (“FASB”)Accounting Standards Codification (the “ASC”) Topic 820, *Fair ValueMeasurements and Disclosures*, provides guidance which defines fairvalue, establishes a framework for measuring fair value and specifiesdisclosures about fair value measurements.  On January 1, 2008we adopted that portion of the standard that relates to those nonfinancialassets and liabilities which are recognized or disclosed at fair value on arecurring basis (that is, at least annually).  On January 1, 2009,subject to the FASB’s delayed implementation, we adopted the remainingprovisions of the standard.  Afteradoption, we now determine fair value as an exit price, representing the pricethat would be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants.

 

The Company does not have balance sheet items carriedat fair value on a recurring basis such as derivative financial instrumentswhich are valued primarily based on quoted prices in active or brokered marketsfor identical as well as similar assets and liabilities. Significant balancesheet items which are subject to non-recurring fair valuemeasurements consist of impairment valuations of goodwill and property andequipment. The standard has not had a significant impact on the determinationof fair value related to non-financial assets and non-financial liabilities in2010.

 

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***Net Loss per Share***

 

Basic net loss per share iscomputed by dividing the net loss for the period by the weighted average numberof common shares outstanding during the period. Diluted net loss per share iscomputed based on the weighted average number of common shares and potentiallydilutive common shares outstanding. The calculation of diluted net loss pershare excludes potential common shares if the effect would be antidilutive.Potential common shares consist of incremental common shares issuable upon theexercise of stock options. Approximately 341,000 and 86,000 stock options forthe three months ended March 31, 2009 and 2010, respectively, have beenexcluded from the calculations of earnings per share because their effect wouldhave been antidilutive.

 

***Concentration of Credit Risk***

 

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

 

Five of our distributors each accounted for more than10% of our consolidated subscriber revenue for both the three months ended March 31,2009 and 2010, and together accounted for a total of 76% and 73% of consolidatedsubscriber revenue during the three months ended March 31, 2009 and 2010,respectively.  Three of our distributorseach accounted for approximately 15% or more of our consolidated subscribersfor the three months ended March 31, 2009 and 2010, respectively, andtogether accounted for 62% and 60% of our subscribers during the three monthsended March 31, 2009 and 2010, respectively.

 

Four of our programming content providers eachaccounted for more than 10% of our total license fee payable for both the threemonths ended March 31, 2009 and 2010, and together accounted for a totalof 77% and 74% of the consolidated programming liability, respectively.

 

***Recently Issued Accounting Pronouncements***

 

In October 2009, the FASB issued Accounting Standards Update,2009-13, Revenue Recognition (ASC Topic 605): *MultipleDeliverable Revenue Arrangements — A Consensus of the FASB Emerging Issues TaskForce.* This update provides application guidance on whether multipledeliverables exist, how the deliverables should be separated and how theconsideration should be allocated to one or more units of accounting. Thisupdate establishes a selling price hierarchy for determining the selling priceof a deliverable. The selling price used for each deliverable will be based onvendor-specific objective evidence, if available, third-party evidence ifvendor-specific objective evidence is not available, or estimated selling priceif neither vendor-specific or third-party evidence is available. The Companywill be required to apply this guidance for fiscal years beginning on or after June 15,2010, prospectively for revenue arrangements entered into or materiallymodified after January 1, 2011; however, earlier application is permitted.The Company has not determined the impact that this update may have on itsfinancial statements.

 

In January 2010, the FASB issued guidance that requires reportingentities to make new disclosures about recurring or nonrecurring fair-valuemeasurements including significant transfers into and out of Level 1 and Level2 fair value measurements and information on purchases, sales, issuances, andsettlements on a gross basis in the reconciliation of Level 3 fair valuemeasurements. The guidance is effective for annual reporting periods beginningafter December 15, 2009, except for Level 3 reconciliation disclosuresthat are effective for annual periods beginning after December 15, 2010.The adoption of this guidance did not have a material impact on ourconsolidated financial statements.

 

***Health Care Reform***

 

During the first quarter of 2010, the U.S. Congresspassed and the President signed into law the Patient Protection and AffordableCare Act as well as the Health Care and Education Reconciliation Act of 2010,which

 

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representsignificant changes to the current U.S. health care system. The legislation isfar-reaching and is intended to expand access to health insurance coverage overtime by increasing the eligibility thresholds for most state Medicaid programsand providing certain other individuals and small businesses with taxincentives to subsidize a portion of the cost of health insurance coverage. Thelegislation includes a requirement that most individuals obtain healthinsurance coverage beginning in 2014 and that most large employers offercoverage to their employees or they will be required to pay a financialpenalty. Some of the more significant changes, including the requirement thatindividuals obtain coverage, do not become effective until 2014 or later. It istoo early to fully understand the impacts of the legislation on our business.

 

**3. Program License Fees**

 

Program license fees arecomprised of the following:

 
| ** **                                             | ** ** | **As of  December 31,** | ** ** | **As of  March 31,** | ** ** |
|--------------------------------------------------------|------------|------------------------------|------------|---------------------------|------------|
| ** **                                             | ** ** | **2009**                     | ** ** | **2010**                  | ** ** |
| ** **                                             | ** ** | **(In  thousands)**          | ** ** |
| Program  license fees — non-affiliates            |       | $                            | 597,206    |                      | $          | 589,568 |   |
| Program  license fees — Hallmark Cards affiliates |       | 12,668                       |       | 13,768                    |       |
| Program  license fees, at cost                         |       | 609,874                      |       | 603,336                   |       |
| Accumulated  amortization                              |       | (324,717                     | )          | (330,435                  | )          |
| Program  license fees, net                             |       | $                            | 285,157    |                      | $          | 272,901 |   |

 

At December 31,2009, and March 31, 2010, $1.8 million and $13.0 million, respectively, ofprogram license fees were included in prepaid and other assets on theaccompanying condensed consolidated balance sheets as the Company made paymentsfor the program license fees prior to commencement of the respective licenseperiods.

 

License fees payable arecomprised of the following:

 
| ** **                                             | ** ** | **As of  December 31,** | ** ** | **As of  March 31,** | ** ** |
|--------------------------------------------------------|------------|------------------------------|------------|---------------------------|------------|
| ** **                                             | ** ** | **2009**                     | ** ** | **2010**                  | ** ** |
| ** **                                             | ** ** | **(In  thousands)**          | ** ** |
| License  fees payable — non-affiliates            |       | $                            | 171,966    |                      | $          | 156,053 |   |
| License  fees payable — Hallmark Cards affiliates |       | 10,409                       |       | 11,193                    |       |
| Total  license fees payable                            |       | 182,375                      |       | 167,246                   |       |
| Less  current maturities                               |       | (99,494                      | )          | (93,594                   | )          |
| Long-term  license fees payable                        |       | $                            | 82,881     |                      | $          | 73,652 |   |

 

In the regular course of evaluating the remaining usefulness of itsvarious program licenses, the Company may determine that certain licenses maybe of little future program value to it. In such instances, the Company shortens the estimated remaining lives tozero, thereby accelerating amortization of the remaining net book value.  During the three months ended March 31,2010, such changes in estimates resulted in additional amortization of programlicense fees of $227,000; the Company made no such changes in estimates duringthe three months ended March 31, 2009.

 

**4. Credit Facility**

 

ByAmendment No. 16 on March 2, 2010, to the credit agreement withJPMorgan Chase Bank, the maturity date of the bank credit facility was extendedto August 31, 2010.  Additionally,in connection with Recapitalization agreements, the Company and the Bank setthe maximum amount that could be borrowed under the bank credit facility at$30.0 million.

 

Thefacility is guaranteed by Hallmark Cards and the Company’s subsidiaries and issecured by all tangible and intangible property of Crown Media Holdings and itssubsidiaries. Interest on the credit facility is the Eurodollar rate plus 2.25%or the alternate base rate plus 1.25%. The Company’s ability to borrow additional amounts under the creditfacility is not otherwise limited or restricted.

 

At December 31, 2009, and March 31, 2010,the Company had outstanding borrowings of $1.0 million and $0, respectively,under the credit facility and there were no letters of credit outstanding. At December 31,2009, all of

 

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the outstanding balance bore interest at the Eurodollar rate (2.49%weighted average rate at December 31, 2009). Interest expense on borrowings under the credit facility for each of thethree months ended March 31, 2009 and 2010, was $108,000 and $4,000,respectively.

 

***Covenants***

 

The credit facility, as amended, contains a number of affirmative andnegative covenants.  The Company was incompliance with these covenants at March 31, 2010.

 

**5. Related Party Long-TermObligations**

 

Since March 2006, substantially all of the Company’s borrowingshave been subject to a Waiver and Standby Purchase Agreement between theCompany, Hallmark Cards and affiliates of Hallmark Cards who hold obligationsof the Company.  Pursuant to the MasterRecapitalization Agreement which included an amendment to the Amended andRestated Waiver and Standby Purchase Agreement (as amended, the “WaiverAgreement”), the waiver termination date was extended to August 31, 2010when the Waiver Agreement automatically terminates (thus concluding the “WaiverPeriod”).  The Waiver Agreement issubject to early termination upon the occurrence of one or more eventsdescribed below, whereupon all deferred amounts would become immediately dueand payable.  The Waiver Agreement deferspayments (excluding interest on the 2001, 2005 and 2006 notes, described below,accruing subsequent to November 15, 2008) otherwise due on any of thefollowing obligations (the “Subject Obligations”) until August 31,2010.  The Waiver Agreement also providesthat interest accruing on the 10.25% Note through August 5, 2010, will beadded to principal.

 

·                                          Note and interest payable to HC Crown,dated December 14, 2001, in the original principal amount of $75.0million, payable to HC Crown. (Total amount outstanding at December 31,2009, and March 31, 2010, including accrued interest was $110.0 millionand $110.0 million, respectively. See *Note and Interest Payableto HC Crown*below.)

 

·                                          $70.0 million note and interest payableto Hallmark Cards affiliate, dated as of March 21, 2006. (Total amount outstanding at both December 31,2009, and March 31, 2010, including accrued interest was $62.8 million.See *Note and Interest Payable to Hallmark CardsAffiliate*below.)

 

·                                          10.25% senior secured note, dated August 5, 2003, in the initial accreted value of $400.0million, payable to HCCrown.  (Total amount outstanding at December 31,2009, and March 31, 2010, including accrued interest was $758.8 millionand $778.0 million, respectively. See *Senior Secured Note*below.)

 

·                                          Note and interest payable to Hallmark Cards affiliate, datedas of October 1, 2005, in the principal amount of $132.8 million.(Total amount outstanding at December 31, 2009, and March 31, 2010,including accrued interest was $172.4 million and $172.3 million, respectively.See *Note and Interest Payable to Hallmark CardsAffiliate*below.)

 

·                                          All obligations of the Company under thebank credit facility by virtue of Hallmark Cards’ deemed purchase ofparticipations in all of the obligations under a guarantee which Hallmark Cardshas given in support of the facility or the purchase by Hallmark Cards of allthese obligations pursuant to the bank credit facility.

 

·                                          Any and all amounts dueand owing to Hallmark Cards pursuant to the Tax Sharing Agreement (Total amountoutstanding at December 31, 2009, and March 31, 2010, was $8.5million and $13.2 million, respectively.).

 

Interest will continue to accrue on these obligations during the WaiverPeriod and is payable as indicated above. The Waiver Agreement also contains certain covenants, including but notlimited to (1) the Company’s covenant not

 

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to take any action(including the issuance of new stock or options) that would prohibit theCompany from being included as a member of Hallmark Cards consolidated federaltax group, (2) compliance with obligations in the loan documents for thebank credit facility and (3) commercially reasonable efforts to refinancethe obligations subject to the Waiver Period. Pursuant to the Waiver Agreement, the Company must make prepayments onthe outstanding debt from 100% of any “Excess Cash Flow” during the WaiverPeriod.  There was Excess Cash Flow of$7.7 million for the year ended December 31, 2009, of which $4.6 millionof interest on the 2001, 2005 and 2006 Notes was remitted to a Hallmark Cards’affiliate on January 5, 2010. Pursuant to the Master RecapitalizationAgreement, we have not made payments representing the remaining amounts ofExcess Cash Flow for 2009.  Paymentcontinues to be deferred under the extension of the Waiver Agreement. There wasExcess Cash Flow of $11.9 million for the three months ended March 31,2010, of which $4.5 million of interest on the 2001, 2005 and 2006 Notes wasremitted to a Hallmark Cards’ affiliate on April 2, 2010. Pursuant to theMaster Recapitalization Agreement, we have not made payments representing theremaining amounts of Excess Cash Flow for 2010.

 

The Waiver Agreement is subject to early termination upon occurrence ofcertain events including but not limited to the following:  (a) the Company fails to pay anyprincipal 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; or (b) the Company fails to pay intereston the bank credit facility described above to the extent that Hallmark Cardshas purchased all or a portion of the indebtedness thereunder or to perform anycovenants in the Waiver Agreement.

 

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

 

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

 

Hallmark Cards has provided to the lending bank under the creditfacility the Hallmark Cards facility guarantee. The guarantee is unconditional for obligations of the Company under thebank credit facility.  If any payment ismade on the guarantee, it will be treated as a purchase of the lending bank’sinterest in the credit facility. Prior to April 2009, Hallmark Cards’credit support for the Company’s bank credit facility consisted of supplying aletter of credit.

 

The above mentioned credit support provided by Hallmark Cards resultedin reductions in the interest rate and commitment fees under the creditfacility; however, the Company agreed to pay and has paid an amount equal tothe reductions in the interest rate and commitment fees to Hallmark Cards.  On April 1, 2009, the interest rate andcommitment fees under the renewed credit facility increased and we began payingHallmark Cards a smaller reduction amount of the interest rate and commitmentfees equal to 0.75% and 0.125%. Commitment fee expense for the three monthsended March 31, 2009 and 2010, was $12,000 and $15,000, respectively.

 

***Senior SecuredNote***

 

In August 2003,the Company issued a senior note to HC Crown for $400.0 million. In accordancewith the Waiver Agreement, cash payments for interest will not be requireduntil February 5, 2011 (which is the first payment date after August 31,2010). The principal amount of the senior secured note accretes at 10.25% perannum, compounding semi-annually, to August 5, 2010.  From that date, interest at 10.25% per annumis scheduled to be payable semi-annually in arrears on the accreted value ofthe senior note to HC Crown on February 5, 2011, and upon maturity on August 5,2011. The senior note is pre-payable without penalty. At December 31,2009, and March 31, 2010, $758.8 million and $778.0 million, respectively,of principal and interest were included in the senior note payable in theaccompanying consolidated balance sheets. The note purchase agreement for thesenior note provides that if there is an event of default with respect to anyother indebtedness in excess of $5.0 million, the accreted value and anyaccrued and unpaid interest on the senior note would become due and payable.Further, the

 

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note purchaseagreement contains certain restrictive covenants which, among other things,prevent the Company from incurring any additional indebtedness, purchasing orotherwise acquiring shares of the Company’s stock, investing in other partiesand incurring liens on the Company’s assets. As a fee for the issuance of the note, the Company paid $3.0 million toHC Crown, which was initially capitalized and is being amortized as additionalinterest expense over the term of the note payable.

 

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

 

On December 14,2001, the Company executed a $75.0 million promissory note with HC Crown.  Pursuant to the Waiver Agreement, the note ispayable in full on August 31, 2010 (although the maturity date of the noteis December 31, 2009). Interest is payable in cash, quarterly in arrearsfive days after the end of each calendar quarter. This note is subordinate tothe bank credit facility. The rate of interest under this note is currentlyLIBOR plus 5% per annum (5.29% and 5.25% at December 31, 2009, and March 31,2010, respectively). At December 31, 2009, and March 31, 2010, $108.6million, is reported as note payable to Hallmark Cards affiliate and $1.5million and $1.4 million, respectively, are reported as interest payable toHallmark Cards affiliate on the accompanying consolidated balance sheet.Interest of $6.3 million was paid in 2009, interest of $1.5 million was paid onJanuary 5, 2010, and interest of $1.4 million was paid on April 2,2010.

 

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

 

On October 1, 2005, the Company converted approximately$132.8 million of its license fees payable to Hallmark affiliates to apromissory note.  The rate of interestunder this note is currently LIBOR plus 5% per annum (5.29% and 5.25% at December 31,2009, and March 31, 2010, respectively). Pursuant to the Waiver Agreement,the promissory note is payable in full on August 31, 2010 (although thematurity date of the note is December 31, 2009).  Interest is payable in cash, quarterly inarrears five days after the end of each calendar quarter. At December 31,2009, and March 31, 2010, $170.1 million is reported as note payable toHallmark Cards affiliate and $2.3 million and $2.2 million, respectively, arereported as interest payable to Hallmark Cards affiliate on the accompanyingconsolidated balance sheet. Interest of $9.8 million was paid in 2009, interestof $2.3 million was paid on January 5, 2010, and interest of $2.2 millionwas paid on April 2, 2010.

 

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

 

On March 21, 2006, the Company convertedapproximately $70.4 million of its payable to a Hallmark Cards affiliate to apromissory note. The rate of interest under this note is currently LIBOR plus5% per annum (5.29% and 5.25% at December 31, 2009, and March 31,2010, respectively). Pursuant to the Waiver Agreement, the promissory note ispayable in full on August 31, 2010 (although the maturity date of the noteis December 31, 2009). Interest is payable in cash, quarterly in arrearsfive days after the end of each calendar quarter. At December 31, 2009,and March 31, 2010, $62.0 million is reported as note payable to HallmarkCards affiliates and $838,000 and $814,000, respectively, are reported asinterest payable to Hallmark Cards affiliate on the accompanying consolidatedbalance sheet. Interest of $3.6 million was paid in 2009, interest of $838,000was paid on January 5, 2010, and interest of $814,000 was paid on April 2,2010.

 

***Interest Paid to HC Crown***

 

Interestexpense paid to HC Crown in connection with the credit facility was $148,000 forthe three months ended March 31, 2009, and $1,000 for the three monthsended March 31, 2010.

 

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

 

Theaggregate maturities of related party long-term debt for each of the five yearssubsequent to March 31, 2010, are as follows:

 

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| ** **                                                                                               | ** ** | **Payments  Due by Period** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                               | ** ** | **Total**                   | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **2013** | ** ** | **2014** | ** ** |
| ** **                                                                                               | ** ** | **(In  thousands)**         | ** ** |
| Note and interest payable  to HC Crown,with principal  deferred until August 31, 2010               |       | $                           | 110,021    |   | $ | 110,021 |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| 10.25 % Senior secured note  to HC Crown,including  accrued interest, due August 5, 2011            |       | 778,012                     |       | — |   | 778,012 |   | — |   | — |   | — |   |
| Note and interest payable  to Hallmark Cards affiliatewith principal deferred until August 31, 2010 |       | 172,342                     |       | 172,342 |   | — |   | — |   | — |   | — |   |
| Note and interest payable  to Hallmark Cards affiliatewith principal deferred until August 31, 2010 |       | 62,821                      |       | 62,821 |   | — |   | — |   | — |   | — |   |
|                                                                                                     |       |                        |       |   |   |   |   |   |   |   |   |   |   |
|                                                                                                     |       | $                           | 1,123,196  |   | $ | 345,184 |   | $ | 778,012 |   | $ | — |   | $ | — |   | $ | — |   |

 

**6. Related Party Transactions**

 

***RecapitalizationProposal***

 

See “Recapitalization” in Note 1 for informationregarding the proposed Recapitalization of outstanding debt obligations owed toaffiliates of Hallmark Cards.

 

***Tax Sharing Agreement***

 

*Overview*

 

On March 11, 2003, Crown Media Holdings became a member ofHallmark Cards consolidated federal tax group and entered into a federal taxsharing agreement with Hallmark Cards (the “tax sharing agreement”). HallmarkCards includes Crown Media Holdings in its consolidated federal income taxreturn.  Accordingly, Hallmark Cards hasbenefited from subsequent tax losses and may benefit from future federal taxlosses, which may be generated by Crown Media Holdings.  Based on the tax sharing agreement, HallmarkCards has agreed to pay Crown Media Holdings all of the benefits realized byHallmark Cards as a result of including Crown Media Holdings in itsconsolidated income tax return.  Thesebenefits are estimated and paid 75% in cash on a quarterly basis and thebalance is to be applied against any future tax liabilities of Crown MediaHoldings.  A final true-up calculation iscompleted within 15 days after Hallmark Cards files its consolidated federalincome tax return for the year.  Pursuantto the true-up calculation, Crown Media Holdings is obligated to reimburseHallmark Cards the amount that any estimated payments have exceeded the actualbenefit realized by Hallmark Cards and Hallmark Cards is obligated to pay CrownMedia Holdings the amount that any actual benefit exceeds the estimatedpayments.  Under the tax sharingagreement, at Hallmark Cards’ option, the non-interest bearing balance of the25% in federal tax benefits may 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. Pursuant tothe amendment to the tax sharing agreement in August 2003, the benefitthat would otherwise result from interest accrued on the 10.25% senior securednote will not be available to the Company until such interest is paid in cash.

 

The Company owed Hallmark Cards $8.5 million under theTax Sharing Agreement during 2009. The Company owed $4.7 million under the TaxSharing Agreement for the three months ended March 31, 2010. Any paymentsreceived from Hallmark Cards or credited against amounts owed by Crown MediaHoldings to any member of the Hallmark Cards consolidated group under the taxsharing agreements have been recorded as additions to paid-in capital in theaccompanying consolidated statements of stockholders’ deficit. Any amounts owedor payments made to Hallmark Cards to any member of the Hallmark Cardsconsolidated group under the tax sharing agreements have been recorded asreductions to paid-in capital in the accompanying consolidated statements ofstockholders’ deficit.

 

***Services Agreement with Hallmark Cards***

 

Hallmark Cards provides Crown Media Holdings with tax,risk management, health safety, environmental, insurance, legal, treasury,human resources, and cash management services and real estate consultingservices.  In exchange, the Company isobligated to pay Hallmark Cards a fee, plus out-of-pocket expenses and thirdparty fees, in arrears on the last business day of each quarter. Fees for Hallmark Cards’ services were $455,000for 2009 and

 

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are scheduled to be $387,000 for 2010. TheCompany has timely paid and will continue to timely pay the monthly amounts duein 2009 and 2010.  Expense for the threemonths ended March 31, 2009 and 2010, was $114,000 and $97,000,respectively.

 

At December 31, 2009, and March 31,2010, non-interest bearing unpaid accrued service fees and unreimbursedexpenses of $15.2 million and $15.3 million, respectively, were included inpayable to affiliates on the accompanying consolidated balance sheets. For theyear ended December 31, 2009, and March 31, 2010, out-of-pocketexpenses and third party fees were $420,000 and $50,000, respectively.

 

***Guarantees with Hallmark Cards***

 

On February 24, 2010, the Company executed a Letter ofCredit/Guaranty Commitment (the “Guaranty”) with respect that certain LeaseAgreement (the “Lease Agreement”) with 12700 Investments, Ltd. (“Landlord”) forthe office space at 12700 Ventura Boulevard, Studio City, California.  The Landlord required that Crown Media United States, the entity which executedthe Lease Agreement, provide a letter of credit of $1.6 million securingcertain obligations of Crown Media United States.  Consequently, HallmarkCards has agreed to guarantee the issuer of such letter of credit against anyloss thereon pursuant to the Guaranty.As an inducement for Hallmark to issue the Guaranty, Crown Media United Stateshas agreed to pay Hallmark Cards a fee which equals 0.75% per annum of theoutstanding letter of credit obligation. Additionally, in the event that Hallmark Cards is required to pay anyamount under the Guaranty, Crown Media United States must reimburse HallmarkCards for any such amount plus any fees and charges associated with making suchpayment, any interest applicable to such amount and any costs and expenses ofHallmark Cards in connection with protecting its rights under the Guaranty.

 

On September 2, 2008, Hallmark Cards issued a guaranty (the “Guaranty”)for the benefit of Crown Media United States, which guaranty pertains to thatcertain Lease Agreement (the “Lease Agreement”) with Paramount Group, Inc.(“Landlord”) for the office space at 1325 Avenue of the Americas, New York, NewYork.  As a condition to executing the Lease Agreement, the Landlordrequired Hallmark to guaranty all obligations of Crown Media United Statesunder the Lease Agreement.  As an inducement for Hallmark Cards to issuethe Guaranty, Crown Media United States has paid Hallmark Cards a fee which equals0.28% per annum of the outstanding obligation under the Lease Agreement.Additionally, in the event that Hallmark Cards is required to pay any amountunder the Guaranty, Crown Media United States must reimburse Hallmark Cards forany such amount plus any feesand charges associated with making such payment, any interest applicable tosuch amount and any costs and expenses of Hallmark Cards in connection withprotecting its rights under the Guaranty.

 

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

 

VISNowns a $25.0 million company obligated mandatorily redeemable preferredinterest in Crown Media United States (the “preferred interest”). On November 13,1998, the Company, Vision Group, VISN and Henson Cable Networks, Inc.signed an amended and restated company agreement governing the operation ofCrown Media United States (the “company agreement”), which agreement wasfurther amended on February 22, 2001, January 1, 2002, March 5,2003, January 1, 2004, November 15, 2004 and December 1, 2005(the “December 2005 NICC Settlement Agreement”).

 

CrownMedia United States may voluntarily redeem the $25.0 million preferred interestat any time; however, it is obligated to do so no later than December 31,2010.

 

On January 2,2008, the Company and NICC resolved disputes amongst themselves and signed anagreement (the “Modification Agreement”) which, among other things, immediatelyextinguished NICC’s conditional right to require the Company to repurchase allof the shares of the Company’s Class A common stock then owned by NICC (“PutRight”).  In addition, the ModificationAgreement also settled the dispute with respect to whether the TerminationPayment provision expired with, or survived, the December 31, 2007expiration of the December 2005 NICC Settlement Agreement. We agreed topay NICC $3.8 million in three equal installments payable each January 20of 2008, 2009 and 2010.  We also agreedto provide NICC a two-hour broadcast period granted each Sunday morning duringthe two year period ending December 31, 2009.  We are also obligated to pay NICC anestimated $3.7 million in yearly installments at the rate of 6% of theoutstanding liquidation preference of the

 

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preferredinterest.

 

During the three monthsended March 31, 2009 and 2010, Crown Media United States paid NICC $4.5million and $2.8 million, respectively, related to the company agreement asamended.

 

**8. Share-Based Compensation**

 

Approximately 200,000 stock options expired, without being exercised,in August 2009 following the resignation of one of the Company’sexecutives in May 2009. Such options were fully vested at the time ofresignation.

 

The Company recorded $171,000 of compensation benefit and $76,000 ofcompensation expense  associated with theemployment and performance restricted stock units (RSUs) during the threemonths ended March 31, 2009 and 2010, respectively, which have beenincluded in selling, general and administrative expense on the accompanyingcondensed consolidated statements of operations.

 

As of December 31,2009, and March 31, 2010, there was no unrecognized compensation cost,related to non-vested stock options granted to the Company’s employees. The closing price of a share of the Company’scommon stock was $1.45 on December 31, 2009, and $1.92 on March 31,2010, which is used to calculate the RSU liability. As of December 31,2009, and March 31, 2010, there was unrecognized compensation cost,related to non-vested RSUs granted to the Company’s employees, in the amount of$190,000 and $200,000, respectively, using the aforementioned stock prices.Actual compensation costs recognized in future periods may vary based uponfluctuations in stock price and forfeitures.

 

The Company issued cash settlements related to the RSUs of $1.5 millionduring the year ended December 31, 2009, and $0 during the three monthsended March 31, 2010.

 

In May 2009, thethen CEO terminated his employment and his shareappreciation rights (“SARs”) were forfeited at that time.  The Company recorded $116,000 incompensation benefit related to SARs for the three months ended March 31,2009, on our condensed consolidated statement of operations as a component ofselling, general and administrative expense. The SARs were recorded as a liability until termination.

 

**9.  Resignation Agreements, Long Term IncentivePlan and Employee Terminations**

 

***ResignationAgreements***

 

The individual thenserving as the Company’s chief executive officer resigned May 31,2009.  Pursuant to the resignationagreement, in June 2009 the Company paid this individual $2.5 million, anamount representing the present value of the salary and bonus that otherwisewould have been paid to him from June 1, 2009 through October 2,2010, the scheduled expiration of his employment contract.  The Company is obligated to provide himoffice space, an assistant and payment of COBRA insurance benefits for periods thatexpire at various times through May 31, 2010. These expenses were recordedas selling, general and administrative expense in the second quarter of 2009.

 

The Executive VicePresident of Programming resigned from his position effective May 31,2009. The executive received continued payment of the regular installments ofhis salary through December 31, 2009 ($523,000) and received his salarythrough May 31, 2010, in one lump sum paid on January 15, 2010($347,000). He also received a payment of a pro-rated annual bonus ofapproximately $14,000, determined by the Company, for the 2009 calendar yearfor the period up to the resignation date. These expenses were recorded as other operating costs in the secondquarter of 2009.

 

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***LongTerm Incentive Compensation Agreements***

 

In the second quarter of2009, the Company granted Long Term Incentive Compensation Agreements (“LTIAgreements”) to each vice president, senior vice president and executive vicepresident of the Company.  The targetaward under each LTI Agreements is a percentage of the employee’s base salaryand range from $26,000 to $469,000.  Ofeach award, 50% is an Employment Award and 50% is a Performance Award.  The Employment Award will vest and be settledin cash on August 31, 2011, subject to earlier pro rata settlement asprovided in the LTI Agreement.  ThePerformance Award will vest and be settled in cash 50% on December 31,2010, and 50% on December 31, 2011, in accordance with the Companyperformance criteria concerning adjusted EBITDA and cash flow and subject toearlier pro rata settlement as provided in the LTI Agreement. Early settlementis provided in the case of involuntary termination of employment without causeon or after January 1, 2010, death or disability.  Potential payouts under the PerformanceAwards depend on achieving 90% or higher of a target threshold and range from0% to 150% of the target award.  TheCompany’s Compensation Committee has the ability to increase or decrease thepayout based on an assessment of demographics achieved, relative marketconditions and management of expenses.

 

In the first quarter of2010, the Company granted LTI Agreements to each vice president, senior vicepresident and executive vice president of the Company.  The target award under each LTI Agreements isa percentage of the employee’s base salary and range from $25,000 to$332,000.  Of each award, 50% is anEmployment Award and 50% is a Performance Award.  The Employment Award will vest on August 31,2012, and be settled in cash within 30 days thereafter, subject to earlier prorata settlement as provided in the LTI Agreement.  The Performance Award will vest on December 31,2012, and be settled in cash the later of 30 days thereafter or 15 days afterthe Company issues its audited financials for 2012, but by no later than March 15,2013. Vesting of the Performance Award will be determined in accordance with the Company performance criteriaconcerning adjusted EBITDA and cash flow and subject to earlier pro ratasettlement as provided in the LTI Agreement. Early settlement is provided inthe case of involuntary termination of employment without cause on or after January 1,2011, death or disability.  Potentialpayouts under the Performance Awards depend on achieving 90% or higher of atarget threshold and range from 0% to 150% of the target award.  The Company’s Compensation Committee has theability to increase or decrease the payout based on an assessment ofdemographics achieved, relative market conditions and management of expenses.

 

The Company recorded$207,000 and $428,000 of expense included in selling, general andadministrative expense in the accompanying consolidated statement of operationsfor the three months ended March 31, 2009 and 2010,  related to these agreements. Additionally,the $540,000 and $968,000 liability for these agreements was included inaccounts payable and accrued liabilities in the accompanying consolidatedbalance sheet at December 31, 2009, and March 31, 2010.

 

**10. Fair Value**

 

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

 
| ** **                                                   | ** ** | **December 31, 2009** | ** ** | **March 31, 2010**                                                  | ** ** |
|--------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **Carrying**                    | ** ** | **Significant  Unobservable********Inputs********(Level 3)********Fair** | ** ** | **Carrying** | ** ** | **Significant  Unobservable********Inputs********(Level 3)********Fair** | ** ** |
| ** **                                                   | ** ** | **Amount**                      | ** ** | **Value**                                                                     | ** ** | **Amount** | ** ** | **Value** | ** ** |
| ** **                                                   | ** ** | **(In thousands)**         | ** ** |
|                                                         |       |                            |       |                                                                          |       |   |   |   |   |
| Senior secured note to HC Crown, including accrued  interest |       | $                               | 758,755    |                                                                          | $          | 641,635 |   | $ | 778,012 |   | $ | 666,756 |   |
| Note and interest payable to HC Crown                        |       | 110,062                         |       | 93,074                                                                        |       | 110,021 |   | 94,288 |   |
| Note and interest payable to Hallmark CardsAffiliate         |       | 62,845                          |       | 53,144                                                                        |       | 62,821 |   | 53,838 |   |
| Note and interest payable to Hallmark CardsAffiliate         |       | 172,407                         |       | 145,795                                                                       |       | 172,342 |   | 147,697 |   |
| Company obligated mandatorily redeemable preferred  interest |       | 22,902                          |       | 19,800                                                                        |       | 23,474 |   | 20,900 |   |
|                                                              |            |                                 |            |                                                                               |            |  |  |  |  |  |  |  |  |

 

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ASCTopic 820 defines fair value of a liabilityas the price that would be paid to transfer a liability in an orderlytransaction between market participants at the measurement date. Whendetermining fair value, the Company considers the principal or mostadvantageous market in which the Company would transact and the market-basedrisk measurements or assumptions that market participants would use in pricingthe liability, such as inherent risk, transfer restrictions, and credit risk.Level 3 is defined as inputs that are generally unobservable and typicallyreflect management’s estimates of assumptions that market participants woulduse in pricing the liability.

 

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

 

SinceJune 30, 2009, the Company has estimated the fair value of its debt toHallmark Cards affiliates on a quarterly basis. The Company (i)** **utilizedthe public company guideline method (which attempts to value the business byidentifying and selecting publicly-traded companies with financial andoperating characteristics similar to our Company and applying valuationmultiples to our Company) as a market-based approach and (ii) a discountedfuture cash flows method (which applies a discount rate to earnings projectionsfor a period of years) to value the Company’s total invested capital.  The Company then used a 75% weighting on thepublic company guideline method and a 25% weighting on the discounted future cashflows method.

 

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

 

Estimates of the fair value of certain of the Company’sfinancial instruments are presented in the tables above. As a result of recentmarket conditions, the Company’s debt obligations with Hallmark Cardsaffiliates and the mandatorily redeemable preferred interest have limited or noobservable market data available. Fair value measurements for these instrumentsare included in Level 3 of the fair value hierarchy of ASC Topic 820. These fair value measurements are based primarily upon the Company’sown estimates and are often based on its current pricing policy, the currenteconomic and competitive environment, the characteristics of the instrument,credit and interest rate risks, and other such factors. Therefore, the resultscannot be determined with precision, cannot be substantiated by comparison toquoted prices in active markets, and may not be realized in an immediatesettlement of the liability. Additionally, there are inherent uncertainties inany fair value measurement technique, and changes in the underlying assumptionsused, including discount rates, liquidity risks, and estimates of future cashflows, could significantly affect the fair value measurement amounts.

 

The majority of the Company’s debt has been transactedwith Hallmark Cards and its affiliates.

 

**11. Commitments and Contingencies**

 

***Lawsuit***

 

On July 13, 2009, alawsuit was brought in the Delaware Court of Chancery against each member ofthe Board of Directors of the Company, Hallmark Cards and its affiliates, aswell as the Company as a nominal defendant, by a minority stockholder of theCompany regarding the then proposed Recapitalization. The plaintiff is S. Muoio &Co. LLC which owns beneficially approximately 5.8% of the Company’s Class Acommon stock, according to the complaint and filings with the SEC. The lawsuitclaims to be a derivative action and a class action on behalf of the plaintiffand other minority stockholders of the Company. The lawsuit alleges, amongother things, that, the defendants have breached fiduciary duties owed to theCompany and minority stockholders in connection with the Recapitalizationtransactions. The lawsuit includes allegations that if the Recapitalizationtransactions are consummated, the minority stockholders’ equity and votinginterests in the Company would be reduced, and that the 

 

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minority stockholders couldbe eliminated through a short-form merger. The complaint requested the courtenjoin the defendants from consummating the Recapitalization transactions andaward plaintiff fees and expenses incurred in bringing the lawsuit.

 

On July 22, 2009, aStipulation Providing for Notice of Transaction (the ‘‘Stipulation’’) was filedwith the Delaware Court of Chancery. The Stipulation provided that the Companycannot consummate the transaction contemplated in the Recapitalizationtransactions until not less than seven weeks after providing the plaintiff witha notice of the terms of the proposed transaction, including copies of thefinal transaction agreements. If the plaintiff moved for preliminary injunctiverelief with respect to any such transaction, the parties would establish aschedule with the Court of Chancery to resolve such motion during the sevenweek period. In addition, following the decision of the Court of Chancery, theCompany would not consummate any transaction for a period of at least one week,during which time any party may seek an expedited appeal. The Stipulationfurther provided that the plaintiff would withdraw its motion for preliminaryinjunction filed on July 13, 2009 and that the action would be stayeduntil the earlier of providing the notice of a transaction or an announcementby the Company that it is no longer considering a transaction.

 

By a letter of February 28,2010, the plaintiff in this lawsuit informed the Special Committee of the Boardof Directors, which considered and negotiated the Recapitalization, that theplaintiff objected to the proposed recapitalization on the terms set forth inthe term sheet dated February 9, 2010. The plaintiff asserted, among otherthings, that the transactions contemplated by the term sheet would unfairlydilute the economic and voting interests of the Company’s minoritystockholders, that the transactions should be subject to a vote of the majorityof the minority stockholders and that the proposed transactions remaininadequate. The plaintiff indicated that if the Company executed definitivedocuments for the Recapitalization, the plaintiff would pursue the litigation.The February 26, 2010 agreements executed by the Company for theRecapitalization materially followed the provisions in the earlier term sheet.

 

Notice of the terms ofthe proposed Recapitalization, including copies of the executed definitivedocuments for the Recapitalization, was provided to the plaintiff on March 1,2010. On March 11, 2010, the plaintiff filed an amended complaint raisingsimilar allegations of breach of fiduciary duty against the Board of Directorsof the Company, Hallmark Cards and its affiliates, as well as the Company as anominal defendant, and seeking rescission of the Recapitalization rather than apreliminary injunction enjoining the consummation of the Recapitalization, oralternatively, an award of rescissory damages. The plaintiff also filed amotion for expedited proceedings and a request that the Chancery Court set atrial date sometime in September 2010. Defendants have informed the Courtthat they do not oppose a trial in August or September 2010 but reservethe right to oppose rescission as an available or proper remedy.  On March 23, 2010, the Court notifiedthe parties that the trial was scheduled for September 21, 2010.

 

It is not currentlypossible to predict the outcome of the proceeding discussed above.  Legal fees incurred to defend the proceedingwill be expensed as incurred.

 

***ContractTermination***

 

During the fourth quarter of 2009, we exercised our rights to terminatetwo agreements in connection with our February 2010 launch of the HallmarkChannel in high definition. The Company estimated the costs of termination tobe approximately $4.7 million and recorded them as a component of cost ofservices in the consolidated statement of operations for 2009.  There were no cash payments required as a resultof the termination of the agreement, but the Company forfeited any amountsprepaid under the agreement.

 

Terminationof one agreement for a standard definition version of the Channel also resultedin a change in the estimated life of a related deferred credit that arose inconnection with the sale of our international business in 2005.  After launch of the high definition service,recurring monthly expenses under the terminated agreement will cease.  Accordingly, in the fourth quarter of 2009,we reduced the deferred credit by approximately $847,000 and recognized a gainon the sale of discontinued operations. Through December 31, 2009, the aggregate loss on sale of theinternational business is $983,000.

 

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**ITEM 2.  *Management’s Discussion and Analysis of Financial Condition and Resultsof Operations***

 

The following discussion and analysis of the Company’sfinancial condition and results of operations should be read in conjunctionwith “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations” in the Company’s Annual Report on Form 10-K for the yearended December 31, 2009.

 

**Description of Business and Overview**

 

*Current Business*

 

We own and operate theChannels. With 89.1 million subscribers (as provided by Nielsen Research) inthe United States at March 31, 2010, the Hallmark Channel is the 38th most widelydistributed advertising-supported cable channel in the United States. At December 31,2009, the Hallmark Channel was the 38th most widely distributed advertising-supportedcable channel in the United States with 88.3 million subscribers (as providedby Nielsen Research). For the first quarter of 2010, the Hallmark Channelfinished the quarter as the 18th highest rated advertising-supported cablechannel for total day household ratings and the 18th highest rated advertising-supported cablechannel in prime time as measured by Nielsen Research.

 

We launched our second24-hour linear channel, the Hallmark Movie Channel, during the first quarter of2005.  Programming on the Hallmark MovieChannel consists of movies and mini-series. The Hallmark Movie Channel hasgenerated subscriber fees and advertising revenue since 2005. As distributioncontinues to expand, the financial contribution of the Hallmark Movie Channelmay grow, including increases in advertising and subscription revenue. TheHallmark Movie Channel is operated through Crown Media Holdings’ existinginfrastructure at a small incremental cost. In April 2008, we began distributing the Hallmark Movie Channel HDin high definition format, resulting in additional costs; however, we expectthat this additional format will continue to contribute to subscriber growthfor the Hallmark Movie Channel.  Seebelow for information regarding a high definition version of the HallmarkChannel.

 

At March 31, 2010,the Hallmark Movie Channel was distributed to over 33.2 million subscribers, anincrease of nearly 4.1 million subscribers from 29.1 million at December 31,2009. This increase in distribution, particularly in certain key markets, and agreater number of advertising spots has contributed to improved Hallmark MovieChannel revenue in 2010 and should continue to do so through the remainder ofthe year. In the second quarter of 2010, we will begin selling Hallmark MovieChannel inventory to advertisers based on audience guarantees, which shouldfurther increase our ability to grow revenues from that channel.

 

***CurrentChallenges***

 

The Company facesnumerous operating challenges. Among them are increasing viewership ratings,maintaining and increasing advertising revenue, maintaining and expanding thedistribution of the Channels, broadening viewership demographics to meet ourtarget audience, and controlling costs and expenses. In addition, the Companybelieves that it is necessary to complete the Recapitalization; see “RecentDevelopments — Recapitalization of the Company” in Note 1 to the CondensedConsolidated Financial Statements in this Report and the “Liquidity” discussionbelow in this Item 2.

 

*Ratings*

 

Ratings success plays asignificant role in our ability to achieve our distribution and advertisinggoals.  Our ratings declined from 14th in total day viewership and 7th for prime time in 2009 to 18th in total day viewership and 18th for prime time in 2010.  We believe our ratings are affected by ourability to (i) acquire and produce series and movies that appeal to ourtarget demographic and (ii) develop a programming schedule that attracts ahigh number of viewers. Original productions are our most high profile programsand generate the Hallmark Channel’s highest ratings. In the past, the Companyhas typically incurred additional marketing and promotional expensessurrounding original productions and certain acquired movies to drive higherratings. Certain acquired series delivered historically strong ratings, butrecently they have been part of the decline experienced in viewer ratings. In orderto reverse the recent decline in ratings, we plan to continue or increase thenumber of our original productions and 

 

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develop a programmingschedule that attracts a greater number of viewers in our target demographic,all while controlling the expenses relating to these actions.

 

Our recent agreementswith Martha Stewart Living Omnimedia, including the acquisition of exclusiverights to the show Martha Stewart Living and rights to the extensive library ofMartha Stewart branded lifestyle programming, represent a key part of ourstrategy to attract viewers that appeal to relatively higher CPM advertisers.  We are introducing this lifestyle programmingin various dayparts in the second quarter of 2010, leading to the September 2010premier of Martha Stewart Living on the Hallmark Channel.  These program changes have resulted and mayresult at least initially in reductions in the ratings delivery of the Channel,but our plan is that, over time, these changes will increase our revenuethrough the delivery of a more targeted demographic and attraction of higherCPM advertisers.

 

The Hallmark MovieChannel has not been the subject of ratings measurement by Nielsen MediaResearch. However, as currently planned, the Hallmark Movie Channel will haveNielsen ratings commencing in the second quarter of 2010, and we will selladvertising inventory for the Hallmark Movie Channel commencing in that quarterbased on a price per unit of audience measurement.

 

*Advertising Revenue*

 

Theoverall improvement in the economy in the first quarter of 2010 had a favorableimpact on cable advertising rates, including the rates for our inventory.  Our first quarter scatter market inventorywas sold at rates 18% above rates in the first quarter 2009 scatter market and73% above the rates for first quarter 2010 inventory sold in the upfront.  Additionally, direct response rates were downby 10-15% compared to that inventory sold in the same period of 2009.   Although our CPMs in the first quarter of2010 were higher than the same period of 2009, our delivery of our keydemographic, women 25-54, was substantially lower than prior periods.  Our demographic delivery in the first quarterof 2010 was lower than the previous quarter and lower than the same period of2009.  This lower demographic deliverymore than offset gains in our CPMs resulting in lower advertising revenue inthe first quarter of 2010 compared to the first quarter of 2009.

 

In the 2009/2010 upfrontprocess, we entered agreements with major advertising firms representingapproximately 41% of our advertising inventory for the last quarter of 2009 andthe first three quarters of 2010.  Thisinventory was sold at CPMs (i.e., advertising rates per thousand viewers)approximately 1.6% lower than the inventory sold in the 2008/2009 upfront.  In the 2008/2009 upfront sales process, weentered agreements for approximately 51% of our advertising inventory for thelast quarter of 2008 and the first three quarters of 2009.  We held more advertising inventory from the2009/2010 upfront than the 2008/2009 upfront, for use in the general scattermarket, because of lower CPMs offered by some advertisers in the 2009/2010upfront. The Company sold much of the balance of the general rate inventory forthe 2009/2010 broadcast season to advertisers that purchase upfront inventoryon a calendar year basis, rather than an advertising year basis, and in the scattermarketplace. The calendar year 2010 upfront was completed with a projected 15%increase on CPMs as compared to the calendar year 2009 upfront.

 

Following the upfrontperiod, sales of our general rate, direct response and paid-programminginventory are made closer to the timing of the actual advertisement.  We have historically seen significantincreases in rates on these remaining advertising sales over the rates obtainedfrom our upfront sales.  As compared tothe upfront sales for the same periods, scatters rates in the first quarter of2010 were 73% higher.

 

Advertisers with upfrontcontracts have an option to terminate their contracts, as well as an option toexpand the amount of inventory purchased under the contracts. In prior years,cancellations of upfront contracts were unusual. During the twelve monthsperiod ended September 2009 comprising the 2008/2009 broadcast season,advertisers canceled approximately 13% of the inventory covered by suchcontracts.  The Company sold the balanceof the 2008/2009 general rate inventory, including that resulting from thecancellations, in the scatter market. A total of 3% cancellation options weretaken during the first quarter of 2010 as compared to 7% during the firstquarter of 2009.

 

*Distribution Agreements*

 

Distribution agreementsare important because they affect our number of subscribers, which in turn havea major impact on our subscriber fees, the number of persons viewing ourprogramming, and the rates charged for advertising. The long-term distributionchallenge is renewing our distribution arrangements with the multiple system 

 

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operators as they expireon favorable terms. Our major distribution agreements haveterms which expire at various times from March 31, 2010, through December 2023,inclusive of renewal options. An Agreement withNational Cable Television Cooperative representing approximately 12% ofour total Hallmark Channel subscriber base expired inDecember 2009. The Company has entered into a series of extensions withthe National Cable Television Cooperative through May 7, 2010. The Companyis currently in negotiations with the National Cable Television Cooperative toenter into a new agreement and anticipates that the agreement will be completedin the second quarter of 2010. Agreements representing an additional 5% of oursubscribers to our Hallmark Channel****will expire prior to December 31, 2010.

 

Domestic telephonecompanies have entered the business of distributing television channels tohouseholds through their wire-lines. We have distribution agreements withseveral telephone companies for the carriage of the Hallmark Channel, theHallmark Movie Channel and Hallmark Movie Channel HD, and continue to seekagreements with other telephone companies.

 

The universe of cable TVsubscribers in the United States is approximately 100 million homes.  The top 30 cable TV networks in the UnitedStates, measured by the number of subscribers, have 90 million or moresubscribers.  Our goal is for theHallmark Channel to reach 91 million subscribers and the Hallmark Movie Channelto reach 40 million subscribers by the end of 2010.

 

*Demographics*

 

As paytelevision channels draw audience share, audience demographics (i.e., viewerscategorized by characteristics such as age, sex and income) become fragmented.As a result, advertisers are able to target the specific groups of viewers whoare most likely to purchase their products by advertising on channels whichattract the desired viewer demographic.

 

Webelieve that the key demographics for the Hallmark Channel are the viewers inthe groups Adults aged 25 to 54 and Women aged 25 to 54.  However, the average median age of a viewerof the Hallmark Channel was 59.5 in 2009. In order to achieve our revenue goals, we need to draw in our targetaudience.  The broadcast on the HallmarkChannel of Martha Stewart Show and other Martha Stewart Living productions,commencing in September 2010, are a key part of our efforts to attract ourtarget audience over time.

 

*CostControl*

 

Welaunched a high definition version of the Hallmark Channel in February 2010.  The costs for this launch were approximately$5.0 million, approximately $4.4 million of which represents a non-cash chargerelated to the terminations of two existing channel delivery agreements, whichwas recorded in 2009. The Company may also incur additional costs including thecost of converting certain television series to high definition.  The launch of a high definition versionfurthers the Company’s efforts to maintain competitiveness.

 

**Revenuefrom Continuing Operations**

 

*Our revenue consists of subscriberfees and advertising fees.*

* *

***Subscriber Fees***

* *

*Subscriber fees are generally payableto us on a per subscriber basis by pay television distributors for the right tocarry our Channels.*Rates we receive per subscriber vary with changes in thefollowing factors, among others:

 

·              the degree of competition in the market;

 

·              the relative position in the market ofthe distributor and the popularity of the channel;

 

·              the packaging arrangements for thechannel; and

 

·              length of the contract term and othercommercial terms.

 

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We are incontinuous negotiations with our existing distributors to increase oursubscriber base in order to enhance our advertising revenue. We have been subjectto past requests by major distributors to pay subscriber acquisition fees foradditional subscribers or to waive or accept lower subscriber fees if certainnumbers of additional subscribers are provided. We also may help fund thedistributors’ efforts to market our Channels or we may permit distributors tooffer limited promotional periods without payment of subscriber fees.

 

We have generallypaid certain television distributors up-front subscriber acquisition fees toobtain initial carriage on domestic pay distributor systems. Subscriberacquisition fees that we pay are capitalized and amortized over the contractualterm of the applicable distribution agreement as a reduction in subscriber feerevenue. If the amortization expense exceeds the revenue recognized on a perdistributor basis, the excess amortization is included as a component of costof services. At the time we sign a distribution agreement and periodicallythereafter, we evaluate the recoverability of the costs we incur against theincremental revenue directly and indirectly associated with each agreement.

 

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

 

Our subscribercount depends on the number of distributors carrying one of our Channels andthe size of such distributors as well as the program tiers on which our Channelis carried by these distributors. From time to time, we experience decreases inthe number of subscribers as promotional periods end, or as a distributorarrangement is amended or terminated by us or the distributor. The level ofsubscribers could also be affected by a distributor repositioning our Channelsfrom one tier to another tier. Management analyzes the estimated effect eachnew or amended distribution agreement will have on revenue and costs. Basedupon these analyses, if subscriber acquisition fees are needed, managementendeavors to achieve a fair combination of subscriber commitments andsubscriber acquisition fees.

 

#### **Advertising**

####  

Historically,revenue from advertising aired on our channels has contributed more than 75% ofour total annual revenue.  We earnadvertising revenue in the form of spot or general rate advertising, directresponse advertising and paid-programming (i.e., “infomercials”).  Spot advertisements and direct responseadvertisements are generally 30 seconds long and are aired during or betweenlicensed program content.  Spotadvertisements are priced at a rate per thousand viewers and almost always bearthe Company’s commitment to deliver a specified number of viewers.  Our revenue from direct response advertisingvaries in proportion to the direct sales achieved by the advertiser.  It is sold without ratings or product salescommitments.  Paid-programming is sold atfixed rates for 30 minute blocks of time, typically airing in the early morninghours.  It requires no licensed programcontent.  Our advertising revenue isaffected by the mix of these forms of advertising.

 

Our rates for spotadvertisements are generally calculated on the basis of an agreed upon priceper unit of audience measurement in return for a guaranteed commitment by theadvertiser. We commit to provide advertisers certain rating levels inconnection with their advertising. Advertising rates also vary by time of yeardue to seasonal changes in television viewership. Revenue is recorded net ofestimated delivery shortfalls (“audience deficiency units” or “ADUs”), whichare usually settled by providing the advertiser additional advertising time.The remainder of the revenue is recognized as the “make-good” advertising timeis delivered in satisfaction of ADUs. Revenue from direct response advertisingdepends largely****upon actions of viewers.

 

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Whenever spotadvertising is aired in programs that do not achieve promised viewershipratings, we issue ADUs which provide the advertiser with additional spots at noadditional cost.  We defer a pro rataamount of advertising revenue and recognize a like amount as a liability forprograms that do not achieve promised viewership ratings.  When the make-good spots are subsequentlyaired, revenue is recognized and the liability is reduced.  The level of inventory that is utilized forADUs varies over time and is influenced by prior fluctuations in ourunder-delivery, if any, of viewers against promised ratings as well as the rateat which we and our customers mutually agree to utilize the ADUs.

 

Our channels arebroadcast 24 hours per day. Our advertising inventory comprises the commercialload or advertising capacity of the program hours in which we intend tobroadcast licensed program content.  Thevolume of inventory that we have available for sale is determined by the numberof our channels (*i.e*., two), our chosen commercialload per hour and the number of broadcast hours in which we air licensedprogram content.  Sales of advertisinginventory are decreased by our need to reserve inventory for the use of ADUs.

 

**Cost ofServices**

 

Our cost of services consists primarily of theamortization of program license fees; the cost of signal distribution; and thecost of promotional segments that are aired between programs.

* *

**CriticalAccounting Policies, Judgments and Estimates**

 

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

 

Forfurther information regarding our critical accounting policies, judgments andestimates, please see Notes to Unaudited Condensed Consolidated FinancialStatements contained in Item 1 of this Report and “Critical AccountingPolicies, Judgments and Estimates” in Item 7 of the Company’s Annual Report on Form 10-Kas filed with the SEC for the year ended December 31, 2009.

 

**Effectsof Transactions with Related and Certain Other Parties**

 

In 2010 and in prioryears, we entered into a number of significant transactions with Hallmark Cardsand certain of its subsidiaries. These transactions include, among otherthings, trademark licenses, an administrative services agreement, a Tax SharingAgreement, a $400.0 million senior note, notes payable and the Amended Waiverand Standby Agreement. For information regarding such transactions andtransactions with other related parties, please see “Effects of Transactionswith Related and Certain Other Parties” in Item 7 of the Company’s AnnualReport on Form 10-K as filed with the SEC for the year ended December 31,2009. Also, please see Notes 5 and 6 of Notes to Unaudited CondensedConsolidated Financial Statements contained in Item 1 of this Report.

 

For information on theproposed Recapitalization, see Note 1 of Notes to the Unaudited CondensedConsolidated Financial Statements contained in Item 1 of this Report.

 

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

 

Inthe table below, we provide selected historical condensed consolidated financialand other data of Crown Media Holdings and its subsidiaries. The followingselected condensed consolidated statement of operations data for three monthsended March 31, 2009 and 2010, are derived from the unaudited financialstatements of Crown Media Holdings and its subsidiaries. Ratings and subscriberinformation also are unaudited. This data should be read together with thecondensed consolidated financial statements and related notes includedelsewhere in this Form 10-Q.

 

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| ** **                                          | ** ** | ** **                                           | ** ** | ** **        | ** ** | **Percent Change** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------|------------|-------------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **Three Months Ended March 31,** | ** ** | **2010 vs.** | ** ** |
| ** **                                          | ** ** | **2009**                                             | ** ** | **2010**          | ** ** | **2009**                | ** ** |
| Revenues:                                           |       |                                                 |       |              |       |                    |       |
| Subscriber fees                                     |       | $                                                    | 15,295     |              | $          | 16,994                  |       | 11 | % |
| Advertising                                         |       | 55,294                                               |       | 51,310            |       | -7                      | %          |
| Sublicense fees and other revenue                   |       | 363                                                  |       | 74                |       | -80                     | %          |
| Total revenues                                      |       | 70,952                                               |       | 68,378            |       | -4                      | %          |
| Cost of Services:                                   |       |                                                 |       |              |       |                    |       |
| Programming costs                                   |       | 32,215                                               |       | 29,157            |       | -9                      | %          |
| Operating costs                                     |       | 4,012                                                |       | 2,697             |       | -33                     | %          |
| Total cost of services                              |       | 36,227                                               |       | 31,854            |       | -12                     | %          |
| Selling, general and administrative expense         |       | 12,564                                               |       | 12,411            |       | 1                       | %          |
| Marketing expense                                   |       | 4,775                                                |       | 973               |       | -80                     | %          |
| Income before interest expense                      |       | 17,386                                               |       | 23,140            |       | 33                      | %          |
| Interest expense                                    |       | (24,837                                              | )          | (25,464           | )          | 3                       | %          |
| Net loss                                            |       | $                                                    | (7,451     | )                 | $          | (2,324                  | )          | -69 | % |
|                                                |       |                                                 |       |              |       |                    |       |
| **Other Data:**                                     |       |                                                 |       |              |       |                    |       |
| Net cash (used in) provided by operating activities |       | $                                                    | (385       | )                 | $          | 7,771                   |       | -2118 | % |
| Net cash used in investing activities               |       | $                                                    | (304       | )                 | $          | (397                    | )          | 31 | % |
| Net cash provided by (used in) financing activities |       | $                                                    | 3,261      |              | $          | (1,215                  | )          | -137 | % |
| Total domestic day household ratings (1)(3)         |       | 0.635                                                |       | 0.501             |       | -21                     | %          |
| Total domestic primetime household ratings (2)(3)   |       | 1.160                                                |       | 0.814             |       | -30                     | %          |
| Subscribers at period end                           |       | 85,891                                               |       | 89,102            |       | 4                       | %          |

 

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(1) Total day is the time period measured from the time each day the broadcast ofcommercially sponsored programming commences to the time such commerciallysponsored programming ends.

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

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

 

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

 

#### *Three Months Ended March 31,2009, Compared to Three Months Ended March 31, 2010*

####  

*Revenue. *Our revenue, comprised primarily of subscriber and advertising fees,decreased $2.6 million or 4% in 2010 over 2009. Our subscriber fee revenueincreased $1.7 million or 11%.  The amount of subscriber acquisition fees that was recorded asa reduction of subscriber fee revenue was approximately $651,000 and $526,000for 2009 and 2010, respectively. Subscriber revenue increased in 2010 primarilydue small contractual rate increases and significant growth in HallmarkMovie Channel subscribers.

 

The$4.0 million or 7% decrease in advertising revenue is primarily due to declines in viewer ratings acrossdemographic categories for 2010 compared 2009. The ratings decline reduced therevenue from all inventory, including inventory used to satisfy deficiencies inaudience delivery.  Audience deficiencyunit revenue decreased $2.3 million from contra-revenue of $1.9 million for2009, to contra-revenue of $4.2 million for the same period in 2010 as a resultof such ratings declines, leading to a corresponding decrease in revenuerecognized by the Company. CPM scatter rates in the first quarter of 2010increased by approximately 18% over the same period of 2009,

 

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thereby increasingrevenues.  However, the increase in CPMrates was more than offset by the decline in ratings which reduced the value ofthe Company’s inventory.

 

We believe that changes to our program schedule in2009 and the first quarter of 2010, along with increased competition (includingthe availability of high definition distribution by competitors), contributedto a decline in ratings. From 2005 until early 2009, our programming scheduledid not change significantly. Beginning in 2008, a number of programs that hadpreviously received strong ratings began to experience ratings declines, and weplaced television series in certain timeslots instead of movies or originalproductions.  Also, a number of programsin the schedule provided strong household ratings performance but lesseffective delivery of our key demographic, women age 25-54.  In 2009, we began to introduce new contentinto the schedule with the objective of increasing the delivery of women25-54.  The schedule changes likelyresulted in some viewer confusion and did result in lower ratings.  We will continue to focus on programacquisitions, original program production and schedule changes that areintended to improve both the viewer ratings and the demographic delivery of theHallmark Channel.

 

The fact that Hallmark Channel was not broadcast inhigh definition may have had a negative impact on ratings in 2009.  Of the top 44 advertising supported cablenetworks with a 0.4 household rating or higher in prime time, only six of thosenetworks (including Hallmark Channel) were not offered in high definition.  Of those six networks, three experienceddouble-digit ratings decreases in 2009 compared to 2008 and three experiencedsingle digit increases.  In 2009, 33% ofviewers with access to high definition programming services tuned to those highdefinition services first.  The growth inpopularity of high definition programming is expected to continue in 2010 andbeyond, and these high definition trends were part of our decision to launchHallmark Channel in high definition in February 2010.

 

In 2009, competition within the cable televisionindustry increased significantly.  Thenumber of cable networks investing in original programming increased 74% in2009 compared to 2008, and, for the full year 2009, acquired (non-original)programming represented only 33% of prime time cable programming. The increasein cable networks’ investment in original programming continues in 2010, and webelieve it continues to negatively impact our ratings.  Although Hallmark Channel continues to investin original programming, our increase in investment for original content didnot match the growth of the market or many of our competitors.  The impact of the programming competition isheightened by the continued growth of time-shifting digital video recordingdevices, or DVR’s. With the proliferation of these devices, viewers are able toincrease their access to the new, compelling content.

 

For the three months ended March 31, 2010, Nielsen ranked theHallmark Channel 18th intotal day viewership with a 0.501 household rating and 18th in primetimewith a 0.814 household rating among the 76 cable channels in the United Statesmarket.

 

*Cost ofservices.*Cost ofservices as a percent of revenue decreased to 47% in 2010 as compared to 51% in2009. This decrease results primarily from the effects of the 9% decrease inprogramming costs, discussed below, offset in part by the 7% decrease inadvertising revenue discussed above.

 

Programming costs decreased $3.1 million or 9% from 2009. During 2009and during the first quarter of 2010, except for Martha Stewart programming, wedid not enter into any significant new third party license agreements, soexpiring program rights and the related amortization were not replaced in fullwith assets and amortization from newer license agreements. At this time, we donot expect significant program acquisitions for the rest of 2010.

 

Operating costs for 2010 decreased $1.3 million over 2009 due in part to the$596,000 decrease in bad debt expense. The Company’s bad debt expense was$622,000 for 2009, as compared to $26,000 for 2010.  Additionally, salary expense decreased$207,000 and playback and transponder expenses decreased $266,000 due toterminations of employment and standard definition provider contracts in 2009.

 

We may incur additional costs subsequent to March 31, 2010, toobtain high definition versions of certain of our programming.

 

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*Selling,general and administrative expense.* Our selling,general and administrative expense decreased slightly period over period.  Salary and bonus expense decreased $1.0million primarily due to terminations of employment in 2009. Additionally,commission expense decreased $386,000 due to lower advertising revenues. Thesedecreases were offset by increases in rent, long-term bonus, RSU, consultingand transportation expenses of $1.0 million.

 

*Marketingexpense*.  Our marketing expense decreased 80% in firstquarter of 2010 versus the first quarter of 2009. During 2009, the Company hadone significant marketing promotion in January 2009 centered on theoriginal movie, “Taking a Chance on Love.” The Company did not have asignificant marketing promotion in the first quarter of 2010.

 

Marketing expenses may increase in 2010 to promote the Hallmark Channel’sprogramming schedule, including the recently acquired Martha Stewart Livingproductions.

 

*Interestexpense. *Interest expense in 2010 increased $627,000 comparedto 2009.   The principal balance underour credit facility was $32.1 million at March 31, 2009, and $0 at March 31,2010. Interest rates on our 2001, 2005 and 2006 notes decreased from 6.42% at March 31,2009, to 5.25% at March 31, 2010. The benefit of these rate decreases wasoffset by a higher principal balance on the Senior Secured Note, resulting ininterest expense for 2010 being nearly the same as for 2009.

 

## **Liquidityand Capital Resources**

 

During the three months ended March 31,2009, our operating activities used $385,000 of cash compared to cash providedof $7.8 million for the three months ended March 31, 2010.**The Company’s netloss for the three months ended March 31, 2010, decreased $5.1 million to$2.3 million from $7.4 million for the three months ended March 31, 2009.Our depreciation and amortization expense for the three months ended March 31,2010 decreased $3.2 million to $30.4 million from $33.6 million in 2009.  The Company made programming payments of $41.2 millionand $45.4 million during the three months ended March 31, 2009 and 2010,respectively.

 

Cash used in investingactivities was $304,000 and $397,000 during the three months ended March 31,2009 and 2010, respectively. During the three months ended March 31, 2009and 2010, we purchased property and equipment of $81,000 and $426,000,respectively. During the three months ended March 31, 2009 and 2010, theCompany paid $223,000 and $0, respectively, to the buyer of the internationalbusiness for amounts due under the terms of the sale agreement, primarily forreimbursement of transponder lease payments. The related liability was recognizedin 2005 as part of the sale of our international business.

 

Cash provided by financingactivities was $3.3 million for the three months ended March 31, 2009, ascompared to cash used in financing activities of $1.2 million for the threemonths ended March 31, 2010. We borrowed $12.4 million and $0 under ourcredit facility to supplement the cash requirements of our operating andinvesting activities during the three months ended March 31, 2009 and2010, respectively. We repaid principal of $8.9 million and $1.0 million underour bank credit facility during the three months ended March 31, 2009 and2010, respectively.

 

*Cash Flows*

 

As of March 31,2010, the Company had $16.6 million in cash and cash equivalents on hand and$30.0 million of borrowing capacity under the bank credit facility.  Day-to-day cash disbursement requirementshave typically been satisfied with cash on hand and operating cash receiptssupplemented with the borrowing capacity available under the bank creditfacility and forbearance by Hallmark Cards and its affiliates.  The Company’s management anticipates that theprincipal uses of cash up to August 31, 2010, will include the payment ofoperating expenses, accounts payable and accrued expenses, programming costs,costs incurred in connection with the Recapitalization, interest and repaymentof principal under the bank credit facility and interest of approximately $15.0million to $18.0 million due under certain notes to Hallmark Cards affiliatesfrom January 1 through August 31, 2010.  The amounts outstanding under the bank creditagreement and those notes to Hallmark affiliates are due August 31, 2010,as discussed in Note 5 to Unaudited Condensed Consolidated Financial Statementscontained in Item 1 of this Report.

 

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The Company generatedpositive cash flows from operating activities for the year ended December 31,2009, and the three months ended March 31, 2010.  As indicated below, there can be no assurancethat the Company’s operating activities will generate positive cash flow infuture periods.

 

Another significantaspect of the Company’s liquidity is the deferral of payments on obligationsowed to Hallmark Cards and its subsidiaries. Under the Amended and RestatedWaiver Agreement with Hallmark Cards and its affiliates, the deferred paymentsunder such obligations are extended to August 31, 2010.  These obligations comprised $345.2 million atMarch 31, 2010.  An additional$778.0 million (10.25% Senior Secured Note) of principal and interestoutstanding at March 31, 2010, payable to a Hallmark Cards’ affiliate in August 2011,is also subject to the Waiver Agreement until August 31, 2010.  Interest amounts related to the 10.25% notewill be added to principal through August 5, 2010.  The deferral of payments under the WaiverAgreement terminates on August 31, 2010. Hallmark Cards and its affiliates have no obligation, and have stated anintention not to extend this waiver termination date. The note purchaseagreement for the senior note provides that if there is an event of defaultwith respect to any other indebtedness in excess of $5.0 million, the accretedvalue and any accrued and unpaid interest on the senior note would become dueand payable.

 

At March 31, 2010,the Company had no liability under the credit facility. The Company’s abilityto pay amounts outstanding under the bank credit facility on the maturity dateis highly dependent upon its ability to generate sufficient, timely cash flowfrom operations between January 1 and the earlier of August 31, 2010,or the date on which the Recapitalization is consummated.  There is uncertainty regarding the Company’sfuture advertising revenues, so it is possible that cash flows may be less thanthe expectations of the Company’s management.

 

Upon maturity of thecredit facility on August 31, 2010, to the extent the facility has notbeen paid in full, renewed or replaced, the Company could exercise its optionunder the Waiver Agreement and require Hallmark Cards to purchase the interestof the lending bank in the facility.  Inthat case, Hallmark Cards would have all the obligations and rights of the lendingbank under the bank credit facility and could demand payment of outstandingamounts at any time after August 31, 2010, under the terms of the WaiverAgreement.

 

The Company believesthat cash on hand, cash generated by operations, and borrowing availabilityunder its bank credit facility through August 31, 2010, when combined with(1) the deferral of otherwise required payments under the 10.25% SeniorSecured Note related-party debt and the tax sharing agreement, and (2) ifnecessary, Hallmark Cards’ purchase of any outstanding indebtedness under thebank credit facility on August 31, 2010 will be sufficient to fund theCompany’s operations and enable the Company to meet its liquidity needs untilthe earlier of August 31, 2010, or the closing of the Recapitalizationdescribed above in Note 1 to Unaudited Condensed Consolidated FinancialStatements contained in Item 1 of this Report .

 

As discussed in suchNote 1, the Company has entered into the Master Recapitalization Agreement forthe Recapitalization transactions, including the exchange of existing debt owedto H C Crown Corp. for new debt, preferred stock and common stock.  It is a condition of the Recapitalizationthat the Company have obtained a revolving credit facility from a third-partylender, guaranteed by Hallmark Cards or one of its affiliates, with a term ofnot less than 360 days of the closing date of the Recapitalization, with theavailability of at least $30.0 million and on other terms and conditionsreasonably acceptable to the Company.  Ifthe Recapitalization is closed as contemplated at this time, the Companybelieves that cash on hand, cash generated by operations and borrowingavailability under the contemplated revolving credit facility will besufficient to fund the Company’s operations and enable the Company to meet itsliquidity needs until at least March 31, 2011.

 

Also, as discussedabove, the form of credit agreement with HC Crown and other Hallmark Cardaffiliates in the Recapitalization requires that, prior to closing of thecredit agreement, the Company establish the NICC Reserve Account in the Company’sname for amounts that the Company may choose as a sinking fund with respect tothe $25.0 million payable by December 31, 2010, for the redemption of thepreferred interest in Crown Media United States.  The preferred interestis held by VISN Management Corp. (“VISN”), a wholly-owned subsidiary ofNICC.  At no time may the amounts in the NICC Reserve Account exceed $25.0million.  In order to redeem the preferred interest, the Company may needto borrow up to $25.0 million under the bank credit facility.

 

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The sufficiency of theexisting sources of liquidity to fund the Company’s operations is dependentupon maintaining subscriber and advertising revenue at or near the amount ofsuch revenue for the year ended December 31, 2009, and consummation of theRecapitalization. A significant decline in the popularity of the Channels, aneconomic decline in the advertising market, an increase in program acquisitioncosts, an increase in competition or other adverse changes in operatingconditions could negatively impact the Company’s liquidity and its ability tofund the current level of operations.

 

The closing of the Recapitalization is subject to anumber of conditions, including, among other things, (a) representationsand warranties of the Company being accurate, (b) there being noinjunction or action by any court or other governmental entity preventing theconsummation of the Recapitalization transactions which has not been vacated,dismissed or withdrawn prior to the completion of the Recapitalizationtransactions, (c) the Company’s obtaining a revolving credit agreement ofat least $30.0 million and a term of at least 360 days from theclosing, (d) Hallmark Cards not having delivered a notice that HallmarkCards, in its sole discretion (but after consultation with legal counsel),shall have determined that the status of any pending or threatened litigation(including, without limitation, the action styled *S. Muoio &Co. LLC v. Abbott et al*, C.A. No. 4729-CC (Del. Ch.)) orregulatory proceeding relating to the Recapitalization transactions isunsatisfactory to Hallmark Cards and (e) the satisfaction or waiver of theconditions to the effectiveness of the new credit agreement.  If for any reason the Recapitalization is notconsummated, the Company would be unable to meet its obligations which becomedue on August 31, 2010, which provides substantial doubt about the Company’sability to continue as a going concern. In addition, it is unlikely that the Company could obtain, without aguarantee or other support of Hallmark Cards, other equity or debt financingprior to August 31, 2010, in order to replace or refinance obligationsbecoming due on that date.  This is theview of the special committee which considered and negotiated theRecapitalization.  Accordingly, theCompany believes the ability of the Company to continue its operations dependsupon completion of the Recapitalization.

 

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

 

The discussion set forth in this Form 10-Qcontains statements concerning potential future events. Such forward-lookingstatements are based on assumptions by Crown Media Holdings management, as ofthe 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 differ materially from those anticipated by suchforward-looking statements.

 

Among the factors that could cause actual resultsto differ materially are those discussed in this Report below and in theCompany’s filings with the Securities and Exchange Commission, including theRisk Factors stated in the Company’s Annual Report on Form 10-K for theyear ended December 31, 2009, and this Report. Such Risk Factors include,but are 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.

 

### **Available Information**

 

**We will makeavailable free of charge through our website, www.hallmarkchannel.com, the 2009Annual Report on Form 10-K, our quarterly reports on Form 10-Q, ourcurrent reports on Form 8-K, and amendments to such reports, as soon asreasonably practicable after we electronically file or furnish such materialwith the Securities and Exchange Commission.**

 

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

 

**Item 3.  *Quantitative andQualitative DisclosuresAbout Market Risk***

 

We only invest in instrumentsthat meet high credit and quality standards, as specified in our investmentpolicy guidelines. These instruments, like all fixed income instruments, aresubject to interest rate risk. The fixed income 

 

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portfolio will decline in value if interest ratesincrease. If market interest rates were to increase immediately and uniformlyby 10% from levels as of March 31, 2010, the decline of the fair value ofthe fixed income portfolio would not be material.

 

As of March 31, 2010, ourcash, cash equivalents and short-term investments had a fair value of $16.6million and were invested in cash and short-term commercial paper. The primarypurpose of these investing activities has been to preserve principal until thecash is required to fund operations and to fund the $25.0 mandatorilyredeemable preferred interest amount payable in December 2010.Consequently, the size of this portfolio fluctuates significantly as cash isprovided by and used in our business.

 

The value of certain investmentsin this portfolio can be impacted by the risk of adverse changes in securitiesand economic markets and interest rate fluctuations. For the three months endedMarch 31, 2010, the impact of interest rate fluctuations, changed businessprospects and all other factors did not have a material impact on the fairvalue of this portfolio, or on our income derived from this portfolio.

 

We have not used derivativefinancial instruments for speculative purposes. As of March 31, 2010, weare not hedged or otherwise protected against risks associated with any of ourinvesting or financing activities.

 

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

 

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

 

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

 

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

 

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

 

Ourmaterial interest bearing assets consisted of cash equivalents and short-terminvestments. The balance of our interest bearing assets was $16.6 million, or2% of total assets, as of March 31, 2010. Our material liabilities subjectto interest rate risk consisted of our bank credit facility, our note andinterest payable to HC Crown, and our notes and interest payable to HallmarkCards affiliates. The balance of those liabilities was $345.2 million, or 25%of total liabilities, as of March 31, 2010. Net interest expense for thethree months ended March 31, 2010, was $25.5 million, 34%, of our totalrevenue. Our net interest expense for 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 (“Eurodollar”) interest ratesaffect the fair value of interest bearing liabilities.

 

Ifmarket interest rates were to increase or decrease by 1% from the ratesdiscussed in Notes 4 and 5 to the financial statements as of March 31,2010, our interest expense for the three months would change by $852,000. SeeNotes 4 and 5 to the Unaudited Condensed Consolidated Financial Statementscontained in Part I, Item 1 above.

 

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

 

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

 

Our management evaluated, with the participation ofour Chief Executive Officer and our Chief Financial Officer, the effectivenessof our disclosure controls and procedures as of the end of the period coveredby this Quarterly Report on Form 10-Q. Based on this evaluation, our ChiefExecutive Officer and our Chief Financial 

 

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Officer have concluded that our disclosure controls and procedures wereeffective as of the end of the period covered by this Quarterly Report on Form 10-Q.

 

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

 

There was no change in the Company’s internal control over financialreporting that occurred during the quarter ended March 31, 2010, thatmaterially affected, or was reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

**PART II.  OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

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

 

**Item 1A.  Risk Factors**

 

***We believe that our ability to continue operations depends uponcompletion of the Recapitalization.***

 

The Recapitalization is intended to exchange theexisting debt obligations to the Hallmark affiliates for new debt, preferredstock and common stock.  Hallmark Cardsand its affiliates own beneficially a sufficient number of shares of Class Aand Class B stock to approve the Recapitalization transactions.  Nevertheless, consummation of the Recapitalizationtransactions is not assured.  Variousconditions must be satisfied for a closing of the Recapitalization, including HallmarkCards not having delivered a notice that Hallmark Cards, in its sole discretion(but after consultation with legal counsel), shall have determined that thestatus of any pending or threatened litigation (including, without limitation,the action styled *S. Muoio & Co. LLC v. Abbott et al*,C.A. No. 4729-CC (Del. Ch.)) or regulatory proceeding relating to theRecapitalization transactions is unsatisfactory to Hallmark Cards.  A lawsuit challenging the original proposalfor the Recapitalization was filed in 2009. In March 2010 the plaintiff filed an amended complaint raisingallegations of breach of fiduciary duty against Hallmark Cards and the directordefendants and seeking rescission of the Recapitalization (rather than apreliminary injunction enjoining the consummation of the Recapitalization asoriginally requested) or alternatively an award of rescissory damages.  The trial in this lawsuit has been scheduledfor September 21, 2010. We do not know what steps will be taken in thisexisting lawsuit or whether any new lawsuits will be brought in regard to theRecapitalization.  So long as anylitigation or regulatory proceeding is threatened or pending, Hallmark canunilaterally prevent the consummation of the Recapitalization by virtue of theclosing conditions in the Master Recapitalization Agreement.  In any event, there can be no assurance thatthe Recapitalization will be completed.

 

If for any reason theRecapitalization is not consummated, the Company would be unable to meet itsobligations which become due on August 31, 2010, which providessubstantial doubt about the Company’s ability to continue as a goingconcern.  In addition, it is unlikelythat the Company could obtain, without a guarantee or other support of HallmarkCards, other equity or debt financing prior to August 31, 2010, in orderto replace or refinance obligations becoming due on that date.  Accordingly, the Company believes the abilityof the Company to continue its operations depends upon completion of theRecapitalization.

 

***If our programming declines inpopularity, our subscriber fees and advertising revenue could fall.***

 

Our success depends partly upon unpredictable andvolatile factors beyond our control, such as viewer preferences, competingprogramming and the availability of other entertainment activities.  We may not be able to anticipate and reacteffectively to shifts in tastes and interests in our markets.  Our competitors may have greater numbers oforiginal productions, better distribution, and greater capital resources, andmay be able to react more quickly to shifts in tastes and interests.  As a result, we may be unable to maintain thecommercial success of any of our current programming, or to generate sufficientdemand and market acceptance for our new programming.  A shift in viewer preferences in programmingor alternative entertainment activities could also cause a decline in bothadvertising and subscriber fees revenue. The decline in revenue could hinder or prevent us from achievingprofitability or maintaining a positive cash flow and could adversely affectthe market price of our Class A common stock.

 

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In the second, third and fourth quarters of 2009,except for the holiday period commencing with Thanksgiving and ending on January 3,2010, we experienced declines in viewer ratings across demographic categories,compared to the same periods of 2008, resulting in decreases in advertisingrevenues and cash flows.  This decline inviewer ratings and advertising revenues has continued in the first quarter of2010.  A number of changes to our programschedule were implemented in the second and third quarters of 2009, includingthe replacement of programs that had appeared in the schedule for a number ofyears, as well as a shift in scheduling strategy to more specifically targetour prime demographic group of women 25-54. These changes have caused a temporary disruption to established viewingpatterns for our audience resulting in declines in household ratings but overtime are intended to increase our delivery of viewers in the women 25-54demographic category.  We plan tocontinue or increase the number of original productions and develop a programschedule that attracts a greater number of viewers in our target demographic.  Our recent agreements with Martha StewartLiving Omnimedia, including rights to an extensive library of Martha Stewart,represent a key part of our strategy to attract viewers that appeal torelatively higher CPM advertisers.  Weare introducing this lifestyle programming in various dayparts in the secondquarter of 2010, leading to the September 2010 premier of Martha StewartLiving on the Hallmark Channel.  We mustsuccessfully implement the program rescheduling with an increase in ratings,which is uncertain, or otherwise address the decrease in ratings in order tomaintain or increase our advertising revenues, to maintain subscriber fees andto maintain or improve our cash flow from operations.

 

In addition, our delivery of key demographicscontinues to be impacted by industry developments.  One potentially significant factor is thecontinued growth of time-shifting digital video recording devices (DVRs). DVRsheighten the impact of competition as viewers are able to increase their accessto what they consider to be new, compelling content.  The number of cable networks investing inoriginal programming increased 74% in 2009 compared to 2008, and, for the fullyear 2009, acquired (non-original) programming represented only 33% of theprime time cable programming.  This trendcontinues in 2010, and although Hallmark Channel continues to invest inoriginal programming, our increase in investment for original content did notmatch the growth of the market or many of our competitors.

 

**Item 6.  *Exhibits***

 

**INDEX TO EXHIBITS**

 
| **Exhibit Number** | ** ** | **Exhibit Title**                                                                                                                                                                                                                                                                                    |
|-------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                                                                                                                                                                                                                      |
| 2.4                     |       | Agreement and Plan of Merger of Crown Media  Holdings, Inc. and Hallmark Entertainment Investments Co., dated as of  February 26, 2010 (previously filed as Exhibit 2.1 to our Current  Report on Form 8-K filed on March 1, 2010 and incorporated herein  by reference).        |
| 2.5                     |       | Agreement and Plan of Merger of Crown Media  Holdings, Inc. and Hallmark Entertainment Holdings, Inc., dated as  of February 26, 2010 (previously filed as Exhibit 2.2 to our  Current Report on Form 8-K filed on March 1, 2010 and incorporated  herein by reference).    |
| 3.1                     |       | Amended and Restated  Certificate of Incorporation (previously filed as Exhibit 3.1 to our  Registration Statement on Form S-1/A (Amendment No. 2), Commission  File No. 333-95573, and incorporated herein by reference).                                                            |
| 3.2                     |       | Amendment to the Amended and  Restated Certificate of Incorporation (previously filed as Exhibit 3.2  to our Quarterly Report on Form 10-Q filed on July 31, 2001 (File  No. 000-30700; Film No. 1693331) and incorporated herein by reference).                                 |
| 3.3                     |       | Amended and Restated By-Laws  (previously filed as Exhibit 3.2 to our Registration Statement on  Form S-1/A (Amendment No. 3), Commission File No. 333-95573,  and incorporated herein by reference).                                                                                 |
| 3.4                     |       | Proposed form of Second Amended and Restated  Certificate of Incorporation of Crown Media Holdings (previously filed as  Exhibit 3.1 to our Current Report on Form 8-K filed on  March 1, 2010 and incorporated herein by reference).                                                      |
| 3.5                     |       | Proposed form of Certificate of Designation, Powers,  Preferences, Qualifications, Limitations, Restrictions and Relative Rights of  Series A Convertible Preferred Stock of Crown Media Holdings, Inc.  (previously filed as Exhibit 3.2 to our Current Report on Form 8-K  filed on |

 

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|   |   | March 1, 2010 and incorporated herein by  reference).                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.6    |   | Proposed form of Third Amended and Restated  Certificate of Incorporation of Crown Media Holdings, Inc. (previously  filed as Exhibit 3.3 to our Current Report on Form 8-K filed on  March 1, 2010 and incorporated herein by reference).                                                                                                                                                                                                                                             |
| 10.1   |   | Amendment No. 16, dated as  of March 2, 2010, to the Credit, Security, Guaranty and Pledge  Agreement, dated as of August 31, 2001 among Crown Media  Holdings, Inc. as Borrower, the Guarantors named therein, and JP Morgan  Chase Bank as Administrative Agent and as Issuing Bank (previously filed as Exhibit 10.26  to our Annual Report on Form 10-K filed on March 4, 2010 and  incorporated herein by reference).                                         |
| 10.2   |   | Waiver to the Trademark License  Extension Agreement (Hallmark Channel and Hallmark Movie Channel) dated  March 3, 2010, by and between Hallmark Licensing Inc. and Crown Media  United States, LLC (previously  filed as Exhibit 10.46 to our Annual Report on Form 10-K filed on  March 4, 2010 and incorporated herein by reference).                                                                                                                                               |
| 10.3   |   | Intercompany Services Extension  Agreement, dated as of January 1, 2010, by and between Hallmark Cards,  Incorporated and Crown Media Holdings, Inc. (previously filed as Exhibit 10.58 to our  Annual Report on Form 10-K filed on March 4, 2010 and incorporated  herein by reference).                                                                                                                                                                                         |
| 10.4   |   | Master Recapitalization  Agreement by and among Hallmark Cards, Incorporated, H C Crown Corp.,  Hallmark Entertainment Holdings, Inc., Crown Media Holdings, Inc.,  Crown Media United States, LLC, and The Subsidiaries of Crown Media  Holdings, Inc. Listed as Guarantors on the Credit Facility, dated as of  February 26, 2010 (previously filed as Exhibit 10.1 to our Current  Report on Form 8-K filed on March 1, 2010 and incorporated herein  by reference). |
| 10.5   |   | Proposed form of Credit  Agreement Among Crown Media Holdings, Inc. as Borrower and HC Crown  Corp., as Lender and Each of the Credit Parties Identified on the Signature  Pages Hereto (previously filed as Exhibit 10.2 to our Current  Report on Form 8-K filed on March 1, 2010 and incorporated herein  by reference).                                                                                                                                                       |
| 10.6   |   | Proposed form of Stockholders  Agreement by and among H C Crown Corp., Hallmark Cards, Incorporated and  Crown Media Holdings, Inc. (previously filed as Exhibit 4.1 to our  Current Report on Form 8-K filed on March 1, 2010 and incorporated  herein by reference).                                                                                                                                                                                                                 |
| 10.7   |   | Proposed form of Registration  Rights Agreement among H C Crown Corp., any Other HEIC Stockholder and Crown  Media Holdings, Inc. (previously filed as Exhibit 4.2 to our  Current Report on Form 8-K filed on March 1, 2010 and incorporated  herein by reference).                                                                                                                                                                                                                   |
| 10.8   |   | Proposed form of Amendment  No. 2 to Federal Income Tax Sharing Agreement between Hallmark Cards,  Incorporated and Crown Media Holdings, Inc. (previously filed as  Exhibit 10.3 to our Current Report on Form 8-K filed on  March 1, 2010 and incorporated herein by reference).                                                                                                                                                                                                |
| 10.9   |   | Amendment by letter dated  March 19, 2010 to Master Recapitalization Agreement.                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.10  |   | Intercompany Services Amendment  and Extension Agreement, dated as of May 1, 2010, by and between  Hallmark Cards, Incorporated and Crown Media Holdings, Inc.                                                                                                                                                                                                                                                                                                                                        |
| 31.1   |   | Rule 13a-14(a) Certification executed by  the Company’s Chief Executive Officer.                                                                                                                                                                                                                                                                                                                                                                                                            |
| 31.2   |   | Rule 13a-14(a) Certification executed by  the Company’s Executive Vice President and Chief Financial Officer.                                                                                                                                                                                                                                                                                                                                                                               |
| 32     |   | Section 1350 Certifications.                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |

 

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*Management contract orcompensating plan or arrangement.

 

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**SIGNATURES**

 

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

 
| CROWN  MEDIA HOLDINGS, INC.                      |                  |               |
|--------------------------------------------------|-----------------------|--------------------|
| ** **                                       | ** **            | ** **         | ** ** | ** ** |
| **Signature**                                    | ** **            | **Title**          | ** ** | **Date** |
|                                             |                  |               |   |   |
| By:                                         | /s/ WILLIAM J. ABBOTT |               | Principal Executive |   | May 5, 2010 |
|                                             |                  | Officer            |   |   |
|      William  J. Abbott |                  |               |   |   |
|                                             |                  |               |   |   |
| By:                                         | /s/ BRIAN C. STEWART  |               | Principal |   | May 5, 2010 |
|                                             |                  | Financial and      |   |   |
|    Brian C.  Stewart              |                  | Accounting Officer |   |   |

 

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