UNITED
STATES SECURITIES AND EXCHANGE COMMISSION





Washington,
D.C. 20549





Form
10-Q





(Mark
One)


[X]   QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d)


OF
THE SECURITIES EXCHANGE ACT OF 1934





For
the quarterly period ended June 30, 2009





or





[  ]   TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d)


OF
THE SECURITIES EXCHANGE ACT OF 1934





For
the transition period
from                    to                    .





Commission
File Number: 000-30700





Crown
Media Holdings, Inc.


(Exact
Name of Registrant as Specified in Its Charter)





Delaware
            84-1524410(State
      or Other Jurisdiction ofIncorporation
      or Organization)
            (I.R.S.
      Employer Identification No.)





12700
Ventura Boulevard,


Suite
200


Studio
City, California  91604


(Address
of Principal Executive Offices and Zip Code)





(818)
755-2400


(Registrant’s
Telephone Number, Including Area Code)





(Former
Name, Former Address, and Former Fiscal Year,


if
Changed Since Last Report.)





Indicate
by check mark whether the registrant:  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90
days.  Yes  [X]     No
[  ]





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files).  Yes  [X]     No
[  ]





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


Large
      accelerated filer [  ]
            Accelerated
      filer [X]





Non-accelerated
      filer (do not check if a smaller reporting company)
      [  ]
            Smaller
      reporting company [  ]





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





As of
August 3, 2009, the number of shares of Class A Common Stock, $.01 par value
outstanding was 74,117,654, and the number of shares of Class B Common Stock,
$.01 par value, outstanding was 30,670,422.














TABLE
OF CONTENTS





PagePART
      I
              Financial
      InformationItem
      1
              Financial
      Statements (Unaudited)CROWN
      MEDIA HOLDINGS, INC. AND SUBSIDIARIESCondensed
      Consolidated Balance Sheets – December 31, 2008 and
                June
      30, 2009 (Unaudited)Condensed
      Consolidated Statements of Operations and Comprehensive Loss
      (Unaudited)-
      Three and Six Months Ended June 30, 2008 and 2009Condensed
      Consolidated Statements of Cash Flows (Unaudited)-
      Six Months Ended June 30, 2008 and 2009Notes
      to Unaudited Condensed Consolidated Financial StatementsItem
      2
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      OperationsItem
      3
              Quantitative
      and Qualitative Disclosures About Market RiskItem
      4
              Controls
      and ProceduresPART
      II
              Other
      InformationItem
      1
              Legal
      ProceedingsItem
      1A
              Risk
      FactorsItem
      6
              ExhibitsSignatures








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




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







PART
I. FINANCIAL INFORMATION





Item
1.  Financial
Statements (Unaudited)








CROWN
MEDIA HOLDINGS, INC. AND SUBSIDIARIES


UNAUDITED
CONDENSED CONSOLIDATED BALANCE SHEETS


(In thousands, except par value
and number of shares)





As
      of December 31,
                  2008
                
                
                As
      of June 30,
                  2009ASSETSCash
      and cash
      equivalents
                
                $
                2,714
                
                
                $
                6,804Accounts
      receivable, less allowance for doubtful accounts of
                  $294
      and $290,
      respectively
                
                
                66,510
                
                
                
                65,780Program
      license
      fees
                
                
                105,936
                
                
                
                110,587Prepaid
      and other
      assets
                
                
                11,722
                
                
                
                11,640Total
      current
      assets
                
                
                186,882
                
                
                
                194,811Program
      license
      fees
                
                
                214,207
                
                
                
                213,745Property
      and equipment,
      net
                
                
                15,392
                
                
                
                14,169Goodwill
                
                
                314,033
                
                
                
                314,033Prepaid
      and other
      assets
                
                
                8,831
                
                
                
                7,105Total
      assets
                
                $
                739,345
                
                
                $
                743,863
































See accompanying notes to unaudited
condensed consolidated financial statements.








CROWN
MEDIA HOLDINGS, INC. AND SUBSIDIARIES


UNAUDITED
CONDENSED CONSOLIDATED BALANCE SHEETS


(In thousands, except par value
and number of shares)


(continued)





As
      of December 31,
                  2008
                
                
                As
      of June 30,
                  2009LIABILITIES
      AND STOCKHOLDERS’ DEFICITLIABILITIES:Accounts
      payable and accrued
      liabilities
                
                $
                23,992
                
                
                $
                17,134Audience
      deficiency reserve
      liability
                
                
                11,505
                
                
                
                16,387License
      fees
      payable
                
                
                128,638
                
                
                
                118,780Payables
      to Hallmark Cards
      affiliates
                
                
                14,799
                
                
                
                21,132Payables
      to National Interfaith Cable
      Coalition
                
                
                2,849
                
                
                
                2,693Credit
      facility and interest
      payable
                
                
                29
                
                
                
                20,353Notes
      and interest payable to Hallmark Cards affiliates
                
                
                3,987
                
                
                
                346,051Total
      current
      liabilities
                
                
                185,799
                
                
                
                542,530Accrued
      liabilities
                
                
                28,857
                
                
                
                26,072License
      fees
      payable
                
                
                112,451
                
                
                
                117,465Payables
      to National Interfaith Cable
      Coalition
                
                
                2,504
                
                
                
                -Credit
      facility
                
                
                28,570
                
                
                
                -Notes
      payable to Hallmark Cards
      affiliates
                
                
                340,697
                
                
                
                -Senior
      secured note to HC Crown, including accrued interest
                
                
                686,578
                
                
                
                721,765Company
      obligated mandatorily redeemable preferred
                  interest
                
                
                20,822
                
                
                
                21,862Total
      liabilities
                
                
                1,406,278
                
                
                
                1,429,694COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS'
      DEFICIT:Class
      A common stock, $.01 par value; 200,000,000 shares authorized; 74,117,654
      shares issued and outstanding as of December 31, 2008 and June 30, 2009,
      respectively
                
                
                741
                
                
                
                741Class
      B common stock, $.01 par value; 120,000,000 shares
                  authorized;
      30,670,422 shares issued and outstanding as of December 31, 2008 and June
      30, 2009, respectively
                
                
                307
                
                
                
                307Paid-in
      capital
                
                
                1,465,293
                
                
                
                1,459,168Accumulated
      deficit
                
                
                (2,133,274
                )
                
                
                (2,146,047
                )Total
      stockholders'
      deficit
                
                
                (666,933
                )
                
                
                (685,831
                )Total
      liabilities and stockholders'
      deficit
                
                $
                739,345
                
                
                $
                743,863





See
accompanying notes to unaudited condensed consolidated financial
statements.








CROWN
MEDIA HOLDINGS, INC. AND SUBSIDIARIES


UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
LOSS


(In thousands, except per share
data)














Three
      Months Ended
                          June
      30,
                        
                        
                        Six
      Months Ended
                          June
      30,2008
                        
                        
                        2009
                        
                        
                        2008
                        
                        
                        2009Revenue:Subscriber
      fees
                        
                        $
                        14,579
                        
                        
                        $
                        15,860
                        
                        
                        $
                        28,432
                        
                        
                        $
                        31,155Advertising
                        
                        
                        56,538
                        
                        
                        
                        51,756
                        
                        
                        
                        112,886
                        
                        
                        
                        106,881Advertising
      by Hallmark Cards
                        
                        
                        82
                        
                        
                        
                        165
                        
                        
                        
                        157
                        
                        
                        
                        334Other
      revenue
                        
                        
                        321
                        
                        
                        
                        401
                        
                        
                        
                        609
                        
                        
                        
                        764Total
      revenue, net
                        
                        
                        71,520
                        
                        
                        
                        68,182
                        
                        
                        
                        142,084
                        
                        
                        
                        139,134Cost
      of Services:Programming
      costsAffiliates
                        
                        
                        195
                        
                        
                        
                        306
                        
                        
                        
                        284
                        
                        
                        
                        599Non-affiliates
                        
                        
                        35,446
                        
                        
                        
                        30,995
                        
                        
                        
                        70,762
                        
                        
                        
                        62,917Other
      costs of services
                        
                        
                        3,594
                        
                        
                        
                        4,488
                        
                        
                        
                        7,063
                        
                        
                        
                        8,500Total
      cost of services
                        
                        
                        39,235
                        
                        
                        
                        35,789
                        
                        
                        
                        78,109
                        
                        
                        
                        72,016Selling,
      general and administrative expense (exclusive of
                          depreciation and amortization expense shown separately
    below)
                        
                        
                        11,865
                        
                        
                        
                        10,711
                        
                        
                        
                        25,326
                        
                        
                        
                        22,792Marketing
      expense
                        
                        
                        2,060
                        
                        
                        
                        842
                        
                        
                        
                        8,458
                        
                        
                        
                        5,617Depreciation
      and amortization expense
                        
                        
                        492
                        
                        
                        
                        484
                        
                        
                        
                        924
                        
                        
                        
                        967Income
      from operations
                        
                        
                        17,868
                        
                        
                        
                        20,356
                        
                        
                        
                        29,267
                        
                        
                        
                        37,742Interest
      income
                        
                        
                        175
                        
                        
                        
                        124
                        
                        
                        
                        365
                        
                        
                        
                        261Interest
      expense
                        
                        
                        (23,967
                        )
                        
                        
                        (25,802
                        )
                        
                        
                        (50,271
                        )
                        
                        
                        (50,776
                        )Net
      loss and comprehensive loss
                        
                        $
                        (5,924
                        )
                        
                        $
                        (5,322
                        )
                        
                        $
                        (20,639
                        )
                        
                        $
                        (12,773
                        )Weighted
      average number of Class A and Class B shares outstanding, basic
      and diluted
                        
                        
                        104,788
                        
                        
                        
                        104,788
                        
                        
                        
                        104,764
                        
                        
                        
                        104,788Net
      loss per share, basic and diluted
                        
                        $
                        (0.06
                        )
                        
                        $
                        (0.05
                        )
                        
                        $
                        (0.20
                        )
                        
                        $
                        (0.12
                        )





See
accompanying notes to unaudited condensed consolidated financial
statements.











CROWN
MEDIA HOLDINGS, INC. AND SUBSIDIARIES


UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(In
thousands)





Six
      Months Ended June 30,2008
                
                
                2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                
                $
                (20,639
                )
                
                $
                (12,773
                )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Depreciation
      and amortization
                
                
                73,583
                
                
                
                66,248Accretion
      on company obligated mandatorily redeemable preferred
    interest
                
                
                1,198
                
                
                
                1,040Provision
      for allowance for doubtful accounts
                
                
                5
                
                
                
                893Residuals
      and participations
                
                
                96
                
                
                
                -Impairment
      of film asset
                
                
                176
                
                
                
                -Stock-based
      compensation (benefit)
                
                
                1,044
                
                
                
                (684
                )Changes
      in operating assets and liabilities:Decrease
      (increase) in accounts receivable
                
                
                1,352
                
                
                
                (163
                )Additions
      to program license fees
                
                
                (68,093
                )
                
                
                (67,704
                )(Increase)
      decrease in prepaid and other assets
                
                
                (13,802
                )
                
                
                40Decrease
      in accounts payable, accrued and other liabilities
                
                
                (16,158
                )
                
                
                (5,373
                )Increase
      in interest payable
                
                
                43,687
                
                
                
                36,494Increase
      (decrease) in license fees payable
                
                
                13,257
                
                
                
                (4,844
                )Increase
      in payables to affiliates
                
                
                1,293
                
                
                
                208Net
      cash provided by operating activities
                
                
                16,999
                
                
                
                13,382CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of property and equipment
                
                
                (1,267
                )
                
                
                (194
                )Payments
      to buyer of international business
                
                
                (2,019
                )
                
                
                (454
                )Net
      cash used in investing activities
                
                
                (3,286
                )
                
                
                (648
                )CASH
      FLOWS FROM FINANCING ACTIVITIES:Borrowings
      under the credit facility
                
                
                18,761
                
                
                
                18,062Principal
      payments on the credit facility
                
                
                (33,810
                )
                
                
                (26,310
                )Principal
      payments on capital lease obligations
                
                
                (361
                )
                
                
                (396
                )Net
      cash used in financing activities
                
                
                (15,410
                )
                
                
                (8,644
                )Net
      (decrease) increase in cash and cash equivalents
                
                
                (1,697
                )
                
                
                4,090Cash
      and cash equivalents, beginning of period
                
                
                1,974
                
                
                
                2,714Cash
      and cash equivalents, end of period
                
                $
                277
                
                
                $
                6,804Supplemental
      disclosure of cash and non-cash activities:Interest
      paid
                
                $
                2,899
                
                
                $
                11,383Tax
      sharing payment from Hallmark Cards applied to
                  note
      payable to Hallmark Cards
                
                $
                10,150
                
                
                $
                -Tax
      sharing amount due to Hallmark
      Cards
                
                $
                -
                
                
                $
                6,125Reclassification
      of Redeemable Common Stock to common stock
                  and
      paid-in
      capital
                
                $
                32,765
                
                
                $
                -Interest
      payable converted to principal on note payable
                  to
      Hallmark Card affiliates
                
                $
                24,747
                
                
                $
                -





See
accompanying notes to unaudited condensed consolidated financial
statements.








CROWN
MEDIA HOLDINGS, INC. AND SUBSIDIARIES


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


For
the Three and Six Months Ended June 30, 2008 and 2009








1.
Business and Organization





Organization





Crown
Media Holdings, Inc. (“Crown Media Holdings,” “Crown Media” or the “Company”),
through its wholly-owned subsidiary, Crown Media United States, LLC (“Crown
Media United States”), owns and operates pay 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 include Hallmark Entertainment Investments Co.
("Hallmark Entertainment Investments"), a subsidiary of Hallmark Cards,
Incorporated ("Hallmark Cards"), the National Interfaith Cable Coalition, Inc.
("NICC"), the DIRECTV Group, Inc. and, indirectly through their investments in
Hallmark Entertainment Investments, Liberty Media Corporation and J.P. Morgan
Partners (BHCA), L. P.





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





Liquidity







As of
June 30, 2009, the Company had $6.8 million in cash and cash equivalents on hand
and $24.6 million of current borrowing capacity under the bank credit
facility.  Day-to-day cash disbursement requirements have typically
been satisfied with cash on hand and operating cash receipts supplemented with
the borrowing capacity available under the bank credit facility and forbearance
by Hallmark Cards and its affiliates.  The Company’s management
anticipates that the principal uses of cash up to May 1, 2010, will include the
payment of operating expenses, accounts payable and accrued expenses,
programming costs, interest and repayment of principal under the bank credit
facility and interest of approximately $20.0 million to $25.0 million due under
certain notes to the Hallmark Cards affiliates.  The amounts
outstanding under the bank credit agreement and those notes are due May 1, 2010
as discussed below.




Operating
activities for the year ended December 31, 2008 and the six months ended June
30, 2009, yielded positive cash flow from operations. As discussed below, there
can be no assurance that the Company’s operating activities will generate
positive cash flow in future periods.




Another
significant aspect of the Company’s liquidity is the deferral of payments on
obligations owed to Hallmark Cards and its subsidiaries. Under the Amended and
Restated Waiver Agreement as amended with Hallmark Cards and its affiliates (the
“Waiver Agreement”), the deferred payments under such obligations are extended
to May 1, 2010.  These obligations were a total of $346.1 million at
June 30, 2009.  An additional $721.8 million of principal and interest
outstanding at June 30, 2009, payable to a Hallmark Cards’ affiliate in August
2011, is also subject to the Waiver Agreement until May 1,
2010.  Interest amounts related to the 10.25% note will be added to
principal through February 5, 2010. The Hallmark affiliate has indicated that it
will not extend the Waiver Agreement beyond May 1, 2010.




In March
2009, effective April 1, 2009, the bank credit facility’s maturity date was
extended to March 31, 2010, and the bank’s lending commitment was set at $45.0
million.  The Company’s ability to pay amounts outstanding on the
maturity date is highly dependent upon the Company’s ability to generate
sufficient, timely cash flow from operations between June 30, 2009 and March 31,
2010.  Based on the Company’s forecasts for 2009 and 2010, which
assume no principal payments on notes payable to Hallmark Cards and its
affiliates, the Company would have sufficient cash to repay all or most of the
bank credit facility on the maturity date, if necessary.  However,
there is uncertainty regarding the advertising revenues, so it is possible that
the cash flow may be less than the expectations of the Company’s
management.







Upon
maturity of the credit facility on March 31, 2010, to the extent the facility
has not been paid in full, renewed or replaced, the Company could require under
the Waiver Agreement that Hallmark Cards purchase the interest of the lending
bank in the facility.  In that case, Hallmark Cards would have all the
obligations and rights of the lending bank under the bank credit facility and
could demand payment of outstanding amounts at any time after May 1, 2010, under
the terms of the Waiver Agreement.




The
Company believes that cash on hand, cash generated by operations, and borrowing
availability under its bank credit facility through March 31, 2010, when
combined with (1) the deferral of any required payments on related-party debt,
any 2009 tax sharing payments and related interest on the 10.25% Senior Secured
Note described under the Waiver Agreement, and (2) if necessary, Hallmark Cards’
purchase of any outstanding indebtedness under the bank credit facility on March
31, 2010, as described below, will be sufficient to fund the Company’s
operations and enable the Company to meet its liquidity needs through May 1,
2010.




The
sufficiency of the existing sources of liquidity to fund the Company’s
operations is dependent upon maintaining subscriber and advertising revenue at
or near the amount of such revenue for the six months ended June 30, 2009. A
significant decline in the popularity of the Channels, a further economic
decline in the advertising market, an increase in program acquisition costs, an
increase in competition or other adverse changes in operating conditions could
negatively impact the Company’s liquidity and its ability to fund the current
level of operations.  In the first half of 2009, lower viewership
ratings for the Company's programming on the Hallmark Channel resulted in an
increase in audience deficiency units owed to advertisers, thereby reducing
revenues and cash flow.  Since the second quarter of 2008, the Company
has also experienced a softening of advertising rates in the direct response and
general rate scatter market because of the national
recession.  Subsequent to the first quarter of 2008, the rates for the
Company's advertising spots in the scatter market and direct response
advertising were lower than 2007 levels.  The Company expects these
market conditions to continue throughout 2009, has implemented certain cost
containment measures for 2009, and has a limited number of additional,
contingent cost cutting measures that can be implemented in the remainder of
2009 depending on market conditions.




Because
of the Company’s current inability to meet its obligations when they come due on
and after May 1, 2010, the Company anticipates that prior to May 1, 2010, it
will be necessary to extend, refinance or restructure (i) the bank credit
facility and (ii) the promissory notes payable to affiliates of Hallmark Cards.
As part of a combination of actions and in order to obtain additional funding,
the Company may consider various alternatives, including restructuring of the
debt if possible, refinancing the bank credit facility, raising additional
capital through the issuance of equity or debt securities, or other strategic
alternatives. If the current credit market conditions continue, a restructuring
or refinancing could be difficult to achieve and if achieved could include
changes to existing interest rates and other provisions within the current debt
arrangements. These changes may have a negative impact on future operating
results and cash flows.




As
discussed in Note 6, the Hallmark Cards' affiliate has proposed a
recapitalization of the Company's obligations.  There can be no
assurance as to whether the proposal will be agreed to by the Company or when,
if ever, a recapitalization of the Company will be consummated, and if
consummated whether the terms will be the same or different than those set forth
in the proposal.




2.
Summary of Significant Accounting Policies and Estimates





Interim
Financial Statements





In the
opinion of management, the accompanying condensed consolidated balance sheets
and related interim condensed consolidated statements of operations and cash
flows include all adjustments, consisting of normal recurring items necessary
for their fair presentation in conformity with accounting principles generally
accepted in the United States. Interim results are not necessarily indicative of
results for a full year. These condensed consolidated financial statements
should be read in conjunction with the audited consolidated financial statements
and the notes to those statements for the year ended December 31, 2008, included
in the Company’s Annual Report on Form 10-K for the year ended December 31,
2008.





Basis
of Presentation





The
condensed consolidated financial statements include the accounts of Crown Media
Holdings and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.





The
preparation of financial statements in accordance with generally accepted
accounting principles requires the consideration of events or transactions that
occur after the balance sheet date but before the financial statements are
issued. Depending on the nature of the subsequent event, financial statement
recognition or disclosure of the subsequent event is
required.  Subsequent events have been evaluated through the time of
filing of the Company’s Form 10-Q Report on August 6, 2009, which represents the
date the unaudited condensed consolidated financial statements were
issued.





Use
of Estimates





The
preparation of the accompanying condensed consolidated financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions about future events. These
estimates and the underlying assumptions affect the amounts of assets and
liabilities reported, disclosures about contingent assets and liabilities, and
reported amounts of revenue and expenses. Such estimates include the valuation
of accounts receivable, goodwill, intangible assets, and other long-lived
assets, legal contingencies, indemnifications, and assumptions used in the
calculation of income taxes and customer incentives, among others. These
estimates and assumptions are based on management’s best estimates and judgment.
Management evaluates its estimates and assumptions on an ongoing basis using
historical experience and other factors, including the current economic
environment, which management believes to be reasonable under the circumstances.
Management adjusts such estimates and assumptions when facts and circumstances
dictate. Illiquid credit markets, volatile markets for equity, foreign currency,
and energy, and declines in consumer spending have combined to increase the
uncertainty inherent in such estimates and assumptions. Estimates of the effects
future events are inherently uncertain; therefore, actual results could differ
significantly from these estimates. Whenever revisions to estimates are
warranted by subsequent events or changes in conditions, the effect of such
revisions will be reflected in the financial statements of future
periods.








Allowance
for Doubtful Accounts





The
allowance for doubtful accounts is based upon the Company’s assessment of
probable loss related to uncollectible accounts receivable.  The
Company uses a number of factors in determining the allowance, including, among
other things, collection trends. The Company’s bad debt expense was $271,000 and
$893,000 for the three and six months ended June 30, 2009, respectively. The
Company’s bad debt expense was $40,000 and $5,000 for the three and six months
ended June 30, 2008, respectively.





Fair
Value of Financial Instruments





In
September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157 (“SFAS 157”), Fair Value Measurements, in
order to establish a single definition of fair value and a framework for
measuring fair value in generally accepted accounting principles that is
intended to result in increased consistency and comparability in fair value
measurements. In early 2008, the FASB issued Staff Position (FSP) FAS-157-2,
which delayed by one year, the effective date of SFAS 157 for all
non-financial assets and non-financial liabilities, except those that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually). The Company adopted the portion of SFAS 157 that
was not delayed by FSP FAS-157-2 as of January 1, 2008, and has adopted the
balance of its provisions as of January 1, 2009.





The
Company does not have balance sheet items carried at fair value on a recurring
basis (to which SFAS 157 applied in 2008) such as derivative financial
instruments which are valued primarily based on quoted prices in active or
brokered markets for identical as well as similar assets and liabilities.
Significant balance sheet items which are subject to non-recurring fair value
measurements (to which SFAS 157 applies in 2009) consist of goodwill,
and property and equipment. The adoption of SFAS 157 in 2008 had no effect
on the measurement of the Company’s financial assets and liabilities. The
standard has not had an impact on the determination of fair value related to
non-financial assets and non-financial liabilities in the first six months of
2009.





Net
Loss per Share





Basic net
loss per share is computed by dividing the net loss for the period by the
weighted average number of common shares outstanding during the period. Diluted
net loss per share is computed based on the weighted average number of common
shares and potentially dilutive common shares outstanding. The calculation of
diluted net loss per share excludes potential common shares if the effect would
be antidilutive. Potential common shares consist of incremental common shares
issuable upon the exercise of stock options. Approximately 341,000 stock options
for each of the three and six months ended June 30, 2008 and 2009, have been
excluded from the calculations of earnings per share because their effect would
have been antidilutive.





Concentration
of Credit Risk





Financial
instruments, which potentially subject Crown Media Holdings to a concentration
of credit risk, consist primarily of cash, cash equivalents and accounts
receivable. Generally, Crown Media Holdings does not require collateral to
secure receivables. Crown Media Holdings has no significant off-balance sheet
financial instruments with risk of losses.





Four and
five of our distributors each accounted for more than 10% of our consolidated
subscriber revenue for the three months ended June 30, 2008 and 2009, and
together accounted for a total of 67% and 76% of consolidated subscriber revenue
during the three months ended June 30, 2008 and 2009,
respectively.  Three of our distributors each accounted for
approximately 15% or more of our consolidated subscribers for both the three
months ended June 30, 2008 and 2009, respectively, and together accounted for
62% of our subscribers during both the three months ended June 30, 2008 and
2009, respectively.





Five of
our distributors each accounted for more than 10% of our consolidated subscriber
revenue for both the six months ended June 30, 2008 and 2009, and together
accounted for a total of 78% and 76% of consolidated subscriber revenue during
the six months ended June 30, 2008 and 2009, respectively.  Three of
our distributors each accounted for approximately 15% or more of our
consolidated subscribers for both the six months ended June 30, 2008 and 2009,
respectively, and together accounted for 62% our subscribers during both the six
months ended June 30, 2008 and 2009, respectively.








Recently
Issued Accounting Pronouncements





In
April 2009, the FASB issued FSP FAS 107-1 and Accounting Principles Board
(APB) 28-1, Interim
Disclosures about Fair Value of Financial Instruments. The FSP amends
SFAS No. 107, Disclosures
about Fair Value of Financial Instruments, to require an entity to
provide disclosures about fair value of financial instruments in interim
financial information. This FSP is to be applied prospectively and is effective
for interim and annual periods ending after June 15, 2009, with early
adoption permitted for periods ending after March 15, 2009. The Company has
included the required disclosures in its financial information for the quarter
ending June 30, 2009.





In May
2009, the FASB issued SFAS No. 165, Subsequent Events (SFAS
165).   SFAS 165 establishes general standards of accounting for
and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued.  SFAS
165 is effective for the Company as of June 30, 2009.  The adoption of
SFAS 165 did not have a material impact on the Company’s condensed consolidated
financial statements.





In July
2009, the FASB issued SFAS No. 168, FASB Accounting Standards
Codification (SFAS 168), as the single source of authoritative
nongovernmental U.S. generally accepted accounting principles. The Codification
is effective for interim and annual periods ending after September 15,
2009. All existing accounting standards are superseded as described in SFAS 168.
All other accounting literature not included in the Codification is
non-authoritative. Management is currently evaluating the impact of the adoption
of SFAS 168 but does not expect the adoption of SFAS 168 to impact the
Company’s condensed consolidated financial statements.








3.
Program License Fees





Program
license fees are comprised of the following:





As of December 31,
                
                
                As of June 30,2008
                
                
                2009(In
      thousands)Program
      license fees —
      non-affiliates
                
                $
                576,779
                
                
                $
                623,005Program
      license fees — Hallmark Cards affiliates
                
                
                10,967
                
                
                
                12,068Program
      license fees, at
      cost
                
                
                587,746
                
                
                
                635,073Accumulated
      amortization
                
                
                (267,603
                )
                
                
                (310,741
                )Program
      license fees,
      net
                
                $
                320,143
                
                
                $
                324,332





At
December 31, 2008, and June 30, 2009, $7.6 million and $6.8 million,
respectively, of program license fees were included in prepaid and other assets
on the accompanying condensed consolidated balance sheets as the Company made
payments for the program license fees prior to commencement of the respective
license periods.





License
fees payable are comprised of the following:





As of December 31,
                
                
                As of June 30,2008
                
                
                2009(In
      thousands)License
      fees payable —
      non-affiliates
                
                $
                231,218
                
                
                $
                225,836License
      fees payable — Hallmark Cards affiliates
                
                
                9,871
                
                
                
                10,409Total
      license fees
      payable
                
                
                241,089
                
                
                
                236,245Less
      current
      maturities
                
                
                (128,638
                )
                
                
                (118,780
                )Long-term
      license fees
      payable
                
                $
                112,451
                
                
                $
                117,465








4.
Credit Facility








On March
2, 2009, the Company and JPMorgan Chase Bank executed Amendment No. 15 to the
credit facility, renewing the Company’s $45.0 million credit line and extending
the maturity date to March 31, 2010, all effective April 1, 2009.  The
facility is guaranteed by Hallmark Cards and the Company’s subsidiaries and is
secured by all tangible and intangible property of Crown Media Holdings and its
subsidiaries.  Interest rates under the credit facility increased from
the Eurodollar rate to the Eurodollar rate plus 2.25% and from the Alternate
Base rate to the Alternate Base rate plus 1.25%.





The
Company had at June 30, 2009, $24.6 million of unused revolving credit capacity.
The Company’s ability to borrow additional amounts under the credit facility is
not limited or restricted.





Each
borrowing under the bank credit facility bears interest at a Eurodollar rate or
an Alternate Base Rate as the Company may request at the time of
borrowing.  The Eurodollar rate is based on the London interbank
market for Eurodollars, and remains in effect for the time period of the loan
ranging from one, two, three, six or twelve months.  The alternate
rate is the greatest of the prime rate of JP Morgan Chase Bank, the one month
London interbank market for Eurodollars plus 1.00% or the Federal Funds
effective rate plus 0.50%, and is adjusted whenever the applicable rate
changes.  Prior to the effectiveness of Amendment No. 15, the Company
was required to pay a commitment fee of 0.15% per annumof the
committed, but not outstanding, amounts under the revolving credit facility,
payable in quarterly installments. Pursuant to Amendment No. 15, the commitment
fee was increased to 0.375% per annum.





At
December 31, 2008, and June 30, 2009, the Company had outstanding borrowings
under the credit facility of $28.6 million and $20.4 million, respectively, and
there were no letters of credit outstanding. At December 31, 2008, the
outstanding balance bore interest at the Eurodollar rate (a 2.02% weighted
average rate). At June 30, 2009, the outstanding balance bore interest at the
Eurodollar rate (a 2.57% weighted average rate). Interest expense on borrowings
under the credit facility for each of the three months ended June 30, 2008 and
2009, was $541,000 and $182,000, respectively. Interest expense on borrowings
under the credit facility for each of the six months ended June 30, 2008 and
2009, was $1.4 million and $289,000, respectively.





Covenants





The
credit facility, as amended, contains a number of affirmative and negative
covenants.  The Company was in compliance with these covenants at June
30, 2009.





5.
Related Party Long-Term Obligations





Waiver
and Standby Purchase





On March
10, 2008, the Company, Hallmark Cards and affiliates of Hallmark Cards who hold
obligations of the Company entered into an Amended and Restated Waiver and
Standby Purchase Agreement, which was most recently amended in May 2009, to
extend the waiver period to May 1, 2010 (the “Waiver Agreement”).  In
connection with the recapitalization proposal described in Note 6, a Hallmark
Cards affiliate stated that it would not further extend the waiver period. The
Waiver Agreement replaced a previous version of the Waiver and Standby Purchase
Agreement dated March 21, 2006 as amended through October 2007.  The
Waiver Agreement defers payments (excluding interest on the 2001, 2005 and 2006
notes mentioned below) due on any of the following obligations (the “Subject
Obligations”) until May 1, 2010, and interest on the 10.25% Note until August 5,
2010, or an earlier date as described below as the waiver termination date,
whereupon all of these amounts become immediately due and payable (the “Waiver
Period”):




·
            Note
      and interest payable to HC Crown, dated December 14, 2001, in the original
      principal amount of $75.0 million, payable to HC Crown. (Total amount
      outstanding at December 31, 2008, and June 30, 2009, including accrued
      interest was $109.8 million and $110.3 million, respectively. See Note and Interest Payable to
      HC Crownbelow.)




·
            $70.0
      million note and interest payable to Hallmark Cards affiliate, dated as of
      March 21, 2006, arising out of the sale to Crown Media Holdings of the
      Hallmark Entertainment film library. (Total amount outstanding at December
      31, 2008, and June 30, 2009, including accrued interest was
      $62.7 million and $63.0 million, respectively. See Note and Interest Payable to
      Hallmark Cards Affiliatebelow.)






·
            10.25%
      senior secured note, dated August 5, 2003, in the initial accreted value
      of $400.0 million, payable to HC Crown.  (Total amount
      outstanding at December 31, 2008, and June 30, 2009, including accrued
      interest was $686.6 million and $721.8 million, respectively. See Senior Secured Notebelow.)




·
            Note
      and interest payable to Hallmark Cards affiliate, dated as of October 1,
      2005, in the principal amount of $132.8 million. (Total amount outstanding
      at December 31, 2008, and June 30, 2009, including accrued interest was
      $172.1 million and $172.8 million, respectively. See Note and Interest Payable to
      Hallmark Cards Affiliatebelow.)






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






·
            Any
      and all amounts due and owing to Hallmark Cards pursuant to the Tax
      Sharing Agreement (Total amount outstanding at June 30, 2009, was $6.1
      million.).




Interest
will continue to accrue on these obligations during the Waiver
Period.  The Waiver Agreement also contains certain covenants,
including but not limited to (1) our covenant not to take any action that
would prohibit us from being included as a member of Hallmark Cards consolidated
federal tax group, (2) compliance with obligations in the loan documents
for the bank credit facility and (3) commercially reasonable efforts to
refinance the obligations subject to the Waiver Period.  Pursuant to
the Waiver Agreement, the Company must make prepayments on the outstanding debt
from 100% of any “Excess Cash Flow” during the Waiver Period.  There
was no Excess Cash Flow for the first or second quarters of 2009. For the six
months ended June 30, 2009, the Company repaid $8.2 million of principal under
the credit facility and $10.4 million of interest due to Hallmark Cards
affiliates, which amounts would otherwise be Excess Cash Flow. Additionally, in
July 2009, the Company paid interest of $5.3 million to Hallmark Cards
affiliates.




The
waiver termination date is May 1, 2010, or earlier upon occurrence of certain
events including but not limited to the following:  (a) the Company
fails to pay any principal or interest, regardless of amount, due on any
indebtedness to unrelated parties with an aggregate principal amount in excess
of $5.0 million or any other event or condition occurs that results in any such
indebtedness becoming due prior to its scheduled maturity, provided that the
waiver will not terminate if the Company reduces the principal amount of such
indebtedness to $5.0 million or less within five business days of a written
notice of termination from Hallmark Cards; or (b) the Company fails to pay
interest on the bank credit facility described above to the extent that Hallmark
Cards has purchased all or a portion of the indebtedness thereunder or to
perform any covenants in the Waiver Agreement.




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










Hallmark
Guarantee; Interest and Fee Reductions





Hallmark
Cards has provided to the lending bank under the credit facility the Hallmark
Cards facility guarantee.  The guarantee is unconditional for
obligations of the Company under the bank credit facility.  If any
payment is made on the guarantee, it will be treated as a purchase of the
lending bank’s interest in the credit facility.





Prior to
April 1, 2009, Hallmark Cards provided an irrevocable letter of credit to JP
Morgan Chase Bank as credit support for our obligations under the Company’s bank
credit facility for which we previously paid the letter of credit fees. This
letter of credit was cancelled on April 1, 2009.





Also,
when Hallmark Cards’ issuance of the letter of credit resulted in reductions in
the interest rate and commitment fees under the credit facility, we agreed to
pay and have paid an amount equal to the reductions to Hallmark
Cards.  With Hallmark Cards’ guarantee issued in place of the letter
of credit, commencing April 1, 2009, such fee is reduced to 0.875%, representing
the 0.75% reduction in the interest rate and the 0.125% reduction in the
commitment fee. These amounts reflect an increase in the credit facility
rates.





Senior
Secured Note





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





In
accordance with the Waiver Agreement, cash payments are not required until
August 5, 2010 (which is the first payment date after May 1, 2010). The
principal amount of the senior secured note accretes at 10.25% per annum,
compounding semi-annually, to February 5, 2010.  From that date,
interest at 10.25% per annum is scheduled to be payable semi-annually in arrears
on the accreted value of the senior note to HC Crown on August 5 and February 5
of each year until maturity.  The note matures on August 5, 2011,
and is pre-payable without penalty. At December 31, 2008, and June 30, 2009,
$686.6 million and $721.8 million, respectively, of principal and interest were
included in the senior note payable in the accompanying consolidated balance
sheets. The note purchase agreement for the senior note provides that if there
is an event of default, the accreted value and any accrued and unpaid interest
on the senior note would become due and payable when there is a default with
respect to any other indebtedness in excess of $5.0 million. The note purchase
agreement for the senior note contains certain restrictive covenants which,
among other things, prevent the Company from incurring any additional
indebtedness, purchasing or otherwise acquiring shares of the Company’s stock,
investing in other parties and incurring liens on the Company’s
assets.  As a fee for the issuance of the notes, the Company paid $3.0
million to HC Crown, which was initially capitalized and is being amortized as
additional interest expense over the term of the note payable.





Note
and 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 is payable in full
on May 1, 2010 (although the maturity date of the note is December 31, 2009).
Under the Waiver Agreement, accrued interest on this 2001 Note was added to
principal through November 15, 2008.  Commencing November 16, 2008,
interest is payable in cash, quarterly in arrears five days after the end of
each calendar quarter. This note is subordinate to the bank credit facility. The
rate of interest under this note is currently LIBOR plus 5% per annum (9.05% and
6.19% at December 31, 2008, and June 30, 2009, respectively). At December 31,
2008, and June 30, 2009, $108.6 million, is reported as note payable to Hallmark
Cards affiliate and $1.3 million and $1.7 million, respectively, are reported as
interest payable to Hallmark Cards affiliate on the accompanying condensed
consolidated balance sheet. Interest of $1.3 million was paid on January 5,
2009, interest of $1.7 million was paid on April 6, 2009, and interest of $1.7
million was paid on July 6, 2009.





Note
and 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 a promissory note.  The
rate of interest under this note is currently LIBOR plus 5% per annum (9.05% and
6.19% at December 31, 2008, and June 30, 2009, respectively). Pursuant to the
Waiver Agreement, the promissory note is payable in full on May 1, 2010
(although the maturity date of the note is December 31, 2009).  Under
the Waiver Agreement, accrued interest on this 2005 Note was added to principal
through November 15, 2008.  Commencing November 16, 2008, interest is
payable in cash, quarterly in arrears five days after the end of each calendar
quarter. At December 31, 2008, and June 30, 2009, $170.1 million is reported as
note payable to Hallmark Cards affiliate and $2.0 million and $2.7 million,
respectively, are reported as interest payable to Hallmark Cards affiliate on
the accompanying condensed consolidated balance sheet. Interest of $2.0 million
was paid on January 5, 2009, interest of $2.7 million was paid on April 6, 2009
and interest of $2.7 million was paid on July 6, 2009.





Note
and Interest Payable to Hallmark Cards Affiliate





On March
21, 2006, the Company converted approximately $70.4 million of its payable to a
Hallmark Cards affiliate to a promissory note. The rate of interest under this
note is currently LIBOR plus 5% per annum (9.05% and 6.19% at December 31, 2008,
and June 30, 2009, respectively). Pursuant to the Waiver Agreement, the
promissory note is payable in full on May 1, 2010 (although the maturity date of
the note is December 31, 2009). Under the Waiver Agreement, accrued interest on
this 2006 Note was added to principal through November 15,
2008.  Commencing November 16, 2008, interest is payable in cash,
quarterly in arrears five days after the end of each calendar quarter. At
December 31, 2008, and June 30, 2009, $62.0 million is reported as note payable
to Hallmark Cards affiliates and $717,000 and $971,000, respectively, are
reported as interest payable to Hallmark Cards affiliate on the accompanying
condensed consolidated balance sheet. Interest of $717,000 was paid on January
5, 2009, interest of $996,000 was paid on April 6, 2009 and interest of $971,000
was paid on July 6, 2009.








Interest
Paid to HC Crown Related to the Credit Facility





Interest
expense paid to HC Crown in connection with the credit facility was $322,000 for
the three months ended June 30, 2008, and $850,000 for the three months ended
June 30, 2009.  Interest expense paid to HC Crown in connection with
the credit facility was $712,000 for the six months ended June 30, 2008, and
$998,000 for the six months ended June 30, 2009.





Related
Party Note Obligations





The
aggregate maturities of related party notes for each of the five years
subsequent to December 31, 2008, are as follows:





Payments
      Due by PeriodTotal
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2011
                  
                  
                  2012
                  
                  
                  2013(In
      thousands)Note
      and interest payable to HC Crown,
                    with
      principal deferred until  May 1, 2010
                  
                  $
                  110,280
                  
                  
                  $
                  1,699
                  
                  
                  $
                  108,581
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -10.25
      % Senior secured note to HC Crown,
                    including
      accrued interest, due August 5, 2011
                  
                  
                  721,765
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  721,765
                  
                  
                  
                  -
                  
                  
                  
                  -Note
      and interest payable to Hallmark Cards affiliate
                    with
      principal deferred until May 1, 2010
                  
                  
                  172,771
                  
                  
                  
                  2,662
                  
                  
                  
                  170,109
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Note
      and interest payable to Hallmark Cards affiliate
                    with
      principal deferred until May 1, 2010
                  
                  
                  62,978
                  
                  
                  
                  971
                  
                  
                  
                  62,007
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -$
                  1,067,794
                  
                  
                  $
                  5,332
                  
                  
                  $
                  340,697
                  
                  
                  $
                  721,765
                  
                  
                  $
                  -
                  
                  
                  $
                  -








6.
Related Party Transactions





Recapitalization
Proposal





On
May 28, 2009, the Company received a proposal (the “Proposal”) from HC
Crown Corp. (“HCC”), a wholly owned subsidiary of Hallmark Cards, Incorporated,
regarding a recapitalization of the Company's existing indebtedness and accounts
payable to HC Crown Corp. and its affiliates (“HCC Debt”) in excess of
$1.05 billion. Under the Proposal, $500.0 million principal amount of
HCC Debt would be restructured into new secured loans (the “New Debt”) with a
maturity date of September 30, 2011 and the remaining balance of the HCC
Debt would be converted into an equal amount of convertible preferred stock (the
“Preferred Stock”).





As stated
in the Proposal, the New Debt would have two tranches: (1) Tranche 1
of $300.0 million would be cash-pay and would bear interest at the rate of 12%
per annum and the Company would have the ability to pay-in-kind up to three
quarterly payments and (2) Tranche 2 of $200.0 million would be
pay-in-kind at the rate of 15% per annum. The New Debt would be secured by the
Company's assets.





The terms
of the Preferred Stock would include (1) an aggregate liquidation
preference, equal to the amount of converted HCC Debt; (2) no preferential
dividend but participation in any dividends on the Common Stock on an “as if
converted” basis; (3) the ability to convert into common stock at a rate
equal to the liquidation preference divided initially by $1.00 per share, which
permits the Company’s existing shareholders (including Hallmark) to retain 15%
ownership of the Company; (4) the Company's ability to redeem the Preferred
Stock at a price equal to the liquidation preference; and (5) the ability
to vote together with the Common Stock on an “as if converted”
basis.





As part
of the Proposal, the Company’s certificate of incorporation would be amended to
authorize additional shares of Preferred Stock and Common Stock in amounts
sufficient for the proposed conversion of HCC Debt into Preferred Stock and the
conversion of such Preferred Stock into Common Stock.  The Proposal
also contemplates a merger of Hallmark Entertainment Holdings and HEIC into the
Company, with the shareholders in Hallmark Entertainment Holdings and HEIC
receiving Common Stock of the Company in accordance with their indirect
ownership of the Company immediately prior to such
mergers.  Additionally, the existing Federal Income Tax Sharing
Agreement would be amended to, among other things, permit the Company to deduct
both cash-pay and pay-in-kind interest due to Hallmark Cards in calculating
tax-sharing payments on a prospective basis.





The HCC
Debt is subject to the Waiver Agreement described above that provides, among
other things, that during the Waiver Period (which is scheduled to expire on
May 1, 2010), HCC will not accelerate the maturity of the HCC Debt,
initiate proceedings for the collection of the HCC Debt, foreclose on the
collateral security for the HCC Debt, or commence or participate in certain
bankruptcy proceedings with respect to the Company. In connection with the
Proposal, HCC stated that it will not further extend the expiration of the
Waiver Period.  The Company's Board of Directors has formed a Special
Committee comprising of A. Drue Jennings (Chairman), Herb Granath and Peter Lund
that is reviewing and considering the proposed recapitalization.  In
July 2009, the Special Committee announced that it has retained an independent
financial advisor to aid in the Special Committee’s review of the proposed
recapitalization.





There can
be no assurance as to whether the Proposal will be agreed to by the Company or
when, if ever, a recapitalization of the Company will be consummated, and if
consummated whether the terms will be the same or different than those set forth
in the Proposal.  The Proposal has been filed with the Securities and
Exchange Commission by the Company in a May 28, 2009 Form 8-K Report
and by Hallmark Cards in an amendment to a Schedule 13D concerning the
Company.





On July
16, 2009, counsel to HCC delivered a letter (the “July 16 Letter”) to counsel to
the Special Committee.  In the July 16 Letter, counsel to HCC
reiterated its understanding that the Special Committee needs time to determine
an appropriate response to the Proposal.  Although HCC had requested
to receive a decision from the Company regarding the Proposed prior to the
filing of the Company’s second quarter Form 10-Q, HCC’s counsel confirmed in the
July 16 Letter that the filing date was in no way intended as a
deadline.  In addition, counsel to HCC confirmed that notwithstanding
HCC’s understanding that the Company is unable to obtain refinancing of the
debt owed to HCC, HCC assumes that the Special Committee will explore other
refinancing alternatives.





For
information on the lawsuit brought in July 2009 with respect to the Proposal,
see Note 11, Subsequent Events.








Tax Sharing
Agreement





Overview





On
March 11, 2003, Crown Media Holdings became a member of Hallmark Cards
consolidated U.S. federal tax group and entered into a federal tax sharing
agreement with Hallmark Cards (the “tax sharing agreement”). Hallmark Cards
includes Crown Media Holdings in its consolidated U.S. federal income tax
return.  Accordingly, Hallmark Cards has benefited from past tax
losses and may benefit from future federal tax losses, which may be generated by
Crown Media Holdings.  Based on the tax sharing agreement, Hallmark
Cards has agreed to pay Crown Media Holdings all of the benefits realized by
Hallmark Cards as a result of including Crown Media Holdings in its consolidated
income tax return.  These benefits are estimated and paid 75% in cash
on a quarterly basis and the balance when Crown Media Holdings becomes a federal
taxpayer.  A final true-up calculation is completed within 15 days
after Hallmark Cards files its consolidated federal income tax return for the
year.  Pursuant to the true-up calculation, Crown Media Holdings is
obligated to reimburse Hallmark Cards the amount that any estimated payments
have exceeded the actual benefit realized by Hallmark Cards and Hallmark Cards
is obligated to pay Crown Media Holdings the amount that any actual benefit
exceeds the estimated payments.  Under the tax sharing agreement, at
Hallmark Cards’ option, the non-interest bearing balance of the 25% in federal
tax benefits not funded immediately may be applied as an offset against any
amounts owed by Crown Media Holdings to any member of the Hallmark Cards
consolidated group under any loan, line of credit or other payable, subject to
limitations under any loan indentures or contracts restricting such
offsets.





The
Company received $5.1 million, which was offset during the first quarter of 2008
against debt owed under the tax sharing agreement with Hallmark Cards, and $5.1
during the second quarter of 2008 under the tax sharing agreement ($10.2 million
for the six months ended June 30, 2008). The Company recorded $2.8 million as a
payable to Hallmark Cards affiliates during the first quarter of 2009 under the
tax sharing agreement and $3.3 million as a payable to Hallmark Cards affiliates
during the second quarter of 2009 ($6.1 million for the six months ended June
30, 2009). Any payments received from Hallmark Cards or credited against amounts
owed by Crown Media Holdings to any member of the Hallmark Cards consolidated
group under the tax sharing agreement have been recorded as paid-in capital in
the consolidated statements of stockholders’ equity (deficit).





Services
Agreement with Hallmark Cards





Hallmark
Cards provides various support services to the Company under a 2003 agreement,
the most recent renewal of which expires December 31, 2009.  Such
services include tax, risk management, health safety, environmental, insurance,
legal, treasury, human resources, cash management services and real estate
consulting services.  In exchange, the Company is obligated to pay
Hallmark Cards a fee, plus out-of-pocket expenses and third party fees, in
arrears on the last business day of each quarter. Fees for Hallmark Cards’
services were $541,000 for 2008 and are scheduled to be $428,000 for 2009. With
the concurrence of Hallmark Cards, the Company deferred payment of fees for
services provided through September 2008. Commencing October 2008, the Company
has paid the required monthly fees, amounting to $135,000 during the three
months ended December 31, 2008, and   $107,000 during both the
three months ended March 31, and June 30, 2009, and $214,000 during the six
months ended June 30, 2009.





At
December 31, 2008, and June 30, 2009, non-interest bearing unpaid accrued
service fees and unreimbursed expenses of $14.8 million and $15.0 million,
respectively, were included in payable to affiliates on the accompanying
consolidated balance sheets. For the year ended December 31, 2008, and the six
months ended June 30, 2009, related out-of-pocket expenses and third party fees
were $1.1 million and $208,000, respectively.





Trademark
License Agreement





Crown
Media United States has a trademark license agreement with Hallmark Licensing,
Inc. for use of the “Hallmark” mark for the Hallmark Channel and for the
Hallmark Movie Channels.  During 2008, Hallmark Cards extended the
trademark license agreements for the Hallmark Channel and the Hallmark Movie
Channels to September 1, 2009. The Company is not required to pay any fees under
the trademark license agreements.





The
Company has accounted for the agreement pursuant to the contractual terms of the
arrangement, which is royalty free.  Accordingly, no amounts have been
reflected in the balance sheet or income statement of the Company.





7.
Company Obligated Mandatorily Redeemable Preferred Interest and NICC License
Agreements





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





Under the
company agreement, the members agreed that if during any year ending after
January 1, 2005 and on or prior to December 31, 2009, Crown Media
United States has Federal taxable income (with possible adjustments) in excess
of $10.0 million, and the preferred interest has not been redeemed, Crown Media
United States will redeem the preferred interest in an amount equal to the
lesser of: (i) such excess Federal taxable income; (ii) $5.0 million; or (iii)
the amount equal to the preferred liquidation preference on the date of
redemption.  Crown Media United States may voluntarily redeem the
preferred interest at any time; however, it is obligated to do so no later than
December 31, 2010.




On
January 2, 2008, the Company and NICC signed an agreement (the “Modification
Agreement”) which, among other things, immediately extinguished a right to put
to the Company common stock owned by NICC.  In addition, the
Modification Agreement also settled the dispute with respect to whether an
obligation to pay $15.0 million upon a change in control of Crown Media Holdings
expired with, or survived, the December 31, 2007 expiration of the December
2005 NICC Settlement Agreement. We agreed to pay NICC $8.3 million in three
equal installments payable in 2008, 2009 and 2010.  We also agreed to
provide NICC a two-hour broadcast period granted each Sunday morning during the
two year period ending December 31, 2009.  The discounted value
of the broadcast period, estimated to be $1.4 million, is reflected as deferred
revenue as of December 31, 2007. The deferred revenue is being amortized to
revenue ratably over NICC’s two-year use of the broadcast
commitment.





During
the three months ended June 30, 2008 and 2009, Crown Media United States paid
NICC $1.5 million and $40,000, respectively, under the terms of the Modification
Agreement mentioned above and one programming agreement. During the six months
ended June 30, 2008 and 2009, Crown Media United States paid NICC $6.4 million
and $4.5 million, respectively, under the terms of the Modification Agreement
mentioned above and one programming agreement.











8.
Share-Based Compensation





Approximately
200,000 stock options will expire in August 2009 related to the resignation of
one of the Company’s executives in May 2009. Such options were fully vested at
the time of resignation.





The
Company recorded $328,000 and $1.7 million of compensation expense associated
with the Employment and Performance restricted stock units (“RSUs”) during the
three and six months ended June 30, 2008, respectively, which have been included
in selling, general and administrative expense on the accompanying condensed
consolidated statements of operations. The Company recorded $266,000 and
$437,000 of compensation benefit associated with the Employment and Performance
restricted stock units (“RSUs”) during the three and six months ended June 30,
2009, respectively, which have been included in selling, general and
administrative expense on the accompanying condensed consolidated statements of
operations. The Company recorded these RSUs at fair value during each
period.





The
Company issued cash settlements related to the RSUs of $3.8 million during the
year ended December 31, 2008, and $724,000 during the six months ended June 30,
2009.





At
December 31, 2008, the CEO’s share appreciation rights (“SARs”) were valued at
$440,000 using the $2.85 closing price of a share of our common stock on
December 31, 2008. At June 30, 2009, the CEO’s SARs were valued at $0 as the CEO
resigned on May 4, 2009. The Company recorded $118,000 and $131,000 in
compensation benefit related to SARs for the three months ended June 30, 2008
and 2009, respectively, on our condensed consolidated statement of operations as
a component of selling, general and administrative expense.  The
Company recorded $688,000 and $247,000 in compensation benefit related to SARs
for the six months ended June 30, 2008 and 2009, respectively, on our condensed
consolidated statement of operations as a component of selling, general and
administrative expense.  The SARs have been recorded in accounts
payable and accrued liabilities on the accompanying condensed consolidated
balance sheet at December 31, 2008.




9.  Resignation
Agreement and Long Term Incentive Plan





Resignation
Agreements





The
individual then serving as the Company’s chief executive officer resigned May
31, 2009.  Pursuant to the resignation agreement, in June 2009 the
Company paid this individual $2.5 million, an amount representing the present
value of the salary and bonus that otherwise would 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 pay this individual a
transaction bonus in the event a change in control of the Company occurs on or
before August 29, 2009.  The Company is also obligated to provide him
office space, an assistant and payment of COBRA insurance benefits for periods
that expire at various times through May 31, 2010.





The
Executive Vice President of Programming resigned from his position effective
May 31, 2009. The executive will receive continued payment of the regular
installments of his salary through December 31, 2009 ($523,000) and his salary
through May 31, 2010 in one lump sum payable on January 15, 2010 ($347,000). He
will also receive a payment of a pro rated annual bonus, determined by the
Company, for the 2009 calendar year for the period up to the resignation
date.  Finally, he received an amount equal to accrued but unused
vacation/personal time ($42,000).




Long
Term Incentive Compensation Agreements





The
Company has granted Long Term Incentive Compensation Agreements (“LTI
Agreements”) to vice presidents and above at the Company, which LTI Agreements
were signed during the second quarter of 2009.  The target award under
each LTI Agreements is a percentage of the employee’s base salary and range from
$26,000 to $469,000 for executive officers of the Company.  Of each
award, 50% is an Employment Award and 50% is a Performance Award.  The
Employment Award will vest and be settled in cash on August 31, 2011, subject to
earlier pro rata settlement as provided in the LTI Agreement.  The
Performance Award will vest and be settled in cash 50% on December 31, 2010, and
50% on December 31, 2011, in accordance with the Company performance criteria
concerning adjusted EBITDA and cash flow and subject to earlier pro rata
settlement as provided in the LTI Agreement. Early settlement is provided in the
case of involuntary termination of employment without cause on or after January
1, 2010, death or disability.  Potential payouts under the Performance
Awards depend on achieving 90% or higher of a target threshold and range from 0%
to 150% of the target award.  The Company’s Compensation Committee has
the ability to increase or decrease the payout based on an assessment of
demographics achieved, relative market conditions and management of
expenses.








10.
Fair Value





The
following table presents the carrying amounts and estimated fair values of the
Company’s financial instruments at December 31, 2008, and June 30,
2009.








December
      31, 2008
                
                
                June
      30, 2009Carrying
                
                
                Significant
      Unobservable
                  Inputs
                  (Level
      3)
                  Fair
                
                
                Carrying
                
                
                Significant
      Unobservable
                  Inputs
                  (Level
      3)
                  FairAmount
                
                
                Value
                
                
                Amount
                
                
                Value(In
      thousands)Senior
      secured note to HC Crown,including
      accrued interest
                
                $
                686,578
                
                
                $
                599,683
                
                
                $
                721,765
                
                
                $
                709,978Note
      and interest payable to HC Crown
                
                
                109,837
                
                
                
                86,544
                
                
                
                110,280
                
                
                
                106,151Note
      and interest payable to Hallmark Cards
                  Affiliate
                
                
                62,724
                
                
                
                49,422
                
                
                
                62,978
                
                
                
                60,619Note
      and interest payable to Hallmark Cards
                  Affiliate
                
                
                172,077
                
                
                
                135,584
                
                
                
                172,771
                
                
                
                166,302Company
      obligated mandatorily redeemablepreferred
      interest
                
                
                20,822
                
                
                
                17,430
                
                
                
                21,862
                
                
                
                17,700








SFAS 157
defines fair value as the price that would be paid to transfer a liability in an
orderly transaction between market participants at the measurement date. When
determining fair value, the Company considers the principal or most advantageous
market in which the Company would transact and the market-based risk
measurements or assumptions that market participants would use in pricing the
liability, such as inherent risk, transfer restrictions, and credit risk. Level
3 is defined as inputs that are generally unobservable and typically reflect
management’s estimates of assumptions that market participants would use in
pricing the liability.





The
carrying amounts shown in the table are included on the accompanying
consolidated balance sheets under the indicated captions. The valuation of the
Company obligated mandatorily redeemable preferred interest is dependent upon
the future pre-tax income of Crown Media United States since the Company is only
obligated to make payments on the instrument within 60 days after the end of any
fiscal year in which pre-tax income is generated by Crown Media United States
with the remaining preferred liquidation preference payable in full on December
31, 2010.





The
Company estimates the fair value of its debt to Hallmark Cards affiliates on a
quarterly basis, commencing June 30, 2009, using the discounted future cash flow
method.





Accounts
payable and receivable are carried at reasonable estimates of their fair values
because of the short-term nature of these instruments. Long-term license fees
payable are also considered carried at reasonable estimates of their fair value.
The interest rates on the bank credit facility is variable, has a relatively
short maturity period and/or resets periodically; therefore, the fair value of
this debt is not significantly affected by fluctuations in interest
rates.  The credit spread in debt is fixed, but the market credit
spread will fluctuate.





Estimates
of the fair value of the Company’s financial instruments are presented in the
tables above. As a result of recent market conditions, the Company has financial
instruments for which limited or no observable market data is available. Fair
value measurements for these instruments fall with Level 3 of the fair value
hierarchy of SFAS 157. These fair value measurements are based primarily upon
the Company’s own estimates and are often based on its current pricing policy,
the current economic and competitive environment, the characteristics of the
instrument, credit and interest rate risks, and other such factors. Therefore,
the results cannot be determined with precision, cannot be substantiated by
comparison to quoted prices in active markets, and may not be realized in an
immediate settlement of the liability. Additionally, there are inherent
uncertainties in any fair value measurement technique, and changes in the
underlying assumptions used, including discount rates, liquidity risks, and
estimates of future cash flows, could significantly affect the fair value
measurement amounts.





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








11.
Subsequent Event





Lawsuit





On July
13, 2009, a lawsuit was brought in the Delaware Court of Chancery against each
member of the Board of Directors of Crown Media Holdings, Hallmark Cards and its
affiliates, as well as the Company as a nominal defendant, by a minority
stockholder of the Company regarding the recapitalization proposal (the
“Proposal”) which the Company received from Hallmark Cards. The plaintiff is S.
Muoio & Co. LLC which owns beneficially approximately 5.8% of the Company's
Class A common stock, according to the complaint and filings with the Securities
and Exchange Commission. The Proposal, which the Company publicly announced on
May 28, 2009, provides for a recapitalization of its outstanding debt to
Hallmark Cards affiliates in exchange for new debt and convertible preferred
stock of the Company. The lawsuit claims to be a derivative action and a class
action on behalf of the plaintiff and other minority stockholders of the
Company. The lawsuit alleges, among other things, that, the defendants have
breached fiduciary duties owed to the Company and minority stockholders in
connection with the Proposal. The lawsuit includes allegations that if the
Proposal is consummated, an unfair amount of equity would be issued to the
majority stockholders, thereby reducing the minority stockholders' equity and
voting interests in the Company, and that the majority stockholders would be
able to eliminate the minority stockholders through a short-form merger. The
complaint requests the court to enjoin the defendants from consummating the
Proposal and to award plaintiff fees and expenses incurred in bringing the
lawsuit.





On July
22, 2009, a Stipulation Providing for Notice of Transaction (the “Stipulation”)
was filed with the Delaware Court of Chancery.  The Stipulation provided
that the Company cannot consummate the transaction contemplated in the Proposal
until not less than seven weeks after providing the plaintiff with a notice of
the terms of the proposed transaction.  If the plaintiff moves for
preliminary injunctive relief with respect to any such transaction, the parties
will establish a schedule with the Court of Chancery to resolve such motion
during the seven week period.  In addition, following the decision of the
Court of Chancery, the Company will not consummate any transaction for a period
of at least one week, during which time any party may seek an expedited appeal.
 The Stipulation further provides that the plaintiff shall withdraw its
motion for preliminary injunction filed on July 13, 2009 and that the action
shall be stayed until the earlier of providing the notice of a transaction or an
announcement by the Company that it is no longer considering a transaction.





It is not
currently possible to predict the outcome of the proceeding discussed in this
Note. The plaintiff does not seek damages from the Company. Legal defense
costs will be expensed as incurred.








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





The
following discussion and analysis of the Company’s financial condition and
results of operations should be read in conjunction with “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” in the
Company’s Annual Report on Form 10-K for the year ended December 31,
2008.





Description
of Business and Overview





Current
Business





We own
and operate the Channels. With 86.2 million subscribers (as provided by Nielsen
Research) in the United States at June 30, 2009, the Hallmark Channel is the
38th
most widely distributed advertising-supported cable channel in the United
States. For the second quarter of 2009, the Hallmark Channel finished the
quarter as the 16th highest
rated advertising-supported cable channel for total day ratings and the 16th highest
rated advertising-supported cable channel in prime time as measured by Nielsen
Research.See
“Results of Operations – Three Months Ended June 30, 2008 compared to Three
Months Ended June 30, 2009 – Revenue” for more information on
ratings.





We
launched our second 24-hour linear channel, the Hallmark Movie Channel, during
the first quarter of 2005.  Programming on the Hallmark Movie Channel
consists of movies and mini-series. The Hallmark Movie Channel has generated
subscriber fees and advertising revenue since 2005. As distribution continues to
expand, the financial contribution of the Hallmark Movie Channel may grow,
including increases in advertising and subscription revenue. The Hallmark Movie
Channel is operated through Crown Media Holdings’ existing infrastructure at a
small incremental cost.  In April 2008, we began distributing the
Hallmark Movie Channel HD in high definition format, resulting in additional
costs; however, we expect that this additional format will continue to
contribute to subscriber growth for the Hallmark Movie Channel.





At June
30, 2009, the Hallmark Movie Channel was distributed to over 18.1 million
subscribers, an increase of nearly 3.6 million subscribers from 14.5 million at
December 31, 2008.  This increase in distribution and a greater number
of advertising spots has contributed to improved Hallmark Movie Channel revenue
in the first six months of 2009 and should continue to do so throughout the
remainder of the year.








Current
Challenges and Developments





The
Company faces numerous operating challenges. Among them are maintaining and
increasing advertising revenue, maintaining and expanding the distribution of
the Channels, broadening viewership demographics to meet our target audience,
and increasing viewership ratings.




In the
2008/2009 upfront sales process, we entered agreements with major advertising
firms representing approximately 51% of our advertising inventory for the last
quarter of 2008 and first three quarters of 2009.  This inventory was
sold at CPMs (i.e., advertising rates per thousand viewers) approximately 7%
higher than the inventory sold in the 2007/2008 upfront.  Advertisers
with upfront contracts have an option to terminate their contracts, as well as
an option to expand the amount of inventory purchased under the contracts.
During the second quarter of 2009 and the first six months of 2009, advertisers
canceled approximately 19% and 13% of the inventory covered by such
contracts.  In prior years, cancellations of upfront contracts were
unusual.  The Company intends to sell the balance of the inventory in
the scatter market. Continued weakness in the economy has resulted generally in
lower demand and lower rates for our inventory of ad spots available for the
scatter market and lower revenue from direct response advertising when compared
to the second quarter of 2008 and the first half of 2008. Advertising revenues
have also decreased because of lower viewer ratings as a result of recent
changes in the program scheduling of the Hallmark Channel.




While we
had sold approximately 51% of our advertising inventory in the 2008-2009 upfront
market (consistent with volumes sold in previous years) at rates that were an
increase over the previous years upfront advertising sales rates, the remaining
advertising sales (scatter and direct response) are made closer to the timing of
the actual advertisement.  We have historically seen significant
increases in rates on these remaining advertising sales over the rates obtained
from our upfront sales.   Subsequent to the first quarter of
2008, the advertising rates for the scatter and direct response advertising
decreased from 2007 levels, although still at levels in excess of our current
upfront sales rates.  Accordingly for this period, while we still saw
increases in rates on that portion of our advertising sales from the upfront,
this was offset by decreases in rates on the remaining advertising inventory
related to scatter and direct response sales.




The
Company is currently engaged in negotiations with advertisers for the 2009-2010
upfront season.  The economic environment has created a more prolonged
upfront season.




Distribution
agreements are important because they affect our number of subscribers, which in
turn has a major impact on our subscriber fees, the number of persons viewing
our programming, and the rates charged for advertising. The long-term
distribution challenge is renewing our distribution arrangements with the
multiple system operators as they expire on favorable terms. Our major
distribution agreements have terms which expire at various times from December
31, 2009, through, with options to renew, December 2023. Agreements representing
approximately 12% of our total Hallmark Channel subscriber base expire by
December 31, 2009, and agreements representing approximately 16% of our
agreements expire between the dates of this Report and December 31,
2010.




Domestic
telephone companies have entered the business of distributing television
channels to households through their wire-lines. We have agreements with several
telephone companies and cooperatives of telephone companies, which permit the
carriage of the Hallmark Channel, the Hallmark Movie Channel and Hallmark Movie
Channel HD, and are negotiating with others.




We expect
to experience increases in our bad debt expense during 2009 due to the economic
downturn. These increases will be due to certain customers (primarily
advertisers) experiencing cash flow problems in this economic
environment.





The
universe of cable TV subscribers in the United States is approximately 100
million homes.  The top 30 cable TV networks in the United States,
measured by the number of subscribers, have 90 million or more
subscribers.  Our goal is for the Hallmark Channel to reach 90 million
subscribers in the next one to two years.




Three
factors have contributed to the ratings of the Hallmark Channel: acquired series
and movies, original productions and marketing and promotional efforts. Original
productions are our most high profile programs and generate the Hallmark
Channel’s highest ratings. Their ratings success is of significant help to our
distribution and advertising sales teams in selling the Hallmark Channel. The
Company typically incurs additional marketing and promotional expenses
surrounding original productions and certain acquired movies.




We plan
to offer a high definition version of the Hallmark Channel in the near
future.  The cost of doing so is estimated at approximately $2.0
million to $7.0 million.  Because of our cost cutting efforts in 2009,
the timing of such an offering has been deferred until 2010.







Revenue
from Continuing Operations





Our
revenue consists of subscriber fees and advertising fees.





Subscriber
Fees





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





•
            the
      degree of competition in the
market;





•
            the
      relative position in the market of the distributor and the popularity of
      the channel;





•
            the
      packaging arrangements for the channel;
and





•
            length
      of the contract term and other commercial
terms.





We are in
continuous negotiations with our existing distributors to increase our
subscriber base in order to enhance our advertising revenue. We have been
subject in the past to requests by major distributors to pay subscriber
acquisition fees for additional subscribers or to waive or accept lower
subscriber fees if certain numbers of additional subscribers are provided. We
also may help fund the distributors' efforts to market our Channels or we may
permit distributors to offer limited promotional periods without payment of
subscriber fees.





In the
past, we generally paid certain television distributors up-front subscriber
acquisition fees to carry the Hallmark Channel. Subscriber acquisition fees that
we pay are capitalized and amortized over the contractual term of the applicable
distribution agreement as a reduction in subscriber fee revenue. If the
amortization expense exceeds the revenue recognized on a per distributor basis,
the excess amortization is included as a component of cost of services. At the
time we sign a distribution agreement, we evaluate the recoverability of the
costs we incur against the incremental revenue directly and indirectly
associated with each agreement.





Our
Channels are usually offered as one of a number of channels on either a basic
tier or part of 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 the tiers and program packages in which one of our Channels is
placed, these customers do not subscribe and unsubscribe to our Channels
alone.  We are not provided with information from the distributors on
their overall subscriber churn and in what manner their churn rates affect our
subscriber counts; instead, we are provided information on the total number of
subscribers who receive the Channels.





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





Advertising







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





Our rates
for spot advertisements are generally calculated on the basis of an agreed upon
price per unit of audience measurement in return for a guaranteed commitment by
the advertiser. We commit to provide advertisers certain rating levels in
connection with their advertising. Advertising rates also vary by time of year
due to seasonal changes in television viewership. Revenue is recorded net of
estimated delivery shortfalls (“audience deficiency units” or “ADUs”), which are
usually settled by providing the advertiser additional advertising time. The
remainder of the revenue is recognized as the “make-good” advertising time is
delivered. Revenue from direct response advertising depends largelyupon actions of
viewers.





Whenever
spot advertising is aired in programs that do not achieve promised viewership
ratings, we issue ADUs which provide the advertiser with additional spots at no
additional cost.  We defer a pro rata amount of advertising revenue
and recognize a like amount as a liability.  When the make-good spots
are subsequently aired, revenue is recognized and the liability is
reduced.  The level of inventory that is utilized for ADUs varies over
time and is influenced by prior fluctuations in our under-delivery, if any, of
viewers against promised ratings as well as the rate at which our advertisers
choose to utilize the ADUs.





Our
channels are broadcast 24 hours per day.  The revenue contribution of
Hallmark Movie Channel has been small relative to that of Hallmark
Channel.  The Hallmark Movie Channel has not been the subject of
ratings measurement by Nielsen Media Research.





Our
advertising inventory comprises the commercial load or advertising capacity of
the program hours in which we intend to broadcast licensed program
content.  The volume of inventory that we have available for sale is
determined by the number of our channels (i.e., two), our chosen
commercial load per hour and the number of broadcast hours in which we air
licensed program content.  Sales of advertising inventory are
decreased by our need to reserve inventory for the use of ADUs.





Cost
of Services





Our cost
of services consists primarily of the amortization of program license fees; the
cost of signal distribution; and the cost of promotional segments that are aired
between programs. We expect cost of services in 2009 to increase as compared to
2008 due to increased bad debt expense and severance expense.








Critical
Accounting Policies, Judgments and Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires Crown Media Holdings to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those
estimates.





For
further information regarding our critical accounting policies, judgments and
estimates, please see Notes to Unaudited Condensed Consolidated Financial
Statements contained in Item 1 of this Report and “Critical Accounting Policies,
Judgments and Estimates” in Item 7 of the Company’s Annual Report on Form 10-K
as filed with the SEC for the year ended December 31, 2008.





Goodwill





The
following discussion regarding Fair Value Measurements of our Non-Financial
Instruments is intended to supplement our critical accounting estimates included
in our Annual Report on Form 10-K for the year ended December 31,
2008.





At
December 31, 2008, the Company had a stockholders’ deficit of $666.9 million and
a goodwill asset of $314.0 million. All of our goodwill relates to our domestic
channel operations segment within Crown Media United States, which is also our
only reporting unit. The Company’s market capitalization exceeds the negative
carrying value of the reporting unit.





We
perform our annual assessment of the recoverability of our goodwill and other
nonamortizable intangible assets as of November 30 in accordance with the
provisions of Statement of Financial Accounting Standards No. 142. We
estimate the fair value of our reporting unit for the Step 1 Test using a
discounted cash flow analysis. The cash flow projections (the "2008 Cash Flow
Projections") used in our analysis were prepared by management and represent
management's estimate of the future cash flows to be generated by operations
during 2009 through 2013 (Years 1-5). For the 5 years ended
December 31, 2008, revenue grew at an annual growth rate of approximately
19.5%. Our gross margin increased over the same time period from a negative
28.7% to a positive 18.5%. Given the downturn in the economy in 2008, management
determined that it was prudent to adjust the growth rates used in the 2008 Cash
Flow Projections. Therefore, the 2008 Cash Flow Projections include growth rates
which are lower than historical growth rates and lower than the growth rates
used in our 2007 cash flow projections. The growth rates used in the 2008 Cash
Flow Projections are considered by management to be appropriate and reflect the
current state of the economy. The 2008 Cash Flow Projections include many
assumptions, including assumptions regarding the timing of an economic recovery
and the impact of any such recovery on operations. In this regard, the 2008 Cash
Flow Projections are based on the economy stabilizing and growing modestly in
the second half of 2009 and through 2010 and that the economy is somewhat more
normalized in the years beyond 2010.





The
projected cash flows were discounted using a blended discount rate of 13.7%,
which represents an estimate of the weighted average cost of capital. The
weighted average cost of capital incorporates risk premiums that reflect the
current economic environment. Such discount rate is higher than the rate used in
prior years due to changes in the marketplace for credit and risk premiums.
Terminal growth rates  (the approximation of ongoing growth rates)
after Year 5 consider the above noted factors for the initial five years
forecasted cash flows and forecasted CPI increases.





We also
used a market approach to validate the fair value determined by our discounted
cash flow analysis. In our market approach, we identified publicly traded
companies whose business and financial risks are comparable to ours. We then
compared the market values of those companies to our calculated value. We also
identified recent sales of companies in lines of business similar to ours and
compared the sales prices in those transactions to the calculated value of ours.
The range of values determined in our market approach corroborated the value
calculated in our discounted cash flow analysis.





We also
reconcile the estimated fair value of our reporting unit to our market
capitalization.  As long as we continue to have a stockholders’
deficit and only one reporting unit, we believe it is unlikely we would have a
goodwill impairment.  However, ignoring that our positive market
capitalization exceeds our shareholders’ deficit, we have discussed below the
sensitivity of our discounted cash flow analysis.





The
estimated fair value determined in our Step 1 Test was in excess of the
reporting unit’s carrying value, and accordingly no Step 2 Test was performed
and no impairment charge was recorded. We note that if our fair value estimate
was 60% lower, we would still not have triggered a Step 1 failure and no
impairment charge would be taken.





The
foregoing impairment test requires a high degree of judgment with respect to
estimates of future cash flows and discount rates as well as other assumptions.
Therefore, any value ultimately derived may differ from our estimate of fair
value. Further, if the environment continues to experience recessionary
pressures for an extended period of time, our cash flow projections will need to
be revised downward and we could have impairment charges in the future. In this
regard, we estimate that if we were to use a compound annual growth rate for
revenue that is approximately 40% to 60% lower than the rate currently used in
the 2008 Cash Flow Projections and that we achieved the margins assumed in the
2008 Cash Flow Projections, we could in the future fail the Step 1 Test and
would be required to perform the Step 2 Test to measure any impairment of
goodwill.








Effects
of Transactions with Related and Certain Other Parties





In 2009
and in prior years, we entered into a number of significant transactions with
Hallmark Cards and its subsidiaries. These transactions include, among other
things, programming, trademark licenses, administrative services, a line of
credit, a tax sharing agreement, the issuance of four promissory notes and a
waiver agreement. For information regarding such transactions and transactions
with other related parties, please see “Effects of Transactions with Related and
Certain Other Parties” in Item 7 of the Company’s Annual Report on Form 10-K as
filed with the SEC for the year ended December 31, 2008. Also, please see Notes
5, 6 and 7 of Notes to Unaudited Condensed Consolidated Financial Statements
contained in Item 1 of this Report.





For
information on a recapitalization proposal received in May 2009 from a Hallmark
Cards affiliate, see Note 6 of Notes to the Unaudited Condensed Consolidated
Financial Statements contained in Item 1 of this Report.











Selected
Historical Consolidated Financial Data of Crown Media Holdings





In the
table below, we provide selected historical condensed consolidated financial and
other data of Crown Media Holdings and its subsidiaries. The following selected
condensed consolidated statement of operations data for three and six months
ended June 30, 2008 and 2009, are derived from the unaudited financial
statements of Crown Media Holdings and its subsidiaries. Ratings and subscriber
information is also unaudited. This data should be read together with the
condensed consolidated financial statements and related notes included elsewhere
in this Form 10-Q.





Percent
      Change
                
                
                
                
                
                
                
                
                Percent
      ChangeThree
      Months Ended June 30,
                
                
                2009
      vs.
                
                
                Six
      Months Ended June 30,
                
                
                2009
      vs.2008
                
                
                2009
                
                
                2008
                
                
                2008
                
                
                2009
                
                
                2008Revenue:Subscriber
      fees
                
                $
                14,579
                
                
                $
                15,860
                
                
                
                9
                %
                
                $
                28,432
                
                
                $
                31,155
                
                
                
                10
                %Advertising
                
                
                56,620
                
                
                
                51,921
                
                
                
                -8
                %
                
                
                113,043
                
                
                
                107,215
                
                
                
                -5
                %Other
      revenue
                
                
                321
                
                
                
                401
                
                
                
                25
                %
                
                
                609
                
                
                
                764
                
                
                
                25
                %Total
      revenue
                
                
                71,520
                
                
                
                68,182
                
                
                
                -5
                %
                
                
                142,084
                
                
                
                139,134
                
                
                
                -2
                %Cost
      of Services:Programming
      costs
                
                
                35,641
                
                
                
                31,301
                
                
                
                -12
                %
                
                
                71,046
                
                
                
                63,516
                
                
                
                -11
                %Operating
      costs
                
                
                3,594
                
                
                
                4,488
                
                
                
                25
                %
                
                
                7,063
                
                
                
                8,500
                
                
                
                20
                %Total
      cost of services
                
                
                39,235
                
                
                
                35,789
                
                
                
                -9
                %
                
                
                78,109
                
                
                
                72,016
                
                
                
                -8
                %Selling,
      general and administrative expense
                
                
                12,357
                
                
                
                11,195
                
                
                
                -9
                %
                
                
                26,250
                
                
                
                23,759
                
                
                
                -9
                %Marketing
      expense
                
                
                2,060
                
                
                
                842
                
                
                
                -59
                %
                
                
                8,458
                
                
                
                5,617
                
                
                
                -34
                %Income
      from operationsbefore
      interest expense
                
                
                17,868
                
                
                
                20,356
                
                
                
                14
                %
                
                
                29,267
                
                
                
                37,742
                
                
                
                29
                %Interest
      expense
                
                
                (23,792
                )
                
                
                (25,678
                )
                
                
                8
                %
                
                
                (49,906
                )
                
                
                (50,515
                )
                
                
                1
                %Net
      loss
                
                $
                (5,924
                )
                
                $
                (5,322
                )
                
                
                -10
                %
                
                $
                (20,639
                )
                
                $
                (12,773
                )
                
                
                -38
                %Other
      Data:Net
      cash provided by operating activities
                
                $
                16,693
                
                
                $
                13,767
                
                
                
                -18
                %
                
                $
                16,999
                
                
                $
                13,382
                
                
                
                -21
                %Net
      cash used in investing activities
                
                $
                (1,999
                )
                
                $
                (344
                )
                
                
                -83
                %
                
                $
                (3,286
                )
                
                $
                (648
                )
                
                
                -80
                %Net
      cash used in financing activities
                
                $
                (17,463
                )
                
                $
                (11,905
                )
                
                
                -32
                %
                
                $
                (15,410
                )
                
                $
                (8,644
                )
                
                
                -44
                %Total
      domestic day household ratings (1)(3)
                
                
                0.678
                
                
                
                0.541
                
                
                
                -20
                %
                
                
                0.705
                
                
                
                0.588
                
                
                
                -17
                %Total
      domestic primetime household ratings (2)(3)
                
                
                1.076
                
                
                
                0.871
                
                
                
                -19
                %
                
                
                1.135
                
                
                
                1.016
                
                
                
                -10
                %Subscribers
      at period end
                
                
                83,247
                
                
                
                86,228
                
                
                
                4
                %
                
                
                83,247
                
                
                
                86,228
                
                
                
                4
                %(1) Total
      day is the time period measured from the time each day the broadcast of
      commercially sponsoredprogramming
      commences to the time such commercially sponsored programming
      ends.(2) Primetime
      is defined as 8:00 - 11:00 P.M. in the United States.(3) These
      Nielsen ratings are for the time period April 1 through June 30 and
      January 1 through June 30, respectively.











Results
of Operations




Three
Months Ended June 30, 2008 Compared to Three Months Ended June 30,
2009







Revenue.Our
revenue from continuing operations, comprised primarily of subscriber fees and
advertising, decreased $3.3 million or 5% in 2009 over 2008. Our subscriber fee
revenue increased $1.3 million or 9%.  The amount of subscriber
acquisition fees that was recorded as a reduction of subscriber fee revenue
declined from $676,000 for the three months ended June 30, 2008, to $651,000 in
2009. Subscriber revenue increased primarily due to an increase in distribution
because of the addition of subscribers in 2009 with some of the Company’s
distributors. Subscriber revenue growth in 2009 compared to 2008 will be limited
to the effects of increases, if any, in our distribution.





We
understand that Charter Communications filed for bankruptcy in March 2009. There
is a risk that a sale of some of the systems under bankruptcy to other
distributors may result in a decline of subscriber revenue.  Charter
Communications has indicated in its press releases that it has received
authorization from the bankruptcy court to pay in the normal course trade
creditor balances which were incurred prior to the bankruptcy filing and that
Charter Communications is authorized to transact business in the ordinary course
of business and as such has been paying its trade creditors in full for balances
incurred after the bankruptcy filing in the normal course.





The $4.7
million or 8% decrease in advertising revenue is primarily due to declines in
viewer ratings across demographic categories in the second quarter of 2009
compared to the second quarter of 2008.  As a result, our liability
for audience deficiency units increased by approximately $3.0 million for the
second quarter of 2009, thereby decreasing advertising revenues, when compared
to the same period in 2008.  A number of  changes to our
program schedule were implemented in second quarter of 2009, including the
replacement of programs that had appeared in the schedule for a number of years,
as well as a shift in scheduling strategy to more specifically target the
demographic group of women 25-54.  This strategy included the
placement of television series in certain timeslots, instead of movies or
original productions. These changes have caused a temporary disruption to
established viewing patterns of our audience resulting in declines in household
ratings, but over time are intended to increase our delivery of viewers in this
target demographic category. At this time, we expect advertising revenue to
improve marginally in the fourth quarter of 2009, consistent with our
historically strong ratings during the Holiday season.





The
decrease in advertising revenue also reflects lower scatter rates in the second
quarter of 2009 compared to the second quarter of 2008, and lower direct
response advertising revenue based on lower programming rates and lower viewer
responses in the second quarter of 2009 than in the second quarter of
2008.  An offsetting factor was an increase in the number of available
general/scatter rate advertising spots.  In response to the lower
advertising revenue, starting in the third quarter of 2008, we reduced the
amount of time allotted to on-air, self-promotion and increased the time
available for paid advertising.  As indicated under “Current
Challenges and Developments” above, we continue to experience a softening of
advertising rates due to economic conditions.





For the
three months ended June 30, 2009, Nielsen ranked the Hallmark Channel 16th in
total day viewership with a 0.541 household rating and 16th in
primetime with a 0.871 household rating among the 76 cable channels in the
United States market.  We believe that these ratings declines are due
primarily to the changes to our programming schedule described
above.





Cost of
services.Cost of services as a percent of revenue decreased
to 52% in 2009 as compared to 55% in 2008. This decrease results primarily from
the effects of the 12% decrease in programming costs, discussed below, offset in
part by the 8% decrease in advertising revenue discussed above.





Programming
costs decreased $4.3 million or 12% from the three months ended June 30, 2008.
In the second and third quarters of 2008, we entered into agreements to amend
significant programming agreements which added programs and deferred certain
payments for programming content to periods beyond 2008. Some of the agreements
resulted in the extension of related program licenses to cover slightly longer
periods of availability, the deferral of expected delivery of certain
programming and the deferral of certain payments primarily from 2008 until 2009.
Upon the amendment of the agreements, we have prospectively changed the
amortization of program license fees for any changes in the period of expected
usage and/or changes in license fees.  The effects of these amendments
on 2008 amortization were not significant.Additionally, we
returned our exclusivity rights to one title, which resulted in a lower asset
and liability balance.  During the first quarter of 2009, we also
entered into amendments to some of our original programming agreements which
extended the current license period to those titles and thus resulted in lower
amortization in the second quarter of 2009 compared to the second quarter of
2008.





Operating
costs for the three months ended June 30, 2009, increased $894,000 over 2008
primarily due to the $912,000 of severance expense recorded in May 2009 related
to one executive’s resignation. The Company’s bad debt expense was $271,000 for
the three months ended June 30, 2009, compared to $40,000 for the three months
ended June 30, 2008.  The increase in bad debt expense is due to
certain advertising customers experiencing cash flow problems under current
economic conditions.  The Company will continue to monitor cash
collections as part of estimating this expense and expects that this expense may
continue at higher levels in 2009 than in 2008.





Selling, general and administrative
expense.Our selling, general and administrative expense decreased $1.2
million or 9%.  The Company recorded $2.5 million of severance expense
associated with the resignation of its President in May 2009. The increase in
severance expense was offset by decreases in the bonus, commission, research and
RSU related expenses. Bonus expense decreased $1.3 million quarter over quarter.
Commission and research expenses each decreased by approximately $600,000
quarter over quarter. Additionally, the Company recorded $328,000 of
compensation expense associated with RSUs during the three months ended June 30,
2008, as compared to $266,000 of compensation benefit associated with RSUs for
the three months ended June 30, 2009. See Note 8 to the Unaudited Condensed
Consolidated Financial Statements in this Report.





Marketing
expense.  Our marketing expense decreased 59%. As part of our
contingency cost reduction efforts, promotional and marketing efforts were
reduced overall during the 2009 quarter compared to the second quarter of
2008.




Interest
expense.Interest expense for the three months ended June 30,
2009, increased $1.9 million compared to the three months ended June 30, 2008.
On April 14, 2008, a note payable with a Hallmark Cards’ affiliate was credited
$1.5 million, which represented the Company’s share of an IRS interest refund
that Hallmark Cards received and reduced interest expense in the second quarter
of 2008. This refund of interest reduced the balance of the note. The principal
balance of our credit facility was $54.5 million at June 30, 2008, and $20.3
million at June 30, 2009. The interest rate on our bank credit facility
decreased from 3.23% at June 30, 2008, to 2.56% at June 30, 2009. Interest rates
of our 2001, 2005 and 2006 notes decreased from 7.68% at June 30, 2008, to 6.19%
at June 30, 2009. The benefit of these rate decreases was offset in part by a
higher principal balance on the Senior Secured Note.










Six
Months Ended June 30, 2008 Compared to Six Months Ended June 30,
2009







Revenue.Our
revenue from continuing operations, comprised primarily of subscriber and
advertising fees, decreased $3.0 million or 2% in 2009 over 2008. Our subscriber
fee revenue increased $2.7 million or 10%.  The amount of subscriber
acquisition fees that was recorded as a reduction of subscriber fee revenue was
approximately $1.3 million for both the six months ended June 30, 2008 and 2009,
respectively. The reasons for the increase in subscriber fees in the six months
ended June 30, 2009 was the same as those stated above for subscriber fee
revenue for the three months ended June 30, 2009.





The $5.8
million or 5% decrease in advertising revenue is primarily due to declines in
viewer ratings across demographic categories for the first six months of 2009
compared 2008.  As a result, our liability for audience deficiency
units increased by approximately $5.1 million for the first half of 2009,
thereby decreasing advertising revenues, when compared to the same period in
2008.  Please see the discussion above of the decrease in advertising
revenue for the three months ended June 30, 2009 for additional information on
the ratings. The decrease in advertising revenue also reflects lower scatter
rates and direct response advertising revenue during the first six months of
2009 compared to 2008 because of the effects of the national recession on the
advertising market.








For the
six months ended June 30, 2009, Nielsen ranked the Hallmark Channel 14th in
total day viewership with a 0.588 household rating and 9th in
primetime with a 1.016 household rating among the 76 cable channels in the
United States market. These ratings declined due to recent changes to our
programming schedule.





Cost of
services.Cost of services as a percent of revenue decreased
to 52% in 2009 as compared to 55% in 2008. This decrease results primarily from
the effects of the 11% decrease in programming costs, discussed below, offset in
part by the 5% decrease in advertising revenue discussed above.





Programming
costs decreased $7.5 million or 11% from the six months ended June 30, 2008. See
the discussion of programming costs for the three months ended June 30, 2009
above as to the primary reason for this decrease.





Operating
costs for the six months ended June 30, 2009, increased $1.4 million over 2008
primarily due to the $888,000 increase in bad debt expense and the $912,000 of
severance expense recorded in May 2009 related to one executive’s resignation.
The Company’s bad debt expense was $893,000 for the six months ended June 30,
2009, as compared to $5,000 for the six months ended June 30, 2008. See the
discussion above on the bad debt expense for the second quarter of 2009 for
additional information.





Selling, general and administrative
expense.Our selling, general and administrative expense decreased $2.5
million or 9%.  The Company recorded $2.5 million of severance expense
associated with the resignation of its President on May 31, 2009. The increase
in severance expense was offset by decreases in the travel, communication,
research and RSU related expenses. Research expense decreased by approximately
$604,000 due to the execution of a new contract in the second quarter of 2009.
Travel and communication events related expenses each decreased approximately
$500,000 period over period. Additionally, the Company recorded $1.7 million of
compensation expense associated with RSUs during the six months ended June 30,
2008, as compared to $437,000 of compensation benefit associated with RSUs for
the six months ended June 30, 2009. On March 13, 2008, the Compensation
Committee determined that 100% of the first vesting of the 2006 Performance RSUs
of 571,578 units vested.  On February 10, 2009, the Compensation
Committee determined that the 100% of the second vesting of the 2006 Performance
RSUs of 307,772 units vested.  See Note 8 to the Unaudited Condensed
Consolidated Financial Statements in this Report.





Marketing
expense.  Our marketing expense decreased 34%. The Company had
two marketing promotions in the first half of 2008: “The Good Witch” in January
2008 and “Bridal Fever” in February 2008. The Company had one significant
marketing promotion in January 2009 centered around the original movie, “Taking
a Chance on Love.” As part of our contingency cost reduction efforts,
promotional and marketing efforts were reduced overall during the 2009 compared
to 2008.




Interest
expense.Interest expense for the six months ended June 30,
2009, increased $609,000 compared to the six months ended June 30, 2008. On
April 14, 2008, a note payable with a Hallmark Cards’ affiliate was credited
$1.5 million, which represented the Company’s share of an IRS interest refund
that Hallmark Cards received. This refund of interest reduced the balance of the
note. The principal balance of our credit facility was $54.5 million at June 30,
2008, and $20.3 million at June 30, 2009. The interest rate on our bank credit
facility decreased from 3.23% at June 30, 2008, to 2.56% at June 30, 2009.
Interest rates of our 2001, 2005 and 2006 notes decreased from 7.68% at June 30,
2008, to 6.19% at June 30, 2009. The benefit of this rate decrease was offset in
part by a higher principal balance on the Senior Secured Note.







Liquidity
and Capital Resources





During
the six months ended June 30, 2008, our operating activities provided $17.0
million of cash compared to $13.4 million in 2009.The Company’s net loss
for the six months ended June 30, 2009, decreased $7.8 million to $12.8 million
from $20.6 million for the six months ended June 30, 2008. Our depreciation and
amortization expense for the six months ended June 30, 2009, decreased $7.3
million to $66.3 million from $73.6 million in 2008.  Due to contract
amendments mentioned above under programming costs, we reduced programming
amortization expense.  Pursuant to the Waiver Agreement, the Company
paid $9.4 million for interest on the 2001, 2005 and 2006 Notes that accrued
from November 16, 2008, through March 31, 2009.





Cash used
in investing activities was $3.3 million and $648,000 for the six months ended
June 30, 2008 and 2009, respectively. During the six months ended June 30, 2008
and 2009, the Company paid $2.0 million and $454,000, respectively, to the buyer
of the international business (sold in April 2005) for amounts due under the
terms of the sale agreement, primarily for reimbursement of transponder lease
payments.





Cash used
in financing activities was $15.4 million and $8.6 million for the six months
ended June 30, 2008 and 2009, respectively. We borrowed $18.8 million and $18.1
million under our credit facility to supplement the cash requirements of our
operating and investing activities during the six months ended June 30, 2008 and
2009, respectively. We repaid principal of $33.8 million and $26.3 million under
our bank credit facility during the six months ended June 30, 2008 and 2009,
respectively.








Cash
Flows





As of
June 30, 2009, the Company had $6.8 million in cash and cash equivalents on hand
and $24.6 million of current borrowing capacity under the bank credit
facility.  Day-to-day cash disbursement requirements have typically
been satisfied with cash on hand and operating cash receipts supplemented with
the borrowing capacity available under the bank credit facility and forbearance
by Hallmark Cards and its affiliates.  The Company’s management
anticipates that the principal uses of cash up to May 1, 2010, will include the
payment of operating expenses, accounts payable and accrued expenses,
programming costs, interest and repayment of principal under the bank credit
facility and interest of approximately $20.0 million to $25.0 million due under
certain notes to the Hallmark Cards affiliates.  The amounts
outstanding under the bank credit agreement and those notes are due May 1, 2010
as discussed below.




Operating
activities for the year ended December 31, 2008 and the six months ended June
30, 2009, yielded positive cash flow from operations. As discussed below, there
can be no assurance that the Company’s operating activities will generate
positive cash flow in future periods.




Another
significant aspect of the Company’s liquidity is the deferral of payments on
obligations owed to Hallmark Cards and its subsidiaries. Under the Amended and
Restated Waiver Agreement as amended with Hallmark Cards and its affiliates (the
“Waiver Agreement”), the deferred payments under such obligations are extended
to May 1, 2010.  These obligations were a total of $346.1 million at
June 30, 2009.  An additional $721.8 million of principal and interest
outstanding at June 30, 2009, payable to a Hallmark Cards’ affiliate in August
2011, is also subject to the Waiver Agreement until May 1,
2010.  Interest amounts related to the 10.25% note will
be added to principal through February 5, 2010. The Hallmark affiliate has
indicated that it will not extend the Waiver Agreement beyond May 1,
2010.




In March
2009, effective April 1, 2009, the bank credit facility’s maturity date was
extended to March 31, 2010, and the bank’s lending commitment was set at $45.0
million.  The Company’s ability to pay amounts outstanding on the
maturity date is highly dependent upon the Company’s ability to generate
sufficient, timely cash flow from operations between June 30, 2009 and March 31,
2010.  Based on the Company’s forecasts for 2009 and 2010, which
assume no principal payments on notes payable to Hallmark Cards and its
affiliates, the Company would have sufficient cash to repay all or most of the
bank credit facility on the maturity date, if necessary.  However,
there is uncertainty regarding the advertising revenues, so it is possible that
the cash flow may be less than the expectations of the Company’s
management.




Upon
maturity of the credit facility on March 31, 2010, to the extent the facility
has not been paid in full, renewed or replaced, the Company could require under
the Waiver Agreement that Hallmark Cards purchase the interest of the lending
bank in the facility.  In that case, Hallmark Cards would have all the
obligations and rights of the lending bank under the bank credit facility and
could demand payment of outstanding amounts at any time after May 1, 2010, under
the terms of the Waiver Agreement.




The
Company believes that cash on hand, cash generated by operations, and borrowing
availability under its bank credit facility through March 31, 2010, when
combined with (1) the deferral of any required payments on related-party debt,
any 2009 tax sharing payments and related interest on the 10.25% Senior Secured
Note described under the Waiver Agreement, and (2) if necessary, Hallmark Cards’
purchase of any outstanding indebtedness under the bank credit facility on March
31, 2010, as described below, will be sufficient to fund the Company’s
operations and enable the Company to meet its liquidity needs through May 1,
2010.




The
sufficiency of the existing sources of liquidity to fund the Company’s
operations is dependent upon maintaining subscriber and advertising revenue at
or near the amount of such revenue for the six months ended June 30, 2009. A
significant decline in the popularity of the Channels, a further economic
decline in the advertising market, an increase in program acquisition costs, an
increase in competition or other adverse changes in operating conditions could
negatively impact the Company’s liquidity and its ability to fund the current
level of operations.  In the first half of 2009, lower viewership
ratings for the Company's programming on the Hallmark Channel resulted in an
increase in audience deficiency units owed to advertisers, thereby reducing
revenues and cash flow.  Since the second quarter of 2008, the Company
has also experienced a softening of advertising rates in the direct response and
general rate scatter market because of the national
recession.  Subsequent to the first quarter of 2008, the rates for the
Company's advertising spots in the scatter market and direct response
advertising were lower than 2007 levels.  The Company expects these
market conditions to continue throughout 2009, has implemented certain cost
containment measures for 2009, and has a limited number of additional,
contingent cost cutting measures that can be implemented in the remainder of
2009 depending on market conditions.




Because
of the Company’s current inability to meet its obligations when they come due on
and after May 1, 2010, the Company anticipates that prior to May 1, 2010, it
will be necessary to extend, refinance or restructure (i) the bank credit
facility and (ii) the promissory notes payable to affiliates of Hallmark Cards.
As part of a combination of actions and in order to obtain additional funding,
the Company may consider various alternatives, including restructuring of the
debt if possible, refinancing the bank credit facility, raising additional
capital through the issuance of equity or debt securities, or other strategic
alternatives. If the current credit market conditions continue, a restructuring
or refinancing could be difficult to achieve and if achieved could include
changes to existing interest rates and other provisions within the current debt
arrangements. These changes may have a negative impact on future operating
results and cash flows.




As
discussed in Note 6, the Hallmark Cards' affiliate has proposed a
recapitalization of the Company's obligations.  There can be no
assurance as to whether the proposal will be agreed to by the Company or when,
if ever, a recapitalization of the Company will be consummated, and if
consummated whether the terms will be the same or different than those set forth
in the proposal.







Risk
Factors and Forward-Looking Statements





The
discussion set forth in this Form 10-Q contains statements concerning potential
future events. Such forward-looking statements are based on assumptions by Crown
Media Holdings management, as of the date of this Form 10-Q including
assumptions about risks and uncertainties faced by Crown Media Holdings. Readers
can identify these forward-looking statements by their use of such verbs as
"expects," "anticipates," "believes," or similar verbs or conjugations of such
verbs. If any of management's assumptions prove incorrect or should
unanticipated circumstances arise, Crown Media Holdings' actual results, levels
of activity, performance, or achievements could differ materially from those
anticipated by such forward-looking statements.





Among the
factors that could cause actual results to differ materially are those discussed
in this Report below and in the Company’s filings with the Securities and
Exchange Commission, including the Risk Factors stated in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008, and this Report. Such
Risk Factors include, but are not limited to, the
following:  competition for distribution of channels, viewers,
advertisers and the acquisition of programming; fluctuations in the availability
of programming; fluctuations in demand for programming which we air on our
channels; our ability to address our liquidity needs; our incurrence of losses;
and our substantial indebtedness affecting our financial condition and
results.





Available
Information







We
will make available free of charge through our website, www.hallmarkchannel.com,
the 2008 Annual Report on Form 10-K, our quarterly reports on Form 10-Q, our
current reports on Form 8-K, and amendments to such reports, as soon as
reasonably practicable after we electronically file or furnish such material
with the Securities and Exchange Commission.





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





Item
3.  Quantitative and
Qualitative Disclosures About Market Risk





We only
invest in instruments that meet high credit and quality standards, as specified
in our investment policy guidelines. These instruments, like all fixed income
instruments, are subject to interest rate risk. The fixed income portfolio will
decline in value if interest rates increase. If market interest rates were to
increase immediately and uniformly by 10% from levels as of June 30, 2009, the
decline of the fair value of the fixed income portfolio would not be
material.





As of
June 30, 2009, our cash, cash equivalents and short-term investments had a fair
value of $6.8 million and were invested in cash and short-term commercial paper.
The primary purpose of these investing activities has been to preserve principal
until the cash is required to fund operations. Consequently, the size of this
portfolio fluctuates significantly as cash is provided by and used in our
business.





The value
of certain investments in this portfolio can be impacted by the risk of adverse
changes in securities and economic markets and interest rate fluctuations. For
the three and six months ended June 30, 2009, the impact of interest rate
fluctuations, changed business prospects and all other factors did not have a
material impact on the fair value of this portfolio, or on our income derived
from this portfolio.





We have
not used derivative financial instruments for speculative purposes. As of June
30, 2009, we are not hedged or otherwise protected against risks associated with
any of our investing or financing activities.





We
are exposed to market risk.





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





If we use
risk management control policies, there will be inherent risks that may only be
partially offset by our hedging programs should there be any unfavorable
movements in interest rates or equity investment prices.





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





Our
interest income and expense is subject to fluctuations in interest
rates.





Our
material interest bearing assets consisted of cash equivalents and short-term
investments. The balance of our interest bearing assets was $6.8 million, or
less than 1% of total assets, as of June 30, 2009. Our material liabilities
subject to interest rate risk consisted of our bank credit facility, our note
and interest payable to HC Crown, and our notes and interest payable to Hallmark
Cards affiliates. The balance of those liabilities was $366.4 million, or 26% of
total liabilities, as of June 30, 2009. Net interest expense for the three
months ended June 30, 2009, was $25.7 million, 38%, of our total revenue. Net
interest expense for the six months ended June 30, 2009, was $50.5 million, 36%,
of our total revenue.  Our net interest expense for these liabilities
is sensitive to changes in the general level of interest rates, primarily U.S.
and LIBOR interest rates. In this regard, changes in U.S. and LIBOR
(“Eurodollar”) interest rates affect the fair value of interest bearing
liabilities.




If market
interest rates were to increase or decrease by 1% from the rates discussed in
Notes 4 and 5 to the financial statements as of June 30, 2009, our interest
expense for the three and six months would change by $929,000 and $1.9 million,
respectively. See Notes 4 and 5.







Item
4.  Controls and
Procedures.





a.  Disclosure
Controls and Procedures





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





b.  b.           Chandes
in Internal Control over Financial Reportingy this Quarterly Rport on Form 10-Q
because we have not yet completed theChanges in Internal Control over Financial
Reporting





There was
no change in the Company’s internal control over financial reporting that
occurred during the quarter ended June 30, 2009, that materially affected, or
was reasonably likely to materially affect, the Company’s internal control over
financial reporting.





PART
II.  OTHER INFORMATION





Item
1.  Legal Proceedings





For
information regarding a lawsuit concerning a recapitalization proposal made in
May 2009 by a Hallmark Cards affiliate, please see Note 11 to the Unaudited
Condensed Consolidated Financial Statements contained in Item 1 of this
Report.





Item
1A.  Risk Factors





Our
liquidity is dependent on external funds.





Although
in the 2008 year and the first half of 2009, we generated positive cash flow
from operations, unanticipated significant expense or any developments that
hamper our growth in revenue or decreases any of our revenue, may result in the
need for additional external funds in order to continue
operations.  We have no arrangements for any such additional external
financings, whether debt or equity, and are not certain whether any new external
financing would be available on acceptable terms.  Any new debt
financing would require the cooperation and agreement of existing
lenders.





Further,
as discussed in this report under “Liquidity and Capital Resources” below, we
need to (1) extend, refinance or replace our credit facility on or prior to
March 31, 2010, or to extend or replace borrowings from Hallmark Cards by
May 1, 2010, that would result from Hallmark Cards' purchasing the loans
under that facility, and (2) extend or refinance outstanding notes payables
to Hallmark Cards and its subsidiaries on or prior to May 1, 2010, for
three obligations and August 2011 in the case of the 10.25% Note, as described
in this Report.





Upon maturity of the credit facility on March 31,
2010, if not paid in full, JP Morgan Chase Bank can elect to initiate a process
to foreclose on the Company's assets.  Such foreclosure proceedings
would affect our ability to continue our operations.  Prior to any
such possible foreclosure proceedings, however, the Company would consider
various alternatives.  The Company could also cause Hallmark Cards,
pursuant to the terms of the waiver and standby purchase agreement, to exercise
its option to purchase the Bank’s interest in the credit facility and the bank
credit facility would then be payable to Hallmark Cards upon demand after
May 1, 2010.





Because
of our current inability to meet obligations when they become due on and after
May 1, 2010, we anticipate that prior to May 1, 2010, it will be
necessary to either extend or refinance the notes payable to affiliates of
Hallmark Cards or to enter into a recapitalization transaction involving
Hallmark Cards affiliates.  See the discussion of the recapitalization
proposal made by a Hallmark Cards affiliate in Note 6 to the Unaudited Condensed
Consolidated Financial Statements contained in Item 1 of this
Report.  A Hallmark Cards affiliate has indicated that it will not
extend the due dates beyond May 1, 2010.  As part of the combination
of actions and in order to obtain additional funding, the Company may consider
various alternatives including restructuring of the debt if possible, raising
additional capital through the issuance of equity or debt securities or other
strategic alternatives.





If
our programming declines in popularity, our subscriber fees and advertising
revenue could fall.





Our
success depends partly upon unpredictable and volatile factors beyond our
control, such as viewer preferences, competing programming and the availability
of other entertainment activities.  We may not be able to anticipate
and react effectively to shifts in tastes and interests in our
markets.  Our competitors may have greater numbers of original
productions, better distribution, and greater capital resources, and may be able
to react more quickly to shifts in tastes and interests.  As a result,
we may be unable to maintain the commercial success of any of our current
programming, or to generate sufficient demand and market acceptance for our new
programming.  A shift in viewer preferences in programming or
alternative entertainment activities could also cause a decline in both
advertising and subscriber fees revenue.  The decline in revenue could
hinder or prevent us from achieving profitability or maintaining a positive cash
flow and could adversely affect the market price of our Class A common
stock.





In the
second quarter of 2009, we experienced declines in viewer ratings across
demographic categories, compared to the second quarter of 2008.  As a
result, audience deficiency units increased, thereby directly decreasing
advertising revenues.  A number of changes to our program schedule
were implemented in the second quarter of 2009, including the replacement of
programs that had appeared in the schedule for a number of years, as well as a
shift in scheduling strategy to more specifically target the demographic group
of women 25-54.  These changes have caused a temporary disruption to
established viewing patterns for our audience resulting in declines in household
ratings but over time are intended to increase our delivery of viewers in the
women 25-54 demographic category.  We must successfully implement the
program rescheduling with an increase in ratings, which is uncertain, or
otherwise address the decrease in ratings in order to maintain or increase our
advertising revenues, to maintain subscriber fees and to maintain or improve our
cash flow from operations.











Item
6.  Exhibits





INDEX
TO EXHIBITS





Exhibit
      Number
            Exhibit
      Title3.1
            Amended
      and Restated Certificate of Incorporation (previously filed as Exhibit 3.1
      to our Registration Statement on Form S-1/A (Amendment No. 2), Commission
      File No. 333-95573, and incorporated herein by
  reference).3.2
            Amendment
      to the Amended and Restated Certificate of Incorporation (previously filed
      as Exhibit 3.2 to our Quarterly Report on Form 10-Q filed on July 31, 2001
      (File No. 000-30700; Film No. 1693331) and incorporated herein by
      reference).3.3
            Amended
      and Restated By-Laws (previously filed as Exhibit 3.2 to our Registration
      Statement on Form S-1/A (Amendment No. 3), Commission File No. 333-95573,
      and incorporated herein by reference).10.1*
            Employment
      Agreement dated as of May 7, 2009 between the Company and William Abbott
      (previously filed as Exhibit 10.1 to our Current Report on Form 8-K filed
      on May 6, 2009 and incorporated herein by reference).10.2*
            Resignation
      Agreement dated May 4, 2009 between the Company and Henry Schleiff
      (previously filed as Exhibit 10.2 to our Current Report on Form 8-K filed
      on May 6, 2009 and incorporated herein by reference).10.3*
            Resignation
      Agreement dated May 19, 2009 between the Company and David Kenin
      (previously filed as Exhibit 10.1 to our Current Report on Form 8-K filed
      on May 21, 2009 and incorporated herein by reference).10.4*
            Form
      of 2009 Long Term Incentive Compensation Agreement effective as of January
      1, 2009 between the Company and employee (previously filed as Exhibit 10.2
      to our Quarterly Report on Form 10-Q filed on May 7, 2009 and incorporated
      herein by reference).31.1
            Rule
      13a-14(a) Certification executed by the Company's Chief Executive
      Officer.31.2
            Rule
      13a-14(a) Certification executed by the Company's Executive Vice President
      and Chief Financial Officer.32
            Section
      1350 Certifications.





__________





*Management
contract or compensating plan or arrangement.











SIGNATURES








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





CROWN MEDIA HOLDINGS,
INC.





Signature
                            Title
                            DateBy:               /s/
      WILLIAM J. ABBOTT
                            Principal
      ExecutiveOfficer
                            August
      6, 2009William
      J. AbbottBy:             /s/
      BRIAN C. STEWART
                            PrincipalFinancial
      and
                            August
      6, 2009Brian
      C. Stewart
                            Accounting
      Officer