** **

**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**Washington,D.C. 20549

** **

**Form 10-Q**

 

**(Mark One)**

**x        QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended June 30, 2006**

 

**or**

 

**o        TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition periodfrom              to              .**

 

**Commission File Number: 000-30700**

 

**Crown Media Holdings, Inc.**

(Exact Name of Registrant as Specified in Its Charter)

 

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

 

**12700 Ventura Boulevard,**

**Suite 200**

**Studio City, California 91604**

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

 

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

Largeaccelerated filer o                                                    Acceleratedfiler x                                             Non-accelerated filer o

 

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

 

As of August 4, 2006, thenumber of shares of Class A Common Stock, $.01 par value outstanding was74,117,654, and the number of shares of Class B Common Stock, $.01 par value,outstanding was 30,670,422.

 

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**TABLE OF CONTENTS**
|             | ** ** | ** **                                                                                    | ** ** | ** ** | ** ** |
|-------------|------------|-----------------------------------------------------------------------------------------------|------------|------------|------------|
| **PART I**  | ** ** | **Financial Information**                                                                     |       |       |       |
|        |       |                                                                                          |       |       |       |
| Item 1      |       | Financial  Statements (Unaudited)                                                             |       |       |       |
|        |       | CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES                                                   |       |       |       |
|        |       | Condensed Consolidated Balance Sheets — December 31,  2005 and June 30, 2006 (Unaudited) |       |       |       |
|        |       | Condensed  Consolidated Statements of Operations and Comprehensive Loss (Unaudited)           |       |       |       |
|        |       | - Three and  Six Months Ended June 30, 2005 and 2006                                          |       |       |       |
|        |       | Condensed  Consolidated Statements of Cash Flows (Unaudited)                                  |       |       |       |
|        |       | - Three and  Six Months Ended June 30, 2005 and 2006                                          |       |       |       |
|        |       | Notes to Unaudited Condensed Consolidated Financial  Statements                               |       |       |       |
|        |       |                                                                                          |       |       |       |
| Item 2      |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations   |       |       |       |
|        |       |                                                                                          |       |       |       |
| Item 3      |       | Quantitative and Qualitative Disclosures  About Market Risk                                   |       |       |       |
|        |       |                                                                                          |       |       |       |
| Item 4      |       | Controls and  Procedures                                                                      |       |       |       |
|        |       |                                                                                          |       |       |       |
| **PART II** | ** ** | **Other Information**                                                                         |       |       |       |
|        |       |                                                                                          |       |       |       |
| Item  1A    |       | Risk Factors                                                                                  |       |       |       |
|        |       |                                                                                          |       |       |       |
| Item 4      |       | Submission of  Matters to a Vote of Security Holders                                          |       |       |       |
|        |       |                                                                                          |       |       |       |
| Item  5     |       | Other Information                                                                             |       |       |       |
|        |       |                                                                                          |       |       |       |
| Item 6      |       | Exhibits                                                                                      |       |       |       |
|        |       |                                                                                          |       |       |       |
| Signatures  |       |                                                                                          |       |       |       |

 

2

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*In this Form 10-Q the terms “Crown Media Holdings” orthe “Company,” refer to Crown Media Holdings, Inc.  and, unless the context requires otherwise,subsidiaries of Crown Media Holdings that operate or have operated ourbusinesses, Crown Media United States, LLC (“Crown Media United States”), CrownMedia Distribution, LLC (“Crown Media Distribution”), and, until completion ofthe sale of our international business in April 2005, Crown MediaInternational, LLC (“Crown Media International”) and Crown EntertainmentLimited (“Crown Entertainment”). The term “common stock” refers to our Class Acommon stock and Class B common stock, unless the context requires otherwise.*

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

**PART I. FINANCIAL INFORMATION**

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

**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATEDBALANCE SHEETS(In thousands, except par value and numberof shares)**

| ** **                                                                                     | ** ** | **As of**        | ** ** | **As of**    | ** ** |
|------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                     | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
| ** **                                                                                     | ** ** | **2005**              | ** ** | **2006**          | ** ** |
|                                                                                           |       |                  | ** ** | ** **        | ** ** |
| ASSETS                                                                                         |       |                  |       |              |       |
|                                                                                           |       |                  |       |              |       |
| Cash  and cash equivalents                                                                     |       | $                     | 15,926     |              | $          | 10,823 |   |
| Accounts  receivable, less allowance for doubtful accounts of  $1,565 and $2,420, respectively |       | 65,935                |       | 58,170            |       |
| Program  license fees — affiliates                                                        |       | 2,656                 |       | 8,291             |       |
| Program  license fees — non-affiliates                                                    |       | 106,542               |       | 102,389           |       |
| Receivable  from RHI Entertainment                                                             |       | 1,815                 |       | 1,024             |       |
| Prepaid  and other assets                                                                      |       | 6,051                 |       | 5,192             |       |
| Receivable  from buyer of international business                                               |       | 422                   |       | 44                |       |
| Prepaid  program license fee assets                                                            |       | 30,377                |       | 33,966            |       |
| Total current assets                                                                           |       | 229,724               |       | 219,899           |       |
|                                                                                           |       |                  |       |              |       |
| Accounts  receivable                                                                           |       | 9,101                 |       | 5,946             |       |
| Program  license fees — affiliates                                                        |       | 5,036                 |       | 9,447             |       |
| Program  license fees — non-affiliates                                                    |       | 222,861               |       | 198,285           |       |
| Film  assets, net                                                                              |       | 380,322               |       | 179,212           |       |
| Subscriber  acquisition fees, net                                                              |       | 80,594                |       | 61,084            |       |
| Property  and equipment, net                                                                   |       | 18,560                |       | 17,064            |       |
| Goodwill                                                                                       |       | 314,033               |       | 314,033           |       |
| Prepaid  and other assets                                                                      |       | 13,595                |       | 12,576            |       |
| Total  assets                                                                                  |       | $                     | 1,273,826  |              | $          | 1,017,546 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

3

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** **

**CROWNMEDIA HOLDINGS, INC. AND SUBSIDIARIESUNAUDITED CONDENSED CONSOLIDATED BALANCESHEETS(In thousands, except par value and numberof shares)(continued)**

** **

| ** **                                                                                                                                                   | ** ** | **As of**        | ** ** | **As of**    | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                   | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
| ** **                                                                                                                                                   | ** ** | **2005**              | ** ** | **2006**          | ** ** |
|                                                                                                                                                         |       |                  | ** ** | ** **        | ** ** |
| LIABILITIES AND STOCKHOLDERS’  DEFICIT                                                                                                                  |       |                  |       |              |       |
|                                                                                                                                                         |       |                  |       |              |       |
| LIABILITIES:                                                                                                                                                 |       |                  |       |              |       |
| Accounts payable and accrued liabilities                                                                                                                     |       | $                     | 29,876     |              | $          | 27,272 |   |
| Accrued restricted stock units                                                                                                                               |       | 9,299                 |       | 1,332             |       |
| Subscriber acquisition fees payable                                                                                                                          |       | 12,238                |       | 2,259             |       |
| License fees payable to affiliates                                                                                                                           |       | 2,730                 |       | 6,679             |       |
| License fees payable to non-affiliates                                                                                                                       |       | 50,460                |       | 27,385            |       |
| Payables to affiliates                                                                                                                                       |       | 12,071                |       | 13,089            |       |
| Payables to RHI Entertainment                                                                                                                                |       | 755                   |       | —            |       |
| Payable to buyer of international business                                                                                                                   |       | 10,050                |       | 5,148             |       |
| Interest payable                                                                                                                                             |       | 169                   |       | 108               |       |
| Capital lease obligation                                                                                                                                     |       | 612                   |       | 642               |       |
| Deferred revenue                                                                                                                                             |       | 1,149                 |       | 1,498             |       |
| Deferred credit from technical services agreement                                                                                                            |       | 1,323                 |       | 1,323             |       |
| Total current liabilities                                                                                                                                    |       | 130,732               |       | 86,735            |       |
|                                                                                                                                                         |       |                  |       |              |       |
| Accrued liabilities                                                                                                                                          |       | 24,427                |       | 25,184            |       |
| License fees payable to affiliates                                                                                                                           |       | 586                   |       | 2,035             |       |
| License fees payable to non-affiliates                                                                                                                       |       | 186,268               |       | 192,474           |       |
| Line of credit and interest payable to HC Crown                                                                                                              |       | 86,309                |       | 89,658            |       |
| Note and interest payable to Hallmark Cards affiliate                                                                                                        |       | —                |       | 72,000            |       |
| Payable to Hallmark Cards affiliates                                                                                                                         |       | 70,000                |       | —            |       |
| Payable to buyer of international business                                                                                                                   |       | 8,395                 |       | 6,640             |       |
| Senior unsecured note to HC Crown, including accrued interest                                                                                                |       | 509,386               |       | 534,761           |       |
| Credit facility                                                                                                                                              |       | 210,000               |       | 225,000           |       |
| Note and interest payable to Hallmark Cards affiliate                                                                                                        |       | 135,187               |       | 140,377           |       |
| Capital lease obligation                                                                                                                                     |       | 16,170                |       | 15,842            |       |
| Company obligated mandatorily redeemable preferred  interest                                                                                                 |       | 14,537                |       | 15,510            |       |
| Deferred credit from technical services agreement                                                                                                            |       | 5,018                 |       | 4,050             |       |
| Total liabilities                                                                                                                                            |       | 1,397,015             |       | 1,410,266         |       |
| Commitments and contingencies                                                                                                                                |       |                  |       |              |       |
| STOCKHOLDERS’ DEFICIT:                                                                                                                                  |       |                  |       |              |       |
| Class A common stock, $.01 par value; 200,000,000 shares   authorized; 74,117,654 shares issued and outstanding as of   December 31, 2005, and June 30, 2006 |       | 741                   |       | 741               |       |
| Class B common stock, $.01 par value; 120,000,000 shares  authorized; 30,670,422 shares issued and  outstanding as of   December 31, 2005, and June 30, 2006 |       | 307                   |       | 307               |       |
| Additional paid-in capital                                                                                                                                   |       | 1,423,815             |       | 1,428,940         |       |
| Accumulated deficit                                                                                                                                          |       | (1,548,052            | )          | (1,822,708        | )          |
| Total stockholders’ deficit                                                                                                                             |       | (123,189              | )          | (392,720          | )          |
| Total liabilities and stockholders’ deficit                                                                                                             |       | $                     | 1,273,826  |              | $          | 1,017,546 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

4

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**CROWN MEDIA HOLDINGS, INC.AND SUBSIDIARIES****UNAUDITED CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS ANDCOMPREHENSIVE LOSS****(In thousands, except per sharedata)**

| ** **                                                                                                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                 | ** ** | **2005**                                            | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                                                                 | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue:                                                                                                                   |       |                                                |       |                                              |       |   |   |   |   |
|  Subscriber fees                                                                                                      |       | $                                                   | 4,193      |                                              | $          | 6,379 |   | $ | 8,803 |   | $ | 12,611 |   |
|  Advertising                                                                                                          |       | 37,635                                              |       | 43,086                                            |       | 70,968 |   | 80,999 |   |
|  Advertising by Hallmark Cards                                                                                        |       | 482                                                 |       | 463                                               |       | 1,025 |   | 943 |   |
|  Film asset license fees                                                                                              |       | 3,169                                               |       | 518                                               |       | 5,252 |   | 788 |   |
|  Sublicense fees and other revenue                                                                                    |       | 213                                                 |       | 76                                                |       | 213 |   | 154 |   |
| Total revenue, net                                                                                                         |       | 45,692                                              |       | 50,522                                            |       | 86,261 |   | 95,495 |   |
| Cost of Services:                                                                                                          |       |                                                |       |                                              |       |   |   |   |   |
|  Programming costs:                                                                                                   |       |                                                |       |                                              |       |   |   |   |   |
| Affiliates                                                                                                                 |       | 2,773                                               |       | 2,846                                             |       | 5,688 |   | 5,502 |   |
| Non-affiliates                                                                                                             |       | 25,640                                              |       | 31,121                                            |       | 50,747 |   | 62,058 |   |
|  Amortization of film assets                                                                                          |       | 13,664                                              |       | 8,279                                             |       | 19,345 |   | 17,143 |   |
|  Impairment of film assets                                                                                            |       | —                                              |       | 184,886                                           |       | — |   | 184,886 |   |
|  Subscriber acquisition fee amortization  expense                                                                     |       | 8,695                                               |       | 7,723                                             |       | 18,203 |   | 15,513 |   |
|  Amortization of capital lease                                                                                        |       | 290                                                 |       | 290                                               |       | 579 |   | 579 |   |
|  Other cost of services                                                                                               |       | 4,440                                               |       | 3,211                                             |       | 5,947 |   | 7,052 |   |
| Total cost of services                                                                                                     |       | 55,502                                              |       | 238,356                                           |       | 100,509 |   | 292,733 |   |
| Selling, general and administrative expense                                                                                |       | 14,619                                              |       | 12,777                                            |       | 26,771 |   | 21,807 |   |
| Marketing expense                                                                                                          |       | 7,420                                               |       | 1,111                                             |       | 17,250 |   | 5,368 |   |
| Depreciation and amortization expense                                                                                      |       | 1,182                                               |       | 803                                               |       | 2,532 |   | 1,682 |   |
| Loss from continuing  operations before interest  expense                                                                  |       | (33,031                                             | )          | (202,525                                          | )          | (60,801 | ) | (226,095 | ) |
| Interest expense                                                                                                           |       | (17,444                                             | )          | (24,913                                           | )          | (34,340 | ) | (46,616 | ) |
| Loss before discontinued  operations and  cumulative effect of change in accounting  principle                             |       | (50,475                                             | )          | (227,438                                          | )          | (95,141 | ) | (272,711 | ) |
| Loss from discontinued operations, net of tax                                                                              |       | (4,431                                              | )          | —                                            |       | (10,672 | ) | — |   |
| (Loss) gain from sale of discontinued operations, net of tax                                                               |       | (1,349                                              | )          | (8                                                | )          | (1,349 | ) | 154 |   |
| Loss before cumulative effect  of change in  accounting principle                                                          |       | (56,255                                             | )          | (227,446                                          | )          | (107,162 | ) | (272,557 | ) |
| Cumulative effect of change in accounting principle                                                                        |       | —                                              |       | —                                            |       | — |   | (2,099 | ) |
| Net loss                                                                                                                   |       | $                                                   | (56,255    | )                                                 | $          | (227,446 | ) | $ | (107,162 | ) | $ | (274,656 | ) |
| Other comprehensive income (loss):                                                                                         |       |                                                |       |                                              |       |   |   |   |   |
|  Foreign currency translation adjustment                                                                              |       | (2,939                                              | )          | —                                            |       | (3,434 | ) | — |   |
| Comprehensive loss                                                                                                         |       | $                                                   | (59,194    | )                                                 | $          | (227,446 | ) | $ | (110,596 | ) | $ | (274,656 | ) |
| Weighted average number of Class A and Class B shares  outstanding, basic and diluted                                      |       | 104,551                                             |       | 104,788                                           |       | 104,542 |   | 104,788 |   |
| Loss per share before discontinued operations and cumulative  effect of change in accounting principle,  basic and diluted |       | (0.48                                               | )          | (2.17                                             | )          | (0.91 | ) | (2.60 | ) |
| Loss per share from discontinued operations, basic and diluted                                                             |       | (0.06                                               | )          | (0.00                                             | )          | (0.12 | ) | (0.00 | ) |
| Cumulative effect of change in accounting principle, basic and diluted                                                     |       | (0.00                                               | )          | (0.00                                             | )          | (0.00 | ) | (0.02 | ) |
| Net  loss per share, basic and diluted                                                                                     |       | $                                                   | (0.54      | )                                                 | $          | (2.17 | ) | $ | (1.03 | ) | $ | (2.62 | ) |

 

See accompanying notes tounaudited condensed consolidated financial statements.

5

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**CROWN MEDIA HOLDINGS, INC.AND SUBSIDIARIES****UNAUDITED CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS****(In thousands)**

| ** **                                                                      | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2005**                                          | ** ** | **2006** | ** ** |
|                                                                            | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                           | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net loss                                                                        |       | $                                                 | (107,162   | ) | $ | (274,656 | ) |
| Adjustments to reconcile net  loss to net cash used in operating activities:    |       |                                              |       |   |   |
| Loss from discontinued  operations                                              |       | 10,672                                            |       | — |   |
| Loss (gain) on sale from  discontinued operations                               |       | 1,349                                             |       | (154 | ) |
| Impairment of film assets                                                       |       | —                                            |       | 184,886 |   |
| Depreciation and amortization                                                   |       | 103,934                                           |       | 106,318 |   |
| Accretion on company obligated  mandatorily redeemable preferred interest       |       | 1,358                                             |       | 973 |   |
| Provision for allowance for  doubtful accounts                                  |       | 1,117                                             |       | 1,271 |   |
| Cumulative effect of change in  accounting principle                            |       | —                                            |       | 2,099 |   |
| Stock-based compensation                                                        |       | 5,243                                             |       | (3,810 | ) |
| Changes in operating assets  and liabilities:                                   |       |                                              |       |   |   |
| (Increase) decrease in  accounts receivable                                     |       | (2,539                                            | )          | 9,648 |   |
| (Increase) decrease in  receivable from buyer of international business         |       | (1,042                                            | )          | 378 |   |
| Additions to program license  fees                                              |       | (85,229                                           | )          | (49,756 | ) |
| Additions to subscriber  acquisition fees                                       |       | (4,426                                            | )          | (331 | ) |
| Increase in prepaid and other  assets                                           |       | (12,385                                           | )          | (2,969 | ) |
| Decrease in accounts payable  and accrued liabilities.                          |       | (14,327                                           | )          | (24,511 | ) |
| Increase in interest payable                                                    |       | 26,210                                            |       | 35,438 |   |
| Decrease in subscriber  acquisition fees payable                                |       | (25,278                                           | )          | (9,979 | ) |
| Increase in license fees  payable to affiliates                                 |       | 2,905                                             |       | 5,398 |   |
| Increase in payables to  affiliates                                             |       | 1,241                                             |       | 1,018 |   |
| Increase in deferred revenue                                                    |       | 554                                               |       | 349 |   |
| Net cash used in continuing  operating activities                               |       | (97,805                                           | )          | (18,390 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                           |       |                                              |       |   |   |
| Purchases of property and  equipment                                            |       | (558                                              | )          | (27 | ) |
| Payments to buyer of  international business                                    |       | (5,843                                            | )          | (6,501 | ) |
| Proceeds from disposition of  international business, net of funds transfer fee |       | 221,979                                           |       | — |   |
| Net cash provided by (used in)  investing activities                            |       | 215,578                                           |       | (6,528 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                           |       |                                              |       |   |   |
| Proceeds from the issuance of  common stock upon exercise of stock options      |       | 643                                               |       | 114 |   |
| Proceeds from tax sharing  agreement with Hallmark Cards                        |       | 21,400                                            |       | 5,000 |   |
| Borrowings under the credit  facility                                           |       | 64,000                                            |       | 15,000 |   |
| Principal payments under the  credit facility                                   |       | (195,000                                          | )          | — |   |
| Principal payments under  capital lease obligations                             |       | (295                                              | )          | (299 | ) |
| Net cash (used in) provided by  financing activities                            |       | (109,252                                          | )          | 19,815 |   |
| CASH FLOWS FROM DISCONTINUED OPERATIONS (Revised — See Note 2):            |       |                                              |       |   |   |
| Net cash used in discontinued  operating activities                             |       | (15,316                                           | )          | — |   |
| Net cash used in discontinued  investing activities                             |       | (60                                               | )          | — |   |
| Net cash used in discontinued  financing activities                             |       | (411                                              | )          | — |   |
| Effect of exchange rate  changes on cash                                        |       | 734                                               |       | — |   |
| Net cash used in discontinued operations                                        |       | (15,053                                           | )          | — |   |
| Net decrease in cash and cash  equivalents                                      |       | (6,532                                            | )          | (5,103 | ) |
| Cash and cash equivalents, beginning of period                                  |       | 12,102                                            |       | 15,926 |   |
| Cash and cash equivalents, end of period                                        |       | $                                                 | 5,570      |   | $ | 10,823 |   |
| Supplemental disclosure of cash and non-cash activities:                        |       |                                              |       |   |   |
| Interest paid                                                                   |       | $                                                 | 8,295      |   | $ | 9,234 |   |
| Income taxes paid                                                               |       | $                                                 | 846        |   | $ | 3 |   |
| Payable to buyer of  international business                                     |       | $                                                 | 26,803     |   | $ | — |   |
| Deferred credit from technical services agreement                               |       | $                                                 | 7,644      |   | $ | — |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

6

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**CROWN MEDIA HOLDINGS, INC.AND SUBSIDIARIES****NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS****For the Three and Six Months EndedJune 30, 2005 and 2006**

**1. Business and Organization**

***Organization***

Crown Media Holdings, Inc. (“Crown Media Holdings,” “CrownMedia” or the “Company”), through its subsidiaries, owns and operates paytelevision channels (collectively the “Hallmark Channel” or the “Channel”)dedicated to high quality, entertainment programming for adults and families,in the United States. The Hallmark Channel is operated and distributed by CrownMedia United States, LLC (“Crown Media United States”). Significant investorsin Crown Media Holdings include Hallmark Entertainment Investments Co. (“HallmarkEntertainment Investments”), a subsidiary of Hallmark Cards, Incorporated (“HallmarkCards”), the National Interfaith Cable Coalition, Inc. (“NICC”), and,indirectly through their investments in Hallmark Entertainment Investments,Liberty Media Corporation (“Liberty Media”) and J.P. Morgan Partners (BHCA),L.P. (“J.P. Morgan”).

***Saleof the International Business***

In April 2005, theCompany completed the sale of  its international business to a group ofinvestors comprised of Equity Partners, 3i and U.K. executive David Elstein(collectively, “Sparrowhawk,” the “buyer” or the “buyer of  internationalbusiness”). The sale included the international versions of the Hallmark Channeldistributed outside the United States, the international rights to over 580titles in the Crown Media film library, and the Network Operations Center basedin Denver, Colorado.  The Company received cash proceeds of $209.3million, net of the prepayment described below, and recognized an accountingloss of $6.5 million from the sale. Approximately $4.7 million of transactioncosts were incurred by the Company in connection with the sale.

Subsequent to thesale, the Company has no continuing economic involvement with the operations ofthe international business.

***Liquidity***

As of June 30,2006, the Company had $10.8 million in cash and cash equivalents on hand. As ofJune 30, 2006, the Company had borrowed $225.0 million from a $240.0 millionrevolving bank credit, which matures May 31, 2007.

The Company’s principal sources of funds are cash onhand, cash generated by operations, tax sharing payments from Hallmark Cardsand amounts available under the Company’s revolving bank credit facility.Payments under the tax sharing agreement are affected by Hallmark Cards’ taxposition and its ability to utilize the Company’s tax losses.  The Company received $5.0 million in taxsharing payments in January 2006 and does not currently expect to receive anyadditional cash payments during 2006. The Company currently has $15.0 millionof unused revolving credit commitments.

The ability of the existing sources of liquidity to besufficient to fund the Company’s operations depends upon the Company’s abilityto achieve forecasts, however, management has not always been able toaccurately forecast future operations. In particular, continued growth in subscriber revenue and advertisingrevenue, as well as maintaining the cash flow from library sales, arerequired.  As a result, any decline inthe popularity of the Hallmark Channel, any significant future modifications tothe Company’s distribution agreements, an economic decline in the advertisingmarket, an increase in program acquisition costs, an increase in competition orother adverse operating conditions would impact the Company’s liquidity and itsability to fund the current level of operations.  To the extent that the Company requiresadditional capital and additional drawings on the bank credit facility areeither not available or insufficient, the Company would be forced to seekadditional funding from the issuance of debt or equity securities, a sale ofcertain assets or from strategic transactions which provide capital. There canbe no assurance that the Company would be able to secure additional financingor complete any such transactions.

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TheCompany expects to continue making investments in programming, marketing anddistribution during the next twelve months ending June 30, 2007. However, theCompany’s liquidity position has demanded that all areas of expenses, includingprogramming, marketing and distribution be closely monitored andcontrolled.  In April, 2006, the Companycommenced a cost reduction program, includingreducing marketing activities and the number of personnel by approximately 20persons.  Management anticipates thatthese actions will result in approximately $10.0 to $13.0 million in annualcost reductions when compared to the 2005 year. The Company has and will continue to seek to sublicense certain of itsprogramming rights but expects that programming expenses and cost of serviceswill increase when compared to these items for 2005.

The Company’sprincipal uses of funds for 2006 are expected to include the payment of 2006operating expenses, accounts payable and accrued expenses, licensing ofprogramming (including prepayment of certain licensing of programming for2007), and interest under its bank credit facility.

TheCompany will also continue to explore ways in which it can improve its capitalstructure, such as a potential sale of its film assets as described in Note 17 below.

TheCompany currently believes that cashon hand, cash generated by operations, and availability on its bank creditfacility, will be sufficient to fund the Company’s operations and meet itsliquidity needs through June 30, 2007.

TheCompany’s bank credit facility will expire on May 31, 2007.   If theCompany is not able to arrange for the extension, refinancing or replacement ofthe bank credit facility prior to its maturity and the bank draws down on theirrevocable letter of credit provided by Hallmark Cards in support of the bankcredit facility, or alternatively Hallmark Cards purchases the interests of thelending banks, Hallmark Cards wouldhave all obligations and the rights of the lending banks under the bank creditfacility.  In that event, Hallmark Cards could demand payment ofoutstanding amounts at any time after August 15, 2007, under the terms of thewaiver and standby purchase agreement (“Waiver Agreement”) describedbelow.  If the Company has not retired the bank credit facility prior toits maturity, it is the Company’s intent to extend the bank credit facilityupon its maturity, which might require continuation of a letter of credit fromHallmark Cards or other steps by the Company.

Upon maturity of the creditfacility on May 31, 2007, the lending group led by JP Morgan Chase has theright to elect to forego the receipt of cash to pay the principal amount of thecredit facility in full, which is provided for under the terms of anirrevocable letter of credit provided by Hallmark Cards,but instead can electto initiate a process to foreclose on the Company’s assets. Suchforeclosure proceedings, which we view as a remote possibility, would affectour ability to continue our operations. Prior to any such possible foreclosureproceedings, however, the Company, if it has not secured an extension of thecredit facility or alternative financing, would cause Hallmark Cards pursuantto the terms of the Waiver Agreement to exercise its option to purchase all ofthe outstanding indebtedness under the credit facility and the credit facilitywould then be subject to terms of the Waiver Agreement not to demand paymentprior to August 15, 2007.

Due tothe Company’s liquidity issues and its possible inability to meet itsobligations when they come due in August 2007, the Company anticipates that prior to August 15, 2007,it will be necessary to either extend or refinance (i) the bank credit facilityand (ii) $678.0 million covered by the promissory notes payable to affiliatesof Hallmark Cards described in the Notes below. As part of a combination ofactions and in order to obtain additional funding, the Company may considervarious alternatives, including refinancing the bank credit facility, raisingadditional capital through the issuance of equity or debt securities, a sale ofcertain assets or other strategic alternatives.

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

***Interim Financial Statements***

In theopinion of management, the accompanying condensed consolidated balance sheetsand related interim consolidated statements of operations and cash flowsinclude all adjustments, consisting of normal recurring items

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necessary for their fairpresentation in conformity with accounting principles generally accepted in theUnited States. Interim results are not necessarily indicative of results for afull year. These consolidated financial statements should be read inconjunction with the audited consolidated financial statements and the notes tothose statements for the year ended December 31, 2005, included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2005.

***Basis of Presentation***

The condensed consolidated financial statements includethe consolidated accounts of Crown Media Holdings, including those of its whollyowned subsidiaries. All significant intercompany balances and transactions havebeen eliminated in consolidation.

In February 2005, the Company signed a definitiveagreement to complete the sale of its international business and, accordingly,classified the operating results of the international business as discontinuedoperations in the accompanying statements of operations for all periodspresented. The Company’s discontinued operations consisted of the internationalchannel operations and the international rights to the film library assets. TheCompany closed such sale in April 2005.

***Use of Estimates***

TheCompany’s condensed consolidated financial statements are prepared inaccordance with accounting principles generally accepted in the United States ofAmerica (“GAAP”). These accounting principles require the Company to makecertain estimates, judgments and assumptions. The Company believes that theestimates, judgments and assumptions made when accounting for items and matterssuch as customer retention patterns, allowance for bad debts, useful lives ofassets, ultimate revenue used in the film asset amortization calculations, cashflow projections used in various asset valuations, income taxes, reserves andother provisions for contingencies are reasonable, based on informationavailable at the time they are made. These estimates, judgments and assumptionscan affect the reported amounts of assets and liabilities as of the date of theconsolidated financial statements, as well as the reported amounts of revenueand expenses during the periods presented. Actual results could differ fromthese estimates.

***FilmAssets and Film Library Impairment***

The Company amortizes itsfilm assets using the individual-film-forecast-computation method over amaximum period of 9.25 years from the date of acquisition. Theindividual-film-forecast-computation method amortizes such assets in the sameratio that current period actual revenue bears to estimated ultimate futurerevenues.

On aquarterly basis, the Company assesses whether events or circumstances havechanged indicating that the fair value of a film is lower than its unamortizedcost or carrying value. If the carrying value of any individual film assetexceeds its fair value, the film asset is written-down to its estimated fairvalue. Usually, a discounted cash flow model, based on management’s anticipatedultimate future revenue of the film, is used to estimate the fair value of theindividual films. The Company considers the following factors, among others, inestimating ultimate future revenue for each film:  (*a*) theoperating environment expected for the next several years, (*b*) the size of the library as a whole, (*c*) historical license fee revenue perfilm, (*d*) each title’s age,quality, and marketability, (*e*)existing sales plans including the amount of product desired to be sold eachyear, (f) future performance estimates, (g) assumptions and estimatesunderlying past and future estimates, and (h) risk factors that could effectfuture operations of the Library.  In estimating a film’s fair value, theCompany considers those cash outflows necessary to generate the film’s cashinflows such as exploitation, residual and participation costs and taxes. The discount rate used in the Company’s discounted cash flow model is basedupon management’s estimate of the rate a purchaser would require related to therisks and uncertainties surrounding the timing and probability of the cash flowestimates.

TheCompany reviews its estimates of ultimate future revenues and participationcosts as of each reporting date to reflect currently available information.Estimated ultimate future revenues are based on the history of each film andsimilar films, sales and marketing plans, and other factors, all of whichrequire significant judgment and estimation by management. Differences betweenamortization expense determined using the new estimates and any 

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amounts previouslyexpensed during that current fiscal year are charged or credited to thestatement of operations in the period in which the estimates are revised.

Foruse of the film assets on the Hallmark Channel and the Hallmark Movie Channel,the Company estimates the fair value of the internal usage based upon theportion of the film’s ultimate revenues attributable to the term of the licensewindow. The Company first calculatesthe amount of cost attributable to the internal use using theindividual-film-forecast-computation method described above and then expensessuch amounts ratably over the term of the license window.

The Company recorded as of June 30, 2006, animpairment related to its film assets and described in Note 3 below.

***Cash and Cash Equivalents***

Cashand cash equivalents include highly liquid investments with original maturitiesof three months or less that are readily convertible into cash and are notsubject to significant risk from fluctuations in interest rates. As a result,the carrying amount of cash and cash equivalents approximates fair value.

***Allowance for Doubtful Accounts***

The allowance for doubtful accounts is based upon theCompany’s assessment of probable loss related to uncollectible accountsreceivable.  The Company’s bad debtexpense was $2.1 million and $1.1 million for the three and six months endedJune 30, 2005. The Company’s bad debt expense was $355,000 and $1.3 million forthe three and six months ended June 30, 2006.

***Program License Fees***

Program license fees are paid in connection with theacquisition of the rights to air programs acquired from others. Program rightsare generally deferred and then amortized on a straight-line basis over theircontractual license periods or anticipated usage. Crown Media Holdingsperiodically evaluates the realizability of these deferred license fees inrelation to the estimated future revenues.

Estimates of net realizable value for program licensefees are determined using future estimated advertising revenues and anticipatedpatterns of programming usage on a day part basis as it pertains to programminglicensed to the channel. These estimates of expected annual future estimatedrevenues are compared to the net book value of the program license fee assetsto determine if the programming assets are expected to be recovered. Where theanalysis indicates the costs are in excess of the estimated net realizablevalue, an impairment is recognized.

***Subscriber Acquisition Fees***

TheCompany has been required to pay subscriber acquisition fees to obtain initialcarriage on major domestic pay distributors’ systems. Under some of theseagreements with pay distributors, Crown Media United States has been obligatedto pay subscriber acquisition fees if defined subscriber levels were met or inorder to obtain additional carriage of the Hallmark Channel by those paydistributors. Such costs are accrued when Crown Media United States receivesnotice from the distributors that they have met the contractual penetrationpercentage or subscriber count.

Subscriber acquisition fees are amortized over thecontractual life of the distribution agreements (ranging from 4 to 9years) as a reduction of subscriber feerevenue. If the amortization expense exceeds the cumulative subscriber feerevenue recognized, or to be recognized, on a per distributor basis, the excessamortization is included as a component of cost of services. Crown MediaHoldings assesses the recoverability of these costs periodically by comparingthe net carrying amount to the estimates of future subscriber fee andadvertising revenues. It also assesses the recoverability when events such aschanges in distributor relationships occur or other indicators suggestimpairment.

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***Property and Equipment***

Property and equipment are stated at historical cost.Equipment under capital leases are initially recorded at the present value ofthe minimum lease payments.

Depreciation on equipment is calculated using thestraight-line method over the estimated useful lives of the assets. Equipmentheld under capital leases and leasehold improvements are amortizedstraight-line over the shorter of the lease term or estimated useful life ofthe asset.

When property and equipment is sold or otherwisedisposed of, the cost and related accumulated depreciation or amortization areremoved from the accounts and any resulting gain or loss is included in income.The costs of normal maintenance and repairs are charged to expense whenincurred.

***Long-Lived Assets***

TheCompany reviews long-lived assets, other than goodwill and other intangibleassets with indefinite lives, for impairment whenever facts and circumstancesindicate that the carrying amounts of the assets may not be recoverable. Animpairment loss is recognized if the carrying amount of the asset is notrecoverable and exceeds its fair value. Recoverability of assets to be held andused is measured by comparing the carrying amount of an asset to the estimatedundiscounted future net cash flows expected to be generated by the asset. Ifthe asset’s carrying value is not recoverable, an impairment charge isrecognized for the amount by which the carrying amount of the asset exceeds itsfair value. The Company determines fair values by using a combination ofcomparable market values and discounted cash flows, as appropriate.

Goodwill is reviewed for impairment annually on November 30 or wheneveran event occurs or circumstances change that indicates fair value might bebelow carrying value. Goodwill is carried at historical cost if the estimatedfair value is greater than the carrying amounts. However, if estimated fairvalue is less than the carrying amount, goodwill is reduced to estimated fairvalue through an impairment charge to the Company’s consolidated statements ofoperations.

***Revenue Recognition***

Subscriber revenue from pay television distributors isrecognized as revenue when an agreement is executed, programming is provided,the price is determinable, and collectibility is reasonably assured. Subscriberfees from pay television distributors are recorded net of amortization ofsubscriber acquisition costs in accordance with Emerging Issues Task Force No.01-9 (“EITF No. 01-9”) , *Accounting for ConsiderationGiven by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)*.If the amortization expense exceeds the cumulative subscriber fee revenuerecognized, or to be recognized, on a per distributor basis, the excessamortization is included as a component of cost of services.

Advertisingrevenues are recognized as earned in the period in which the advertising istelecast. Revenue is recognized as commercial spots or long form programmingare aired and as ratings guarantees to advertisers are achieved. Advertisingrevenues are recorded net of agency commissions. Agency commissions arecalculated based on a stated percentage applied to gross billing revenue forthe Company’s broadcasting operations. Customers remit the gross billing amountto the agency and the agency remits gross billings less their commission to theCompany. Payments received in advance of being earned are recorded as deferredrevenue.

Revenue from film asset licensing agreements isrecognized in accordance with Statement of Position (“SOP”) 00-2,*Accounting by Producers or Distributors of Films*.Revenues are recognized when all of the following have occurred:  an agreement is executed, the film isavailable for exhibition by the licensee, the license fee is fixed ordeterminable, collectibility is reasonably assured and the cost of each film isknown or reasonably determinable. Revenue from film asset licensing agreementscontaining multiple film titles is allocated among the various film titlesbased on their relative estimated fair values. Payments received from licenseesprior to the availability of a film are recorded as deferred revenue. Feesreceivable with terms in excess of one year are discounted for revenuerecognition purposes at the customer’s estimated incremental borrowing rate inaccordance with Accounting 

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Principles Board (“APB”) Opinion No. 21, *Interest onReceivables and Payables.*

***Taxes on Income***

Pursuant to the tax sharing agreement entered into withHallmark Cards in March 2003, the Company’s results of operations for taxpurposes became a part of the Hallmark Cards consolidated federal tax return asof and subsequent to March 2003. However, the Company continues to account for income taxes on a separatereturn basis. Accordingly, the Company accounts for income taxes using an assetand liability method, which requires the recognition of deferred tax assets andliabilities for the expected future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases and net operating loss and taxcredit carryforwards. Deferred tax assets and liabilities are measured usingenacted tax rates expected to be applied to taxable income in the years inwhich those temporary differences are expected to be recovered or settled. TheCompany reduces deferred tax assets by a valuation allowance if it is morelikely than not that some portion or all of the deferred tax assets will not berealized. Any payments received fromHallmark Cards under the tax sharing agreement are recorded as an increase inadditional paid-in capital and any future utilization of deferred tax assetsgenerated after March 2003 will be recorded as a reduction in paid-in capital,to the extent payments were previously received from Hallmark Cards for suchbenefits under the tax sharing agreement.

***Stock-Based Compensation***

Duringthe first quarter of fiscal 2006, we adopted the provisions of, and account forstock-based compensation in accordance with, the Financial Accounting StandardsBoard’s (“FASB”) Statement of Financial Accounting StandardsNo. 123—revised 2004 (“SFAS 123R”), “*Share-Based Payment*”which replaced Statement of Financial Accounting Standards No. 123 (“SFAS123”), “*Accounting for Stock-Based Compensation*”and supersedes APB Opinion No. 25 (“APB 25”), “*Accountingfor Stock Issued to Employees*.” Under the fair value recognitionprovisions of this statement, stock-based compensation cost is measured at thegrant date based on the fair value of the award and is recognized as expense ona straight-line basis over the period during which the holder is required toprovide services in exchange for the award, i.e., usually the vesting period.We elected the modified-prospective method, under which prior periods are notrevised for comparative purposes. The valuation provisions of SFAS 123R applyto new grants and to grants that were outstanding as of the effective date andare subsequently modified. Estimated compensation for grants that wereoutstanding as of the effective date are recognized over the remaining serviceperiod using the compensation cost estimated for the SFAS 123 pro formadisclosures.

Inconnection with the adoption of SFAS123R, we recorded total compensation costrelated to RSUs granted under the Amended and Restated Crown Media Holdings,Inc. 2000 Long Term Incentive Plan (the “Plan”) of $2.1 million as a cumulativecatch-up adjustment during the six months ended June 30, 2006. See Note12 for further information regarding our stock-based compensation assumptionsand expenses.

Thefollowing table sets forth the pro forma amounts of net income and net loss pershare, for the three and six months ended June30, 2005, that would have resultedif we had accounted for our employee stock options under the fair valuerecognition provisions of SFAS 123:

**Pro Forma Effects(In thousands, except per share amounts)**
| ** **                                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                              | ** ** | **June 30, 2005**      | ** ** |
|                                                    |       |                             |       |                           |       |
| Net loss                                                |       | $                                | (56,255    | )                              | $          | (107,162 | ) |
| Pro forma stock options expense at estimated fair value |       | (93                              | )          | (261                           | )          |
| Stock option expense included in net loss               |       | 7                                |       | 14                             |       |
| Pro forma net loss                                      |       | $                                | (56,341    | )                              | $          | (107,409 | ) |
| Weighted average shares                                 |       | 104,551                          |       | 104,542                        |       |
| Pro forma net loss per share, basic and diluted         |       | $                                | (0.54      | )                              | $          | (1.03 | ) |

 

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Uponexercise of outstanding stock options, we have and will continue to issuecommon stock.

***Net Loss per Share***

Basic net loss per share is computed by dividing the netloss for the period by the weighted average number of common shares outstandingduring the period. Diluted net loss per share is computed based on the weightedaverage number of common shares and potentially dilutive common sharesoutstanding. The calculation of diluted net loss per share excludes potentialcommon shares if the effect would be antidilutive. Potential common sharesconsist of incremental common shares issuable upon the exercise of stockoptions and restricted stock units. Approximately 1.2 million and 855,000 stockoptions for the three and six months ended June 30, 2005 and 2006, respectively,have been excluded from the calculations of earnings per share because theireffects would have been antidilutive.

***Translation of Foreign Currency***

Through April 26, 2005, the balance sheets andstatements of operations and comprehensive loss of certain Crown Media Holdings’foreign subsidiaries were measured using local currency as the functionalcurrency. Revenues, expenses and cash flows of such subsidiaries weretranslated into United States dollars at the average exchange rates prevailingduring the period. Assets and liabilities were translated at the rates ofexchange at the balance sheet date. Translation gains and losses were deferredas a component of accumulated other comprehensive income (loss). Foreigncurrency transaction gains and losses recorded upon the remeasurement offinancial assets and liabilities denominated in currencies other than thefunctional currency of the subsidiary were included in determining net loss forthe period.

***Concentration of Credit Risk***

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

***Reclassifications***

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

***Cash Flows***

In 2005, the Company has separately disclosed theoperating, investing and financing portions of the cash flows attributable toits discontinued operations, which in prior periods were reported on a combinedbasis as a single amount.

***Recently Issued Accounting Pronouncements***

In May 2005, theFASB issued SFAS No. 154, *AccountingChanges and Error Corrections—Replacement of APB Opinion No. 20 and FASBStatement No. 3* (“SFAS 154”). SFAS 154 replaces APB OpinionNo. 20, *Accounting Changes,*and FASB Statement No. 3, *ReportingAccounting Changes in Interim Financial Statements,* and changes therequirements for the accounting for and reporting of a change in accountingprinciple. Opinion No. 20 previously required that most voluntary changes inaccounting principle be recognized by including in net income of the period ofthe change the cumulative effect of changing to the new accounting principle.SFAS 154 requires retrospective application to prior periods’ financialstatements of changes in accounting principle. SFAS 154 defines retrospectiveapplication as the application of a different accounting principle to prioraccounting periods as if that principle had always been used or as theadjustment of previously issued financial statements to reflect a change in thereporting entity. SFAS 154 also requires that a change in depreciation,amortization, or depletion method for long-lived, non-financial assets beaccounted for as a change in accounting estimate affected by a change inaccounting principle. We adopted the provisions of SFAS 154 as ofJanuary 1, 2006.

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SFAS No. 155*, Accounting for Certain Hybrid Financial Instruments — AnAmendment of FASB Statement No. 133 and 140.*  InFebruary 2006, the FASB issued SFAS No. 155, “Accounting for CertainHybrid Financial Instruments — An Amendment of FASB Statement No. 133 and 140” (“SFAS 155”).SFAS 155 simplifies the accounting for certain hybrid financialinstruments that contain an embedded derivative that otherwise would haverequired bifurcation. SFAS 155 also eliminates the interim guidance inFASB Statement No. 133, which provides that beneficial interest insecuritized financial assets is not subject to the provisions of FASB StatementNo. 133. SFAS 155 is effective for all financial instruments acquiredor issued after the beginning of an entity’s first fiscal year that beginsafter September 15, 2006. The Company does not believe that the adoptionof SFAS 155 will have an effect on its financial statements.

FASB Staff PositionNo. FAS No. 123(R)-4*,Classification of Options and Similar Instruments Issued as EmployeeCompensation That Allow for Cash Settlement upon the Occurrence of a ContingentEvent.*  In February 2006, the FASB issued FASBStaff Position No. FAS 123(R)-4, “Classification of Options andSimilar Instruments Issued as Employee Compensation That Allow for CashSettlement upon the Occurrence of a Contingent Event.” This position amendsSFAS 123R to incorporate that a cash settlement feature that can beexercised only upon the occurrence of a contingent event that is outside theemployee’s control does not meet certain conditions in SFAS 123R until itbecomes probable that the event will occur. This pronouncement currently doesnot have an impact on the Company’s financial statements.

InJuly 2006, the FASB issued FASBInterpretation No. 48, *Accounting for Uncertaintyin Income Taxes* (“FIN 48”). FIN 48 is an interpretation of FASBStatement No. 109, *Accounting for IncomeTaxes*, and it seeks to reduce the diversity in practice associatedwith certain aspects of measurement and recognition in accounting for incometaxes. In addition, FIN 48 requires expanded disclosure with respect to theuncertainty in income taxes and is effective as of the beginning of our 2007fiscal year. We are currently evaluating the impact, if any, that FIN 48 willhave on the Company’s financial statements.

**3. Film Library Impairment**

TheCompany retained in the second quarter of 2006 an investment banking firm tosolicit expressions of interest from third parties for the potential purchaseof the Company’s film library. As part any sale of the library, the Companycurrently plans on retaining the non-exclusive right to use certain programmingfrom the film library on the Hallmark Movie Channel.  As a result of non-binding bids received fromthird party organizations, management deemed it necessary to review its filmasset titles for impairment in the second quarter of 2006.  Management completed a valuation analysis ofthe film library as of June 30, 2006. The estimated fair value is derived by management from taking intoaccount the following:  (1) Animplied purchase price from third parties (including the impact of a possibleretention by the Company of residual and participation liabilities); (2) thefair value of rights to the non-exclusive internal use of certain films by theHallmark Movie Channel as indicated above; and (3) the amount of accountsreceivable related to the film library, that would be part of any such sale.The resulting non-cash impairment charge of $184.9 million is included inimpairment of film assets on the accompanying statement of operations for thethree and six months ended June 30, 2006.

The bids used in management’s valuation of the filmassets involve lump sum amounts with no values applied to individual films orgroups of films.  However, it isnecessary under applicable accounting requirements to allocate the fair valueof the film library as a whole to each individual film.  Based upon the conclusion that individualfilms have retained their relative value within the film library taken as awhole, management has allocated the estimated total fair value to each film ona relative fair value basis.  Aggregate non-cashimpairment charges of $184.9 million were recorded at June 30, 2006, foreach film where the estimated fair value was less than its carrying value.

Thefair value of the film library used by management to complete the valuation ofthe film library as of June 30, 2006, relied upon certain estimates based on current informationknown to management at that period in time. In addition, it was necessary formanagement to rely upon certain estimates made by consultants retained by theCompany. Estimates are subject to risks and uncertainties, which could causeactual results to differ materially from those projected or implied in thedetermination of the fair value of the film library as of June 30, 2006.  Such risks 

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and uncertaintiescould include, among others, the ultimate receipt of lower bid amounts frompotential purchasers of the film library, a change in the composition of theultimate structure of a sale of the film library, and a change in interestrates. In addition, there is no certainty that a sale of the film library willever occur.

**4. Subscriber Acquisition Fees**

Subscriber acquisition fees are comprised of thefollowing:

|                                        | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **2005**                              | ** ** | **2006**                          | ** ** |
| ** **                             | ** ** | **(In thousands)**               | ** ** |
| Subscriber acquisition fees, at cost   |       | $                                     | 221,594    |                              | $          | 192,997 |   |
| Accumulated amortization               |       | (141,000                              | )          | (131,913                          | )          |
|  Subscriber acquisition fees, net |       | $                                     | 80,594     |                              | $          | 61,084 |   |

 

*Of the net balance at June 30, 2006,the Company expects $14.4 million will be recognized as a reduction ofsubscriber fee revenue and $46.7 million will be recognized as subscriberacquisition fee expense in future periods.*

*As of December 31, 2005, and June30, 2006, the consolidated balance sheets also reflect subscriber acquisitionfees payable of $12.2 million and $2.3 million, respectively. For the threemonths ended June 30, 2005 and 2006, Crown Media United States made cashpayments of $25.9 million and $2.3 million, respectively. For the six monthsended June 30, 2005 and 2006, Crown Media United States made cash payments of$29.8 million and $10.3 million, respectively.*

**5. Program License Fees**

Program license fees are comprised of the following:

|                                                            | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|
| ** **                                                 | ** ** | **2005**                              | ** ** | **2006**                          | ** ** |
| ** **                                                 | ** ** | **(In thousands)**               | ** ** |
| Program license fees — RHI Entertainment Distribution |       | $                                     | 164,752    |                              | $          | 174,048 |   |
| Program license fees — NICC                           |       | 9,411                                 |       | 22,039                            |       |
| Program license fees — other affiliates               |       | 368                                   |       | 368                               |       |
| Program license fees — non-affiliates                 |       | 365,429                               |       | 368,635                           |       |
| Program license fees, at cost                              |       | 539,960                               |       | 565,090                           |       |
| Accumulated amortization                                   |       | (202,865                              | )          | (246,678                          | )          |
| Program license fees, net                                  |       | $                                     | 337,095    |                              | $          | 318,412 |   |

 

Programming costs for the three months ended June 30, 2005 and 2006,were $28.4 million and $34.0 million, respectively. Programming costs for thesix months ended June 30, 2005 and 2006, were $56.4 million and $67.6 million,respectively.

At December 31, 2005, andJune 30, 2006, $30.4 million and $34.0 million of program license fees wereincluded in prepaid program license fee assets on the accompanying condensedconsolidated balance sheets as the Company had made payments, but the airingwindows had not commenced.

License fees payable are comprised of the following:

|                                                            | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|
| ** **                                                 | ** ** | **2005**                              | ** ** | **2006**                          | ** ** |
| ** **                                                 | ** ** | **(In thousands)**               | ** ** |
| License fees payable — RHI Entertainment Distribution |       | $                                     | 22,704     |                              | $          | 21,120 |   |
| License fees payable — NICC                           |       | 3,315                                 |       | 8,714                             |       |
| License fees payable — non-affiliates                 |       | 214,025                               |       | 198,739                           |       |
| Total license fees payable                                 |       | 240,044                               |       | 228,573                           |       |
| Less current maturities                                    |       | (53,190                               | )          | (34,064                           | )          |
| Long-term license fees payable                             |       | $                                     | 186,854    |                              | $          | 194,509 |   |

 

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**6. Property and Equipment**

Property and equipment are comprised of the following:

 
| ** **                         | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** | **Depreciable Life** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|---------------------------|------------|
| ** **                         | ** ** | **2005**                              | ** ** | **2006**                          | ** ** | **(In years)**       | ** ** |
| ** **                         | ** ** | **(In thousands)**               | ** ** | ** **                        | ** ** |
| Technical  equipment and computers |       | $                                     | 14,650     |                              | $          | 14,686                    |       | 3-5 |   |
| Leased  assets                     |       | 17,363                                |       | 17,363                            |       | 15                        |       |
| Furniture,  fixtures and equipment |       | 1,235                                 |       | 1,241                             |       | 5                         |       |
| Leasehold  improvements            |       | 3,344                                 |       | 3,348                             |       | 3-7                       |       |
| Construction-in-progress           |       | 18                                    |       | —                            |       |                      |       |
| Property and equipment, at cost    |       | 36,610                                |       | 36,638                            |       |                      |       |
| Accumulated  depreciation          |       | (18,050                               | )          | (19,574                           | )          |                      |       |
| Property  and equipment, net       |       | $                                     | 18,560     |                              | $          | 17,064                    |       |   |   |

 

Depreciation expense related to property andequipment was $886,000 and $740,000 for the three months ended June 30, 2005and 2006, respectively. Depreciation expense related to property and equipmentwas $1.8 million and $1.5 million for the six months ended June 30, 2005 and2006, respectively.

Software and other intangibleassets of $2.0 million and $1.4 million as of December 31, 2005, and June 30,2006, respectively, have been included in prepaid and other assets in theaccompanying condensed consolidated balance sheets.

**7. Credit Facility**

 The Company has a credit agreement with asyndicate of banks, led by JP Morgan Chase Bank, under which the banks haveextended to the Company a secured revolving credit facility of up to $240.0million. Borrowings under the revolving credit facility are contingent upon theapproval of the Company’s Board of Directors. The Company and the lending banks originally entered into the facilityin 2001 and have subsequently amended the terms of this facility, with the mostrecent amendment dated as of April 28, 2006. The facility is guaranteed by the Company’s subsidiaries and is securedby all tangible and intangible property of Crown Media Holdings and its subsidiaries.

Eachloan under the bank credit facility bears interest at a Eurodollar rate or analternate base rate as the Company may request at the time of borrowing inaccordance with the credit agreement. The Eurodollar rate is based on the London interbank market forEurodollars, and remains in effect for the time period of the loan ranging fromone, two, three, six or twelve months. The alternate rate is based upon the prime rate of JP Morgan Chase Bank,a certificate of deposit rate or the Federal Funds effective rate, which isadjusted whenever the rates change.  TheCompany is required to pay a commitment fee of 0.15% per annum (0.2% from March1, 2005, to April 27, 2006) of the committed, but not outstanding, amountsunder the revolving credit facility, payable in quarterly installments.

AtDecember 31, 2005, and June 30, 2006, Crown Media Holdings had outstandingborrowings of $210.0 million and $225.0 million, respectively, under the creditfacility At December 31, 2005, $210.0 million of the outstanding balance boreinterest at the Eurodollar rate (5.39% at December 31, 2005). At June 30, 2006,$225.0 million of the outstanding balance bore interest at the Eurodollar rate(6.10% at June 30, 2006). Interest expenseon borrowings under the credit facility for the three months ended June 30,2005 and 2006, was $2.0 million, and $3.3 million, respectively. Interestexpense on borrowings under the credit facility for the six months ended June30, 2005 and 2006, was $5.9 million, and $6.2 million, respectively.

***Covenants***

The creditfacility, as amended, contains a number of affirmative and negativecovenants.  The Company’s Annual Reporton Form 10-K contains a detailed description of these covenants.

By an AmendmentNo. 9 dated as of March 21, 2006, to the agreement for the bank creditfacility, Hallmark Cards has been provided the right, by giving five businessdays written notice, to purchase all of the bank lenders’ 

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interest in the loansunder the bank credit facility for an amount equal to the principal plusaccrued, unpaid interest and other amounts owing to any of the lendingbanks.  Under the Waiver Agreementdescribed below, we can cause Hallmark Cards to complete such a purchase.  We view this purchase right as an alternativeto the lending banks drawing down on the letter of credit described below.

Byan Amendment No. 10, dated as of April 28, 2006, to the credit agreement, thematurity date of the credit facility has been extended to May 31, 2007 and thesize of the revolving credit facility has been increased from $220.0 million to$240.0 million.  Additionally, theamendment provided for the following: (1) 0.25% reduction in theinterest rate in the case of Eurodollar Loans, from 1.0% per annum to 0.75% perannum, (2) 0.05% reduction in the commitment fee from 0.20% per annum to 0.15%per annum and (3) amendment to the limitation on Restricted Payments to allowus to issue common stock or make payments pursuant to employees’ restrictedstock unit agreements.  Amendment No. 10also deleted certain events of defaults no longer relevant and the followingnegative covenants: (1) changing the location of the Company’s chief executiveoffice or the Company’s name, (2) limiting capital expenditures, (3) incurringcash program acquisition guarantees in excess of a certain amount, (4) usingthe proceeds of the loans for any purpose other than set forth in the CreditAgreement, (5) permitting EBITDA (as defined in the Credit Agreement) to beless than specified amounts per quarter and (6) permitting payments totelevision distributors for subscribers to be greater than certain amounts.

The Company was incompliance with its debt covenants at June 30, 2006.

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

***Waiver and Standby Purchase Agreement***

 Under the Waiver Agreement dated March 21,2006, as amended on August 8, 2006, Hallmark Cards agreed to defer all paymentsdue on any of the following obligations and, except where noted, payment ofinterest thereon until August 15, 2007 or an earlier date as described below asthe waiver termination date, whereupon all of these amounts become immediatelydue and payable (the “Waiver Period”):

·                                          Note,dated December 14, 2001, in the original principal amount of $75.0 million,payable to HC Crown. (See *Line of Credit Payable toHC Crown*below.)

·                                          10.25% senior unsecured discount note, dated August5, 2003, in the initial accreted value of $400.0 million, payable to HCCrown.  (See *SeniorUnsecured Note*below.)

·                                          $70.0 million account payable to HallmarkEntertainment Holdings arising out of the saleto Crown Media Holdings of the Hallmark Entertainment film library. (See*Promissory Note with Hallmark EntertainmentHoldings*below.)

·                                          Note, dated as ofOctober 1, 2005, in the principal amount of $132.8 million, payable to Hallmark EntertainmentHoldings. (See *Promissory Note with Hallmark EntertainmentHoldings*below.)

·                                          Allobligations of the Company under the bank credit facility to Hallmark Cards,Incorporated by virtue of Hallmark Cards’ deemed purchase of participations inall of the obligations under a letter of credit which Hallmark Cards has givenin support of the facility or the purchase by Hallmark Cards of all theseobligations pursuant to Amendment No. 9 to the bank credit facility.

Hallmark Cards hasagreed that it will not accelerate the maturity of any of the foregoingobligations or initiate collection proceedings during the Waiver Period.  Interest will continue to accrue on theseobligations during the Waiver Period. The Company will continue to pay thebanks and/or Hallmark Cards interest on the credit facility during the WaiverPeriod.

The waivertermination date is August 15, 2007 or earlier upon occurrence of any of thefollowing events:  (a) the Company failsto pay any principal or interest, regardless of amount, due on any indebtednesswith an aggregate 

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principal amount inexcess of $5.0 million or any other event or condition occurs that results inany such indebtedness becoming due prior to its scheduled maturity, providedthat the waiver will not terminate if the Company reduces the principal amountof such indebtedness to $5.0 million or less within five business days of awritten notice of termination from Hallmark Cards; (b) certain bankruptcyevents occur; (c) the Company defaults in its payment of licensing fees underthe Second Amended and Restated Program License Agreement with RHIEntertainment Distribution (formerly known as Hallmark EntertainmentDistribution); (d) a representation and warranty of the Company in the WaiverAgreement is false or misleading in any material respect; or (e) the Companyfails to pay interest on the deferred obligations listed above or to performany covenants in the Waiver Agreement.

Under the WaiverAgreement, if the bank’s lenders under the bank credit facility accelerate anyof the indebtedness under the bank credit facility or seek to collect anyindebtedness under it, then the Company may elect to exercise its right torequire that Hallmark Cards or its designated subsidiary exercise an option topurchase all the outstanding indebtedness under the bank credit facility asprovided in the bank credit facility. All expenses and fees in connection with this purchase would be added tothe principal amount of the credit facility obligations.

The Waiver Agreement does not limit any existingrights of Hallmark Cards or its affiliates to offset amounts owed to us underthe Hallmark Tax Sharing Agreement and Hallmark Cards’ share of the amountspayable under the December 1, 2005, agreement with NICC (described in Notes 9and 10) against these obligations. Pursuant to the Waiver Agreement, the Company must make prepayments onthe outstanding debt from 100% of any “Excess Cash Flow” during the WaiverPeriod.   “Excess Cash Flow” is definedas 1) the net proceeds of any debt or equity financings or sale of assets; 2)the net cash proceeds from the incurrence by the Company of indebtedness; 3)the net cash proceeds from the sale, transfer or release by the Company ofassets outside the ordinary course of business; and 4) if positive, the consolidated net cash flow from operations ofCrown Holdings for any calendar quarter as shown in an SEC report, less cashfunds used to pay current operating expenses and to pay or establish reasonablereserves for future expenses, indebtedness payments, and capital improvementsand replacements as determined by the Board of Directors of the Company.

As considerationfor the Waiver Agreement in March 2006, we converted the $70.0million account payable to Hallmark Entertainment Holdings arising outof our purchase of the Hallmark Entertainment film library to apromissory note bearing interest at LIBOR plus 3% per annum.  This note ispayable in full on August 15, 2007.   We also agreed inMarch 2006 to:

·        amendthe 2001 and 2005 notes described above to add the accrued but unpaid interest,currently and annually, to the outstanding principal amounts ;

·        use  our commercially reasonable efforts to refinance all of  our obligations to Hallmark Cards and affiliates noted above;  and

·        complywith  our  covenants and obligations under the bank creditfacility .

In addition,we provided a release to Hallmark Cards and related parties for anymatters prior to the date of the Waiver Agreement and relating to the capacityof the released parties as beneficiaries of our obligations under theWaiver Agreement or the deferred obligations listed above.  This releasewas extended in the August 8, 2006, amendment to matters prior to the date ofthat amendment.

***Hallmark Letter of Credit***

Pursuant to Amendment No. 8 to the bank creditfacility, Hallmark Cards has provided an irrevocable letter of credit issued byCitibank, N.A. to JP Morgan Chase Bank in the original amount of $320.0million, as credit support for our obligations under the Company’s creditfacility (the “credit facility”).  Thesupport letter of credit was reduced to $220.0 million upon the consummation ofthe sale of the Company’s international business and the reduction of theaggregate outstanding credit exposure of its lenders to $220.0 million.  Drawdowns under the letter of credit may bemade for amounts due and payable under the credit facility and upon theoccurrence of certain other events.  Anyproceeds received by JP Morgan Chase Bank from drawing under this supportletter of credit will be used to purchase from the bank lenders, on behalf ofHallmark Cards, subordinated participations in our obligations 

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under the bank credit facility.  We agreed to pay Hallmark Cards’ the amountsresulting from the 2.0% reduction in the interest rate and the 0.3% reductionin the commitment fee payable by the Company under the bank credit facility asprovided in Amendment No. 8.  Inaddition, we agreed to pay the fee charged by Citigroup for the letter ofcredit which was 0.625% of the amount of the letter of credit.

In conjunction with Amendment No. 10, Hallmark Cardshas extended its letter of credit to correlate to the maturity date of thecredit facility and also has increased the size of the letter of credit from$220.0 million to $240.0 million.  Inconsideration of this extension and increase in the size of the letter ofcredit, the Company agreed to continue to pay Hallmark Cards the differencebetween the interest rate formerly charged the Company before the letter ofcredit was available and the rate now charged with the backing of the letter ofcredit.  Since the interest rate wasfurther reduced in Amendment No. 10 to LIBOR plus 0.75%, the interestdifferential now payable to Hallmark Cards is 2.25% of the outstandingindebtedness under the credit facility. In addition, the Company agreed tocontinue to pay the fee charged by Citigroup for the letter of credit which wasincreased to 0.875% of the amount of the letter of credit.

***Senior Unsecured Note***

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

Thesenior unsecured note payable to HC Crown does not require cash payments untilAugust 2007. Instead, the principal amount of the senior unsecured noteaccretes at 10.25% per annum, compounding semi-annually, to $596.6 million atAugust 5, 2007.  From that date, interestat 10.25% per annum will be payable semi-annually on the accreted value of thesenior unsecured note to HC Crown.  Thenote matures on August 5, 2011, and is pre-payable by Crown Media Holdingsat any time after August 5, 2004, without penalty. At December 31, 2005, andJune 30, 2006, $509.4 million and $534.8 million, respectively, of principaland accreted interest were included in the senior unsecured note payable in theaccompanying consolidated balance sheets. The note purchase agreement for thesenior unsecured note contains certain covenants which restrict on the part ofthe Company, among other matters, from the incurrence of any additionalindebtedness, the repurchase or other acquisitions of the Company’s stock,investments in other parties and the incurrence of liens on the Company’sassets.  As a fee for the issuance of thenotes, the Company paid $3.0 million to HC Crown, which was initiallycapitalized and is being amortized as additional interest expense over the termof the note payable.

***Line of Credit Payable to HC Crown***

OnDecember 14, 2001, the Company executed a $75.0 million promissory note with HCCrown maturing on the earlier of six months from the termination of the bankcredit facility or December 21, 2007. Due to the Waiver Agreement, the line of credit and related interest arenot due until August 15, 2007. This line of credit is subordinate to the bankcredit facility. The rate of interest under this line of credit is equal toLIBOR plus three percent. At December 31, 2005, and June 30, 2006, theprincipal amounts of the note were $75.0 million and $86.3 million,respectively. Accrued interest on the note of $11.3 million (which wassubsequently added to the principal amount of the note) and $3.4 million areincluded in line of credit and interest payable to HC Crown as of December 31,2005, and June 30, 2006, respectively, on the accompanying condensedconsolidated balance sheets. At December 31, 2005, and June 30, 2006, theoutstanding balances bore interest at the Eurodollar rates of 7.08% and 8.00%,respectively.

***PromissoryNote with Hallmark Entertainment Holdings***

Asconsideration for extending the demand period for the possible reimbursement ofamounts drawn on the letter of credit supporting the credit facility, theCompany agreed in October 2005 to convert a portion of its license fees payableto Hallmark affiliates, which were approximately $132.8 million, to apromissory note bearing interest at LIBOR plus 3% per annum.  The term of the promissory note began onOctober 1, 2005 and is payable in full on August 31, 2006 (amended to August15, 2007, by the Waiver Agreement). Accrued interest on the note of $2.4 million and $7.6 million,respectively, is included in note and interest payable to Hallmark Cards affiliateas of December 31, 2005, and June 30, 2006, on the accompanying condensedconsolidated balance sheets. Due to the Waiver Agreement, interest is not dueuntil August 15, 2007. At December 31, 2005, and June 30, 2006, $132.8 

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millionof the outstanding balance bore interest at the Eurodollar rates of 7.08% and8.00%. This note was transferred to a subsidiary of Hallmark Cards prior to thesale by Hallmark Cards of its interests in Hallmark Entertainment LLC, nowcalled RHI Entertainment LLC (“RHI Entertainment”).

***Promissory Note with Hallmark Entertainment Holdings***

Asconsideration for extending the demand period for the possible reimbursement ofamounts drawn on the letter of credit supporting the credit facility, theCompany agreed in March 2006 to convert its payable to a Hallmark Cardsaffiliate, which was approximately $70.4 million, to a promissory note bearinginterest at LIBOR plus 3% per annum.  Theterm of the promissory note began on March 21, 2006, and is payable in full onAugust 15, 2007. Accrued interest on the note of $1.6 million is included innote and interest payable to Hallmark Cards affiliate as of June 30, 2006, onthe accompanying condensed consolidated balance sheets. Due to the WaiverAgreement, interest is not due until August 15, 2007. At June 30, 2006, $70.4million of the outstanding balance bore interest at the Eurodollar rates of8.00%.

***Interest Paid to HC Crown***

Interestexpense payable to HC Crown, which formerly was payable to the Company’s banksyndicate and resulted from a reduction in the interest rate and commitment feepayable to the Company’s bank syndicate in Amendment No. 8 to the Company’scredit facility, was $3.2 million and $21,000 at December 31, 2005 and June 30,2006, respectively.  Such interestexpense payable to HC Crown was $1.2 million and $1.1 million for the threemonths ended June 30, 2005 and 2006, respectively. Such interest expensepayable to HC Crown was $1.5 million and $2.2 million for the six months endedJune 30, 2005 and 2006, respectively.

**9. Related Party Transactions**

***Tax Sharing Agreement***

On March 11,2003, Crown Media Holdings became a member of Hallmark Cards consolidatedfederal tax group and entered into a federal tax sharing agreement withHallmark Cards (the “tax sharing agreement”). Hallmark Cards includes CrownMedia Holdings in its consolidated federal income tax return.  Accordingly, Hallmark Cards has benefitedfrom past tax losses and may benefit from future federal tax losses, which maybe generated by Crown Media Holdings. Based on the tax sharing agreement, Hallmark Cards has agreed to payCrown Media Holdings all of the benefits realized by Hallmark Cards as a resultof including Crown Media Holdings in its consolidated income tax return.  These benefits are estimated and paid 75% incash on a quarterly basis and the balance when Crown Media Holdings becomes afederal taxpayer.  A final true-upcalculation is completed within 15 days after Hallmark Cards files itsconsolidated federal income tax return for the year.  Pursuant to the true-up calculation, CrownMedia Holdings is obligated to reimburse Hallmark Cards the amount that anyestimated payments have exceeded the actual benefit realized by Hallmark Cardsand Hallmark Cards is obligated to pay Crown Media Holdings the amount that anyactual benefit exceeds the estimated payments. Under the tax sharing agreement, at Hallmark Cards’ option, thenon-interest bearing balance of the 25% in federal tax benefits may be appliedas an offset against any amounts owed by Crown Media Holdings to any member ofthe Hallmark Cards consolidated group under any loan, line of credit or otherpayable, subject to limitations under any loan indentures or contractsrestricting such offsets. During the third quarter of 2005, Hallmark Cards used$30.0 million of the approximately $45.7 million balance of this 25% balance tooffset intercompany debt.

TheCompany did not receive any amounts under the tax sharing agreement duringeither of the three months ended June 30, 2005 and 2006. The Company received$21.4 million and $5.0 million under the tax sharing agreement during the sixmonths ended June 30, 2005 and 2006, respectively. Any payments received fromHallmark Cards or credited against amounts owed by Crown Media Holdings to anymember of the Hallmark Cards consolidated group under the tax sharingagreements are recorded as an addition to paid-in capital in the accompanyingconsolidated statements of stockholders’ equity.

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***Services Agreement with Hallmark Cards***

TheCompany has an intercompany services agreement with Hallmark Cards, which wasentered into in 2003 for a term of three years and then extended for anadditional year through January 1, 2007. Under the agreement, Hallmark Cards provides Crown Media Holdings withtax, risk management, health safety, environmental, insurance, legal, treasuryand cash management services and real estate consulting services.  Under the agreement, the Company agreed topay Hallmark Cards $515,000 per year for these services, plus out-of-pocketexpenses and third party fees, payable in arrears on the last business day ofeach quarter. This amount was increased to$530,000 for 2006. However, the Company has not been paying these amounts asthey are due. For the three months ended June 30, 2005 and 2006, Crown MediaHoldings had accrued $129,000 and $133,000, respectively, under the agreement.For the six months ended June 30, 2005 and 2006, Crown Media Holdings hadaccrued $258,000 and $265,000, respectively, under the agreement. At December31, 2005, and June 30, 2006, non-interest bearing unpaid accrued service feesand unreimbursed expenses of $10.1 million and $11.0 million, respectively,were included in payable to affiliates in the accompanying condensedconsolidated balance sheets.

***Trademark Agreement with Hallmark Cards***

CrownMedia United States has a trademark license agreement with Hallmark Licensing,Inc. for use of the “Hallmark” mark for the Hallmark Channel and for theHallmark Movie Channel.  During thesecond quarter of 2006, Hallmark Cards extended the trademark licenseagreements for the Hallmark Channel and the Hallmark Movie Channel to September1, 2007. The Company is not required to pay any fees under the trademarklicense agreements.

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

VISNowns a $25.0 million company obligated mandatorily redeemable preferredinterest in Crown Media United States (the “preferred interest”) issued inconnection with an investment by the Company in Crown Media United States. OnNovember 13, 1998, the Company, Vision Group, VISN and Henson Cable Networks,Inc. signed an amended and restated company agreement governing the operationof Crown Media United States, which agreement was further amended on February22, 2001, January 1, 2002, March 5, 2003, January 1, 2004, November 15,2004  and December 1, 2005 (the “companyagreement”).

Underthe company agreement, the members agreed that if during any year ending afterJanuary 1, 2005 and prior to December 31, 2009, Crown Media UnitedStates has net profits in excess of $10.0 million, and the preferred interesthas not been redeemed, Crown Media United States will redeem the preferredinterest in an amount equal to the lesser of: (i) such excess net profits; (ii)$5.0 million; or (iii) the amount equal to the preferred liquidation preferenceon the date of redemption.  Crown MediaUnited States may voluntarily redeem the preferred interest at any time,however, it is obligated to do so on the date of redemption (December 31, 2010).Due to the mandatory redemption provision of the preferred interest, on July 1,2003, the preferred interest was remeasured at fair value and reclassified tonon-current liabilities in accordance with the provisions of SFAS No. 150. Thepreferred interest has a liquidation preference of $25.0 million.

InDecember 2005, Crown Media Holdings entered into an agreement with NICC,which replaced a prior program production agreement and settled variousdisputes which had arisen under the prior agreement.  In the new agreement, the Company agreed tofund and license the following programming produced by NICC through the end of2007:

·                                          ASunday Morning one-hour series entitled “New Morning with Naomi Judd” at a costof $3.5 million in 2005, $4.6 million in 2006 and $5.6 million in 2007. The 2006 and 2007 amounts are payable quarterly in those years.

·                                          Aweekday one-hour daily series entitled “New Morning” at a cost of $1.9 millionin 2005, $4.2 million in 2006 and $5.1 million in 2007.  The 2005 amountincludes a deferred amount of $535,000 to be paid as indicated below fordeferred payments.  The 2006 and 2007 amounts are payable quarterly inthose years.

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·                                          ASunday morning programming block, broadcast from 6 a.m. to 12 noon, at acost of approximately $485,000 in 2005, $5.8 million in 2006 and $5.8 million,increased by a percentage equal to the increase in the Consumer Price Index, in2007.  These amounts include deferred payments of $125,000 for 2005 and$1.5 million for each of 2006 and 2007.  The 2006 and 2007 amounts notdeferred are payable quarterly in those years.

In addition, CrownMedia Holdings agreed to finish funding four specials, the production of whichhad been commenced prior to the amendment, at a total additional cost of $1.4million in 2005 and 2006, and to fund an additional two non-dramatic specials,to be produced in 2006 and 2007, at a total cost of $1.3 million.  Aquarter of the amounts for the additional two specials was paid in January2006, another quarter was paid in June 2006 and the remaining one-half ispayable in June 2007, or upon a change in control (that is, a sale or mergerwhere the aggregate ownership of Crown Media Holdings by the current ownersbecomes less than 50%).  The Hallmark Channel is not obligated to broadcastthe latter two specials.  Crown Media Holdings will also provide or hasprovided $2.0 million in each of 2005, 2006 and 2007 to fund the development byNICC of “made for television” movies and will pay NICC an additional $1.0million if the movie “A Reason to Believe,” which was to be produced under theprior agreement, is not ultimately produced.  The 2005 amount includes adeferred payment of $1.8 million; the 2006 amount is payable semi-annually in2006; and the 2007 amount is payable in January 2007.  The HallmarkChannel will have a right of first negotiation to acquire broadcast rights tothe movies resulting from this development and, if it elects not to acquirethese rights, may still recover a portion of its funding if the movies areproduced for others.  In addition, NICC will receive $45,000 in consultingfees from a series which RHI Entertainment has produced, payable no later thanJuly 2006, and a deferred payment of $750,000 as the last payment for certainterminated obligations.

The deferredpayments mentioned above are payable to NICC on December 31, 2007 or upona change in control, whichever comes first.  Added to the deferred amountswill be (1) interest at the rate charged by NICC’s prime lender or(2) if NICC sells Crown Media Holdings common stock to finance anydeficit, the increase in the sale price of the common stock between the timeNICC sells the stock to fund a deferred amount and a market price of the CrownMedia Holdings common stock on the date the deferred amounts are paid by Crown MediaHoldings.

In the event thereis a change of control of Crown Media Holdings prior to the expiration of theagreement (i.e., December 31, 2007), NICC will immediately receive a $15.0million “termination payment,” any remaining portions of the payments for thenon-dramatic specials and the “made for television” movie development describedabove and the deferred payments described above.  The Hallmark Channelwill be obligated to continue to broadcast and pay for the Sunday “New Morningwith Naomi Judd” and weekday “New Morning” series and the Sunday morningprogramming block for an additional six months following the change in control,after which all funding and broadcast obligations to NICC will cease. Also, under existing obligations, Crown Media Holdings would be required toredeem the $25.0 million preferred interest of NICC in Crown Media UnitedStates, LLC, for that amount plus accrued interest at LIBOR fromNovember 27, 2005.

If there has notbeen a change of control of the Company by June 30, 2007, Crown MediaHoldings is required to negotiate with NICC for a period of 60 days regardingcontinuation of the programming commitments.  If at the end of thenegotiating period the parties have not reached agreement and Crown MediaHoldings is not willing to continue the programming commitments at the samelevels, NICC may compel Crown Media Holdings to buy all NICC’s outstandingshares of Crown Media Holdings common stock at the then current market value bya written notice given no later than November 1, 2007.  If NICC sellsmore than 50% of the shares of Crown Media Holdings common stock which it ownedas of February 22, 2001, except as part of a sale of Crown Media Holdings,most of the commitments and obligations related to programming as described abovecease (at the option of Crown Media United States) at the end of the thencurrent broadcast season (approximately August 31).

Duringthe three months ended June 30, 2005 and 2006, Crown Media United States paidNICC $2.6 million and $3.9 million, respectively, pursuant to the companyagreement, as amended. During the six months ended June 30, 2005 and 2006,Crown Media United States paid NICC $5.2 million and $11.3 million,respectively, pursuant to the company agreement, as amended.

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**11.  RHI Entertainment**

***Costs Incurred on Crown Media Holdings’ Behalf***

Since inception of Crown Media Holdings, RHIEntertainment has at times paid certain costs on behalf of Crown MediaHoldings. Non-interest bearing unreimbursed costs of $567,000 and $0 areincluded in payable to RHI Entertainment in the accompanying condensedconsolidated balance sheets as of December 31, 2005, and June 30, 2006,respectively.

***Film Asset Services Agreement with RHI Entertainment***

The Company has a film asset services agreement with RHIEntertainment, under which RHI Entertainment provides Crown Media Holdings withservices related to the administration, distribution and other exploitation ofthe Company’s film assets. In consideration for the services provided by RHIEntertainment, Crown Media Holdings was, prior to the sale of the Company’sinternational operations, obligated to pay a service fee of $1.5 million peryear, payable in quarterly installments of $375,000. At December 31, 2005, andJune 30, 2006, non-interest bearing unpaid accrued service fees of $188,000 and$0 were included in payable to RHI Entertainment in the accompanying condensedconsolidated balance sheets. Following the sale of the Company’s internationaloperations, the annual fee for these services was reduced to $750,000 per year.

***Program License Agreements with RHI Entertainment Distribution***

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

Underthe Second Restated Agreement, RHI Entertainment Distribution is required toproduce and deliver to Crown Media United States, and Crown Media United Statesis required to order and license from RHI Entertainment Distribution, 13original movies and 3 original mini-series in 2005, 31 original movies and 6original mini-series in 2006 and 18 original movies and 3 original mini-seriesin 2007.   Crown Media United States may,however, completely cancel the 2007 commitment to order 18 original movies and3 original mini-series or it may reduce the number of original movies it isrequired to license in each of 2006 and 2007 by up to six movies per year.  Crown Media United States has exercised thisoption to reduce by six the number of original movies produced in 2006 and hasadvised RHI Entertainment Distribution that it will not exercise its right tocancel the 2007 original productions. Crown Media United States has exclusiverights to these original movies and mini-series during a three year exhibitionwindow (the window is five years for certain holiday-themed movies and moviesproduced in 2005).  Crown Media UnitedStates may exhibit the original movies and mini-series in any television mediain the United States, its territories and possessions (together with PuertoRico), including pay per view and high definition television. Crown MediaUnited States may also sublicense its exhibition rights in any television mediaregarding the original and other movies and mini-series covered by theagreement to third parties, subject to the reasonable consent of RHIEntertainment Distribution.  The licensefee payable for the original movies produced in 2005 is $1,600,000 per movie;in 2006 is $1,680,000 per movie and in 2007 is $1,764,000 per movie.  If the movies are produced for the Hallmark Channel’s“Mystery Movie” series, the license fees are increased by $200,000 and if theyare holiday-themed movies, the license fees are increased by $100,000.  The license fees for mini-series produced in2005 are $800,000 per hour; in 2006 are $840,000 per hour; and in 2007 are$882,000 per hour.   Crown Media UnitedStates must also share any revenues from video on demand or pay per viewexploitation with RHI Entertainment Distribution.

Inaddition to the original movies and mini-Series, Crown Media United States hasagreed to license from RHI Entertainment Distribution 22 “off-network” moviesand mini-series in 2005 and a maximum of 15 such movies and mini-series in 2006through 2008.  These programs generallywill not have been seen on cable television in the United States prior to theirexhibition on the Hallmark Channel.  Thelicense fees payable for the off-network movies are $268,029 per movie in 2005;$281,420 per movie in 2006; $295,491 per movie in 2007 and $310,266 per moviein 2008.  The license fees payable forthe off-network mini-series are $335,024 per hour in 2005; $351,775 per hour in2006; $369,364 per hour in 2007 and $387,832 per hour in 2008.  Crown Media United States’ initial exhibitionperiod for these off-network movies and mini-series is three years and CrownMedia United States’ exhibition rights are exclusive in all television media inthe United States, including Puerto Rico. Crown Media United States’ 

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exhibition rights tothese off-network movies and mini-series do not, however, include pay per viewor video on demand.  RHI EntertainmentDistribution has an option to require Crown Media United States to licensethese off-network movies and mini-series for an additional, consecutive threeyear period at a cost of 50% of the initial license fee.

CrownMedia United States has also agreed to license up to 143 older movies andmini-series from the RHI Entertainment Distribution Library for a three yearexclusive exhibition window, at an approximate total cost of $57.5 million.  Most of these movies and mini-series havepreviously been exhibited on the Hallmark Channel or Hallmark Movie Channel.

Bothunder the current and previous agreements with RHI Entertainment Distribution,if Crown Media United States sub-licenses any licensed program to a thirdparty, it must equally share with RHI Entertainment Distribution the excess, ifany, of the sublicensing fee over the initial program license fee paid by theCrown Media United States.  Crown Media UnitedStates did not sub-license any RHI licensed program to a third party during thethree months ended June 30, 2005 and 2006. Crown Media United States did notsub-license any RHI licensed program to a third party during the six monthsended June 30, 2005 and 2006.

Programmingcosts related to the RHI Entertainment Distribution program agreements were$7.2 million and $10.7 million for the three months ended June 30, 2005 and2006, respectively. Programming costs related to the RHI EntertainmentDistribution program agreements were $13.8 million and $20.5 million for thesix months ended June 30, 2005 and 2006, respectively. As of December 31, 2005,and June 30, 2006, $22.7 million and $21.1 million, respectively, are includedin license fees payable to non-affiliates in the accompanying consolidatedbalance sheets. Crown Media Holdings paid RHI Entertainment Distribution $40.0million and $12.7 million for license fees during the three months ended June30, 2005 and 2006, respectively. Crown Media Holdings paid RHI EntertainmentDistribution $40.0 million and $20.1 million for license fees during the sixmonths ended June 30, 2005 and 2006, respectively.

**12. Employee Incentives**

Crown Media Holdings has one stock plan, the Amended andRestated Crown Media Holdings, Inc. 2000 Long Term Incentive Plan. The Plancovers two types of share-based compensation, stock options and restrictedstock units (RSU) that are subject to FAS 123R commencing on January 1, 2006.

***Stock Option Plan***

Crown Media Holdings may grant options for up to 10.0million shares under the Plan. The stock options expire 10 years from the dateof grant and generally vest over service periods that range from date of grantto four years.  Certain option and shareawards provide for accelerated vesting if there is a change in control (asdefined in the Plan).

***Stock Compensation***

Beginning with our first quarter offiscal 2006, we adopted SFAS 123R. We currently use the Black-Scholes optionpricing model to determine the fair value of stock options. The determinationof the fair value of stock-based payment awards on the date of grant using anoption-pricing model is affected by our stock price as well as assumptionsregarding a number of complex and subjective variables. These variables includeour expected stock price volatility over the term of the awards, actual andprojected employee stock option exercise behaviors, risk-free interest rate andexpected dividends.

We estimate the expected term ofoptions granted by taking the average of the vesting term and the contractualterm of the option. We estimate the expected volatility of our common stock byusing historical volatility. We base the risk-free interest rate that we use inthe option valuation model on U.S. Treasury zero-coupon issues with remainingterms similar to the expected term on the options. We do not anticipate payingany cash dividends in the foreseeable future and therefore use an expecteddividend yield of zero in the option valuation model. We are required toestimate forfeitures at the time of grant and revise those estimates insubsequent periods if actual 

24

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forfeitures differ from those estimates. We usehistorical data to estimate pre-vesting option forfeitures and recordstock-based compensation expense only for those awards that are expected tovest. The fair value of all stock-based payment awards is amortized on astraight-line basis over the requisite service periods of the awards, which aregenerally the vesting periods.

The Company recorded a $1.9 millioncompensation credit related to restricted stock units and $3,000 compensationexpense related to stock options for the three months ended June 30, 2006, onour consolidated statement of operations as a component of selling, general andadministrative expense. The Company recorded a $3.8 million compensation creditrelated to restricted stock units and $10,000 compensation expense related tostock options for the six months ended June 30, 2006, on our consolidatedstatement of operations as a component of selling, general and administrativeexpense.

As of June 30, 2006, there was nounrecognized compensation cost, adjusted for estimated forfeitures, related tonon-vested stock options granted to our employees. Total unrecognizedcompensation cost will be adjusted for future changes in estimated forfeitures.

***General Stock Option Information***

The following table sets forth thesummary of option activity under our stock option program for the six monthsended June 30, 2006:
| ** **                  | ** ** | **Shares  (in thousands)** | ** ** | **Exercise  Price  Per Option** | ** ** | **Weighted-   Average  Exercise  Price  Per Option** | ** ** | **Aggregate  Intrinsic  Value** | ** ** | **Weighted-  Average  Fair Value** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** |
|-----------------------------|------------|---------------------------------|------------|--------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------|------------|-----------------------------------------|------------|------------------------------------------------------|------------|
| ** **                  | ** ** | ** **                      | ** ** | ** **                           | ** ** | ** **                                                     | ** ** | ** **                      | ** ** | ** **                              | ** ** | ** **                                           | ** ** |
| Balance,  December 31, 2005 |       | 867                             |       |                                 |       | $                                                              | 10.42      |                            |       |                                    |       |                                                 |       |   |
|  Options cancelled     |       | (12                             | )          | $                                    | 8.94-16.38 |                                                           | $          | 11.97                           |       |                                    |       |                                                 |       |   |   |
| Balance, June  30, 2006     |       | 855                             |       |                                 |       | $                                                              | 10.39      |                            | $          | 0.00                                    |       | $                                                    | 3.60       |   | 2.64 |   |
| Exercisable                 |       | 855                             |       |                                 |       | $                                                              | 10.39      |                            | $          | 0.00                                    |       | $                                                    | 3.60       |   | 2.64 |   |
|                             |            |                                 |            |                                      |            |                                                                |            |                                 |            |                                         |            |                                                      |            |  |  |  |  |

 

Informationregarding stock options at June 30, 2006, is summarized below: 
| Options Outstanding and Exercisable       | ** ** |
|----------------------------------------------------------|------------|
| **Range of  Exercise Prices  Per Option** | ** ** | **Shares  Outstanding** | ** ** | **Weighted Average  Remaining  Contractual Life** | ** ** | **Weighted Average  Exercise Price  Per Option** | ** ** |
| ** **                                               | ** ** | **(In thousands)** | ** ** | **(In years)** | ** ** | ** ** | ** ** |
| $6.30-10.50                                              |       | 530 |   | 1.13 |   | $ | 9.11 |   |
| $10.51-12.60                                             |       | 240 |   | 5.46 |   | $ | 11.49 |   |
| $12.61-14.70                                             |       | 43 |   | 3.71 |   | $ | 14.00 |   |
| $14.71-21.00                                             |       | 42 |   | 4.58 |   | $ | 16.61 |   |
|                                                     |       | 855 |   | 2.64 |   | $ | 10.39 |   |

 

***General Restricted Stock Unit Information***

The Company’s restricted stock units(“RSUs”) vest based on either employment or performance conditions. CertainRSUs vest in one-third increments on the anniversary of the grant date in eachof the three years following the grant based on continuing employment (“EmploymentRSUs”). Other RSUs vest on the third anniversary date of the grant date,provided that the price of the Company’s Class A common stock is at least $14or higher on that date (“Performance RSUs”). See Note 17, Subsequent Events,below for information regarding RSUs granted in August 2006.

 

25

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

Prior tothe adoption of SFAS 123R, we recognized the estimated compensation cost ofemployment restricted stock units over the vesting term, including changes infair value at each reporting period. The estimated compensation cost was andcontinues to be based on the fair value of our stock price at the end of eachreporting period. We will continue to recognize the compensation cost, net ofestimated forfeitures, over the vesting term and include changes in fair valueat each reporting period.

TheCompany made an offer in May 2003 to senior management and vice presidents toexchange their options for Employment RSUs, resulting in a total of 5,126,732options exchanged for 2,050,693 Employment RSUs. The Employment RSUs vestedover three years in one-third increments on the anniversary of the grant dateeach year and the Company accrued expense related to the Employment RSUsratably over each increment’s vesting period using the price of our Class Acommon stock on the last day of the reporting period.

InMay 2004, the Company’s Board of Directors approved an additional grant toemployees of 1,065,000 RSUs. The Employment RSUs, which constitute 70% of theaward granted in 2004, vest in equal one-third installments over the next threeyears on the anniversary of the grant date each year. The Performance RSUs,constituting 30% of the award granted in 2004, vest on the 3rd anniversary of the grant date, provided thatthe price of the Company’s common stock is $14 or higher on that date.

The Companyrecorded $2.8 million of compensation expense and $1.9 million of compensationbenefit associated with the Employment and Performance RSUs during the threemonths ended June 30, 2005 and 2006, respectively, which has been recorded as aliability for RSUs in the accompanying consolidated balance sheets and isincluded in selling, general and administrative expense in the accompanyingconsolidated statements of operations. The Company recorded $5.2 million ofcompensation expense and $3.8 million of compensation benefit associated withthe Employment and Performance RSUs during the six months ended June 30, 2005and 2006, respectively, which has been recorded as a liability for RSUs in theaccompanying consolidated balance sheets and is included in selling, generaland administrative expense in the accompanying consolidated statements ofoperations.

The Company settled certain Employment RSUs during the three months endedMarch 31, 2005, for approximately $4.2 million in cash. Additionally, inconjunction with the close of the international transaction, the Companyimmediately vested and settled Employment RSUs held by individuals employed bythe international business in May 2005 for approximately $4.0 million incash.  In June 2005, the Company settledvested Employment RSUs for approximately $3.8 million in cash. In January 2006, the Companysettled vested Employment RSUs to one executive for approximately $4.4 million.In June 2006, the Company settledvested Employment RSUs for approximately $1.5 million in cash.

In June 2005, the Company’s Board of Directors approved agrant to those Directors who were not employees of the Company or of HallmarkCards or its affiliated companies, of 70,884 RSUs.  The RSUs vest in equal one-third installmentsover three years on the anniversary of the grant dates each year. In June 2006,the Company settled vestedRSUs for approximately $80,000 in cash.

In August 2005, the Company’s Board of Directorsapproved an additional grant of 828,000 Employment and Performance RSUs toemployees. The Employment RSUs, which constitute 50% of the award granted in2005, vest in equal one-third installments over the next three years on theanniversary of the grant date each year. The Performance RSUs, constituting 50%of the award granted in 2005, vest on the 3rd anniversary of the grant date, provided thatthe price of the Crown common stock is $14 or higher on that date.

In August 2005,the Company’s Board of Directors approved an additional grant to one executiveof 115,000 RSUs (“CEO Grant”). The Employment RSUs, which constitute 50% of theaward granted in 2005, vested in equal one-third installments on dates whichwere three months, six months and nine months, respectively, after the grantdate and the Company has settled these RSUs for $203,000 in November 2005,$165,000 in February 2006 and 

26

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$76,000 in May 2006. The Performance RSUs,constituting the remaining 50% of the award granted in 2005, have lapsedwithout vesting.

In August 2005, theCompany’s Board of Directors approved a grant to those Directors who were notemployees of the Company or of Hallmark Cards or its affiliated companies, atotal of 31,570 RSUs. The RSUs vest in equal one-third installments over threeyears on the anniversary of the grant dates each year.

Under FAS 123R,the fair value of each Employment RSU grant is estimated using a Black-ScholesMerton option pricing model.  The fairvalue of each Performance RSU grant is estimated at each reporting date using aMonte Carlo Lattice option pricing model. Beginning in 2006, the Company isapplying a forfeiture rate to the RSUs as required by SFAS No. 123R.

*** ***
| ** **                              | ** ** | ** **              | ** ** | **Weighted-Average Remaining** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|-------------------------------------|------------|
| **Employment RSUs**                | ** ** | **Units**               | ** ** | **Contractual Term**           | ** ** |
| ** **                              | ** ** | **(in thousands)** | ** ** | ** **                          | ** ** |
|                                    |       |                    |       |                                |       |
| Outstanding  Balance, December 31, 2005 |       | 1,477,343               |       |                                |       |
| Units settled in cash                   |       | (889,520                | )          |                                |       |
| Units cancelled                         |       | (89,589                 | )          |                                |       |
| Outstanding Balance, June  30, 2006     |       | 498,234                 |       | 1.77                                |       |

 

The closing price of a share of our common stock onDecember 31, 2005, was $9.17, $6.34 on March 31, 2006 and was $4.12 on June 30,2006.

** **
| ** **                              | ** ** | ** **              | ** ** | **Weighted-Average Remaining** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|-------------------------------------|------------|
| **Performance RSUs**               | ** ** | **Units**               | ** ** | **Contractual Term**           | ** ** |
| ** **                              | ** ** | **(in thousands)** | ** ** | ** **                          | ** ** |
|                                    |       |                    |       |                                |       |
| Outstanding  Balance, December 31, 2005 |       | 688,500                 |       |                                |       |
| Units cancelled                         |       | (144,700                | )          |                                |       |
| Outstanding Balance, June  30, 2006     |       | 543,800                 |       | 1.70                                |       |

 

At December 31, 2005, the 2004Performance RSUs were valued at $1.61 per unit, the 2005 Performance RSUs werevalued at $4.36 per unit, and the CEO Performance RSUs were valued at $1.23 perunit. At June 30, 2006, the 2004 Performance RSUs were valued at $0.07 per unitand the 2005 Performance RSUs were valued at $0.52 per unit. The CEOPerformance grant expired in May 2006.

Thefollowing table includes assumptions used to value the Employment andPerformance RSUs at June 30, 2006.

** **

|                           | ** ** | **2004 Grant** | ** ** | **2005 Grant** | ** ** |
|---------------------------|------------|---------------------|------------|---------------------|------------|
| Expected  volatility      |       | 53.90               | %          | 47.30               | %          |
| Expected  dividends       |       | 0                   |       | 0                   |       |
| Expected Term  (in years) |       | 0.92                |       | 2.13                |       |
| Risk-free rate            |       | 5.21                | %          | 5.16                | %          |

 

27

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The following table includesassumptions used to value the Performance RSUs at January 1, 2006.

|                           | ** ** | **2004 Grant** | ** ** | **2005 Grant** | ** ** | **CEO Grant** | ** ** |
|---------------------------|------------|---------------------|------------|---------------------|------------|--------------------|------------|
| Expected  volatility      |       | 39.34               | %          | 48.87               | %          | 40.04              | %          |
| Expected  dividends       |       | 0                   |       | 0                   |       | 0                  |       |
| Expected Term  (in years) |       | 1.42                |       | 2.67                |       | 0.46               |       |
| Risk-free rate            |       | 4.38                | %          | 4.37                | %          | 4.37               | %          |

 

In connection with the adoption of SFAS 123R, werecorded total compensation costs relatedto RSUs granted under the Plan of $2.1 million as a cumulative catch-upadjustment during the six months ended June 30, 2006. The Performance RSUs werenot previously recorded on the Company’s financial statements as a liability,as it was not deemed probable that these units would be settled based on theperformance of the Company’s common stock.

 
| ** **                                 | ** ** | ** **              | ** ** | **Weighted-Average  Remaining** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|---------------------------------|------------|
| **Board of Directors RSUs** | ** ** | **Units**               | ** ** | **Contractual Term**       | ** ** |
| ** **                                 | ** ** | **(in thousands)** | ** ** | ** **                      | ** ** |
| ** **                                 | ** ** | ** **              | ** ** | ** **                      | ** ** |
| Outstanding  Balance, December 31, 2005    |       | 32,468                  |       |                            |       |
| Units issued                               |       | 31,570                  |       |                            |       |
| Units settled in cash                      |       | (19,690                 | )          |                            |       |
| Units cancelled                            |       | (11,395                 | )          |                            |       |
| Outstanding Balance, June  30, 2006        |       | 32,953                  |       | 1.87                            |       |

 

**13. Employee Benefits**

***Deferred Compensation Plans***

TheCompany sponsors a deferred compensation plan for its management. Participantsin this plan earn interest on their deferred compensation. The Company’sdeferred compensation obligations for this plan are included in itsconsolidated balance sheet in short and long-term accrued liabilities. Thedeferred compensation liability related to management as of December 31,2005, and June 30, 2006, was $3.2 and $3.1 million, respectively. TheCompany has suspended this plan for 2006 and there will be no deferrals of employeecompensation earned in 2006.  The Companywill, however, continue to pay interest on amounts deferred in previous yearsand pay out these amounts in accordance with the terms of the plan.

***Severance***

In April 2006, the Company terminated approximately 20employees in conjunction with its cost savings efforts. The Company’s severancecosts were approximately $2.4 million.

**14. Segment Reporting**

TheCompany’s continuing operations are currently organized into two principaldivisions representing operating segments: domestic channels and filmdistribution. The Company evaluates performance and allocates resources basedon the results of these segments. The key operating performance criteria usedin this evaluation include revenue, operating income (loss) and totalassets.  The results of operations of ourinternational channel operating segment are not included in the segmentreporting as they are classified separately as discontinued operations in theCompany’s consolidated financial statements.

28

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* *

The followingtables present the Company’s key performance measures (in thousands):

*Three Months Ended June 30, 2005*
| ** **                                               | ** ** | ** **   | ** ** | **Film**         | ** ** | ** **      | ** ** | ** **       | ** ** |
|----------------------------------------------------------|------------|--------------|------------|------------------|------------|-----------------|------------|------------------|------------|
| ** **                                               | ** ** | **Domestic** | ** ** | **Distribution** | ** ** | **Adjustments** | ** ** | **Consolidated** | ** ** |
| ** **                                               | ** ** | ** **   | ** ** | ** **       | ** ** | ** **      | ** ** | ** **       | ** ** |
| Total revenues                                           |       | $            | 42,310     |             | $          | 79,603          |       | $                | (76,221    | )(1) | $ | 45,692 |   |
|                                                     |       |         |       |             |       |            |       |             |       |
| Programming  costs                                       |       | (39,757      | )          | (103             | )          | 11,447          | (1)        | (28,413          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Amortization of  film assets                             |       | —       |       | (65,131          | )          | 51,467          | (1)        | (13,664          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Subscriber  acquisition fee amortization expense         |       | (9,542       | )          | —           |       | 847             | (1)        | (8,695           | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Operating costs                                          |       | (2,922       | )          | (1,855           | )          | 47              | (1)        | (4,730           | )          |
| Selling,  marketing, general and administrative expenses |       | (15,213      | )          | (8,033           | )          | 25              | (1)        | (23,221          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Loss from continuing operations                          |       | (25,124      | )          | 4,481            |       | (12,388         | )          | (33,031          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Interest expense                                         |       | (1,097       | )          | (16,540          | )          | 193             | (1)        | (17,444          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Loss from  discontinued operations                       |       | —       |       | (4,431           | )          | —          | (2)        | (4,431           | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Loss on sale of  discontinued operations                 |       | —       |       | (1,349           | )          | —          | (2)        | (1,349           | )          |
| Net loss                                                 |       | $            | (26,221    | )                | $          | (17,839         | )          | $                | (12,195    | ) | $ | (56,255 | ) |
|                                                     |       |         |       |             |       |            |       |             |       |
| Total assets                                             |       | $            | 783,724    |             | $          | 505,074         |       | $                | —     |   | $ | 1,288,798 |   |

 

*Six Months Ended June 30, 2005*

* *
| ** **                                               | ** ** | ** **   | ** ** | **Film**         | ** ** | ** **      | ** ** | ** **       | ** ** |
|----------------------------------------------------------|------------|--------------|------------|------------------|------------|-----------------|------------|------------------|------------|
| ** **                                               | ** ** | **Domestic** | ** ** | **Distribution** | ** ** | **Adjustments** | ** ** | **Consolidated** | ** ** |
|                                                     |       |         |       |             |       |            |       |             |       |
| Total revenues                                           |       | $            | 80,796     |             | $          | 87,016          |       | $                | (81,551    | )(1) | $ | 86,261 |   |
|                                                     |       |         |       |             |       |            |       |             |       |
| Programming  costs                                       |       | (71,586      | )          | (207             | )          | 15,358          | (1)        | (56,435          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Amortization of  film assets                             |       | —       |       | (72,223          | )          | 52,878          | (1)        | (19,345          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Subscriber  acquisition fee amortization expense         |       | (19,896      | )          | —           |       | 1,693           | (1)        | (18,203          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Operating costs                                          |       | (4,611       | )          | (2,124           | )          | 209             | (1)        | (6,526           | )          |
| Selling,  marketing, general and administrative expenses |       | (32,769      | )          | (13,997          | )          | 213             | (1)        | (46,553          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Loss from continuing operations                          |       | (48,066      | )          | (1,535           | )          | (11,200         | )          | (60,801          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Interest expense                                         |       | (2,193       | )          | (33,726          | )          | 1,579           | (1)        | (34,340          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Loss from  discontinued operations                       |       | —       |       | (10,672          | )          | —          | (2)        | (10,672          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Loss on sale of  discontinued operations                 |       | —       |       | (1,349           | )          | —          | (2)        | (1,349           | )          |
| Net loss                                                 |       | $            | (50,259    | )                | $          | (47,282         | )          | $                | (9,621     | ) | $ | (107,162 | ) |
|                                                     |       |         |       |             |       |            |       |             |       |
| Total assets                                             |       | $            | 783,724    |             | $          | 505,074         |       | $                | —     |   | $ | 1,288,798 |   |

 

29

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* *

*Three Months Ended June 30, 2006*

* *
| ** **                                               | ** ** | ** **   | ** ** | **Film**         | ** ** | ** **      | ** ** | ** **       | ** ** |
|----------------------------------------------------------|------------|--------------|------------|------------------|------------|-----------------|------------|------------------|------------|
| ** **                                               | ** ** | **Domestic** | ** ** | **Distribution** | ** ** | **Adjustments** | ** ** | **Consolidated** | ** ** |
|                                                     |       |         |       |             |       |            |       |             |       |
| Total revenues                                           |       | $            | 50,006     |             | $          | 3,738           |       | $                | (3,222     | )(1) | $ | 50,522 |   |
|                                                     |       |         |       |             |       |            |       |             |       |
| Programming  costs                                       |       | (40,104      | )          | (1,581           | )          | 7,718           | (1)        | (33,967          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Amortization of  film assets                             |       | —       |       | (3,452           | )          | (4,827          | )(1)       | (8,279           | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Impairment of  film assets                               |       | —       |       | (167,908         | )          | (16,978         | )(1)       | (184,886         | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Subscriber  acquisition fee amortization expense         |       | (8,569       | )          | —           |       | 846             | (1)        | (7,723           | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Operating costs                                          |       | (2,188       | )          | (1,313           | )          | —          |       | (3,501           | )          |
| Selling,  marketing, general and administrative expenses |       | (9,053       | )          | (5,638           | )          | —          |       | (14,691          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Loss from continuing operations                          |       | (9,908       | )          | (176,154         | )          | (16,463         | )          | (202,525         | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Interest expense                                         |       | (3,275       | )          | (21,638          | )          | —          |       | (24,913          | )          |
| Loss from  discontinued operations                       |       | —       |       | —           |       | —          |       | —           |       |
|                                                     |       |         |       |             |       |            |       |             |       |
| Gain on sale of  discontinued operations                 |       | —       |       | (8               | )          | —          | (2)        | (8               | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Cumulative  effect of change in accounting principle     |       | —       |       | —           |       | —          |       | —           |       |
| Net loss                                                 |       | $            | (13,183    | )                | $          | (197,800        | )          | $                | (16,463    | ) | $ | (227,446 | ) |
|                                                     |       |         |       |             |       |            |       |             |       |
| Total assets                                             |       | $            | 807,270    |             | $          | 210,276         |       | $                | —     |   | $ | 1,017,546 |   |

 

*Six Months Ended June 30, 2006*

* *
| ** **                                               | ** ** | ** **   | ** ** | **Film**         | ** ** | ** **      | ** ** | ** **       | ** ** |
|----------------------------------------------------------|------------|--------------|------------|------------------|------------|-----------------|------------|------------------|------------|
| ** **                                               | ** ** | **Domestic** | ** ** | **Distribution** | ** ** | **Adjustments** | ** ** | **Consolidated** | ** ** |
| ** **                                               | ** ** | ** **   | ** ** | ** **       | ** ** | ** **      | ** ** | ** **       | ** ** |
| Total revenues                                           |       | $            | 94,707     |             | $          | 9,560           |       | $                | (8,772     | )(1) | $ | 95,495 |   |
|                                                     |       |         |       |             |       |            |       |             |       |
| Programming  costs                                       |       | (81,122      | )          | (1,844           | )          | 15,406          | (1)        | (67,560          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Amortization of  film assets                             |       | —       |       | (7,810           | )          | (9,333          | )(1)       | (17,143          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Impairment of  film assets                               |       | —       |       | (167,908         | )          | (16,978         | )(1)       | (184,886         | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Subscriber  acquisition fee amortization expense         |       | (17,206      | )          | —           |       | 1,693           | (1)        | (15,513          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Operating costs                                          |       | (5,875       | )          | (1,756           | )          | —          |       | (7,631           | )          |
| Selling,  marketing, general and administrative expenses |       | (20,085      | )          | (8,772           | )          | —          |       | (28,857          | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Loss from continuing operations                          |       | (29,581      | )          | (178,530         | )          | (17,984         | )          | (226,095         | )          |
|                                                     |       |         |       |             |       |            |       |             |       |
| Interest expense                                         |       | (6,419       | )          | (40,197          | )          | —          |       | (46,616          | )          |
| Loss from  discontinued operations                       |       | —       |       | —           |       | —          |       | —           |       |
|                                                     |       |         |       |             |       |            |       |             |       |
| Gain on sale of  discontinued operations                 |       | —       |       | 154              |       | —          | (2)        | 154              |       |
|                                                     |       |         |       |             |       |            |       |             |       |
| Cumulative  effect of change in accounting principle     |       | —       |       | (2,099           | )          | —          |       | (2,099           | )          |
| Net loss                                                 |       | $            | (36,000    | )                | $          | (220,672        | )          | $                | (17,984    | ) | $ | (274,656 | ) |
|                                                     |       |         |       |             |       |            |       |             |       |
| Total assets                                             |       | $            | 807,270    |             | $          | 210,276         |       | $                | —     |   | $ | 1,017,546 |   |

----

(1)             Representselimination of intersegment transactions

(2)             Representsgains and losses from discontinued operations

* *

 

30

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Five of our distributors each accounted for more than10% of our consolidated subscriber revenue for both the three months ended June30, 2005 and 2006, and together accounted for a total of 89% and 90% ofconsolidated subscriber revenue at that date, respectively.  Three of our distributors each accounted formore than 15% of our consolidated subscribers for both the three months endedJune 30, 2005 and 2006, and together accounted for 57% and 61% of oursubscribers on that date, respectively.

Five of our distributors each accounted for more than10% of our consolidated subscriber revenue for both the six months ended June30, 2005 and 2006, and together accounted for a total of 86% and 90% ofconsolidated subscriber revenue at that date, respectively.  Three of our distributors each accounted formore than 15% of our consolidated subscribers for both the six months endedJune 30, 2005 and 2006, and together accounted for 57% and 61% of oursubscribers on that date, respectively.

**15.  Assets Held for Sale andDiscontinued Operations**

OnFebruary 23, 2005, the Company signed an agreement for the sale of theassets associated with its international operations and obtained other agreementsenabling the Company to then conduct the sale on an “as is” basis.  The sale closed on April 26, 2005. Theaccompanying condensed consolidated statements of operations and cash flows forthe three and six months ended June 30, 2005, present the associated results ofoperations and cash flows of the international assets as “discontinuedoperations.”

The net loss from discontinued operations during thethree and six months ended June 30, 2005, consisted of the following:

 

|                                    | ** ** | **Three Months Ended  June 30, 2005** | ** ** | **Six Months Ended  June 30, 2005** | ** ** |
|------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                         | ** ** | **(In thousands)**                                   | ** ** |
|                               |       |                                                      |       |                                                    |       |
| Revenue                            |       | $                                                         | 8,361      |                                                    | $          | 34,575 |   |
| Costs and  expenses                |       | (12,168                                                   | )          | (42,358                                                 | )          |
| Interest expense                   |       | (309                                                      | )          | (2,081                                                  | )          |
| Income tax  provision              |       | (315                                                      | )          | (808                                                    | )          |
| Loss from discontinued  operations |       | $                                                         | (4,431     | )                                                       | $          | (10,672 | ) |

 

EffectiveFebruary 23, 2005, the Company ceased depreciating and amortizing certainof the international assets held for sale. Had the Company not ceased such depreciation and amortization, the lossfor discontinued operations for the three months ended June 30, 2005 would haveincluded an additional $835,000 of depreciation and amortization expense and anadditional $2.0 million of amortization of film assets. Had the Company notceased such depreciation and amortization, the loss for discontinued operationsfor the six months ended June 30, 2005 would have included an additional $1.8million of depreciation and amortization expense and an additional $3.8 millionof amortization of film assets.

Interestexpense includes an allocation of interest related to the Company’s bank creditfacility that was required to be paid as a result of the sale.  The allocation was required by EmergingIssues Task Force (“EITF”) Issue No. 87-24, *Allocation of Interest toDiscontinued Operations*.  Suchinterest expense amounted to $193,000 for the three months ended June 30,2005.  Such interest expense amounted to$1.6 million for the six months ended June 30, 

31

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2005. Upon receiptof cash from the sale, the Company was required to repay and retire $100.0million of the Company’s bank credit facility.

**16. Commitments and Contingencies**

In the normal course of business, the Company hasentered into agreements that commit it to make cash payments in future periodswith respect to non-cancelable leases and programming contracts.

On May 22, 2006, theCompany entered into an agreement with a major cable programming distributor tolicense to this distributor exclusive domestic television distribution rightsto certain television mini-series from the Company’s film library. The term ofdistributor’s rights to each mini-series is 54 months and during that periodthe distributor may sublicense its rights to third parties.  The distributor made an advance payment of$6.0 million to the Company for these rights. The Company also has rights to share in certain net proceeds ofsublicensing by the distributor. The Company has the right to cancel thisagreement at any time prior to January 1, 2007 and the distributor cannot enterinto any sublicenses before that date without the approval of the Company.  If the Company cancels the agreement, it mustrefund the $6.0 million advance payment to the distributor.  The distributor also has the right toterminate the agreement during the period June 1, 2008 through July 30,2008.  If the distributor terminates theagreement, the Company is obligated to refund to the distributor the differencebetween the $6.0 million advance payment and the revenues the distributor hasreceived from sublicensing the mini-series. The Company has included the $6.0million in accounts payable and accrued liabilities on the accompanyingcondensed consolidated balance sheet.

**17. Subsequent Events**

***Restricted Stock Units***

InAugust 2006, the Company’s Board of Directors approved an additional grant of1,278,000 Employment and Performance RSUs to the executive officers and otheremployees. The Employment RSUs constitute 35% of the grant and the PerformanceRSUs 65%.  The Employment RSUs will vestand be settled in stock or cash on August 17, 2009, the third anniversary ofthe grant date, provided the individual holding the RSUs is employed by theCompany on that date. Performance RSUs become eligible to vest (“AchievedPerformance RSUs”), in the range of 150% (which results in an award ofadditional Performance RSUs) to 0% of the Performance RSUs, depending upon thesuccessful renewal of specific distributor agreements within certain timeperiods.  Sixty-five percent of theAchieved Performance RSUs are also then fully vested.  In a second vesting, 65% to 135% (the “Modifier”)of the Achieved Performance RSUs (less the Achieved Performance RSUs previouslyvested) will vest on December 31, 2008, based upon a formula using subscriberrevenue achieved for a specified time period.

 The Compensation Committee of the Board of theCompany has the discretion to increase or decrease the Modifier by 20% and alsomay extend the deadlines for satisfaction of the vesting conditions in theevent that a renewal of the distribution agreements is delayed for factors beyondthe control of Crown.  In order to beeligible for vesting and settlement of the Achieved Performance RSUs, theindividual holding them must either be employed at the time of the firstvesting or have been terminated without cause within 90 days of a vestingdate.  The vesting of Employment RSUsaccelerates upon death or disability of an executive officer. Employment RSUsand Performance RSUs have accelerated vesting if the executive is involuntarilyterminated without cause within 90 days before or after a change in control.

***Potential Sale of Film Assets***

The Company retained an investment banking firm tosolicit expressions of interest from third parties for the potential purchaseof the Company’s film library.  TheCompany is in the process of obtaining bids from potential purchasers that mayresult in the sale of the Company’s film library.  The Company cannot predict at this timewhether a sale of the film library will occur.

32

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** **

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

The following discussion andanalysis of the Company’s financial condition and results of operations shouldbe read in conjunction with the “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” of the Company’s Annual Reporton Form 10-K for the year ended December 31, 2005.

**Description of Business and Overview**

*Current Business*

Crown Media Holdings, Inc. (“CrownMedia Holdings,” “Crown Media” or the “Company”), through its subsidiaries,owns and operates pay television channels (collectively the “Hallmark Channel,”the “Hallmark Movie Channel,” the “channel” or collectively the “channels”)dedicated to high quality, entertainment programming for adults and families,in the United States. In addition, the Company owns a film library withapproximately 600 titles.  The libraryproduct is used on the Hallmark Channel, the Hallmark Movie Channel and sold tothird parties.

With 73.3 million subscribers in the United States atJune 30, 2006, an increase of 1.4 million subscribers from March 31, 2006,Crown Media Holdings is the 39th most widely distributed advertising-supportedcable channel in the United States. For the second quarter of 2006, we finished the quarter as the 9th highest rated advertising-supported cablechannel for total day ratings and the10th highest rated advertising-supported cablechannel in prime time as measured by Nielsen Research.

We launched our second24-hour linear channel, the Hallmark Movie Channel, during the first quarter of2005.  The Hallmark Movie Channel focuseson movies and mini-series and utilizes content from our film library forprogramming.  At June 30, 2006, we hadapproximately 450,000 subscribers (up from 340,000 subscribers at March 31,2006) to the Hallmark Movie Channel. We are developing the Hallmark MovieChannel as an additional revenue source. While it can play a critical role in terms of contract renewals with thevarious distributors and can justify itself on that basis, it can also stand onits own in terms of its business model. It will generate advertising revenue in 2006 and as distributioncontinues to expand, the financial contribution of the Hallmark Movie Channelwill continue to grow. The Hallmark Movie Channel is operated through CrownMedia Holdings existing infrastructure at a small incremental cost.

As mentioned above, the Company owns a film library comprised of approximately 600titles.  Through our subsidiary, CrownMedia Distribution, we license rights in the United States to titles in the libraryto a variety of customers. In addition, the Company utilizes the film libraryfor programming content on the Hallmark Channel and Hallmark Movie Channel. Wehave retained Salem Partners, LLC to explore the possibility of selling thefilm library.  Salem Partners, LLC hasprepared an information memorandum concerning the film library and hasdistributed it to various interested parties. The Company is analyzing its options concerning the sale of the filmlibrary.  There is no certainty about theprice the film library will be sold for or if a transaction can be completed.

For information regarding a possible sale of theCompany’s film library, see Note 3 of Notes to the Unaudited CondensedConsolidated Financial Statements inthis Report regarding valuation of the film library, and Note 17, SubsequentEvents.

As the Hallmark Channeland the Hallmark Movie Channel continue to develop, the core focus for thebusiness remains unchanged.  First,distribution must continue to expand. While the ratings performance of theHallmark Channel ranks in or near the top ten of cable networks according toNielsen, in terms of distribution, the Hallmark Channel is only in the top 40cable networks. Increased distribution can have a positive impact on oursubscriber revenue (depending on any subscriber acquisition fees incurred) andshould increase our advertising revenue as advertisers pay higher rates tocable networks that are more broadly distributed. However, combining growingdistribution with increasing ratings is more powerful in terms of advertisingrevenue. As a result, the Hallmark Channel will continue to focus on enhancingits programming schedule through the acquisition of new series, additionaloriginal movies such as the recent Mystery Movies, and through uniquescheduling concepts.

33

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In addition, if we do not sell the film library, wewill continue to make library sales. Our film library is a large collection ofaward winning movies and mini-series, which is unique in that it is such alarge collection of family oriented films.

Effective June 16, 2006, the President and ChiefExecutive Officer left the Company.  Asearch committee, which includes independentdirectors, is reviewing candidates for that position.

*Current Challenges*

The Hallmark Channelfaces challenges on the distribution front. The distribution agreements are important because they affect our numberof subscribers, which in turn has a major impact on our subscriber fees, thenumber of persons viewing our programming, and thus rates charged foradvertising. We have an ongoing focus on growing our subscriber base. Thecurrent and long-term distribution challenges will be renewing our distributionarrangements with the multiple system operators as they expire. Majordistribution agreements expire from December 2006 through December 2010; ofthese distribution agreements, agreements accounting for approximately 80% ofour subscriber base at December 31, 2005 will terminate and be the subject ofrenewal negotiations prior to or on December 31, 2007. While the economics ofthe renewals and potential cash incentive payments are unknown and could have asignificant impact on our business, we believe that the success of the HallmarkChannel in terms of ratings and the environment we have created with ourprogramming schedule will enhance our renewal discussions. We also believe thatour ability to offer to multiple systems operators a second channel, theHallmark Movie Channel, as well as programming for their other distributionplatforms, such as video-on-demand, are value added components of the renewalequation.  Any renewals of thesedistribution agreements may also be significant as to whether we are able tomaintain or increase our subscriber fees. In October 2005, we entered into a renewal of our distributionagreements with one of the major distributors in the United States for a periodof 3.3 years.

Domestic telephone companies are entering into thebusiness of distributing television channels to households through theirwire-lines. We have reached agreement with several telephone companies, whichpermit the carriage of the Hallmark Channel and Movie Channel, and are negotiating with others.  We expect that subscribers to these telephoneservices will in large part be customers previously served by existing cabletelevision companies and satellite television companies.  To date, subscribers and revenues throughtelephone companies have been insignificant.

Three factors have contributed to the ratingsimprovements of the Hallmark Channel: acquired series and movies, originalproductions and marketing.  Acquired series such as *Perry Mason*,*Walker, Texas Ranger* and *M*A*S*H* have consistently delivered strong ratings acrossall day-parts.  Original productions areour most high profile programs and generate the channel’s highest ratings.  Original productions are significant inhelping our distribution and advertising sales teams sell the channel.Substantially all of our original programming is provided by RHI Entertainment.

To continue the ratings growth and enhance thedemographics of our viewers, the Hallmark Channel must continue to invest inprogramming and marketing.  For theHallmark Channel to continue to increase its attractiveness to distributors andadvertisers, it has to increase itsratings and draw a younger, more upscale audience, which is generally moreattractive to advertisers.

Delivering strong ratings growth to larger audienceshas made it possible for our advertising sales to grow rapidly over the lastfew years.  To advertisers, the HallmarkChannel offers a strong brand, positive environment and family friendlyprogramming with a successful growth pattern. These characteristics have enabled the channel to sell to advertisers inthe packaged goods and pharmaceuticalindustries.

We anticipate selling approximately 45% to 50% of ourinventory for advertising on our Channels in the upfront market (generallysales in June and July for the last quarter of 2006 and the first threequarters of 2007), compared to 50% to 55% sold in the 2005 upfront market.  The balance of advertising inventory will bemade available in the scatter market, with a goal of achieving higheradvertising rates in that market.

 

34

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**InternationalBusiness**

Please see Note 1 in Item 1 — Sale of theInternational Business of Notes to Unaudited Condensed Consolidated FinancialStatements in this Report.

**Revenue from Continuing Operations**

*Our revenue consists primarily of subscriber fees, advertising and filmasset license fees.*

*Subscriber Fees*

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

Rates we receive per subscribervary according to:

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

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

·     thepackaging arrangements for the channel; and

·     othercommercial terms and length of the contract term.

We are in continuous negotiationswith our existing distributors to increase our subscriber base in order toenhance our advertising results. We have been subject to requests by majordistributors to pay subscriber acquisition fees for additional subscribers orto waive or accept lower subscriber fees if certain numbers of additionalsubscribers are provided. We also may help fund the distributors’ efforts tomarket our channels or we may permit distributors to offer limited promotionalperiods without payment of subscriber fees. As we continue our efforts to addsubscribers, our domestic subscriber revenue may continue to be negativelyaffected by subscriber acquisition fee amortization, waiver of subscriber feesand bulk discounts resulting from the attainment of certain subscriber levels;however, we believe these measures, if necessary, will help us increase oursubscriber base more quickly, which in turn will allow us to attract additionaladvertisers and command higher advertising rates.

Our channel is usually offered asone of a number of channels on either a basic tier or part of other programpackages and is not generally offered on a stand-alone basis. Thus, whilea cable or satellite customer may subscribe and unsubscribe to the tiers andprogram packages in which our channel is placed, these customers do notsubscribe and unsubscribe to our channel alone. We are not provided with information from the distributors on theiroverall subscriber churn and in what manner their churn rates affect oursubscriber counts; instead, we are provided information on the total number ofsubscribers who receive the Hallmark Channel.

Our subscriber count depends onthe number of distributors carrying the Hallmark Channel and the size of suchdistributors as well as the program tiers on which our channel is carried bythese distributors. From time to time, we experience decreases in the number ofsubscribers as promotional periods end, or as a distributor arrangement isamended or terminated by us or the distributor. Changes to distributionarrangements during the six months ended June 30, 2006, have not beensignificant. Management analyzes the estimated effect each new or amendeddistribution agreement will have on revenues and costs. Based upon theseanalyses, management endeavors to achieve a fair combination of subscribercommitments and subscriber acquisition fees with each of our domesticdistributors.

35

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#### *Advertising*

Our advertising rates aregenerally calculated on the basis of an agreed upon price per unit of audiencemeasurement in return for a guaranteed commitment by the advertiser. We committo provide advertisers certain rating levels in connection with theiradvertising. Revenue is recorded net of estimated delivery shortfalls, whichare usually settled by providing the advertiser additional advertising time.Advertising rates also vary by time of year due to seasonal changes intelevision viewership.

*Film AssetLicense Fees*

Crown Media Distribution generates revenue from the film assets bygranting licenses to third parties to exhibit the films in the United States.We are also using the films as programming for the Hallmark Channel and theHallmark Movie Channel. Customers for our film assets consist of othertelevision channels, home video distributors and brokers who resell rights toour film assets. License fees for our film assets are generally negotiatedbased, among other things, upon the size of the potential audience who will beviewing the programming. The marketfor our film library is typically seasonal, with over half of the annual salesoccurring in the fourth quarter in past years. This seasonality is generally due to the timing of our customers’program scheduling activities.

**Cost of Services**

Our cost of services consists primarily ofprogram license fees, amortization of our film assets; subscriber acquisitionfee expense; the cost of signal distribution; administration, distribution andother exploitation of our film assets; and the cost of promotional segmentsthat are aired between programs. We expect cost of services to continue toincrease in the future as we expand our existing markets and third party programmingto support our advertising strategy.

**Critical Accounting Policies, Judgmentsand Estimates**

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

For further information regarding our critical accounting policies,judgments and estimates, please see the Notes to Unaudited ConsolidatedFinancial Statements contained in this Report and “Critical AccountingPolicies, Judgments and Estimates” of the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005, filed with the SEC. Thesepolicies, judgments and estimates concern, among other things, the film assets,allowance for doubtful accounts, program license fees, subscriber acquisitionfees, long-lived assets, revenue recognition and stock-based compensation.

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

In 2006 and in prior years, we entered into a number of significant transactionswith Hallmark Cards and its subsidiaries. These transactions include, amongother things, programming, trademark licenses, administrative services, a lineof credit, a tax sharing agreement, the issuance of four promissory notes and awaiver agreement. For information regardingsuch transactions and transactions with other related parties, please see “Effectsof Transactions with Related and Certain Other Parties” of the Company’s AnnualReport on Form 10-K for the year ended December 31, 2005, filed with the SEC andNotes 8 and 9 of Notes to Unaudited Condensed Consolidated Financial Statementsin Item 1 of this Report.

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

In the table below, we provide selected historical consolidatedfinancial and other data of Crown Media Holdings and its subsidiaries. Thefollowing selected consolidated statement of operations data for three and sixmonths ended June 30, 2005 and 2006, are derived from the unaudited financialstatements of Crown Media Holdings and its subsidiaries. This data should beread together with the consolidated financial statements and related notesincluded elsewhere in this Form 10-Q.
| ** **                                                 | ** ** | ** **                                          | ** ** | ** **          | ** ** | **Percent   Change**                         | ** ** | ** **          | ** ** | ** ** | ** ** | **Percent   Change** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------|------------|---------------------------------------------------|------------|---------------------|------------|------------|------------|---------------------------|------------|
| ** **                                                 | ** ** | **Three Months Ended June 30,** | ** ** | **2006   vs.** | ** ** | **Six Months Ended June 30,** | ** ** | **2006   vs.** | ** ** |
| ** **                                                 | ** ** | **2005**                                            | ** ** | **2006**            | ** ** | **2005**                                          | ** ** | **2005**            | ** ** | **2006**   | ** ** | **2005**                  | ** ** |
| Revenues:                                                  |       |                                                |       |                |       |                                              |       |                |       |       |       |                      |       |
|  Subscriber  fees                                     |       | $                                                   | 4,193      |                | $          | 6,379                                             |       | 52                  | %          | $          | 8,803      |                      | $          | 12,611 |   | 43 | % |
|  Advertising                                          |       | 38,117                                              |       | 43,549              |       | 14                                                | %          | 71,993              |       | 81,942     |       | 14                        | %          |
|  Film asset  license fees                             |       | 3,169                                               |       | 518                 |       | -84                                               | %          | 5,252               |       | 788        |       | -85                       | %          |
|  Sublicense  fees and other revenue                   |       | 213                                                 |       | 76                  |       | -64                                               | %          | 213                 |       | 154        |       | -28                       | %          |
| Total revenues                                             |       | 45,692                                              |       | 50,522              |       | 11                                                | %          | 86,261              |       | 95,495     |       | 11                        | %          |
| Cost of Services:                                          |       |                                                |       |                |       |                                              |       |                |       |       |       |                      |       |
|  Programming  costs                                   |       | 28,413                                              |       | 33,967              |       | 20                                                | %          | 56,435              |       | 67,560     |       | 20                        | %          |
|  Amortization  of film assets                         |       | 13,664                                              |       | 8,279               |       | -39                                               | %          | 19,345              |       | 17,143     |       | -11                       | %          |
|  Impairment of  film assets                           |       | —                                              |       | 184,886             |       | 100                                               | %          | —              |       | 184,886    |       | 100                       | %          |
|  Subscriber  acquisition fee amortization             |       | 8,695                                               |       | 7,723               |       | -11                                               | %          | 18,203              |       | 15,513     |       | -15                       | %          |
|  Operating  costs                                     |       | 4,730                                               |       | 3,501               |       | -26                                               | %          | 6,526               |       | 7,631      |       | 17                        | %          |
| Total cost of  services                                    |       | 55,502                                              |       | 238,356             |       | 329                                               | %          | 100,509             |       | 292,733    |       | 191                       | %          |
| Selling, general  and administrative expense               |       | 15,801                                              |       | 13,580              |       | -14                                               | %          | 29,303              |       | 23,489     |       | -20                       | %          |
| Marketing expense                                          |       | 7,420                                               |       | 1,111               |       | -85                                               | %          | 17,250              |       | 5,368      |       | -69                       | %          |
| Loss from  continuing operations before   interest expense |       | (33,031                                             | )          | (202,525            | )          | 513                                               | %          | (60,801             | )          | (226,095   | )          | 272                       | %          |
| Interest expense                                           |       | (17,444                                             | )          | (24,913             | )          | 43                                                | %          | (34,340             | )          | (46,616    | )          | 36                        | %          |
| Loss from  continuing operations                           |       | (50,475                                             | )          | (227,438            | )          | 351                                               | %          | (95,141             | )          | (272,711   | )          | 187                       | %          |
| Loss from  discontinued operations                         |       | (4,431                                              | )          | —              |       | -100                                              | %          | (10,672             | )          | —     |       | -100                      | %          |
| Loss on sale from  discontinued operations                 |       | (1,349                                              | )          | (8                  | )          | -99                                               | %          | (1,349              | )          | 154        |       | -111                      | %          |
| Cumulative effect  of change in   accounting principle     |       | —                                              |       | —              |       | 0                                                 | %          | —              |       | (2,099     | )          | 100                       | %          |
| Net loss                                                   |       | $                                                   | (56,255    | )                   | $          | (227,446                                          | )          | 304                 | %          | $          | (107,162   | )                         | $          | (274,656 | ) | 156 | % |

 
| **Other Data:**                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Net cash used in  operating activities                 |       | $          | (84,946    | )          | $          | 1,970      |       | -102       | %          | $          | (97,805    | )          | $          | (18,390 | ) | -81 | % |
| Capital  expenditures                                  |       | $          | (310       | )          | $          | (24        | )          | -92        | %          | $          | (558       | )          | $          | (27 | ) | -95 | % |
| Proceeds from  disposition of   international business |       | $          | 221,979    |       | $          | —     |       | -100       | %          | $          | 221,979    |       | $          | — |   | -100 | % |
| Net cash provided  by (used in)   financing activities |       | $          | (130,495   | )          | $          | 4,849      |       | -104       | %          | $          | (109,252   | )          | $          | 19,815 |   | -118 | % |
| Net cash used in  discontinued operations              |       | $          | (9,561     | )          | $          | —     |       | -100       | %          | $          | (15,053    | )          | $          | — |   | -100 | % |
| Total domestic  day household ratings (1)(3)           |       | 0.661      |       | 0.717      |       | 8          | %          | 0.683      |       | 0.730      |       | 7          | %          |
| Total domestic  primetime household ratings   (2)(3)   |       | 0.907      |       | 1.140      |       | 26         | %          | 0.935      |       | 1.127      |       | 21         | %          |
| Subscribers at period end                              |       | 68,471     |       | 73,274     |       | 7          | %          | 68,471     |       | 73,274     |       | 7          | %          |

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(1)             Total day is the time period measured fromthe time each day the broadcast of commercially sponsored programming commencesto 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 timeperiod January 1 through June 30.

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

#### *Three Months Ended June30, 2005 Compared to Three Months Ended June 30, 2006*

*Revenue.*

Our revenue from continuingoperations, which is comprised of subscriber fees, advertising and film assetlicense fees, increased 11% to $50.5 million for the three months ended June30, 2006. Our 52% increase to $6.4million in subscriber fee revenue for the three months ended June 30, 2006, wasa result of the expiration of free carriage periods during both the first andsecond quarters of 2006 for certain of our domestic distributors. Many of thedistribution deals we have require us to provide a period of free carriage tothe cable operator. Subscriber acquisition fee expense recorded as a reductionof revenue was $2.2 million for the three months ended June 30, 2006, and $3.4million for the comparable period in 2005. Subscribers have increased as aresult of previously amended distribution agreements in the United States,which provided for incentives for growth in distribution.

The increase in advertising revenue to $43.5 million forthe three months ended June 30, 2006, compared to $38.1 million for the threemonths ended June 30, 2005, reflects the growth in domestic subscribers, anincrease in household primetime ratings, and an increase in advertising rates.Generally, as we have expanded our domestic subscribers and provided higherrated programming, our advertising revenues have increased. We anticipategrowth across each of these factors to continue. The number of advertisers was427 at both March 31 and June 30, 2006, compared to 432 at June 30, 2005.

Revenue from thesale of our film assets totaled $518,000 for the three months ended June 30, 2006, comparedwith $3.2 million for the comparable period in 2005.  We had a smallamount of library sales in the second quarter of 2006 due to the Company’sconsideration of a possible sale of the film assets. Generally, our librarysales are condensed in the second half of the year as this coincides with ourcustomers scheduling of the upcoming programming schedules.

*Cost of services. *Cost of services as apercent of revenue increased to 472% in 2006, as compared to 121% in 2005. Thisincrease was primarily due to the impairment of our film assets explainedbelow.

The Companyrecorded a $184.9 million impairment of its film assets during the three monthsended June 30, 2006, based in part upon preliminary bids received from potentialbuyers of our film assets. See Notes 3 and 17 of Notes to Unaudited CondensedConsolidated Financial Statements above. Total programming costs for the threemonths ended June 30, 2006, increased 20% dueto our focus on retaining and acquiring higher quality series programming andthe related amortization. The $5.4 million decrease in amortization offilm assets was primarily due to the reduction in third party licenses oflibrary assets for the three months ended June 30, 2006.

Asnoted above, the Company amended distribution agreements with multiple systemoperators in prior periods. In the past, some of our distribution agreementshave required the Company to pay subscriber acquisition fees, which the Companyamortizes over the remaining life of the distribution agreement, todistributors for additional subscribers. As we fully amortized certainof our agreements with our domestic distributors, our subscriber acquisition fee amortization expense for the periodended June 30, 2006, as compared to the prior year period, decreased 11%.

The Company’s bad debt expense was $2.1 million for thethree months ended June 30, 2005, as compared to $355,000 for the three monthsended June 30, 2006.

*Selling, general andadministrative expense.* Our selling, general and administrativeexpense decreased 14% 

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primarily due to acompensation credit associated with the decline in our stock price and therelated obligation to purchase restricted stock units partially offset byincreases in consulting expenses and audit fees associated with our compliancewith Sarbanes-Oxley requirements. With the implementation of our cost reductionplans in April 2006, we intend that selling, general and administrativeexpenses will continue to decrease during 2006 when compared to 2005. Weanticipate that the effect on these expenses of the August 2006 grant of RSUswill vary depending on the price of our Class A Common Stock.

*Marketing expense. *Our marketing expense decreased 85% primarily due tothe elimination of the Mystery Movie marketing campaign for the HallmarkChannel. With the implementation of our cost reduction plan, we expect thatmarketing expense during 2006 will continue to decrease when compared to 2005.

*Interest expense. *Interestexpense increased for the three months ended June 30, 2006, compared to June30, 2005, by $7.5 million.  This increasewas due to the $2.7 million interest on our $132.8 million note payable toHallmark Cards affiliates commencing October 1, 2005, the $1.4 million intereston our $70.4 million note payable to Hallmark Cards affiliates commencing March21, 2006, the $1.6 million increase in interest on our bank credit facility andthe $1.6 million of interest reclassified as discontinued operations associatedwith the sale of our international business.

*Lossfrom Continuing Operations. *Lossfrom operations for the three months ended June 30, 2006, was $227.4 million.Loss from continuing operations for the three months ended June 30, 2005, was$50.5 million. Our loss from continuing operations increased primarily due tothe impairment in the value of our film assets described above as well ashigher programming and interest expenses.

*Lossfrom Discontinued Operations. *Lossfrom discontinued operations for the three months ended June 30, 2005, was $4.4million. The Company sold the international business on April 26, 2005.

#### *Six Months Ended June 30,2005 Compared to Six Months Ended June 30, 2006*

*Revenue.*

Our revenue from continuingoperations, which is comprised of subscriber fees, advertising and film assetlicense fees, increased 11% to $95.5 million for the six months ended June 30,2006. Our 43% increase to $12.6million in subscriber fee revenue for the six months ended June 30, 2006, was aresult of the expiration of free carriage periods for certain of our domesticdistributors. Subscriber acquisition fee expense recorded as a reduction ofrevenue was $4.3 million for the six months ended June 30, 2006, and $6.6million for the comparable period in 2005.

The increase in advertising revenue to $81.9 million forthe six months ended June 30, 2006, compared to $72.0 million for the sixmonths ended June 30, 2005, reflects the growth in domestic subscribers, anincrease in household primetime ratings, and an increase in advertising rates.

Amongthe 65 ad-supported cable channels in the United States market, the HallmarkChannel ranked11th in totalday with a 0.730 household rating for the six months ending June 30, 2006 and10th forprimetime with a 1.127 household rating for the same period based on Nielsenratings. This ratings performance is significant, particularly because theHallmark Channel is not a fully distributed network. Most of the channels thatrate above the Hallmark Channel have higher levels of distribution.

Revenue from thesale of our film assets totaled $788,000 for the six months ended June 30, 2006, comparedwith $5.3 million for the comparable period in 2005.  We had a smallamount of library sales in the second quarter of 2006 and minimal library salesin the first quarter of 2006 due to the Company’s consideration of a possiblesale of the film assets. Generally, our library sales are condensed in thesecond half of the year as this coincides with our customers scheduling of theupcoming programming schedules.

*Cost of services. *Cost of services as apercent of revenue increased to 307% in 2006, as compared to 117% in 2005. Thisincrease was primarily due to the impairment of our film assets explainedbelow.

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The Companyrecorded a $184.9 million impairment of its film assets during the six monthsended June 30, 2006, based in part upon bids received from potential buyers ofour film assets. Total programming costs for the six months ended June 30,2006, increased 20% due to our focus onretaining and acquiring higher quality series programming and the relatedamortization. The $2.2 million decrease in amortization of film assetswas primarily due to the reduction in third party licenses of library assetsfor the six months ended June 30, 2006.

As we fully amortizedcertain of our agreements with our domestic distributors, our subscriber acquisition fee amortizationexpense for the period ended June 30, 2006, as compared to the prior yearperiod, decreased 15%.

The Company’s bad debt expense was $1.1 million for thesix months ended June 30, 2005, as compared to $1.3 million for the six monthsended June 30, 2006.

*Selling, general andadministrative expense.* Our selling, general and administrativeexpense decreased 20% primarily due to a compensation credit associated withthe decline in our stock price and the related obligation to purchaserestricted stock units partially offset by increases in consulting expenses andaudit fees associated with our execution of requirements under Sarbanes-Oxley.

*Marketing expense. *Our marketing expense decreased 69% primarily due tothe elimination of the Mystery Movie marketing campaign for the HallmarkChannel.

*Interest expense. *Interestexpense increased for the six months ended June 30, 2006, compared to June 30,2005, by $12.3 million.  This increasewas due to the $5.2 million interest on our $132.8 million note payable toHallmark Cards affiliates commencing October 1, 2005, the $1.6 million intereston our $70.4 million note payable to Hallmark Cards affiliates commencing March21, 2006, the $1.8 million increase in interest on our bank credit facility,the $990,000 increase in interest on our $86.3 million line of credit toHallmark Cards affiliates, the $899,000 increase in interest payable to HCCrown on the bank credit facility and the $1.6 million of interest reclassifiedas discontinued operations associated with the sale of our internationalbusiness.

*Lossfrom Continuing Operations. *Lossfrom operations for the six months ended June 30, 2006, was $272.7 million.Loss from continuing operations for the six months ended June 30, 2005, was$95.1 million. Our loss from continuing operations increased primarily due tothe impairment in the value of our film assets described above as well asincreased programming and interest expenses.

*Lossfrom Discontinued Operations. *Lossfrom discontinued operations for the six months ended June 30, 2005, was $10.7million. The Company sold the international business on April 26, 2005.

*Cumulative effect of change in accounting principle.  *On January 1, 2006, weadopted SFAS 123R. The total compensationcost related to performance RSUs granted under the Plan net of estimatedforfeitures was $2.1 million, which was recorded as a cumulative catch-upadjustment during the six months ended June 30, 2006. Under prior accountingtreatment, the performance RSUs were not classified as a liability as it wasdeemed improbable that these RSUs would settle based upon the performance ofour Class A common stock.

## **Liquidityand Capital Resources**

Cash used in operating activities from continuingoperations was $97.8 million and $18.4 million for the six months ended June30, 2005 and 2006.**Lossfrom operations for the six months ended June 30, 2005 and 2006, was $95.1million and $272.7 million, respectively. Duringthe six months ending June 30, 2006, the Company made payments of $10.3 millionfor subscriber acquisition fees and $20.1 million for license fees payable toRHI Entertainment as compared to payments of $29.8 million and $40.0 millionfor the same items during of the same period of 2005. The payments toRHI Entertainment were higher in the first six months of 2005, since theCompany paid RHI amounts due from previous periods, which had been deferredwith the consent of RHI Entertainment. These payments of past due amounts continued throughout 2005.  The Company is now paying RHI Entertainmenton a current basis. The Company improvedits collections on its outstanding accounts receivable during the six monthsended June 30, 2006.

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Cash provided by investing activities was $215.6 millionfor the six months ended June 30, 2005. Cash used in investing activities was $6.5 million for the six monthsended June 30, 2006.  This increase is dueto payments to the buyer of the international business during 2006. TheCompany sold the international business on April 26, 2005, and will continue tomake payments to the buyer of the international business in accordance with thesale agreement.

Cash used in financing activities was $109.3 million forthe six months ended June 30, 2005. Cash provided by financing activities was$19.8 million for the six months ended June 30, 2006. During the six monthsending June 30, 2005 and 2006, we received proceeds of $21.4 million and $5.0million, respectively, from our tax sharing agreement with Hallmark Cards. Weborrowed $64.0 million under our credit facility to repay certain programmingobligations to Hallmark Cards affiliates, pay severance and RSU settlements forcertain employees of the international business and to meet our operatingdemands during the six months ended June 30, 2005. We borrowed $15.0 millionunder our credit facility to cover the cash we used in operating and investingactivities during the six months ended June 30, 2006. During the six monthsended June 30, 2005, we repaid $195.0 million under our bank credit facilityfollowing the sale of our international business.

Cashused in discontinued operations was $15.1 million and $0 for the six monthsended June 30, 2005 and 2006, respectively. Cash was used primarily to fund operating expenditures related to lossesfrom discontinued operations of $10.7 million for the six months ended June 30,2005. The significant decrease in cash used by discontinued operations is becausethe Company sold the international business on April 26, 2005.

The following table aggregates all of our contractualcommitments as of June 30, 2006.
| ** **                                                                                            | ** ** | **Scheduled Payments by Period** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| **Contractual Obligations**                                                                      | ** ** | **Total**                                       | ** ** | **Less than 1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **After 5 Years** | ** ** |
| Credit facility  and interest payable                                                                 |       | $                                               | 225.1      |   | $ | — |   | $ | 225.1 |   | $ | — |   | $ | — |   |
| Company obligated  mandatorily redeemable preferred interest, including accretion                     |       | 25.0                                            |       | — |   | 5.0 |   | 20.0 |   | — |   |
| HC Crown line of  credit and interest payable                                                         |       | 89.7                                            |       | — |   | 89.7 |   | — |   | — |   |
| Senior unsecured  note to HC Crown, including accretion                                               |       | 596.6                                           |       | — |   | — |   | — |   | 596.6 |   |
| Note payable to  Hallmark Cards affiliate                                                             |       | 140.4                                           |       | — |   | 140.4 |   | — |   | — |   |
| Note payable to  Hallmark Cards affiliates                                                            |       | 72.0                                            |       | — |   | 72.0 |   | — |   | — |   |
| Capital lease  obligations                                                                            |       | 16.5                                            |       | 0.6 |   | 1.5 |   | 1.8 |   | 12.6 |   |
| Operating leases  (off-balance sheet commitments)                                                     |       | 11.8                                            |       | 3.8 |   | 5.5 |   | 2.2 |   | 0.3 |   |
| Other obligations                                                                                     |       |                                            |       |   |   |   |   |   |   |   |   |
|  Program  license fees payable to non-affiliates                                                 |       | 219.9                                           |       | 27.4 |   | 125.7 |   | 60.3 |   | 6.5 |   |
|  Program  license fees payable to affiliates                                                     |       | 8.7                                             |       | 6.7 |   | 2.0 |   | — |   | — |   |
|  Program  license fees payable for non-affiliate future windows (off-balance sheet  commitments) |       | 223.7                                           |       | 98.4 |   | 83.1 |   | 30.3 |   | 11.9 |   |
|  Program  license fees payable for affiliate future windows (off-balance sheet  commitments)     |       | 25.4                                            |       | 22.9 |   | 2.5 |   | — |   | — |   |
|  Subscriber  acquisition fees                                                                    |       | 2.3                                             |       | 2.3 |   | — |   | — |   | — |   |
|  Deferred  compensation and interest                                                             |       | 3.2                                             |       | 0.5 |   | 2.7 |   | — |   | — |   |
|  Payable to  buyer of international business                                                     |       | 11.7                                            |       | 5.0 |   | 5.8 |   | 0.9 |   | — |   |
|  Other payables  to buyer of international business                                              |       | 6.6                                             |       | 1.1 |   | 1.9 |   | 1.5 |   | 2.1 |   |
| Total Contractual Cash  Obligations                                                                   |       | $                                               | 1,678.6    |   | $ | 168.7 |   | $ | 762.9 |   | $ | 117.0 |   | $ | 630.0 |   |

 

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*Cash Flows*

As of June 30,2006, the Company had $10.8 million in cash and cash equivalents on hand. As ofJune 30, 2006, the Company had borrowed $225.0 million from a $240.0 millionrevolving bank credit, which matures May 31, 2007.

The Company’s principal sources of funds are cash onhand, cash generated by operations, tax sharing payments from Hallmark Cardsand amounts available under the Company’s revolving bank credit facility.Payments under the tax sharing agreement are affected by Hallmark Cards’ taxposition and its ability to utilize the Company’s tax losses.  The Company received $5.0 million in taxsharing payments in January 2006 and does not currently expect to receive anyadditional cash payments during 2006. The Company currently has $15.0 millionof unused revolving credit commitments.

The ability of the existing sources of liquidity to besufficient to fund the Company’s operations depends upon the Company’s abilityto achieve forecasts, however, management has not always been able toaccurately forecast future operations. In particular, continued growth in subscriber revenue and advertisingrevenue, as well as maintaining the cash flow from library sales, arerequired.  As a result, any decline inthe popularity of the Hallmark Channel, any significant future modifications tothe Company’s distribution agreements, an economic decline in the advertisingmarket, an increase in program acquisition costs, an increase in competition orother adverse operating conditions would impact the Company’s liquidity and itsability to fund the current level of operations.  To the extent that the Company requiresadditional capital and additional drawings on the bank credit facility areeither not available or insufficient, the Company would be forced to seekadditional funding from the issuance of debt or equity securities, a sale ofcertain assets or from strategic transactions which provide capital. There canbe no assurance that the Company would be able to secure additional financingor complete any such transactions.

The Company expects tocontinue making investments in programming, marketing and distribution duringthe next twelve months ending June 30, 2007. However, the Company’s liquidityposition has demanded that all areas of expenses, including programming,marketing and distribution be closely monitored and controlled.  In April, 2006, the Company commenced a costreduction program, including reducing marketing activities and the number ofpersonnel by approximately 20 persons. Management anticipates that theseactions will result in approximately $10.0 to $13.0 million in annual costreductions when compared to the 2005 year. The Company has and will continue to seek to sublicense certain of itsprogramming rights but expects that programming expenses and cost of serviceswill increase when compared to these items for 2005.

The Company’s principaluses of funds for 2006 are expected to include the payment of 2006 operatingexpenses, accounts payable and accrued expenses, licensing of programming(including prepayment of certain licensing of programming for 2007), andinterest under its bank credit facility.

The Company will alsocontinue to explore ways in which it can improve its capital structure, such asa potential sale of its film assets as described in Note 17 above.

The Company currentlybelieves that cash on hand, cash generated by operations, and availability onits bank credit facility, will be sufficient to fund the Company’s operationsand meet its liquidity needs through June 30, 2007.

The Company’s bank creditfacility will expire on May 31, 2007.   If the Company is not able toarrange for the extension, refinancing or replacement of the bank creditfacility prior to its maturity and the bank draws down on the irrevocableletter of credit provided by Hallmark Cards in support of the bank creditfacility, or alternatively Hallmark Cards purchases the interests of thelending banks, Hallmark Cards would have all obligations and the rights of thelending banks under the bank credit facility.  In that event, HallmarkCards could demand payment of outstanding amounts at any time after August 15,2007, under the terms of the Waiver Agreement described above.  If theCompany has not retired the bank credit facility prior to its maturity, it isthe Company’s intent to extend the bank credit facility upon its maturity,which might require continuation of a letter of credit from Hallmark Cards orother steps by the Company.

Upon maturity of the credit facilityon May 31, 2007, the lending group led by JP Morgan Chase has the right toelect to forego the receipt of cash to pay the principal amount of the creditfacility in full, which is provided for 

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under the terms of an irrevocable letter of credit providedby Hallmark Cards, butinstead can elect to initiate a process to foreclose on the Company’s assets.Such foreclosure proceedings, which we view as a remote possibility, wouldaffect our ability to continue our operations. Prior to any such possible foreclosureproceedings, however, the Company, if it has not secured an extension of thecredit facility or alternative financing, would cause Hallmark Cards pursuantto the terms of the Waiver Agreement to exercise its option to purchase all ofthe outstanding indebtedness under the credit facility and the credit facilitywould then be subject to terms of the Waiver Agreement not to demand paymentprior to August 15, 2007.

Due to the Company’sliquidity issues and its possible inability to meet its obligations when theycome due in August 2007, the Company anticipates that prior to August 15, 2007,it will be necessary to either extend or refinance (i) the bank credit facilityand (ii) $678.0 million covered by the promissory notes payable to affiliates ofHallmark Cards described in the Notes below. As part of a combination ofactions and in order to obtain additional funding, the Company may considervarious alternatives, including refinancing the bank credit facility, raisingadditional capital through the issuance of equity or debt securities, a sale ofcertain assets or other strategic alternatives.

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

For information regarding our Bank Credit Facility,HC Crown Loans and Tax Sharing Agreement, please see “Bank Credit Facility, HCCrown Loans, and Tax Sharing Agreement” of the Company’s Annual Report on Form10-K for the year ended December 31, 2005, filed with the SEC and Notes7, 8 and 9 of Notes to Unaudited Condensed Consolidated Financial Statements inthis Report.

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

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

Among the factors thatcould cause actual results to differ materially are those discussed in thisReport below and in the Company’s filings with the Securities and ExchangeCommission, including the Risk Factors stated in the Company’s Form 10-K Reportfor the year ended December 31, 2005. Such Risk Factors include, but are notlimited to, the following:  competitionfor distribution of channels, viewers, advertisers and the acquisition ofprogramming; fluctuations in the availability of programming; fluctuations indemand for programming which we air on our channels; our ability to address ourliquidity needs; our incurrence of losses; and our substantial indebtednessaffecting our financial condition and results.

There are stated belowcertain Risk Factors which contain significant changes from those stated in theCompany’s Form 10-K Report for the year ended December 31, 2005. Crown MediaHoldings will not update any forward-looking statements contained in that Form10-K to reflect future events or developments.

If we do not successfullyaddress the risks described below and in our prior Reports mentioned above, ourbusiness, prospects, financial condition, results of operations or cash flowcould be materially adversely affected. The trading price of our Class A commonstock could decline because of any of these risks.

**Risks Relating to Our Business**

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

Because we currentlyoperate at a loss, we may have a negative cash flow and any unanticipatedsignificant expense or any development that hampers our growth in revenue ordecreases any of our revenue would result in the 

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need for additionalexternal funds in order to continue operations. We have no arrangements for anysuch additional external financings, whether debt or equity, and are notcertain whether any such new external financing would be available onacceptable terms. Any new debt financing would require the cooperation andagreement of existing lenders.

Further, as discussed inthis report under “Liquidity and Capital Resources” above, we need to (1)extend, refinance or replace our bank line of credit on or prior to May 31,2007, or to extend or replace borrowings from Hallmark Cards by August 15, 2007, that would result from the banksdrawing upon the irrevocable letter of credit supporting the bank creditfacility, and (2) extend or refinance license fees and payables to HallmarkCards and its subsidiaries on or prior to August 15, 2007.

Upon maturity ofthe credit facility on May 31, 2007, the lending group led by JP Morgan Chasehas the right to elect to forego the receipt of cash to pay the principalamount of the credit facility in full, which is provided for under the terms ofan irrevocable letter of credit provided by Hallmark Cards, but instead canelect to initiate a process to foreclose on the Company’s assets. Suchforeclosure proceedings, which we view as a remote possibility, couldaffect our ability to continue our operations. Prior to any such possibleforeclosure proceedings, the Company would consider various alternatives asindicated below.  The Companycould also cause Hallmark Cards, pursuant to the terms of the Waiver Agreement,to exercise its option to purchase all of the outstanding indebtedness underthe credit agreement. The credit facility would then be subject to HallmarkCards agreement not to demand payment prior to August 15, 2007.

### **Available Information**

**We willmake available free of charge through our website, www.hallmarkchannel.com, theAnnual Report, our quarterly reports on Form 10-Q, our current reports on Form8-K, and amendments to such reports, as soon as reasonably practicable after weelectronically file or furnish such material with the Securities and ExchangeCommission.**

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

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

We only invest ininstruments that meet high credit and quality standards, as specified in ourinvestment policy guidelines. These instruments, like all fixed incomeinstruments, are subject to interest rate risk. The fixed income portfolio willdecline in value if there is an increase in interest rates. If market interestrates were to increase immediately and uniformly by 10% from levels as of June30, 2006, the decline of the fair value of the fixed income portfolio would notbe material.

As of June 30, 2006, ourcash, cash equivalents and short-term investments had a fair value of $10.8million, which were invested in cash and short-term commercial paper. Theprimary purpose of these investing activities has been to preserve principaluntil the cash is required to fund operations. Consequently, the size of thisportfolio fluctuates significantly as cash is provided by and used in ourbusiness.

The value of certaininvestments in this portfolio can be impacted by the risk of adverse changes insecurities and economic markets and interest rate fluctuations. At June 30,2006, all of our investments in this category were in fixed rate instruments ormoney market type accounts. A decrease in interest rates has the effect ofreducing our future annual interest income from this portfolio, since fundswould be reinvested at lower rates as the instruments mature. Over time, anynet percentage decrease in our interest rates could be reflected in acorresponding net percentage decrease in our interest income. For the three and six months ended June 30, 2006, theimpact of interest rate fluctuations, changed business prospects and all otherfactors did not have a material impact on the fair value of this portfolio, oron our income derived from this portfolio.

 

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We have not used derivative financial instruments forspeculative purposes. As of June 30, 2006, we are not hedged or otherwiseprotected against risks associated with any of our investing or financingactivities.

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

Weare exposed to market risk, including changes to interest rates. To reduce thevolatility relating to these exposures, we may enter into various derivativeinvestment transactions in the near term pursuant to our investment and riskmanagement policies and procedures in areas such as hedging and counterpartyexposure practices. We have not and will not use derivatives for speculativepurposes.

Thoughwe intend to use risk management control policies, there will be inherent risksthat may only be partially offset by our hedging programs should there be anyunfavorable movements in interest rates or equity investment prices.

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

Our material interest bearing assets consisted of cashequivalents and short-term investments. The balance of our interest bearingassets was $10.8 million, or less than 1% of total assets, as of June 30, 2006.Our material liabilities subject to interest rate risk consisted of capitallease obligations, our bank credit facility, our lines of credit with HC Crown,our note payable to HC Crown, and our note payable to a Hallmark Cardsaffiliate. The balance of those liabilities was $1.1 billion, or 76% of totalliabilities, as of June 30, 2006. Net interest expense for the three monthsended June 30, 2006, was $24.9 million, 49%, of our total revenue. Net interestexpense for the six months ended June 30, 2006, was $46.6 million, 49%, of ourtotal revenue. Our net interest expense of these liabilities is sensitive tochanges in the general level of interest rates, primarily U.S. and LIBORinterest rates. In this regard, changes in U.S. and LIBOR interest rates affectthe fair value of interest bearing liabilities.

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

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

Ourmanagement  evaluated, with theparticipation of our Chief Executive Officer and our Chief Financial Officer,the effectiveness of our disclosure controls and procedures as of the end ofthe period covered by this Quarterly Report on Form 10-Q. Based on thisevaluation, our Chief Executive Officer and our Chief Financial Officer haveconcluded that our disclosure controls and procedures were not effective as ofthe end of the period covered by this Quarterly Report on Form 10-Q because we havenot yet completed the remediation of the material weaknesses discussed in ourAnnual Report on Form 10-K for the year ended December 31, 2005 (“2005 Form10-K”).

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

There was nochange in the Company’s internal control over financial reporting that occurredduring the quarter ended June 30, 2006, that materially affected, or wasreasonably likely to materially affect, the Company’s internal control overfinancial reporting, except for the remediation measures implemented in thesecond quarter of 2006 as described below in this Item 4.

***c.  Remediation of Weakness in Internal Controlover Financial Reporting***

As discussed inmore detail in our 2005 Form 10-K, as of December 31, 2005, we did not maintaineffective controls over  (a) the reviewof the consolidated statement of cash flows; (b) the underlying informationsupporting the amounts included in the Company’s annual and interimconsolidated financial statements; and (c) the information available subsequentto the financial reporting close process for appropriate recognition anddisclosure in the Company’s annual and interim consolidated financialstatements. In addition, the Company’s controls over access to the generalledger and certain accounting application systems were not designed effectivelyto provide adequate segregation of duties. Specifically, the following design deficiencies were identified: (a)certain members 

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of accounting managementhad the ability to both initiate and approve journal entries; (b) certainmembers of accounting management had the ability to initiate and approve thepayment of invoices and sign checks; and (c) a member of accounting managementhad access to an accounting application system and the ability to change informationincluded therein without review and approval.

In order toidentify controls to address certain of the material weaknesses discussedabove, management is in the process of evaluating existing policies andcontrols related to (a) the review of the consolidated statement of cash flows;(b) the underlying information supporting the amounts included in the Company’sannual and interim consolidated financial statements; and (c) the informationavailable subsequent to the financial reporting close process for appropriaterecognition and disclosure in the Company’s annual and interim consolidatedfinancial statements.

Management hasimplemented, or plans to implement, the measures described below to remediatecertain of the material weaknesses described above:

·                  Management’sAbility to Both Initiate and Approve Journal Entries — We have designedcontrols which were implemented in the second quarter of 2006 to ensure that nopersonnel of the Company can both initiate and approve journal entries.

·                  Management’sAbility to Both Initiate, Approve the Payment of Invoices and Sign Checks - Wehave designed controls which were implemented in the second quarter of 2006 toensure that no personnel of the Company can both initiate and approve thepayment of invoices and sign checks.

·                  Management’sAbility to Change Accounting Applications without Review or Approval - We havedesigned controls which were implemented in the second quarter of 2006 toensure that no personnel of the Company can make changes to accounting applicationswithout appropriate review and approval.

The aforementionedmaterial weaknesses will not be considered remediated until new processes havebeen fully implemented, operated for a reasonable period of time, tested bymanagement, and evaluated as operating effectively. We anticipate that we willreport in our Quarterly Report on Form 10-Q for the third quarter of 2006 thatmaterial weaknesses in our internal control over financial reporting continueto exist and that our disclosure controls and procedures are not effective asof September 30, 2006.

We are fullycommitted to remediating our material weaknesses in internal control overfinancial reporting, and we believe we are taking the appropriate steps toproperly address these issues during 2006. However, the remediation of thedesign of the deficient controls and the associated testing efforts are notcomplete, and may require further remediation.

**PART II.  OTHER INFORMATION**

**Item1A.  *Risk Factors***

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

**Item 4.  *Submission of Matters to a Vote of Security Holders***

Our2005 annual meeting of stockholders was held on June 23, 2006.  The following proposal was voted upon at themeeting, with the following number of votes cast for, against or withheld:

*Proposal* — Elect 13directors to our Board of Directors.

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| Name                    | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** | **Abstentions and  Broker Non-Votes** | ** ** |
|-------------------------|------------|---------------|------------|--------------------|------------|---------------------------------------|------------|
|                    |       |          |       |               |       |                                  |       |
| Wilford V. Bane, Jr.    |       | 373,885,974   |       | 989,623            |       | -0-                                   |       |
| Arnold L. Chavkin       |       | 373,711,353   |       | 1,164,244          |       | -0-                                   |       |
| Glenn Curtis            |       | 373,863,726   |       | 1,011,871          |       | -0-                                   |       |
| Robert J. Druten        |       | 373,806,341   |       | 1,069,256          |       | -0-                                   |       |
| Brian E. Gardner        |       | 373,774,133   |       | 1,101,464          |       | -0-                                   |       |
| Herbert Granath         |       | 374,402,052   |       | 473,545            |       | -0-                                   |       |
| David E. Hall           |       | 373,872,957   |       | 1,002,640          |       | -0-                                   |       |
| Donald J. Hall, Jr.     |       | 373,875,712   |       | 999,885            |       | -0-                                   |       |
| Irvine O. Hockaday, Jr. |       | 373,853,539   |       | 1,022,061          |       | -0-                                   |       |
| Anil Jagtiani           |       | 374,017,434   |       | 858,163            |       | -0-                                   |       |
| A. Drue Jennings        |       | 374,466,887   |       | 408,710            |       | -0-                                   |       |
| Peter A. Lund           |       | 374,329,750   |       | 545,847            |       | -0-                                   |       |
| Deanne R. Stedem        |       | 373,901,023   |       | 974,574            |       | -0-                                   |       |

 

All 13 persons listed abovewere existing directors and were re-elected as our directors at that meeting.

**Item 5.*  Other Information.***

***EmploymentAgreement with Paul FitzPatrick***

On August 8, 2006,the Company entered into a new employment agreement with Paul FitzPatrick, forhis services as Executive Vice President and Chief Operating Officer.  This agreement replaced Mr. Fitzpatrick’sprevious 3 year employment agreement which would have expired on September 24,2006.

The new agreement is fora term of two years, expiring on August 8, 2008, and provides for an annualbase salary of $650,475, subject to adjustment in the discretion of the Companyin September of each year.  Mr. FitzPatrickis also entitled to receive a bonus each year of up to 27% of his base salary,conditioned on the Company’s achievement of certain EBITDA, advertising revenueand ratings goals. The agreement also provides for the grant of 46,200Employment RSUs and 85,800 Performance RSUs, which were granted in August 2006(see Note 17, Subsequent Events, of the Notes to the Unaudited CondensedConsolidated Financial Statements for information on RSUs).

***Employment Agreement with WilliamAbbott***

On August 8, 2006,the Company entered into a new employment agreement with William Abbott, forhis services as Executive Vice President, National Advertising Sales.  This agreement replaced Mr. Abbott’s previous3 year and 7 month employment agreement which would have expired on February 7,2007.

The new agreement is for a term of two years, expiringon August 8, 2008, and provides for an annual base salary of $523,688, subjectto adjustment in the discretion of the Company in February of each year.  Mr. Abbott is also entitled to receive abonus each year of up to 33.75% of his base salary, conditioned on the Company’sachievement of certain EBITDA, advertising revenue and ratings goals. Theagreement also provides for the grant of 46,200 Employment RSUs and 85,800Performance RSUs, which were granted in August 2006.

***Employment Agreement with CharlesStanford***

On August 8, 2006,the Company entered into a new employment agreement with Charles Stanford, forhis services as Executive Vice President, Legal and Business Affairs andGeneral Counsel.  This agreement replacedMr. Stanford’s previous 3 year employment agreement which would have expired onOctober 24, 2006.

The new agreement is for a term of two years, expiringon August 8, 2008, and provides for an annual base salary of $436,000, subjectto adjustment in the discretion of the Company in October of each year.  Mr. Stanford is 

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also entitled to receive a bonus each year of up to27% of his base salary, conditioned on the Company’s achievement of certainEBITDA, advertising revenue and ratings goals. The agreement also provides forthe grant of 46,200 Employment RSUs and 85,800 Performance RSUs, which weregranted in August 2006.

***Employment Agreement with LauraMasse***

On August 8, 2006,the Company entered into an employment agreement with Laura Masse, for herservices as Senior Vice President, Marketing.

The agreement isfor a term of two years, expiring on August 8, 2008, and provides for an annualbase salary of $375,000, subject to annual adjustment in the discretion of theCompany.  Ms. Masse is also entitled to receive a bonus each year of up to27% of her base salary, conditioned on the Company’s achievement of certainEBITDA, advertising revenue and ratings goals. The agreement also provides forthe grant of 35,000 Employment RSUs and 65,000 Performance RSUs, which weregranted in August 2006.

***Employment Agreement with BrianStewart***

On July 24, 2006,the Company entered into an employment agreement with Brian Stewart, for hisservices as Senior Vice President, Finance and interim Chief Financial Officer.

The agreement isfor a term of two years, expiring on July 23, 2008, and provides for an annualbase salary of $340,000, subject to annual adjustment in the discretion of theCompany.  Mr. Stewart is also entitled to receive a bonus each year of upto 27% of his base salary, conditioned on the Company’s achievement of certainEBITDA, advertising revenue and ratings goals. The agreement also provides forthe grant of 21,000 Employment RSUs and 39,000 Performance RSUs, which weregranted in August 2006.

Under eachemployment agreement, the Company also has the right to terminate theemployment of the executive officer upon five days’ written notice.  In that event, severance benefits include thepresent value of 12 months base salary and a pro rata bonus.  Ms. Masse may receive, in the alternative,payments under a severance plan in the event of a change in control, if theamount is higher under that plan.

**Item 6.  *Exhibits***

**INDEX TO EXHIBITS**

 
| Exhibit Number | ** ** | **Exhibit Title**                                                                                                                                                                                                                                                                                              |
|----------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1            |       | Amended and Restated  Certificate of Incorporation (previously filed as Exhibit 3.1 to our  Registration Statement on Form S-1/A (Amendment No. 2), Commission File No.  333-95573, and incorporated herein by reference).                                                                                     |
| 3.2            |       | Amendment to the Amended and  Restated Certificate of Incorporation (previously filed as Exhibit 3.2 to our  Quarterly Report on Form 10-Q filed on July 31, 2001 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*          |       | Separation Agreement dated May 10, 2006 between  Crown Media Holdings, Inc. and David Evans (previously filed as Exhibit 99.2 to our Current Report on Form 8-K  filed on May 11, 2006 and incorporated herein by reference).                                                                                  |
| 10.2*          |       | Separation Agreement dated July 21, 2006 between  Crown Media Holdings, Inc. and William Aliber (previously filed as Exhibit 99.1 to our Current Report on Form 8-K filed  on July 24, 2006 and incorporated herein by reference).                                                                             |
| 10.3           |       | Trademark License Extension Agreement (Hallmark  Movie Channel), dated as of April 10, 2006, by and between Hallmark  Licensing, Inc. and Crown Media United States, LLC (previously filed as  Exhibit 10.2 to our Quarterly Report on Form 10-Q filed on May 10, 2006 and  incorporated herein by reference). |

 

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| 10.4   |   | Trademark License Extension Agreement (Hallmark  Channel), dated as of April 10, 2006, by and between Hallmark Licensing, Inc.  and Crown Media United States, LLC (previously filed as Exhibit 10.3 to our  Quarterly Report on Form 10-Q filed on May 10, 2006 and incorporated herein  by reference).                                                                                                                                            |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.5   |   | Letter Agreement dated May 2, 2006 by and between  Hallmark Cards Incorporated and Crown Media Holdings, Inc. (previously filed  as Exhibit 10.6 to our Quarterly Report on Form 10-Q filed on May 10, 2006  and incorporated herein by reference).                                                                                                                                                                                                 |
| 10.6   |   | Amendment No. 1 to Waiver and Standby Purchase  Agreement dated August 8, 2006 by and between Hallmark Cards Incorporated and  Crown Media Holdings, Inc.                                                                                                                                                                                                                                                                                           |
| 10.7   |   | Amendment No. 10, dated as of April 28, 2006 to the  Credit, Security, Guaranty and Pledge Agreement dated as of August 31, 2001  among Crown Media Holdings, Inc. as Borrower, the Guarantors named therein,  the Lenders named therein and JP Morgan Chase Bank as administrative agent  and as issuing bank (previously filed as Exhibit 10.5 to our Quarterly Report  on Form 10-Q filed on May 10, 2006 and incorporated herein by reference). |
| 10.8*  |   | Employment Agreement dated August 8, 2006, between  Crown Media Holdings, Inc. and Paul FitzPatrick.                                                                                                                                                                                                                                                                                                                                                |
| 10.9*  |   | Employment Agreement dated August 8, 2006, between  Crown Media Holdings, Inc. and William Abbott.                                                                                                                                                                                                                                                                                                                                                  |
| 10.10* |   | Employment Agreement dated August 8, 2006, between  Crown Media Holdings, Inc. and Charles Stanford.                                                                                                                                                                                                                                                                                                                                                |
| 10.11* |   | Employment Agreement dated August 8, 2006, between  Crown Media Holdings, Inc. and Laura Masse.                                                                                                                                                                                                                                                                                                                                                     |
| 10.12* |   | Employment  Agreement dated July 24, 2006, between Crown Media Holdings, Inc. and  Brian Stewart.                                                                                                                                                                                                                                                                                                                                              |
| 31.1   |   | Rule 13a-14(a) Certification executed by the  Company’s Acting Chief Executive Officer.                                                                                                                                                                                                                                                                                                                                                        |
| 31.2   |   | Rule 13a-14(a) Certification executed by the  Company’s Executive Vice President and Chief Financial Officer.                                                                                                                                                                                                                                                                                                                                  |
| 32     |   | Section 1350 Certifications.                                                                                                                                                                                                                                                                                                                                                                                                                        |

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*                    Management contract or compensating plan orarrangement.

 

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**SIGNATURES**

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

     CROWN MEDIAHOLDINGS, INC.

|        | **Signature**           | ** ** | **Title**               | ** ** | **Date**       |
|--------|-------------------------|------------|-------------------------|------------|----------------|
|   |                    |       |                    |       |           |
| By:    | /s/ PAUL A. FITZPATRICK |       | Acting Principal        |       | August 9, 2006 |
|   | Paul A. FitzPatrick     |       | Executive Officer       |       |           |
|   |                    |       |                    |       |           |
| By:    | /s/ WILLIAM J. ALIBER   |       | Principal Financial and |       | August 9, 2006 |
|   | William J. Aliber       |       | Accounting Officer      |       |           |
|   |                    |       |                    |       |           |

 

 

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