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**UNITED STATES SECURITIES ANDEXCHANGE 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 30,2010**

 

**or**

 

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

 

**For the transition period from                to                .**

 

**Commission File Number: 000-30700**

 

**Crown Media Holdings, Inc.**

(Exact Name of Registrant as Specified in ItsCharter)

 

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

 

**12700 Ventura Boulevard,**

**Suite 200**

**Studio City, California  91604**

(Address of Principal Executive Offices and ZipCode)

 

**(818) 755-2400**

(Registrant’s Telephone Number, IncludingArea Code)

 

 

(Former Name, Former Address, and Former FiscalYear,

if Changed Since Last Report.)

 

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

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files).  Yes  o  No o

 

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

 

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

 

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

 

As of August 9, 2010, the number of shares of Class ACommon Stock, $.01 par value outstanding was 359,675,936.

 

 

 

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**TABLE OFCONTENTS**

** **
| ** **       | ** **                                                                                                            | **Page** |
|------------------|-----------------------------------------------------------------------------------------------------------------------|----------|
| **PART I**  | **Financial  Information**                                                                                            |     |
|             |                                                                                                                  |     |
| Item 1           | Financial  Statements (Unaudited)                                                                                     | 3        |
|             | CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES                                                                      |     |
|             | Condensed Consolidated Balance Sheets —  December 31, 2009 andJune 30,  2010 (Unaudited)               | 3        |
|             | Condensed Consolidated Statements of Operations  (Unaudited) - Three and Six Months Ended June 30, 2009 and 2010 | 5        |
|             | Condensed Consolidated Statements of Cash Flows  (Unaudited) - Six Months Ended June 30, 2009 and 2010           | 6        |
|             | Notes to Unaudited Condensed Consolidated Financial  Statements                                                       | 7        |
|             |                                                                                                                  |     |
| Item 2           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                           | 22       |
|             |                                                                                                                  |     |
| Item 3           | Quantitative  and Qualitative Disclosures About Market Risk                                                           | 39       |
|             |                                                                                                                  |     |
| Item 4           | Controls and  Procedures                                                                                              | 40       |
|             |                                                                                                                  |     |
| **PART II** | **Other  Information**                                                                                                | 41       |
|             |                                                                                                                  |     |
| Item 1           | Legal Proceedings                                                                                                     | 41       |
|             |                                                                                                                  |     |
| Item  1A         | Risk  Factors                                                                                                         | 41       |
|             |                                                                                                                  |     |
| Item 5           | Other Information                                                                                                     | 41       |
|             |                                                                                                                  |     |
| Item  6          | Exhibits                                                                                                              | 42       |
|             |                                                                                                                  |     |
| Signatures       |                                                                                                                  | 44       |

 

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*In this Form 10-Q the terms “CrownMedia Holdings” and the “Company” refer to Crown Media Holdings, Inc. and,unless the context requires otherwise, subsidiaries of Crown Media Holdingsthat operate or have operated our businesses including Crown Media UnitedStates, LLC (“Crown Media United States”). The term “common stock” refers toour Class A common stock and Class B common stock, unless the contextrequires otherwise.  As part of therecapitalization transactions described below, each outstanding share of Class Bcommon stock was reclassified as a share of Class A common stock and the Class Bcommon stock was eliminated.*

 

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

 

**PART I.FINANCIAL INFORMATION**

 

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

 

**CROWN MEDIAHOLDINGS, INC. AND SUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED BALANCE SHEETS**

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

** **
| ** **                                                                                 | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **                                                                                 | ** ** | **2009**                    | ** ** | **2010**                | ** ** |
|                                                                                       |       |                        |       |                    |       |
| ASSETS                                                                                     |       |                        |       |                    |       |
|                                                                                       |       |                        |       |                    |       |
| Cash and cash equivalents                                                                  |       | $                           | 10,456     |                    | $          | 18,192 |   |
| Restricted cash                                                                            |       | —                      |       | 15,007                  |       |
| Accounts receivable, less  allowance for doubtful accounts of  $476 and $208, respectively |       | 68,817                      |       | 65,531                  |       |
| Program license fees                                                                       |       | 106,825                     |       | 99,268                  |       |
| Prepaid program license fees                                                               |       | 1,778                       |       | 11,437                  |       |
| Prepaid and other assets                                                                   |       | 2,271                       |       | 3,925                   |       |
| Total current assets                                                                       |       | 190,147                     |       | 213,360                 |       |
|                                                                                       |       |                        |       |                    |       |
| Program license fees                                                                       |       | 178,332                     |       | 154,337                 |       |
| Property and equipment, net                                                                |       | 13,176                      |       | 12,701                  |       |
| Goodwill                                                                                   |       | 314,033                     |       | 314,033                 |       |
| Prepaid and other assets                                                                   |       | 2,373                       |       | 1,376                   |       |
| Total assets                                                                               |       | $                           | 698,061    |                    | $          | 695,807 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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

**UNAUDITED CONDENSED CONSOLIDATEDBALANCE SHEETS**

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

**(continued)**

 
| ** **                                                                                                                                                                                                                     | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                                                                                                     | ** ** | **2009**                    | ** ** | **2010**                | ** ** |
| ** **                                                                                                                                                                                                                     | ** ** | ** **                  | ** ** | ** **              | ** ** |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY (DEFICIT)                                                                                                                                                                           |       |                        |       |                    |       |
|                                                                                                                                                                                                                           |       |                        |       |                    |       |
| LIABILITIES:                                                                                                                                                                                                                   |       |                        |       |                    |       |
| Accounts payable and accrued  liabilities                                                                                                                                                                                      |       | $                           | 19,642     |                    | $          | 19,836 |   |
| Audience deficiency reserve  liability                                                                                                                                                                                         |       | 17,872                      |       | 29,003                  |       |
| License fees payable                                                                                                                                                                                                           |       | 99,494                      |       | 88,408                  |       |
| Payables to Hallmark Cards  affiliates                                                                                                                                                                                         |       | 23,745                      |       | 1,555                   |       |
| Credit facility and interest  payable                                                                                                                                                                                          |       | 1,002                       |       | —                  |       |
| Notes and interest payable  to HCC                                                                                                                                                                                             |       | 345,314                     |       | 32,225                  |       |
| Company obligated mandatorily  redeemable preferred  interest                                                                                                                                                                  |       | 22,902                      |       | 24,047                  |       |
| Total current liabilities                                                                                                                                                                                                      |       | 529,971                     |       | 195,074                 |       |
|                                                                                                                                                                                                                           |       |                        |       |                    |       |
| Accrued liabilities                                                                                                                                                                                                            |       | 24,484                      |       | 21,341                  |       |
| License fees payable                                                                                                                                                                                                           |       | 82,881                      |       | 60,772                  |       |
| Notes payable to HCC                                                                                                                                                                                                           |       | —                      |       | 404,802                 |       |
| Senior secured note to HCC,  including accrued interest                                                                                                                                                                        |       | 758,755                     |       | —                  |       |
| Total liabilities                                                                                                                                                                                                              |       | 1,396,091                   |       | 681,989                 |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                                                                                 |       |                        |       |                    |       |
| STOCKHOLDERS’ EQUITY  (DEFICIT):                                                                                                                                                                                          |       |                        |       |                    |       |
| Preferred stock, $.01 par  value; $1,000 liquidation preference;  10,000,000 and 1,000,000 shares authorized; 0 and 185,000 shares issued  and outstanding as of December 31, 2009, and June 30, 2010,  respectively |       | —                      |       | 185,000                 |       |
| Class A common stock,  $.01 par value; 200,000,000 and 500,000,000 shares authorized; 74,117,654 and  359,675,936 shares issued and outstanding as of December 31, 2009, and  June 30, 2010, respectively       |       | 741                         |       | 3,597                   |       |
| Class B common stock,  $.01 par value; 120,000,000 and 0 shares  authorized; 30,670,422 and 0 shares issued and outstanding as of  December 31, 2009, and June 30, 2010, respectively                           |       | 307                         |       | —                  |       |
| Paid-in capital                                                                                                                                                                                                                |       | 1,456,788                   |       | 1,992,393               |       |
| Accumulated deficit                                                                                                                                                                                                            |       | (2,155,866                  | )          | (2,167,172              | )          |
| Total stockholders’ equity  (deficit)                                                                                                                                                                                     |       | (698,030                    | )          | 13,818                  |       |
| Total liabilities and  stockholders’ equity (deficit)                                                                                                                                                                     |       | $                           | 698,061    |                    | $          | 695,807 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                                                                                                | ** ** | **Three Months Ended********June 30,** | ** ** | **Six Months Ended********June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                | ** ** | **2009**                                    | ** ** | **2010**                                  | ** ** | **2009** | ** ** | **2010** | ** ** |
| Revenue:                                                                                                                  |       |                                        |       |                                      |       |   |   |   |   |
| Subscriber fees                                                                                                           |       | $                                           | 15,860     |                                      | $          | 15,872 |   | $ | 31,155 |   | $ | 32,866 |   |
| Advertising                                                                                                               |       | 51,756                                      |       | 49,682                                    |       | 106,881 |   | 100,928 |   |
| Advertising by Hallmark  Cards                                                                                            |       | 165                                         |       | 144                                       |       | 334 |   | 208 |   |
| Other revenue                                                                                                             |       | 401                                         |       | 11                                        |       | 764 |   | 85 |   |
| Total revenue, net                                                                                                        |       | 68,182                                      |       | 65,709                                    |       | 139,134 |   | 134,087 |   |
| Cost of Services:                                                                                                         |       |                                        |       |                                      |       |   |   |   |   |
| Programming costs                                                                                                         |       |                                        |       |                                      |       |   |   |   |   |
| Hallmark Cards affiliates                                                                                                 |       | 306                                         |       | 410                                       |       | 599 |   | 837 |   |
| Non-affiliates                                                                                                            |       | 30,995                                      |       | 29,804                                    |       | 62,917 |   | 58,534 |   |
| Contract termination                                                                                                      |       | —                                      |       | —                                    |       | — |   | 103 |   |
| Other costs of services                                                                                                   |       | 4,488                                       |       | 2,713                                     |       | 8,500 |   | 5,307 |   |
| Total cost of services                                                                                                    |       | 35,789                                      |       | 32,927                                    |       | 72,016 |   | 64,781 |   |
| Selling, general and  administrative expense (exclusive of depreciation and amortization expense  shown separately below) |       | 10,711                                      |       | 12,259                                    |       | 22,792 |   | 24,287 |   |
| Marketing expense                                                                                                         |       | 842                                         |       | 464                                       |       | 5,617 |   | 1,437 |   |
| Depreciation and  amortization expense                                                                                    |       | 484                                         |       | 383                                       |       | 967 |   | 766 |   |
| Loss on sale of film assets                                                                                               |       | —                                      |       | 155                                       |       | — |   | 155 |   |
| Income from operations  before interest and income  tax  expense                                                          |       | 20,356                                      |       | 19,521                                    |       | 37,742 |   | 42,661 |   |
| Interest income                                                                                                           |       | 124                                         |       | 32                                        |       | 261 |   | 50 |   |
| Interest expense                                                                                                          |       | (25,802                                     | )          | (25,638                                   | )          | (50,776 | ) | (51,120 | ) |
| Income from operations  before income tax expense                                                                         |       | $                                           | (5,322     | )                                         | $          | (6,085 | ) | $ | (12,773 | ) | $ | (8,409 | ) |
| Income tax expense                                                                                                        |       | —                                      |       | (2,897                                    | )          | — |   | (2,897 | ) |
| Net loss and comprehensive  loss                                                                                          |       | $                                           | (5,322     | )                                         | $          | (8,982 | ) | $ | (12,773 | ) | $ | (11,306 | ) |
| Weighted average number of  common shares  outstanding,  basic and diluted                                                |       | 104,788                                     |       | 110,452                                   |       | 104,788 |   | 107,620 |   |
| Net loss per common share,  basic and diluted                                                                             |       | $                                           | (0.05      | )                                         | $          | (0.08 | ) | $ | (0.12 | ) | $ | (0.11 | ) |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

 
| ** **                                                                           | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                           | ** ** | **2009**                           | ** ** | **2010** | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                               | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Net loss                                                                             |       | $                                  | (12,773    | ) | $ | (11,306 | ) |
| Adjustments to reconcile net  loss to net cash provided by operating activities:     |       |                               |       |   |   |
| Loss on sale of film assets                                                          |       | —                             |       | 155 |   |
| Depreciation and  amortization                                                       |       | 66,248                             |       | 61,962 |   |
| Accretion on company  obligated mandatorily redeemable preferred interest            |       | 1,040                              |       | 1,144 |   |
| Provision for allowance for  doubtful accounts                                       |       | 893                                |       | 32 |   |
| Loss on sale of fixed asset                                                          |       | —                             |       | 2 |   |
| Debt issuance costs                                                                  |       | —                             |       | 1,044 |   |
| Income tax expense                                                                   |       | —                             |       | 2,897 |   |
| Stock-based compensation  (benefit)                                                  |       | (684                               | )          | 109 |   |
| Changes in operating assets  and liabilities:                                        |       |                               |       |   |   |
| (Increase) decrease in  accounts receivable                                          |       | (163                               | )          | 3,255 |   |
| Additions to program license  fees                                                   |       | (67,704                            | )          | (27,819 | ) |
| (Increase) decrease in  prepaid and other assets                                     |       | 40                                 |       | (12,308 | ) |
| Increase (decrease) in  accounts payable, accrued and other liabilities              |       | (5,373                             | )          | 8,966 |   |
| Increase in interest payable                                                         |       | 36,494                             |       | 33,797 |   |
| Decrease in license fees  payable                                                    |       | (4,844                             | )          | (33,196 | ) |
| Increase in payables to  affiliates                                                  |       | 208                                |       | 54 |   |
| Net cash provided by  operating activities                                           |       | 13,382                             |       | 28,788 |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                               |       |                               |       |   |   |
| Purchases of property and  equipment                                                 |       | (194                               | )          | (600 | ) |
| Payments to buyer of  international business                                         |       | (454                               | )          | (512 | ) |
| Net cash used in investing  activities                                               |       | (648                               | )          | (1,112 | ) |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                               |       |                               |       |   |   |
| Funding of restricted cash  account                                                  |       | —                             |       | (15,007 | ) |
| Borrowings under the credit  facility                                                |       | 18,062                             |       | — |   |
| Principal payments on the  credit facility                                           |       | (26,310                            | )          | (1,000 | ) |
| Payment on notes payable to  HCC                                                     |       | —                             |       | (67 | ) |
| Payments for debt issuance  costs under the troubled debt restructuring              |       | —                             |       | (3,431 | ) |
| Principal payments on  capital lease obligations                                     |       | (396                               | )          | (435 | ) |
| Net cash used in financing  activities                                               |       | (8,644                             | )          | (19,940 | ) |
| Net increase in cash and  cash equivalents                                           |       | 4,090                              |       | 7,736 |   |
| Cash and cash equivalents,  beginning of period                                      |       | 2,714                              |       | 10,456 |   |
| Cash and cash equivalents,  end of period                                            |       | $                                  | 6,804      |   | $ | 18,192 |   |
|                                                                                 |       |                               |       |   |   |
| Supplemental disclosure of  cash and non-cash activities:                            |       |                               |       |   |   |
| Interest paid                                                                        |       | $                                  | 11,556     |   | $ | 14,764 |   |
| Reduction of additional paid-in  capital for obligation under  tax sharing agreement |       | $                                  | 6,125      |   | $ | 1,540 |   |
| Non-cash activities related  to the troubled debt restructuring:                     |       |                               |       |   |   |
| Acceleration of prepaid and  other assets                                            |       | $                                  | —     |   | $ | 475 |   |
| Satisfaction of payable to  Hallmark Cards affiliates                                |       | —                             |       | (23,798 | ) |
| Issuance of new notes  payable to HCC                                                |       | —                             |       | 437,094 |   |
| Satisfaction of old notes  and interest payable to HCC                               |       | —                             |       | (340,697 | ) |
| Satisfaction of senior  secured note to HCC, including accrued interest              |       | —                             |       | (797,423 | ) |
| Issuance of preferred stock                                                          |       | —                             |       | 185,000 |   |
| Issuance of common stock                                                             |       | —                             |       | 2,856 |   |
| Elimination of Class B  common stock designation                                |       | —                             |       | (307 | ) |
| Additional paid-in capital  from preferred and common stock  issuance                |       | —                             |       | 536,800 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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

**NOTES TOUNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**For the Three and Six MonthsEnded June 30, 2009 and 2010**

 

**1. Business and Organization**

 

***Organization***

 

Crown Media Holdings, Inc. (“Crown Media Holdings”or the “Company”), through its wholly-owned subsidiary, Crown Media UnitedStates, LLC (“Crown Media United States”), owns and operates pay televisionchannels (collectively the “Channels” or the “channels”) dedicated to highquality, entertainment programming for adults and families, in the UnitedStates. At June 30, 2010, following the recapitalization of the Company asdescribed below, the significant investor in the Company was H C Crown Corp. (“HCC”),a subsidiary of Hallmark Cards, Incorporated (“Hallmark Cards”).

 

TheCompany’s continuing operations are currently organized into one operatingsegment, the channels.

 

***RecentDevelopments***

 

*Recapitalization of the Company*

 

On June 29, 2010the Company consummated a series of recapitalization transactions (the “Recapitalization”)pursuant to a Master Recapitalization Agreement dated February 26, 2010,by and among the Company, Hallmark Cards, HCC and related entities.

 

Among other things, theRecapitalization included the following:

 

·                  Exchange of approximately $1.162 billion ofdebt (the “HCC Debt”) for new debt, preferred stock and common stock;

 

·                  Mergers of two intermediate holding companies,Hallmark Entertainment Investments Co. (“HEI”) and Hallmark EntertainmentHoldings, Inc. (“HEH”), with and into the Company (collectively, the “Mergers”);

 

·                  Reclassification of Class B shares ofcommon stock into shares of Class A common stock upon the filing of theSecond Amended and Restated Certificate of Incorporation; and

 

·                  Approval and authorization for the futurefiling of the Third Amended and Restated Certificate of Incorporation, theprincipal effect of which would be a reverse split of shares of common stock atsuch time as authorized by the Company’s Board of Directors.

 

The following wereissued in exchange for HCC Debt:

 

·                  $315.0 million principal amount of new debtissued pursuant to the terms of the credit agreement between the Company andHCC (the “Credit Agreement”) in two tranches: (i) the $200.0 million Term A Loan bearing interest at 9.5% perannum through December 31, 2011, and 12% thereafter and (ii) the$115.0 million Term B Loan bearing interest at 11.5% through December 31,2011, and 14.0% thereafter (collectively, the “New Debt”);

 

·                  185,000 shares of the Company’s Series AConvertible Preferred Stock (“Preferred Stock”), $0.01 par value, with theterms summarized under “Preferred Stock Terms” in Item 2 *Management’s Discussion and Analysis of FinancialCondition and Results of Operations* below; and

 

·                  254,887,860 shares of the Company’s Class Acommon stock in exchange for the residual amount of HCC Debt converted at$2.5969 per share.

 

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 Immediately after consummation of the Mergers and issuance of commonstock in partial exchange for HCC Debt, HCC owned approximately 90.3% of theCompany’s Class A common stock and all of the outstanding Preferred Stock.

 

In addition, thetransactions resulted in the following:

 

·                  The increase of the authorized shares of Class Acommon stock to 500,000,000 shares; the decrease of the authorized PreferredStock to 1,000,000 shares; and the elimination of the Class B commonstock;

 

·                  Amendment No. 2 to the Tax SharingAgreement between the Company and Hallmark Cards, to among other things,(i)  permit Hallmark Cards to defer any future tax benefit payable to theCompany for application against future tax liabilities of the Company and (ii) allowthe Company to deduct interest accrued on the 10.25% Senior Secured Note fromJanuary 1, 2010,  through June 29,2010; and (iii) provide for the treatment of the Recapitalization underthe Tax Sharing Agreement (see Note 6 below);

 

·                  Execution of the registration rights agreement,by and among the Company, HCC and certain HEIC stockholders;

 

·                  Extension of the Company’s $30.0 millionrevolving line of credit to June 30, 2011, and Hallmark Card’s agreementto guarantee up to $30.0 million for such revolving line of credit (see Notes 4and 5 below); and

 

·                  A Stockholders Agreement, by and among theCompany, HCC and Hallmark Cards, pursuant to which, among other things,Hallmark Cards entities agreed not to acquire, through December 31, 2013,additional shares of Class A common stock, subject to certain exceptions,and agreed to certain restrictions on their ability to sell or transfer sharesof Class A common stock until December 31, 2013 and, subject tolesser restrictions, until December 31, 2020.

 

See“Recapitalization” in Note 5 for the accounting treatment of theRecapitalization.

 

***Liquidity***

 

Asof June 30, 2010, the Company had $18.2 million in cash and cashequivalents on hand.  Also available tothe Company was the full $30.0 million bank credit facility which expires June 30,2011.  Day-to-day cash disbursementrequirements have typically been satisfied with cash on hand and operating cashreceipts supplemented with the borrowing capacity available under the bankcredit facility and, prior to the Recapitalization, forbearance by HallmarkCards and its affiliates.

 

TheCompany’s management anticipates that the principal uses of cash during thetwelve month period ending June 30, 2011, will include the payment ofoperating expenses, accounts payable and accrued expenses, programming costs,and interest of approximately $30.0 million to $35.0 million due under the NewDebt issued in the Recapitalization. Subject to the legal availability of funds and approval by the Company’sboard of directors, the Company may also pay approximately $13.0 million forcash dividends on Preferred Stock during the six months ending June 30,2011; at the option of the Company’s board of directors, such dividends, ifany, may be paid in the form of additional shares of Preferred Stock.

 

AtJune 30, 2010, the Company also had an additional $15.0 million of cash,the use of which is restricted to payment of the $25.0 million companyobligated, mandatorily redeemable preferred interest payable to NICC on December 31,2010.  As of July 31, 2010, theCompany had increased such restricted cash to $20.0 million.  The Company believes that it will be able tofund all, or substantially all, of the remaining $5.0 million with cashprovided by operating activities.

 

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

 

***Interim FinancialStatements***

 

Inthe opinion of management, the accompanying condensed consolidated balancesheets and related interim 

 

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condensedconsolidated statements of operations and cash flows include all adjustments,consisting of normal recurring items necessary for their fair presentation inconformity with accounting principles generally accepted in the United States.Interim results are not necessarily indicative of results for a full year. These condensed consolidated financial statementsshould be read in conjunction with the consolidated financial statements andthe notes to those statements, included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2009.

 

***Basis of Presentation***

 

The condensed consolidated financial statements includethe accounts of Crown Media Holdings and its wholly-owned subsidiaries. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

 

Thepreparation of financial statements in accordance with generally acceptedaccounting principles requires the consideration of events or transactions thatoccur after the balance sheet date but before the financial statements areissued. Depending on the nature of the subsequent event, financial statementrecognition or disclosure of the subsequent event is required.  Subsequent events have been evaluated.

 

***Use of Estimates***

 

Thepreparation of the accompanying consolidated financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions about future events. Theseestimates and the underlying assumptions affect the amounts of assets andliabilities reported, disclosures about contingent assets and liabilities, andreported amounts of revenues and expenses. Such estimates include the collectabilityof accounts receivable, the valuation of goodwill, intangible assets, and otherlong-lived assets, legal contingencies, indemnifications, and assumptions usedin the calculation of income taxes, among others. A significant non-recurringuse of estimates occurred in the course of recording the Company’s June 2010troubled debt restructuring which required that the Company estimate the fairvalues of preferred stock and common stock issued in the Recapitalization.

 

Allof the estimates that are employed are based on management’s best estimates andjudgment. Management evaluates its estimates and assumptions on an ongoingbasis using historical experience and other factors, including the currenteconomic environment, which management believes to be reasonable under thecircumstances. Management adjusts such estimates and assumptions when facts andcircumstances dictate. Illiquid credit markets, volatile equity, foreigncurrency, and energy markets, and declines in consumer spending have combinedto increase the uncertainty inherent in such estimates and assumptions. Asfuture events and their effects cannot be determined with precision, actualresults could differ significantly from these estimates. Changes in thoseestimates resulting from continuing changes in the economic environment will bereflected in the financial statements in future periods.

 

***Allowance for Doubtful Accounts***

 

The allowance for doubtful accounts is based upon theCompany’s assessment of probable loss related to uncollectible accountsreceivable.  The Company uses a number offactors in determining the allowance, including, among other things, collectiontrends. The Company’s bad debt expense was $271,000 and $6,000 for the threemonths ended June 30, 2009 and 2010, respectively. The Company’s bad debtexpense was $893,000 and $32,000 for the six months ended June 30, 2009and 2010, respectively.

 

***Fair Value of Financial Instruments***

 

FinancialAccounting Standards Board (“FASB”) Accounting Standards Codification (the “*ASC*”) Topic 820, *Fair Value Measurementsand Disclosures*, provides guidance which defines fair value,establishes a framework for measuring fair value and specifies disclosuresabout fair value measurements.  On January 1, 2008 we adoptedthat portion of the standard that relates to those financial assets andliabilities and nonfinancial assets and liabilities which are recognized ordisclosed at fair value on a recurring basis (that is, at leastannually).  On January 1, 2009, subject to the FASB’s delayedimplementation, we adopted the remaining provisions of the standard.  After 

 

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adoption,we now determine fair value as an exit price, representing the price that wouldbe received to sell an asset or paid to transfer a liability in an orderlytransaction between market participants.

 

TheCompany does not have balance sheet items carried at fair value on a recurringbasis such as derivative financial instruments which are valued primarily basedon quoted prices in active or brokered markets for identical as well as similarassets and liabilities. Significant balance sheet items which are subject tonon-recurring fair value measurements consist of impairment valuations ofgoodwill and property and equipment. The standard has not had a significantimpact on the determination of fair value related to non-financial assets andnon-financial liabilities in 2010.

 

***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 stock optionsor the conversion of Preferred Stock. Approximately 71.2 million incrementalshares related to the Preferred Stock issued June 29, 2010, in connectionwith the Recapitalization have been excluded from the calculations of earningsper share for the three and six months ended June 30, 2010, because theireffect would have been antidilutive. Approximately 341,000 and 66,000 stockoptions for the three and six months ended June 30, 2009 and 2010,respectively, have been excluded from the calculations of earnings per sharebecause their effect would have been antidilutive.

 

Additionally, no consideration has been given topreferred dividends, because there were not any accrued or paid dividends in2010.

 

***Concentration of Credit Risk***

 

Financial instruments, which potentially subject CrownMedia Holdings to a concentration of credit risk, consist primarily of cash,cash equivalents and accounts receivable. Generally, Crown Media Holdings doesnot require collateral to secure receivables. Crown Media Holdings has nosignificant off-balance sheet financial instruments with risk of accountinglosses.

 

Fiveand four of our distributors each accounted for more than 10% of ourconsolidated subscriber revenue for both the three months ended June 30,2009 and 2010, and together accounted for a total of 76% and 63% ofconsolidated subscriber revenue during the three months ended June 30,2009 and 2010, respectively.  Three ofour distributors each accounted for approximately 15% or more of ourconsolidated subscribers for the three months ended June 30, 2009 and2010, respectively, and together accounted for 62% and 60% of our subscribersduring the three months ended June 30, 2009 and 2010, respectively.

 

Fiveand four of our distributors each accounted for more than 10% of ourconsolidated subscriber revenue for the six months ended June 30, 2009 and2010, and together accounted for a total of 76% and 64% of consolidatedsubscriber revenue during the six months ended June 30, 2009 and 2010,respectively.  Three of our distributorseach accounted for approximately 15% or more of our consolidated subscribersfor the six months ended June 30, 2009 and 2010, respectively, andtogether accounted for 62% and 60% of our subscribers during the six monthsended June 30, 2009 and 2010, respectively.

 

Fourof our programming content providers each accounted for more than 10% of ourtotal license fees payable for both the six months ended June 30, 2009 and2010, and together accounted for a total of 64% and 71% of the consolidatedprogramming liability, respectively.

 

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***Recently Issued Accounting Pronouncements***

 

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

 

InJanuary 2010, the FASB issued guidance that requires reporting entities tomake new disclosures about recurring or nonrecurring fair-value measurementsincluding significant transfers into and out of Level 1 and Level 2 fair valuemeasurements and information on purchases, sales, issuances, and settlements ona gross basis in the reconciliation of Level 3 fair value measurements. Theguidance is effective for annual reporting periods beginning afterDecember 15, 2009, except for Level 3 reconciliation disclosures that areeffective for annual periods beginning after December 15, 2010. Theadoption of this guidance did not have a material impact on our consolidated financialstatements.

 

***Health Care Reform***

 

Duringthe first quarter of 2010, the U.S. Congress passed and the President signedinto law the Patient Protection and Affordable Care Act as well as the HealthCare and Education Reconciliation Act of 2010, which represent significantchanges to the current U.S. health care system. The legislation is far-reachingand is intended to expand access to health insurance coverage over time byincreasing the eligibility thresholds for most state Medicaid programs andproviding certain other individuals and small businesses with tax incentives tosubsidize a portion of the cost of health insurance coverage. The legislationincludes requirements that most individuals obtain health insurance coverageand that most large employers offer coverage to their employees or payfinancial penalties. Some of the more significant changes, including therequirement that individuals obtain coverage, do not become effective until2014 or later. It is too early to fully understand the impacts of the legislationon our business.

 

**3. Program License Fees**

 

Program license fees are comprised of the following:

 
| ** **                                             | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** |
|--------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **                                             | ** ** | **2009**                    | ** ** | **2010**                | ** ** |
| ** **                                             | ** ** | **(In thousands)**          | ** ** |
| Program license fees —  non-affiliates            |       | $                           | 597,206    |                    | $          | 591,544 |   |
| Program license fees —  Hallmark Cards affiliates |       | 12,668                      |       | 14,167                  |       |
| Program license fees, at  cost                         |       | 609,874                     |       | 605,711                 |       |
| Accumulated amortization                               |       | (324,717                    | )          | (352,106                | )          |
| Program license fees, net                              |       | $                           | 285,157    |                    | $          | 253,605 |   |

 

At December 31, 2009,and June 30, 2010, $1.8 million and $11.4 million, respectively, ofprogram license fees were included in prepaid and other assets on theaccompanying condensed consolidated balance sheets because the related licenseperiods had not commenced.

 

License fees payable are comprised of the following:

 
| ** **                                             | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** |
|--------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **                                             | ** ** | **2009**                    | ** ** | **2010**                | ** ** |
| ** **                                             | ** ** | **(In thousands)**          | ** ** |
| License fees payable —  non-affiliates            |       | $                           | 171,966    |                    | $          | 137,929 |   |
| License fees payable —  Hallmark Cards affiliates |       | 10,409                      |       | 11,251                  |       |
| Total license fees payable                             |       | 182,375                     |       | 149,180                 |       |
| Less current maturities                                |       | (99,494                     | )          | (88,408                 | )          |
| Long-term license fees  payable                        |       | $                           | 82,881     |                    | $          | 60,772 |   |

 

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Inthe regular course of evaluating the remaining usefulness of its variousprogram licenses, the Company may determine that certain licenses may be oflittle future program value to it.  Insuch instances, the Company shortens the estimated remaining lives to zero,thereby accelerating amortization of the remaining net book value.  During the three months ended March 31,2010, such changes in estimates resulted in additional amortization of programlicense fees of $227,000; the Company made no such changes in estimates duringthe three and six months ended June 30, 2009, and the three months ended June 30,2010.

 

**4. Credit Facility**

 

TheCompany entered into Amendment No. 17, effective June 29, 2010,to the Company’s amended credit agreement with JP Morgan Chase Bank. Amendment No. 17, among other things, extends the maturitydate of the credit facility provided by the credit agreement to June 30,2011, from August 31, 2010.  Pursuant to Amendment No. 16to the credit facility, entered into on March 2, 2010, the maximum amountthat may be borrowed under the credit facility is $30.0 million.

 

AmendmentNo. 17 terminates the Hallmark Cards Subordination and SupportAgreement.  The Hallmark Cards Facility Guarantee remains in place and anintercreditor agreement among HCC, JP Morgan Chase Bank and the Company wasentered into, which among other things defines the lien priorities and allowsfor payments to HCC pursuant to the Recapitalization.  The credit facilityis guaranteed by Hallmark Cards and the Company’s subsidiaries and is securedby all tangible and intangible assets of the Company and its subsidiaries.Interest under the credit facility is equal to the LIBOR Rate (as defined inAmendment No. 17) plus 2.25%, in the case of a Eurodollar Loan (as definedin Amendment No. 17), and the Alternate Base Rate (as defined in AmendmentNo. 17) plus 1.25%, in the case of an Alternate Base Rate Loan.

 

Thecredit facility, as amended, contains a number of affirmative and negativecovenants.  The affirmative and negative covenants and default provisionsare described in the Company’s Annual Report on Form 10-K. The Company wasin compliance with these covenants as of June 30, 2010.

 

AtDecember 31, 2009, and June 30, 2010, the Company had outstandingborrowings of $1.0 million and $0, respectively, under the credit facility andthere were no letters of credit outstanding. At December 31, 2009, all ofthe outstanding balance bore interest at the Eurodollar rate (2.49% weightedaverage rate at December 31, 2009). Interestexpense on borrowings under the credit facility for each of the three monthsended June 30, 2009 and 2010, was $182,000 and $0, respectively. Interest expense on borrowings under the creditfacility for each of the six months ended June 30, 2009 and 2010, was $289,000and $4,000, respectively.

 

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

 

***Recapitalization***

 

Forfinancial reporting purposes, the Recapitalization has been accounted for as atroubled debt restructuring in accordance with the guidance of *Accounting Standards Codification*(the “*ASC*”)*Topic 470-60 Debt—Troubled DebtRestructurings*, based on the estimated fair value of theCompany’s Preferred Stock and Common Stock as of June 29, 2010.Identification of the Recapitalization as a troubled debt restructuring involvedboth qualitative and quantitative aspects. Among the qualitative aspectsconsidered were (i) the Company’s expectations that it would have beenunable to fulfill the debt service requirements associated with approximately$342.2 million of principal and interest payable to HCC on May 1,2010 upon the expiration of the waiver agreement (which was extended toAugust 31, 2010 pursuant to the master recapitalization agreement), alongwith an additional $784.6 million of principal and interest that would becomeimmediately due pursuant to cross-default provisions, and (ii) the goingconcern opinion rendered by the Company’s independent registered publicaccounting firm in connection with the financial statements included in theCompany’s Annual Report on Form 10-K for the year ended December 31,2009. Quantitatively, Hallmark Cards is deemed to have granted a “concession”within the meaning of *ASC* 470-60. Prior to consummation of theRecapitalization, the weighted average interest rate of HCC debt was approximately8.3%. After consideration of (x) the estimated fair values of PreferredStock and Common Stock issued in the 

 

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Recapitalizationand (y) the debt service requirements of New Debt, the overall effectiveinterest rate resulting from the Recapitalization is less than 1%.

 

Pursuantto the guidance in the *ASC*, we(1) recorded the issuance of Preferred Stock and Common Stock at theirrespective estimated fair values as of June 29, 2010 and (2) recordedNew Debt in an amount equal to the residual of (i) the carrying value ofHCC Debt less (ii) the estimated fair values of such Preferred Stock andCommon Stock.  New Debt has beenapportioned between the Term A and Term B Loans on the basis of their relativefair values.  The amounts by which theapportioned Term Loans exceeded the respective stated amounts of principal arebeing amortized over the terms of the loans as reductions of the interest expense that otherwise would arise from thestated cash interest rates.  Theresulting effective interest rates are approximately 0.429% and 0.607%, for theTerm A Loan and Term B Loan, respectively. If, and when, any of the available pay-in-kind (where interest is addedto principal) options are exercised, the effects of such elections will berecognized prospectively.

 

TheMergers of HEI and HEH involve non-substantive subsidiaries of Hallmark Cards.The Mergers were recorded at carry-over basis pursuant to the guidance of *ASC 805-50 Business Combinations—Related Issues*.HEIC and HEH did not have assets other than their investment in the Company;neither company had any liabilities.

 

Thefair value estimates used in the accounting for the recapitalization arepreliminary and are subject to change based on final valuations andfinalization of the related costs.

 

Thefollowing table summarizes the accounting for the Recapitalization:

 
| ** **                                                                                                    | ** ** | ** ** | ** ** | **In thousands** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------------|------------|
| **Pre-Recapitalization**                                                                                      |       |       |       |             |       |
| HCC Debt                                                                                                      |       |       |       | $                | 1,161,918  |   |
| Deferred debt issuance costs                                                                                  |       |       |       | (475             | )          |
| Transaction costs                                                                                             |       |       |       | (3,596           | )          |
|                                                                                                          |       |       |       | $                | 1,157,847  |   |
|                                                                                                          |       |       |       |             |       |
| **Post-Recapitalization**                                                                                     |       |       |       |             |       |
| New Debt                                                                                                      |       |       |       | $                | 437,094    |   |
| Preferred stock, $185,000 shares, $0.01 par value,  $1,000 liquidation preference                             |       |       |       | 185,000          |       |
| Common stock, $0.01 par value                                                                                 |       |       |       | 2,549            |       |
| Additional paid-in capital                                                                                    |       |       |       |             |       |
| Fair values of new preferred stock and common  stock, less liquidation preference and par value, respectively |       | $          | 536,800    |             |       |   |
| Transaction costs related to new preferred stock  and common stock                                            |       | (2,552     | )          | 534,248          |       |
| Transaction costs related to the New Debt included  in selling, general and administrative expense            |       |       |       | (1,044           | )          |
|                                                                                                          |       |       |       | $                | 1,157,847  |   |
|                                                                                                               |            |            |            |                  |            |  |  |

 

See“Recapitalization of the Company” in Note 1 for information regarding the debtobligations owed to HCC immediately prior to the Recapitalization.

 

The aggregatematurities of related party long-term debt and future interest (assuming noutilization of the payment-in-kind options) for each of the five yearssubsequent to June 30, 2010, are as follows:

 
| ** **                                                                                                                                        | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                        | ** ** | **Total**                  | ** ** | **Less  than 1  Year** | ** ** | **2 Years** | ** ** | **3 Years** | ** ** | **4 Years** | ** ** | **5 Years** | ** ** |
| ** **                                                                                                                                        | ** ** | **(In thousands)**         | ** ** |
| Term A note, due December 31, 2013, interest  payable quarterly to HCC at 9.5% per annum through December 31, 2011 and  12% thereafter  |       | $                          | 276,579    |   | $ | 19,000 |   | $ | 21,513 |   | $ | 23,967 |   | $ | 212,099 |   | $ | — |   |
| Term B note, due December 31, 2013, interest  payable quarterly to HCC at 11.5% per annum through December 31, 2011  and 14% thereafter |       | 167,092                    |       | 13,225 |   | 14,673 |   | 16,078 |   | 123,116 |   | — |   |
|                                                                                                                                              |       | $                          | 443,671    |   | $ | 32,225 |   | $ | 36,186 |   | $ | 40,045 |   | $ | 335,215 |   | $ | — |   |

 

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***Senior Secured Note***

 

In August 2003,the Company issued a senior note to HCC for $400.0 million. Cash payments forinterest were not required from inception through June 29, 2010. Theprincipal amount of the senior secured note accreted at 10.25% per annum,compounding semi-annually, to June 29, 2010.  At December 31, 2009, $758.8 million ofprincipal and interest were included in the senior note payable in theaccompanying consolidated balance sheet. The obligations under this note wereterminated in connection with the Recapitalization.

 

***Notes and Interest Payable to HCC***

 

On December 14,2001, the Company executed a $75.0 million promissory note with HCC.  Interest was payable in cash, quarterly inarrears five days after the end of each calendar quarter. The rate of interestunder this note was LIBOR plus 5% per annum (5.29% at December 31, 2009).At December 31, 2009, $108.6 million is reported as note payable toHallmark Cards affiliate and $1.5 million is reported as interest payable toHallmark Cards affiliate on the accompanying consolidated balance sheet. Interestof $6.3 million was paid in 2009, interest of $1.5 million was paid on January 5,2010, interest of $1.4 million was paid on April 2, 2010, and interest of$1.4 million was paid on June 29, 2010. The obligations under this notewere terminated in connection with the Recapitalization.

 

OnOctober 1, 2005, the Company converted approximately $132.8 million of itslicense fees payable to a Hallmark Cards affiliate to a promissory notesubsequently transferred to HCC.  Therate of interest under this note was LIBOR plus 5% per annum (5.29% at December 31,2009). At December 31, 2009, $170.1 million is reported as note payable toHCC and $2.3 million is reported as interest payable to HCC on the accompanyingconsolidated balance sheet. Interest of $9.8 million was paid in 2009, interestof $2.3 million was paid on January 5, 2010, interest of $2.2 million waspaid on April 2, 2010, and interest of $2.3 million was paid on June 29,2010. The obligations under this notewere terminated in connection with the Recapitalization.

 

OnMarch 21, 2006, the Company converted approximately $70.4 million of itspayable to a a Hallmark Cards affiliate to a promissory note subsequentlytransferred to HCC. The rate of interest under this note was LIBOR plus 5% perannum (5.29% at December 31, 2009). At December 31, 2009, $62.0million is reported as note payable to HCC and $838,000 is reported as interestpayable to HCC on the accompanying consolidated balance sheet. Interest of $3.6million was paid in 2009, interest of $838,000 was paid on January 5,2010, interest of $814,000 was paid on April 2, 2010, and interest of$820,000 was paid on June 29, 2010. The obligations under this notewere terminated in connection with the Recapitalization.

 

***Interest Paid toHCC***

 

Interest expense paidto HCC in connection with the JPMorgan Chase Bank credit facility was $850,000for the three months ended June 30, 2009, and $0 for the three monthsended June 30, 2010. Interest expense paid to HCC in connection with thecredit facility was $998,000 for the six months ended June 30, 2009, and$2,000 for the six months ended June 30, 2010.

 

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

 

HallmarkCards has provided to JPMorgan Chase Bank under the credit facility theHallmark Cards facility guarantee.  Theguarantee is unconditional for obligations of the Company under the bank creditfacility.  If any payment is made on theguarantee, it will be treated as a purchase of the lending bank’s interest inthe credit facility. Prior to April 2009, Hallmark Cards’ credit supportfor the Company’s bank credit facility consisted of supplying a letter ofcredit.

 

Theabove mentioned credit support provided by Hallmark Cards resulted inreductions in the interest rate and commitment fees under the credit facility;however, the Company agreed to pay and has paid an amount equal to thereductions in the interest rate and commitment fees to Hallmark Cards.  On April 1, 2009, the interest rate and 

 

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commitmentfees under the renewed credit facility increased and we began paying HallmarkCards a smaller reduction amount of the interest rate and commitment fees equalto 0.75% and 0.125%. Commitment fee expense for both the three months ended June 30,2009 and 2010, was $10,000. Commitment fee expense for the six months ended June 30,2009 and 2010, was $25,000 and $22,000, respectively.

 

***Other Agreementswith Hallmark Cards and Affiliates***

 

See Item 2 *Management’s Discussion and Analysis of FinancialCondition and Results of Operations* below for discussion regardingother agreements with Hallmark Cards and its affiliates.

 

**6. Related Party Transactions**

 

***Tax SharingAgreement***

 

*Overview*

 

OnMarch 11, 2003, Crown Media Holdings became a member of Hallmark Cardsconsolidated federal tax group and entered into a federal tax sharing agreementwith Hallmark Cards (the “tax sharing agreement”). Hallmark Cards includesCrown Media Holdings in its consolidated federal income tax return.  Accordingly, Hallmark Cards has benefitedfrom subsequent tax losses and may benefit from future federal tax losses,which may be generated by Crown Media Holdings. Based on the tax sharing agreement, Hallmark Cards has agreed to payCrown Media Holdings all of the benefits realized by Hallmark Cards as a resultof including Crown Media Holdings in its consolidated income tax return.  Through December 31, 2009, thesebenefits have been paid 75% in cash on a quarterly basis with the balanceapplied as an offset against other amounts owed by Crown Media Holdings to anymember of the Hallmark Cards consolidated group under any loan, line of creditor other payable, subject to limitations under any loan indentures or contractsrestricting such offsets.  As a result ofthe Recapitalization, the tax agreement has been amended to provide that 100%of any such benefit will be deferred for application against future tax liabilitiesof the Company.  Pursuant to theamendment to the tax sharing agreement in August 2003, the benefit thatwould otherwise result from interest accrued on the 10.25% senior secured notewill not be available to the Company until such interest is paid in cash. As aresult of the Recapitalization, such interest accrued from January 1,2010, through June 29, 2010, will be treated as a deduction under theamended tax sharing agreement.

 

TheCompany owed Hallmark Cards $8.5 million under the tax sharing agreement for2009. The liability was satisfied on June 29, 2010, in connection with theRecapitalization. The Company owed $1.5 million under the amended tax sharingagreement for the six months ended June 30, 2010, a reduction of $3.2million from the March 31, 2010, estimated amount owed of $4.7 million.Any payments received from Hallmark Cards or credited against amounts owed byCrown Media Holdings to any member of the Hallmark Cards consolidated groupunder the tax sharing agreements have been recorded as additions to paid-incapital in the accompanying consolidated statements of stockholders’ (deficit)equity. Any amounts owed or payments made to Hallmark Cards or to any member ofthe Hallmark Cards consolidated group under the tax sharing agreement have beenrecorded as reductions to paid-in capital in the accompanying consolidatedstatements of stockholders’ (deficit) equity.

 

Thefirst payment by the Company pursuant to theamended tax sharing agreement will occur after the first fullquarter following the closing of the Recapitalization Transactions andwill be made in respect of the period commencing from January 1, 2010,through the last day of the first full quarter following the closing. TheCompany expects to make its first cash payment through the third quarter of 2010on December 15, 2010, for tax liabilities incurred under the tax sharingagreement as amended.

 

Historically,the Company has accounted for income taxes as if it were a separate taxpayernot included in the consolidated tax return of Hallmark Cards.  For tax purposes, the recapitalizationgenerated cancellation of debt income which is currently estimated atapproximately $200.0 million. Accordingly, the Company is expected to generate federal and statetaxable income for both regular tax and alternative minimum tax (“AMT”)purposes.  For regular tax purposes, thisincome will be fully offset by net operating loss carryforwards.  However, for federal AMT purposes, losscarryforwards can be used against AMT income but are limited to 90% of AMTincome.  As a result, the Company hasrecorded an income tax expense of approximately $2.9 million for the estimatedAMT in its consolidated statements of operations.

 

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However,as a result of being included in the consolidated tax return of Hallmark Cards,this AMT expense is not required to be paid to the Internal Revenue Service norto Hallmark Cards under the tax sharing agreement. Accordingly, the Company hasreduced the liability for the aforementioned AMT and credited paid-in capital.The net result for AMT calculated as if the Company is a separate taxpayer is acharge to the consolidated statements of operations and a corresponding creditto paid-in capital.

 

***Services Agreement with Hallmark Cards***

 

HallmarkCards provides Crown Media Holdings with tax, risk management, health safety,environmental, insurance, legal, treasury, human resources, and cash managementservices and real estate consulting services. In exchange, the Company is obligated to pay Hallmark Cards a fee, plusout-of-pocket expenses and third party fees, in arrears on the last businessday of each quarter. Fees for HallmarkCards’ services were $455,000 for 2009 and are scheduled to be $387,000 for2010. The Company has timely paid and will continue to timely pay the monthlyamounts due in 2009 and 2010. Intercompany service fee expense for the three months ended June 30,2009 and 2010, was $114,000 and $97,000, respectively. Intercompany service feeexpense for the six months ended June 30, 2009 and 2010, was $228,000 and$194,000, respectively.

 

At December 31, 2009, and June 30, 2010,non-interest bearing unpaid accrued service fees and unreimbursed expenses of$15.2 million and $0, respectively, were included in payable to affiliates onthe accompanying consolidated balance sheets. The $15.2 million outstanding at December 31,2009, was satisfied on June 29, 2010, in connection with theRecapitalization. For the year ended December 31, 2009, and the six monthsended June 30, 2010, out-of-pocket expenses and amounts paid to thirdparties on the Company’s behalf by Hallmark Cards  were $420,000 and $54,000, respectively.

 

***Lease Guarantees with Hallmark Cards***

 

OnFebruary 24, 2010, the Company executed a letter of credit/guarantycommitment with respect to certain lease agreement with 12700 Investments, Ltd.for the office space at 12700 Ventura Boulevard, Studio City,California.   The landlord required that Crown Media United States,the entity which executed the lease, provide a letter of credit of $1.6 millionsecuring certain obligations of Crown Media United States.  Consequently,Hallmark Cards has agreed to guarantee the issuer of such letter of creditagainst any loss thereon pursuant to the guaranty. As an inducement for Hallmark Cards to issue the guaranty, Crown MediaUnited States has agreed to pay Hallmark Cards a fee which equals 0.75% perannum of the outstanding letter of credit obligation.  Additionally, in the event that HallmarkCards is required to pay any amount under the guaranty, Crown Media UnitedStates must reimburse Hallmark Cards for any such amount plus any fees andcharges associated with making such payment, any interest applicable to such amountand any costs and expenses of Hallmark Cards in connection with protecting itsrights under the guaranty.

 

OnSeptember 2, 2008, Hallmark Cards issued a guaranty for the benefit ofCrown Media United States, which guaranty pertains to that certain leaseagreement with Paramount Group, Inc. for the office space at 1325 Avenueof the Americas, New York, New York.  As a condition to executing thelease agreement, the landlord required Hallmark Cards to guaranty allobligations of Crown Media United States under the lease agreement.  As aninducement for Hallmark Cards to issue the guaranty, Crown Media United Stateshas paid Hallmark Cards a fee which equals 0.28% per annum of the outstandingobligation under the lease agreement. Additionally, in the event that HallmarkCards is required to pay any amount under the guaranty, Crown Media UnitedStates must reimburse Hallmark Cards for any such amount plus any fees and charges associatedwith making such payment, any interest applicable to such amount and any costsand expenses of Hallmark Cards in connection with protecting its rights underthe guaranty.

 

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**7. Company Obligated Mandatorily Redeemable Preferred Interest and NICCLicense Agreements**

 

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

 

Crown Media United States may voluntarily redeem the$25.0 million preferred interest at any time; however, it is obligated to do sono later than December 31, 2010. The terms of the Recapitalizationrequired the Company to set aside in its own name an unspecified amount, not toexceed $25.0 million, for the sole purpose of redeeming the preferredinterest.  The $15.0 million set aside asof June 30, 2010, is reflected as restricted cash in the accompanying condensed,consolidated balance sheet.  As of July 31,2010, the Company had set aside $20.0 in this restricted fund.

 

On January 2, 2008, the Company and NICC resolveddisputes amongst themselves and signed an agreement (the “ModificationAgreement”) which, among other things, immediately extinguished NICC’sconditional right to require the Company to repurchase all of the shares of theCompany’s Class A common stock then owned by NICC (“Put Right”).  In addition, the Modification Agreement alsosettled the dispute with respect to whether the Termination Payment provisionexpired with, or survived, the December 31, 2007 expiration of the December 2005NICC Settlement Agreement. The Company agreed to pay NICC $3.8 million in threeequal installments payable each January 20 of 2008, 2009 and 2010.  The Company also agreed to provide NICC atwo-hour broadcast period granted each Sunday morning during the two yearperiod ending December 31, 2009. The Company is also obligated to pay NICC an estimated $3.7 million inyearly installments at the rate of 6% of the outstanding liquidation preferenceof the preferred interest.

 

During the three months ended June 30, 2009 and2010, Crown Media United States paid NICC $40,000 and $0, respectively, relatedto the company agreement as amended. During the six months ended June 30,2009 and 2010, Crown Media United States paid NICC $4.5 million and $2.8million, respectively, related to the company agreement as amended.

 

**8. Share-Based Compensation**

 

Approximately 200,000 stock options expired, withoutbeing exercised, in August 2009 following the resignation of one of theCompany’s executives in May 2009. Such options were fully vested at thetime of resignation.

 

The Company recorded $266,000 of compensation benefitand $33,000 of compensation expense associated with the employment and performance restricted stock units(RSUs) during the three months ended June 30, 2009 and 2010, respectively,which have been included in selling, general and administrative expense on theaccompanying condensed consolidated statements of operations. The Companyrecorded $437,000 of compensation benefit and $109,000 of compensationexpense  associated with the employmentand performance restricted stock units (RSUs) during the six months ended June 30,2009 and 2010, respectively, which have been included in selling, general andadministrative expense on the accompanying condensed consolidated statements ofoperations.

 

Asof December 31, 2009, and June 30, 2010, there was no unrecognizedcompensation cost, related to non-vested stock options granted to the Company’semployees. The closing price of a share ofthe Company’s common stock was $1.45 on December 31, 2009, and $1.76 on June 30,2010, which is used to calculate the RSU liability. As of December 31,2009, and June 30, 2010, there was unrecognized compensation cost, relatedto non-vested RSUs granted to the Company’s employees, in the amount of$190,000 and $136,000, respectively, using the aforementioned stock prices.Actual compensation costs recognized in future periods may vary based uponfluctuations in stock price and forfeitures.

 

The Company issued cash settlements related to the RSUsof $1.5 million during the year ended December 31, 2009, and $0 duringboth the three and six months ended June 30, 2010.

 

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InMay 2009, the then CEO terminated his employment and his share appreciation rights (“SARs”) wereforfeited at that time.  The Companyrecorded $131,000 and $247,000 in compensation benefit related to SARs for thethree and six months ended June 30, 2009, on the Company’s condensedconsolidated statement of operations as a component of selling, general andadministrative expense.  The SARs wererecorded as a liability until termination.

 

**9.  Long Term Incentive Plan**

 

Inthe second quarter of 2009, the Company granted Long Term IncentiveCompensation Agreements (“LTI Agreements”) to each vice president, senior vicepresident and executive vice president of the Company.  The target award under each LTI Agreements isa percentage of the employee’s base salary and range from $26,000 to$469,000.  Of each award, 50% is anEmployment Award and 50% is a Performance Award.  The Employment Award will vest and be settledin cash on August 31, 2011, subject to earlier pro rata settlement asprovided in the LTI Agreement.  ThePerformance Award will vest and be settled in cash 50% on December 31,2010, and 50% on December 31, 2011, in accordance with the Companyperformance criteria concerning adjusted EBITDA and cash flow and subject toearlier pro rata settlement as provided in the LTI Agreement. Early settlementis provided in the case of involuntary termination of employment without causeon or after January 1, 2010, death or disability.  Potential payouts under the PerformanceAwards depend on achieving 90% or higher of a target threshold and range from0% to 150% of the target award.  TheCompany’s Compensation Committee has the ability to increase or decrease thepayout based on an assessment of demographics achieved, relative marketconditions and management of expenses.

 

Inthe first quarter of 2010, the Company granted LTI Agreements to each vice president,senior vice president and executive vice president of the Company.  The target award under each LTI Agreements isa percentage of the employee’s base salary and range from $25,000 to$536,000.  Of each award, 50% is anEmployment Award and 50% is a Performance Award.  The Employment Award will vest on August 31,2012, and be settled in cash within 30 days thereafter, subject to earlier prorata settlement as provided in the LTI Agreement.  The Performance Award will vest on December 31,2012, and be settled in cash the later of 30 days thereafter or 15 days afterthe Company issues its audited financials for 2012, but by no later than March 15,2013. Vesting of the Performance Award will be determined in accordance with the Company performance criteriaconcerning adjusted EBITDA and cash flow and subject to earlier pro ratasettlement as provided in the LTI Agreement. Early settlement is provided inthe case of involuntary termination of employment without cause on or after January 1,2011, death or disability.  Potentialpayouts under the Performance Awards depend on achieving 90% or higher of atarget threshold and range from 0% to 150% of the target award.  The Company’s Compensation Committee has theability to increase or decrease the payout based on an assessment ofdemographics achieved, relative market conditions and management of expenses.

 

TheCompany recorded $119,000 and $288,000 of expense included in selling, generaland administrative expense in the accompanying consolidated statement ofoperations for the three months ended June 30, 2009 and 2010,  related to these agreements. The Companyrecorded $326,000 and $716,000 of expense included in selling, general andadministrative expense in the accompanying consolidated statement of operationsfor the six months ended June 30, 2009 and 2010,  related to these agreements. Additionally,the $540,000 and $1.3 million liability for these agreements was included inaccounts payable and accrued liabilities in the accompanying consolidated balancesheets at December 31, 2009, and June 30, 2010.

 

**10. Fair Value**

 

The following table presents the carrying amounts andestimated fair values of certain of the Company’s financial instruments at December 31,2009, and June 30, 2010.

 

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| ** **                                                   | ** ** | **December 31, 2009** | ** ** | **June 30, 2010**                                                   | ** ** |
|--------------------------------------------------------------|------------|----------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **Carrying**               | ** ** | **Significant  Unobservable********Inputs********(Level 3)********Fair** | ** ** | **Carrying** | ** ** | **Significant  Unobservable********Inputs********(Level 3)********Fair** | ** ** |
| ** **                                                   | ** ** | **Amount**                 | ** ** | **Value**                                                                | ** ** | **Amount** | ** ** | **Value** | ** ** |
| ** **                                                   | ** ** | **(In thousands)**         | ** ** |
|                                                         |       |                       |       |                                                                     |       |   |   |   |   |
| Senior secured note to HCC, including accrued  interest      |       | $                          | 758,755    |                                                                     | $          | 641,635 |   | $ | — |   | $ | — |   |
| Note and interest payable to HCC                             |       | 110,062                    |       | 93,074                                                                   |       | — |   | — |   |
| Note and interest payable to HCC                             |       | 62,845                     |       | 53,144                                                                   |       | — |   | — |   |
| Note and interest payable to HCC                             |       | 172,407                    |       | 145,795                                                                  |       | — |   | — |   |
| Term A note payable to HCC                                   |       | —                     |       | —                                                                   |       | 272,966 |   | 190,865 |   |
| Term B note payable to HCC                                   |       | —                     |       | —                                                                   |       | 164,061 |   | 114,721 |   |
| Company obligated mandatorily redeemable preferred  interest |       | 22,902                     |       | 19,800                                                                   |       | 24,047 |   | 23,000 |   |
|                                                              |            |                            |            |                                                                          |            |  |  |  |  |  |  |  |  |

 

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

 

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

 

The Company estimates the fair value of its debt to HCCon a quarterly basis.  The Company utilized adiscounted future cash flows method (which applies a discount rate to earningsprojections for a period of years) to value the Company’s total investedcapital.

 

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

 

Estimates of the fair value of certain of the Company’sfinancial instruments are presented in the tables above. As a result of recentmarket conditions, the Company’s debt obligations with HCC and the mandatorilyredeemable preferred interest have limited or no observable market dataavailable. Fair value measurements for these instruments are included in Level3 of the fair value hierarchy of *ASC Topic 820*. These fair value measurements are based primarily upon the Company’sown estimates and are often based on its current pricing policy, the currenteconomic and competitive environment, the characteristics of the instrument,credit and interest rate risks, and other such factors. Therefore, the resultscannot be determined with precision, cannot be substantiated by comparison toquoted prices in active markets, and may not be realized in an immediatesettlement of the liability. Additionally, there are inherent uncertainties inany fair value measurement technique, and changes in the underlying assumptionsused, including discount rates, liquidity risks, and estimates of future cashflows, could significantly affect the fair value measurement amounts.

 

The majority of the Company’s debt has been transactedwith HCC.

 

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**11.Commitments and Contingencies**

 

***Lawsuit***

 

OnJuly 13, 2009, a lawsuit was brought in the Delaware Court of Chanceryagainst each member of the Board of Directors of the Company, Hallmark Cardsand its affiliates, as well as the Company as a nominal defendant, by aminority stockholder of the Company regarding the then proposedRecapitalization. The plaintiff is S. Muoio & Co. LLC which ownsbeneficially approximately 5.8% of the Company’s Class A common stock atthe time of the complaint, according to the complaint and filings with the SEC.The lawsuit claims to be a derivative action and a class action on behalf ofthe plaintiff and other minority stockholders of the Company. The lawsuitalleges, among other things, that, the defendants have breached fiduciaryduties owed to the Company and minority stockholders in connection with theRecapitalization transactions. The lawsuit includes allegations that theconsummation of the Recapitalization transactions would result in an unfairamount of equity issued to the majority stockholders, thereby reducing theminority stockholders’ equity and voting interests in the Company, and that themajority stockholders would be able to eliminate the minority stockholdersthrough a short-form merger. The complaint requested the court enjoin thedefendants from consummating the Recapitalization transactions and awardplaintiff fees and expenses incurred in bringing the lawsuit.

 

OnJuly 22, 2009, a Stipulation Providing for Notice of Transaction (the ‘‘Stipulation’’)was filed with the Delaware Court of Chancery. The Stipulation provided thatthe Company could not consummate the transaction contemplated in theRecapitalization transactions until not less than seven weeks after providingthe plaintiff with a notice of the terms of the proposed transaction, includingcopies of the final transaction agreements. If the plaintiff moved forpreliminary injunctive relief with respect to any such transaction, the partieswould establish a schedule with the Court of Chancery to resolve such motionduring the seven week period. In addition, following the decision of the Courtof Chancery, the Company would not consummate any transaction for a period ofat least one week, during which time any party may seek an expedited appeal.The Stipulation further provided that the plaintiff would withdraw its motionfor preliminary injunction filed on July 13, 2009 and that the actionwould be stayed until the earlier of providing the notice of a transaction oran announcement by the Company that it was no longer considering a transaction.

 

Bya letter of February 28, 2010, the plaintiff in this lawsuit informed theSpecial Committee of the Board of Directors, which considered and negotiatedthe Recapitalization, that the plaintiff objected to the proposedrecapitalization on the terms set forth in the term sheet dated February 9,2010. The plaintiff asserted, among other things, that the transactionscontemplated by the term sheet would unfairly dilute the economic and votinginterests of the Company’s minority stockholders, that the transactions shouldbe subject to a vote of the majority of the minority stockholders and that theproposed transactions remain inadequate. The plaintiff indicated that if theCompany executed definitive documents for the Recapitalization, the plaintiffwould pursue the litigation. The February 26, 2010 agreements executed bythe Company for the Recapitalization materially followed the provisions in theearlier term sheet.

 

Noticeof the terms of the proposed Recapitalization, including copies of the executeddefinitive documents for the Recapitalization, was provided to the plaintiff onMarch 1, 2010. On March 11, 2010, the plaintiff filed an amendedcomplaint raising similar allegations of breach of fiduciary duty againstHallmark Cards and the director defendants and seeking rescission of theRecapitalization rather than a preliminary injunction enjoining theconsummation of the Recapitalization, or alternatively, an award of rescissorydamages. The plaintiff also filed a motion for expedited proceedings and arequest that the Chancery Court set a trial date sometime in September 2010.Defendants have informed the Court that they do not oppose a trial in August orSeptember 2010 but reserve the right to oppose rescission as an availableor proper remedy.  On March 23,2010, the Court notified the parties that the trial was scheduled for September 21,2010. By July 2010, all depositions and discovery efforts were completed,unless further ordered by the court.

 

Itis not currently possible to predict the outcome of the proceeding discussedabove.  Legal fees incurred to defend theproceeding will be expensed as incurred.

 

Fromtime to time, the Company, together with, in some instances, certain of itsdirectors and officers is a defendant or codefendant in various other legalactions involving various claims incident to the conduct of its business.

 

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**12. Third Party Indemnity**

 

InDecember 2006, the Company sold its film library consisting of domesticrights and certain international ancillary rights to approximately 620television movies, mini-series and series (the “Crown Library”) to RHIEntertainment LLC (“RHI”).  As a condition of the sale, the Company agreedto pay up to $22.5 million for residuals and profit participations related toRHI’s domestic exploitation of the Crown Library for a ten-year period ending December 14,2016. The Company estimated the fair value of this obligation to beapproximately $10.6 million at December 15, 2006, assuming the maximumpayout. Any revisions to this estimated liability will be reflected as gain(loss) from sale of film assets in future periods. In 2006, the Companyrecorded an $8.2 million gain related to the sale of these film assets.

 

InDecember 2009 the Company concluded that payments for residuals andparticipations under its liability to RHI would occur generally later thanoriginally estimated in December 2006. Accordingly, the Company reduced the carrying amount of the liability by$682,000 and recognized a corresponding gain from sale of film assets in theaccompanying statement of operations. InJuly 2010, the Company received notification of pending requests forpayments of approximately $8.0 million related to exploitation of the CrownLibrary through mid-2010.  Accordingly,the Company increased the carrying amount of the liability by $155,000 and recognizeda corresponding loss from sale of film assets in the accompanying statement ofoperations.

 

Carryingamounts of this liability of $13.9 million and $14.1 million as of December 31,2009, and June 30, 2010, respectively, are included in accrued liabilitieson the accompanying consolidated balance sheets.  The aggregate amount of payments that theCompany will make under this obligation is dependent upon the relative successRHI achieves in exploiting these film assets. However, in no event will the actual cash payments under this obligationexceed $22.5 million.  The timing of suchpayments is dependent upon not only the timing of RHI’s exploitation of thesefilm assets but RHI’s administrative processes by which it will requestpayments from the Company. Accordingly, it is likely that, during the remainingterm of this liability, the carrying amount will be adjusted as additionalinformation becomes available to the Company.

 

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

 

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

 

**Description of Business and Overview**

 

*CurrentBusiness*

 

Weown and operate the Channels. With 89.8 million subscribers (as provided byNielsen Research) in the United States at June 30, 2010, the HallmarkChannel is the 38th most widely distributed advertising-supportedcable channel in the United States. At December 31, 2009, the HallmarkChannel was the 38th most widely distributed advertising-supportedcable channel in the United States with 88.3 million subscribers (as providedby Nielsen Research). For the second quarter of 2010, the Hallmark Channelfinished the quarter as the 23rd highest ratedadvertising-supported cable channel for total day household ratings and the 23rd highest rated advertising-supported cablechannel in prime time as measured by Nielsen Research.

 

Welaunched our second 24-hour linear channel, the Hallmark Movie Channel, duringthe first quarter of 2005.  Programmingon the Hallmark Movie Channel consists primarily of movies and mini-series. TheHallmark Movie Channel has generated subscriber fees and advertising revenuesince 2005. As distribution continues to expand, the financial contribution ofthe Hallmark Movie Channel may grow, including increases in advertising andsubscription revenue. The Hallmark Movie Channel is operated through CrownMedia Holdings’ existing infrastructure at a small incremental cost.  In April 2008, we began distributing theHallmark Movie Channel HD in high definition format, resulting in additionalcosts; however, we expect that this additional format will continue tocontribute to subscriber growth for the Hallmark Movie Channel.  See below for information regarding a highdefinition version of the Hallmark Channel.

 

AtJune 30, 2010, the Hallmark Movie Channel was distributed to over 35.8million subscribers, an increase of nearly 6.7 million subscribers from 29.1million at December 31, 2009. This increase in distribution, particularlyin certain key markets, and a greater number of advertising spots hascontributed to improved Hallmark Movie Channel revenue in 2010 and shouldcontinue to do so through the remainder of the year. In the second quarter of2010, we began selling Hallmark Movie Channel inventory to advertisers based onaudience guarantees, which has increased and will continue to increase ourability to grow revenues from that channel.

 

***Current Challenges***

 

TheCompany faces numerous operating challenges. Among them are increasingviewership ratings, maintaining and increasing advertising revenue, maintainingand expanding the distribution of the Channels, broadening viewershipdemographics to meet our target audience, and controlling costs and expenses.

 

*Ratings*

 

Ratingssuccess plays a significant role in our ability to achieve our distribution andadvertising goals.  Our ratings declinedfrom 14th in total day viewership and 10th for prime time in 2009 to 23rd in total day viewership and 23rd for prime time in 2010.  We believe our ratings are affected by ourability to (i) acquire and produce series and movies that appeal to ourtarget demographic and (ii) develop a programming schedule that attracts ahigh number of viewers. Original productions are our most high profile programsand generate the Hallmark Channel’s highest ratings. In the past, the Companyhas typically incurred additional marketing and promotional expenses surroundingoriginal productions and certain acquired movies to drive higher ratings.Certain acquired series delivered historically strong ratings, but recentlythey have been part of the decline experienced in viewer ratings. In order toreverse the recent decline in ratings, we plan to continue or increase thenumber of our original productions and develop a programming schedule thatattracts a greater number of viewers in our target demographic, all whilecontrolling the expenses relating to these actions.

 

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Ourrecent agreements with Martha Stewart Living Omnimedia, including theacquisition of exclusive rights to the live daytime lifestyle program TheMartha Stewart Show and rights to the extensive library of Martha Stewartbranded lifestyle programming, represent a key part of our strategy to attractviewers that appeal to relatively higher CPM advertisers.  We introduced this lifestyle programming invarious dayparts in the second quarter of 2010, leading to the September 2010premier of The Martha Stewart Show on the Hallmark Channel.  Additionally in September, Hallmark Channelwill premier several other original lifestyle shows for the daytime lifestyleblock.  These program changes haveresulted and may result at least initially in reductions in the ratingsdelivery of the Channel, but our plan is that, over time, these changes willincrease our revenue through the delivery of a more targeted demographic andattraction of higher CPM advertisers.

 

Priorto the second quarter of 2010, the Hallmark Movie Channel had not been thesubject of ratings measurement by Nielsen Media Research. Since then, however,the Hallmark Movie Channel has had Nielsen ratings and we have been sellingadvertising inventory for the Hallmark Movie Channel based on a price per unitof audience measurement.

 

*Advertising Revenue*

 

Theoverall improvement in the economy during the first six months of 2010 had afavorable impact on cable advertising rates, including the rates for ourinventory.  Our second quarter scattermarket inventory was sold at rates 22% above rates in the second quarter 2009scatter market and 74% above the rates for second quarter 2010 inventory soldin the upfront.  Additionally, directresponse rates were down by 11% compared to that inventory sold in the sameperiod of 2009.   Although our CPMs(i.e., advertising rates per thousand viewers) in the second quarter of 2010were higher than the same period of 2009, our delivery of our key demographic,women 25-54, was substantially lower than prior periods.  Our demographic delivery in the secondquarter of 2010 was lower than the previous quarter and lower than the sameperiod of 2009.  This lower demographicdelivery more than offset gains in our CPMs resulting in lower advertising revenuein the second quarter of 2010 compared to the second quarter of 2009.

 

Inthe 2010/2011 upfront process representing the sale of our inventory for thelast quarter of 2010 and the first three quarters of 2011, we entered intoagreements with major advertising firms representing approximately 44% of ouradvertising inventory.  In the prior year2009/2010 upfront we sold approximately 40% of our inventory.  The 2010/2011 inventory was sold at CPMs over20% higher than the inventory sold in the 2009/2010 upfront, includingsignificant increases in rates related to our new lifestyle programming block.  The Company will sell the balance of thegeneral rate inventory for the 2010/2011 broadcast season to advertisers thatpurchase upfront inventory on a calendar year basis, rather than an advertisingyear basis, and in the scatter marketplace. Additionally, we sold approximately37% of the Hallmark Movie Channel’s available inventory in the 2010/2011upfront.

 

Followingthe upfront period, sales of our general rate, direct response andpaid-programming inventory are made closer to the timing of the actualadvertisement.  As compared to the upfrontsales for the same periods, scatters rates in the second quarter of 2010 were74% higher.

 

Advertiserswith upfront contracts have an option to terminate their contracts, as well asan option to expand the amount of inventory purchased under the contracts. Inprior years, cancellations of upfront contracts were unusual. During the twelvemonths period ended September 2009 comprising the 2008/2009 broadcastseason, advertisers canceled approximately 13% of the inventory covered by suchcontracts.  The Company sold the balanceof the 2008/2009 general rate inventory, including that resulting from thecancellations, in the scatter market.  Advertiserscancelled a total of 3% of the inventory covered by upfront contracts duringthe second quarter of 2010 as compared to 21% during the second quarter of2009.

 

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TheCompany was able to sell the Martha Stewart programming time block at rates117% higher than prior year’s rates during that same time block.

 

*DistributionAgreements*

 

Distributionagreements with multiple systems operators are important because they affectour number of subscribers, which in turn has a major impact on our subscriberfees, the number of persons viewing our programming, and the rates charged foradvertising. Our long-term distribution challenge will be obtaining favorablerenewals of our major distribution agreements as they expire. Our major distribution agreements have terms which expireat various times from June 30, 2010, through December 2023, inclusiveof renewal options. Agreements representing an additional 5% of subscribers to the HallmarkChannel****willexpire prior to December 31, 2010.

 

Our agreement with NationalCable Television Cooperative (“NCTC”),representing approximately 12% of our total Hallmark Channel subscriber base,expired in December 2009.Since then, we entered into a series of extensions with NCTC, the last of whichexpired May 7, 2010. The Company is currently in negotiations with theNational Cable Television Cooperative and anticipates that an agreement will becompleted in the third quarter of 2010. In the mean time, we continue todistribute the Channels to NCTC member operators, generally in accordance withthe provisions of the most recently expired agreement.  Due to lack of an agreement from May 8,2010, through June 30, 2010, the Company recognized revenue on a cashbasis; thus, causing a decrease in advertising revenue during that period.

 

Theuniverse of cable and satellite TV subscribers in the United States isapproximately 104 million homes.  The top30 cable TV networks in the United States, measured by the number ofsubscribers, have 90 million or more subscribers.  Our goal is for the Hallmark Channel to reach91 million subscribers and the Hallmark Movie Channel to reach 40 millionsubscribers by the end of 2010.

 

*Demographics*

 

Aspay television channels draw audience share, audience demographics (i.e., viewerscategorized by characteristics such as age, gender and income) becomefragmented. As a result, advertisers are able to target the specific groups ofviewers who are most likely to purchase their products by advertising onchannels which attract the desired viewer demographic.

 

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

 

*Launch of High Definition*

 

Welaunched a high definition version of the Hallmark Channel in February 2010.  The costs for this launch were approximately$5.0 million, of which a non-cash charge of $4.4 million was recognized in December 2009in connection with the terminations of two existing channel deliveryagreements. The Company may also incur additional costs including the cost ofconverting certain television series to high definition.  The launch of a high definition versionfurthers the Company’s efforts to maintain competitiveness.

 

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**Revenue from Continuing Operations**

 

Our revenue consists of subscriber fees and advertising fees.

 

*Subscriber Fees*

 

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

 

·                                          the degree ofcompetition in the market;

 

·                                          the relativeposition in the market of the distributor and the popularity of the channel;

 

·                                          the packagingarrangements for the channel; and

 

·                                          length of thecontract term and other commercial terms.

 

We are in continuous negotiations with our existing distributors toincrease our subscriber base in order to enhance our advertising revenue. Wehave been subject to past requests by major distributors to pay subscriber acquisitionfees for additional subscribers or to waive or accept lower subscriber fees ifcertain numbers of additional subscribers are provided. We also may help fundthe distributors’ efforts to market our Channels or we may permit distributorsto offer limited promotional periods without payment of subscriber fees.

 

In the past, we have generally paid certain television distributorsup-front subscriber acquisition fees to obtain initial carriage on domestic paydistributor systems. Subscriber acquisition fees that we paid in the past werecapitalized and amortized over the contractual term of the applicabledistribution agreement as a reduction in subscriber fee revenue. If theamortization expense exceeds the revenue recognized on a per distributor basis,the excess amortization is included as a component of cost of services. At thetime we sign a distribution agreement and periodically thereafter, we evaluatethe recoverability of the costs we incur against the incremental revenuedirectly and indirectly associated with each agreement.

 

Our Channels are usually offered as one of a number of channels oneither a basic tier or part of other program packages and are not generallyoffered on a stand-alone basis. Thus, while a cable or satellite customer maysubscribe and unsubscribe to the tiers and program packages in which one of ourChannels is placed, these customers do not subscribe and unsubscribe to ourChannels alone.  We are not provided withinformation from the distributors on their overall subscriber churn and in whatmanner their churn rates affect our subscriber counts; instead, we are providedinformation on the total number of subscribers who receive the Channels.

 

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

 

*Advertising*

 

Historically, revenue from advertising aired on our channels hascontributed more than 75% of our total annual revenue.  We earn advertising revenue in the form ofspot or general rate advertising, direct response advertising andpaid-programming (i.e., “infomercials”). Spot advertisements and direct response advertisements are generally 30seconds long and are aired during or between licensed program content.  Spot advertisements are priced at a rate perthousand viewers and almost always bear the Company’s commitment to deliver a specifiednumber of viewers.  Our revenue fromdirect response advertising varies in proportion to the direct sales achievedby the advertiser.  It is sold withoutratings or product sales commitments. Paid-programming is sold at fixed rates for 30 minute blocks of time,typically airing in the early morning hours. It requires no licensed program content. Our advertising revenue is affected by the mix of these forms ofadvertising.

 

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Our rates for spot advertisements are generally calculated on the basisof an agreed upon price per unit of audience measurement in return for aguaranteed commitment by the advertiser. We commit to provide advertiserscertain rating levels in connection with their advertising. Advertising ratesalso vary by time of year due to seasonal changes in television viewership.Revenue is recorded net of estimated delivery shortfalls (“audience deficiencyunits” or “ADUs”), which are usually settled by providing the advertiseradditional advertising time. The remainder of the revenue is recognized as the “make-good”advertising time is delivered in satisfaction of ADUs. Revenue from directresponse advertising depends largely****upon actionsof viewers.

 

Whenever spot advertising is aired in programs that do not achievepromised viewership ratings, we issue ADUs which provide the advertiser withadditional spots at no additional cost. We defer a pro rata amount of advertising revenue and recognize a likeamount as a liability for programs that do not achieve promised viewershipratings.  When the make-good spots aresubsequently aired, revenue is recognized and the liability is reduced.  The level of inventory that is utilized forADUs varies over time and is influenced by prior fluctuations in ourunder-delivery, if any, of viewers against promised ratings as well as the rateat which we and our customers mutually agree to utilize the ADUs.

 

Our channels are broadcast 24 hours per day. Our advertising inventorycomprises the commercial load or advertising capacity of the program hours inwhich we intend to broadcast licensed program content.  The volume of inventory that we haveavailable for sale is determined by the number of our channels (*i.e*., two), our chosen commercial load per hour and thenumber of broadcast hours in which we air licensed program content.  Sales of advertising inventory for cash aredecreased by our need to reserve inventory for the use of ADUs.

 

**Cost of Services**

 

Our cost of services consists primarily of the amortization of programlicense fees; the cost of signal distribution; and the cost of promotionalsegments that are aired between programs.

 

**Critical Accounting Policies, Judgments and Estimates**

 

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

 

For further information regarding our criticalaccounting policies, judgments and estimates, please see Notes to UnauditedCondensed Consolidated Financial Statements contained in Item 1 of this Reportand “Critical Accounting Policies, Judgments and Estimates” in Item 7 of theCompany’s Annual Report on Form 10-K as filed with the SEC for the yearended December 31, 2009.

 

**Effects of Transactions with Related and Certain OtherParties**

 

In2010 and in prior years, we entered into a number of significant transactionswith Hallmark Cards and certain of its subsidiaries. These transactionsinclude, among other things, trademark licenses, an administrative servicesagreement, a tax sharing agreement and the Recapitalization, including theloans under the Credit Agreement, a registration rights agreement and astockholders agreement. For information regarding such transactions andtransactions with other related parties, please see “Effects of Transactionswith Related and Certain Other Parties” in Item 7 of the Company’s Annual Reporton Form 10-K as filed with the SEC for the year ended December 31,2009, and “The Recapitalization” in the Company’s Schedule 14C InformationStatement filed with the SEC on May 21, 2010. Also, please see Notes 1, 5and 6 of Notes to Unaudited Condensed Consolidated Financial Statementscontained in Item 1 of this Report.

 

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***Credit Agreement***

 

Pursuantto the Recapitalization, the Company and HCC entered into a Credit Agreementproviding for the restructuring of approximately $315.0 million principalamount of the HCC Debt into new debt instruments on terms including thefollowing:

 

·*Maturity:*  Thematurity of the New Debt will be December 31, 2013.

 

·*Tranches:*  TheNew Debt includes two tranches:

 

· Term A Loan of $200.0 million is cash pay and bears interest atthe rate of 9.5% per annum through December 31, 2011, and 12% thereafter.

 

· Term B Loan of $115.0 million allows PIK throughDecember 31, 2010 and requires interest to be paid in cash only for thequarterly periods beginning on January 1, 2011. The interest rate is 11.5%through December 31, 2011, and 14% thereafter.

 

TheCompany has the option to PIK up to three quarterly cash payments in theaggregate for the Term A Loan and the Term B Loan. Contractual PIK paymentsunder the Term B Loan will not reduce the number of optional PIK paymentsavailable to the Company, and if the Company opts to PIK both the Term A Loanand the Term B Loan cash payments in a single quarter, then that will count astwo of the Company’s three quarterly PIK options.

 

*Default Interest:*    TheCompany will be required to pay interest on its obligations to HCC at aninterest rate equal to the original interest rate applicable to suchobligations plus 2% if: (i) any amount of principal of the New Debt is notpaid when due; (ii) any amount payable under any Fundamental Document (asdefined in the Credit Agreement) is not paid when due; or (iii) an Eventof Default (as described below) exists.

 

*Prepayment:*    TheNew Debt is prepayable at any time at par plus accrued interest.

 

*Mandatory Prepayments:*    Thefollowing amounts must be used to prepay the New Debt. All net cash proceedsfrom asset sales or other dispositions, except to the extent such net cashproceeds are reinvested in productive assets of a kind then used or usable inthe business of the Company or its subsidiaries within 180 days of thesale or other disposition; 100% of net cash proceeds from equity issuances;100% of net cash proceeds from debt issuances (exclusive of the bank creditfacility); 75% of Excess Cash Flow (as defined in the Credit Agreement); andupon the sale of assets in advance of a condemnation proceeding, or followingthe occurrence of a casualty or condemnation for which the Company or itssubsidiaries have received proceeds, any such proceeds in excess of the amountused to replace the subject assets. Prepayments must be applied in thefollowing order (i) first to PIK interest on the Term A Loan(ii) then to principal on the Term A Loan (iii) then to PIK intereston the Term B Loan, and (iv) finally to principal on the Term B Loan.

 

*Acceleration:*    Theprincipal and interest on the New Debt will become immediately due and payableupon a change in control arising from (i) a Premium Transaction (asdescribed below under “Stockholders Agreement”) or (ii) a transactionapproved by the Company’s Board of Directors. Upon an Event of Default, HCC may declare the principal and interest onthe New Debt due and payable, without presentment, demand, protest or othernotice.

 

*Collateral:*   Theobligations under the Credit Agreement are secured by substantially all of theCompany’s assets. This security interest is subordinate to the lender’ssecurity interest under the bank credit facility.

 

*Affirmative Covenants:*    Underthe Credit Agreement, the Company and its subsidiary guarantors will, amongother things:

 

(i)      Provide annual and quarterly financial statementsand compliance certificates to HCC.

 

(ii)     Maintain their corporate existence and materialrights, licenses and permits and comply in all material respects withapplicable law.

 

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(iii)    Keep their tangible properties that are material tothe business in good repair and working condition and their assets of aninsurable character.

 

(iv)    Provide prompt notice to HCC of material eventsincluding any Event of Default, any material adverse change in the party’scondition or operations or any event which could reasonably be expected tomaterially and adversely affect performance of such party’s obligations to HCC,result in a Material Adverse Effect (as defined in the Credit Agreement) orotherwise cause the loss of more than 7.5 million subscribers.

 

(v)     Provide prompt notice to HCC of the institution ofany action or investigation by any governmental authority or materialdevelopment in any action or investigation, which might, if adverselydetermined, reasonably be expected to have a material adverse effect orotherwise cause the loss of more than 7.5 million subscribers.

 

(vi)    Upon HCC’s request, take all actions necessary toregister copyrights or trademarks.

 

(vii)   Defend the collateral against liens other thanpermitted encumbrances.

 

(viii)  Notify HCC ofany potential violation of, non-compliance with or potential liability under,any environmental laws which could reasonably be expected to have a materialadverse effect.

 

(ix)     Upon HCC’s request, obtain credit ratings issued byMoody’s or S&P.

 

*Negative Covenants:*    TheCredit Agreement includes restrictions on the ability of the Company and itssubsidiary guarantors (the “Credit Parties”) to, among other things:

 

(i)      Incur additional indebtedness, subject to certainexceptions including, but not limited to, indebtedness in respect of securedpurchase money financings not to exceed $30.0 million at any time,ordinary trade payables, indebtedness to another Credit Party and the$30.0 million revolving credit facility.

 

(ii)     Incur liens on any collateral, subject to certainexceptions including, but not limited to, subordinated liens in favor of guildsas required by collective bargaining agreements and liens incurred in theordinary course of business.

 

(iii)    Incur guaranties, subject tocertain exceptions including, but not limited to, certain guaranties that wouldconstitute investments.

 

(iv)    Make investments orpayments, subject to certain exceptions including investments of less than$5 million in the aggregate to entities that are not wholly-ownedsubsidiaries, intercompany advances, payments to other Credit Parties and toHallmark Cards pursuant to the terms of a service agreement.

 

(v)     Sell, lease, transfer,license, or otherwise dispose of (A) movies or television programs otherthan in the ordinary course of business (provided that the Company will not beentitled to sell, transfer or alienate its entire interest items of suchproducts with an aggregate value in excess of $5 million),(B) channels owned or operated by the Credit Parties or (C) otherproperty except de minimus dispositions made in the ordinary course ofbusiness.

 

(vi)    Sell, discount or otherwisedispose of notes, accounts receivable, or other obligations owing to HCC exceptin the ordinary course of business.

 

(vii)   Make or incur obligations tomake capital expenditures in excess of $10.0 million for fiscal year 2010,$5.0 million for fiscal year 2011, $5.0 million for fiscal year 2012,and $5.0 million for fiscal year 2013.

 

(viii)  Amend any material agreementin a manner materially disadvantageous to HCC.

 

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(ix)     Enter into anyagreement prohibiting the creation or assumption of liens upon the propertiesor assets of the Credit Parties or requiring an obligation to be secured ifsome other obligation is secured.

 

(x)      Enter into anyinterest rate protection agreement or currency agreement other than for bonafide hedging purposes.

 

(xi)     Permit the CashInterest Coverage ratio (as defined in the Credit Agreement) of the Company andits consolidated subsidiaries, as at the end of each fiscal quarter, to be lessthan 2.0:1.0.

 

*Events of Default:*    TheCredit Agreement defines “Events of Default” to include the following:

 

(i)      Any representation or warranty made by any CreditParty in the Credit Agreement, other Fundamental Document or in any documentfurnished to HCC pursuant to the Credit Agreement or other FundamentalDocument, is proven to have been false or misleading in any material respect.

 

(ii)     Default in the payment of any principal of orinterest on the New Debt (subject to a five day grace period) or other feespayable by the Company under the Credit Agreement.

 

(iii)    Default by any Credit Party in the performance ofthe covenant requiring notice of material events, any other negative covenantor the requirement to establish the NICC reserve account.

 

(iv)    Default by any Credit Party in the performance ofany other covenant or agreement contained in the Credit Agreement or anyFundamental Document, continuing unremedied for thirty days after thedefaulting party obtains knowledge thereof or receives written notice from HCC.

 

(v)     Default with respect to any indebtedness of anyCredit Party in excess of $1.0 million when due or the performance of anyobligation relating to such indebtedness, if the effect is to accelerate orpermit the acceleration of the maturity of such indebtedness.

 

(vi)    Any CreditParty does not pay its debts as they become due or admits in writing itsinability to pay its debts, makes a general assignment for the benefit ofcreditors or is subject of a voluntary or involuntary bankruptcy or similarproceeding.

 

(vii)   Final judgmentsfor payments in excess of $1.0 million are rendered in the aggregate againstany Credit Party that is not discharged or stayed pending appeal within thirtydays from the entry of the judgment.

 

(viii)  The Credit Agreement or other Fundamental Documentceases to be in full force and effect.

 

(ix)     The CreditParties fail to maintain employee benefit plans in accordance with ERISA.

 

(ix)     The Companydefaults on the NICC Preferred Interest and such default is not remedied,cured, waived or consented to within the grace period with respect thereto.

 

(xi)     Any demand forpayment is made pursuant to Hallmark Card’s guaranty with respect to the bankcredit facility.

 

***Stockholders Agreement***

 

Pursuantto the Recapitalization, the Company, Hallmark Cards and HCC entered into theStockholders Agreement which provides for, among other things, the following.

 

*Standstill Provisions:*    HallmarkCards will not, and will cause its controlled affiliates not to, acquire anyadditional shares of Common Stock (including pursuant to a short form merger)until December 31, 2013 except:

 

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(i)      acquisitionsthat are effected with the prior approval of a special committee of the Boardof Directors comprised solely of independent, disinterested directors;

 

(ii)     acquisitions inconnection with the conversion of Preferred Stock;

 

(iii)    in the eventthat the Company issues additional shares of capital stock, such additionalshares as are necessary to ensure that Hallmark Cards continues to hold atleast the same percentage of the shares of all classes of the Company’s capitalstock as Hallmark Cards owned immediately prior to such issuance; and

 

(iv)    acquisitionseffected between January 1, 2012 and December 31, 2013 and either(x) in connection with certain Premium Transactions (as defined below) or(y) pursuant to a tender offer by Hallmark Cards or its affiliates for allof the outstanding shares of Common Stock, provided the holders of Common Stocknot affiliated with Hallmark Cards tender, in the aggregate, at least a majorityof the shares of Common Stock held by all such stockholders at such time.

 

“PremiumTransaction” means a transaction involving the sale or transfer by HCC of itsshares of Common Stock to a third party (by merger or otherwise) in which allstockholders unaffiliated with Hallmark Cards are entitled to participate andare entitled to receive both (i) consideration equivalent in value to thehighest consideration per share of Common Stock received by HCC in connectionwith such transaction, and (ii) a premium of $0.50 per share of CommonStock (subject to adjustment for any stock splits, combinations,reclassifications, adjustments, sale of Common Stock by the Company, or sale ofCommon Stock by HCC pursuant to a public offering or block trade as describedabove, or any similar transaction). For the avoidance of doubt, the aggregatepremium shall not exceed $17,400,880, which is the product of the number ofoutstanding shares owned by minority stockholders as of the date of the MasterRecapitalization Agreement multiplied by $0.50. Also, for the avoidance ofdoubt, HCC may effectuate a Premium Transaction pursuant to a short-form merger(or other merger) between the Company and HCC or any purchaser of its shares,so long as the holders of Class A Common Stock not affiliated with HCCreceive the consideration provided for in this paragraph in connection withsuch merger.

 

*Co-sale Provisions:*    UntilDecember 31, 2013, HCC will not sell or transfer its Common Stock to athird party except:

 

(i)      to an affiliate of Hallmark Cards or pursuant to abona fide pledge of the shares to a lender that is not an affiliate of HallmarkCards (collectively, a “Permitted Transfer”);

 

(ii)     with the prior approval of a special committee ofthe Board of Directors comprised solely of independent disinterested directors;or

 

(iii)    after January 1, 2012 until December 31,2013 (x) in a Premium Transaction or (y) pursuant to a publicoffering or block trade in which to the knowledge of HCC, no purchaser(together with its affiliates and associates) acquires beneficial ownership ofa block of shares of the Company in such transaction in excess of 5% (in thecase of a public offering) or 2% (in the case of any block trade) of theoutstanding Common Stock.

 

Fromand after January 1, 2014 until the earlier of December 31, 2020 andsuch time as Hallmark Cards and its controlled affiliates no longerbeneficially own a majority of the Common Stock, HCC will not sell or transfer,in one or a series of related transactions, a majority of the outstandingshares of Common Stock to a third party, unless (x) in a PermittedTransfer, (y) with the prior approval of a special committee of the Boardof Directors or (z) all stockholders unaffiliated with Hallmark Cards willat Hallmark Card’s option be entitled to either participate in such transactionon the same terms as HCC or receive cash consideration equivalent in value tothe highest consideration per share of Common Stock received by HCC inconnection with such transaction.

 

*Subscription Rights:*    Exceptas otherwise set forth below, any time the Company proposes to issue equitysecurities of any kind, including any warrants, options or other rights toacquire equity securities and debt securities convertible into equity securities(“Proposed Securities”), the Company will:

 

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(i)      give written notice setting forth in reasonabledetail (w) the designation and all of the terms and provisions of theProposed Securities, including the voting powers, preferences and relativeparticipating, optional or other special rights, and the qualification,limitations or restrictions thereof and interest rate and maturity,(x) the price and other terms of the proposed sale of such securities,(y) the amount of such securities proposed to be issued, and (z) suchother information as HCC reasonably requests in order to evaluate the proposedissuance; and

 

(ii)     offer to issue to HCC or its affiliate a portion ofthe Proposed Securities equal to a percentage (the “Fully Diluted OwnershipPercentage”) determined by dividing (x) the number of shares owned by HCCand its affiliates immediately prior to the issuance of the Proposed Securitiesby (y) the total number of shares of Common Stock then outstanding,including for purposes of this calculation all shares outstanding on a fullydiluted basis.

 

Ifthe Proposed Securities are to be issued to employees of the Company or itsaffiliates as compensation with the approval of the Board of Directors (the “EmployeeProposed Securities”), the Company must comply with the following:

 

(i)      If the Employee Proposed Securities are shares ofcapital stock, subject to vesting or other similar conditions (“RestrictedStock”), then HCC and, if applicable, its affiliates have the right to purchasecapital stock of the same class as the Restricted Stock but which is notsubject to vesting or other similar conditions. HCC or its affiliates maypurchase up to the number of shares of capital stock equal to the number ofshares of Restricted Stock to be issued multiplied by a fraction, the numeratorof which is the Fully Diluted Ownership Percentage and the denominator of whichis 100% minus the Fully Diluted Ownership Percentage. The purchase price forsuch securities will be the fair market value of the Restricted Stock on thedate of issuance.

 

(ii)     If the Employee Proposed Securities are options toacquire capital stock of the Company, then the issuance of the ProposedSecurities will be deemed to occur upon the exercise of the options and notupon the issuance of the options, and HCC and, if applicable, its affiliates,will have the right to purchase, prior to the expiration of ten(10) business days after receipt of notice of such exercise from theCompany, capital stock of the same class as the underlying security. HCC or itsaffiliates may purchase up to the number of shares of capital stock equal tothe number of shares of the underlying security to be issued upon the exerciseof such Employee Proposed Securities multiplied by a fraction, the numerator ofwhich is the Fully Diluted Ownership Percentage and the denominator of which isthe quantity 100% minus the Fully Diluted Ownership Percentage. The issuanceprice will be deemed to be the fair market value of the underlying security onthe date of exercise and not the exercise price of the option or right.

 

Ifthe Proposed Securities are options or rights to acquire capital stock of theCompany but are not Employee Proposed Securities, then the issuance of theProposed Securities will be deemed to occur upon the exercise of the options orrights and not upon the issuance of the options or rights, and HCC and, ifapplicable, its affiliates have the right to purchase capital stock of the sameclass as the underlying security. HCC or its affiliates may purchase up to thenumber of shares of capital stock equal to the number of shares of theunderlying security to be issued upon the exercise of such Proposed Securitiesmultiplied by a fraction, the numerator of which is the Fully Diluted OwnershipPercentage and the denominator of which is the quantity 100% minus the FullyDiluted Ownership Percentage. The issuance price will be deemed to be the sumof the purchase price for such options or rights, plus any additionalconsideration paid upon exercise of such options or rights.

 

HCCand, if applicable, its affiliates, must exercise their purchase rights withinten (10) business days after receipt of such notice from the Company. Uponthe expiration of the offering period, the Company will be free to sell suchProposed Securities that HCC and its affiliates have not elected to purchaseduring the ninety (90) days following such expiration on terms and conditionsno more favorable to the purchasers thereof than those offered HCC and itsaffiliates.

 

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Themajority of the obligations of Hallmark Cards set forth in the StockholdersAgreement will terminate upon a payment default on the New Debt, subject to a60-day cure period. The Stockholders Agreement also terminates on the earliestof (i) such time as Hallmark Cards and its controlled affiliates cease tohold a majority of the Common Stock, (ii) such time as Hallmark Cards andits affiliates own all of the outstanding Common Stock and(iii) December 31, 2020.

 

*Inapplicability of Prior Stockholders Agreement:*    Asa result of the Mergers and the terms of the Stockholders Agreement, HallmarkCards will no longer be subject to the prior stockholders agreement with theCompany. The prior stockholders agreement among the Company and its largeststockholders set forth certain corporate governance rights, and limitations onthe Company’s ability, directly or indirectly, to enter into any materialcontracts or transactions with any affiliate of certain stockholders, includinga wholly-owned subsidiary of Hallmark Cards, unless certain conditions weremet.

 

***Registration Rights Agreement***

 

Inconnection with the Recapitalization, the Company, HCC and any priorstockholders of HEIC that execute a joinder are parties to a RegistrationRights Agreement (the “Registration Rights Agreement”) relating to the sharesof Common Stock (i) issued to HCC or any joined party in connection withthe Mergers, (ii) issuable to HCC upon conversion of the HCC Debt and uponconversion of the Preferred Stock, (iii) acquired by HCC pursuant to itssubscription rights as set forth in the Stockholders Agreement and(iv) issued as a dividend or other distribution with respect to, or inexchange for or in replacement of the shares of Common Stock referred to inclauses (i)—(iii) (the shares described in clauses (i)—(iv) collectively,the “Registrable Securities”). The Registration Rights Agreement grants(i) three (3) demand registration rights exercisable by the holdersof a majority of the Registrable Securities, (ii) three (3) resaleshelf demand rights exercisable by holders of a majority of the RegistrableSecurities and (iii) unlimited piggyback rights. The expenses of any ofthese registrations will be borne by the Company.

 

***Preferred Stock Terms***

 

Inconnection with the Recapitalization, the Company issued to HCC 185,000 sharesof Preferred Stock.  The terms of thePreferred Stock include the following:

 

*Dividends:*    Nodividends will accrue or be payable from the date of issue of the PreferredStock through December 31, 2010. Cumulative dividends will accrue from andafter January 1, 2011 through December 31, 2011 at the rate of 14%per annum of the Original Issue Price. The “Original Issue Price” is $1,000 pershare subject to adjustment in the event of any stock dividends, stock splits,stock distributions or combinations and other corporate actions having asimilar effect with respect to the Preferred Stock. Cumulative dividends willaccrue from and after January 1, 2012 at the rate of 16% per annum of theOriginal Issue Price. Until December 31, 2014, dividends are payable incash or in additional shares of Preferred Stock, at the option of the Company.After December 31, 2014, dividends on the Preferred Stock are payable incash only. The Preferred Stock will participate with the Common Stock as to anydeclared dividends on an “as converted” basis.

 

*Optional Conversion:*    Eachshare of Preferred Stock will become and remain convertible at the earlier ofDecember 31, 2013, or upon a payment or refinancing of the New Debt (a “Refinancing”)at the option of the holder into a share of Common Stock at the rate equal tothe Original Issue Price plus accrued and unpaid cash dividends with respect tosuch shares of Preferred Stock divided by the Preferred Conversion Price. “PreferredConversion Price” was $2.5969 as of the closing of the Recapitalization, whichprice is subject to adjustments for stock splits, combinations, dividends,mergers, recapitalizations and other corporate actions having a similar effectwith respect to the Preferred Stock and other adjustments as provided belowunder “Anti-Dilution Protection.”

 

*Anti-Dilution Protection:*    ThePreferred Conversion Price will be subject to adjustment for stock splits,combinations, dividends, mergers, recapitalizations and other corporate actionshaving a similar effect with respect to the Preferred Stock. The PreferredConversion Price will also be subject to adjustment on a full-ratchet basis inthe event that the Company issues additional shares (other Board approvedemployee options or shares in an acquisition, merger or joint venture) at apurchase price less than the prevailing Preferred Conversion Price.Full-ratchet basis means an adjustment of the Preferred Conversion Price to thelowest consideration paid per share for

 

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theadditional shares. Shares subject to options, other rights to acquire andconvertible securities are deemed issued at their then exercise or conversionprice.

 

*Mandatory Redemption:*    TheCompany must provide written notice (the “Excess Proceeds Notice”) to holdersof Preferred Stock, when and as the Company receives, upon a refinancing of theNew Debt, net proceeds from such refinancing in excess of the aggregateoutstanding principal and interest amounts of New Debt (the “Excess RefinancingProceeds”). Upon receipt of such notice, the holders of Preferred Stock mayelect to apply such Excess Refinancing Proceeds to redeem (to the extent offunds legally available for such redemption) at the Redemption Price a numberof the outstanding shares of Preferred Stock. The “Redemption Price” means aprice per share equal to the Original Issue Price, plus an amount equal to anyaccrued but unpaid cash dividends with respect to such share, together with anyother dividends declared but unpaid. If the Company receives any such requests,it must redeem on the twentieth day after delivery of the Excess ProceedsNotice, the number of outstanding shares of Preferred Stock set forth in allsuch notices received by the Company within fifteen days after delivery of theExcess Proceeds Notice. If the Excess Refinancing Proceeds are not sufficientto redeem all shares of Preferred Stock to be redeemed, the Company will redeema pro rata portion of redeemable shares based on the holders’ respectiveredemption requests.

 

*Optional Redemption:*    TheCompany will be able to redeem the Preferred Stock at any time, upon 10-dayswritten notice, at the Redemption Price.

 

*Voting Rights:*    ThePreferred Stock will vote together with the Common Stock as a single class,with the Preferred Stock voting on an “as converted” basis.

 

*Protective Provisions:*    Theconsent of holders of more than 50% of the Preferred Stock, voting as aseparate class, will be required to approve certain actions, including withoutlimitation:

 

(i)      Any authorization, offer, sale or issuance of anyequity securities pari passu or senior in right of liquidation, dividends orotherwise to the Preferred Stock or any additional shares of Preferred Stock.

 

(ii)     Repurchase or redemption of equity securities (otherthan from an employee following termination), or declaration or payment of anydividend on the Common Stock.

 

(iii)    Any sale, merger, liquidationor dissolution of the Company.

 

(iv)    Any significant acquisitions involving the payment,contribution or assignment by or to the Company or its subsidiaries of money orassets greater than $5,000,000.

 

(v)     Any action that adversely alters or changes therights, preferences or privileges of the Preferred Stock.

 

(vi)    The issuance of any additional shares of CommonStock (other than pursuant to options outstanding on the Closing Date) oroptions or rights to acquire Common Stock.

 

(vii)   Except for certain indebtedness, liens andguaranties permitted by the Credit Agreement, authorization or issuance of anydebt security unless the debt security has received the prior approval of theBoard of Directors, or amendment of the terms of any agreement regarding materialindebtedness of the Company, unless the amendment has been approved by theBoard of Directors.

 

*Liquidation Preference:*    Inthe event of any liquidation or winding up of the Company, the holders of thePreferred Stock will be entitled to receive, in preference to the holders ofthe Common Stock, an amount equal to the greater of (x) the Original IssuePrice per share plus accrued but unpaid cash dividends thereon, or(y) that amount that would be received by such holders on an “as converted”basis had all Preferred Stock been converted into Common Stock immediatelyprior to such liquidation or winding up. A consolidation, merger or other formof acquisition of the Company or a sale of all or substantially all of itsassets will be deemed to be a liquidation or winding up for purposes of theliquidation preference.

 

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***Tax Sharing Agreement***

 

Inconnection with the Recapitalization, thetax sharing agreement was amended, effective as ofJanuary 1, 2010. The amendment provides, among other things, that:

 

·              Hallmark Cards will not pay any Crown Tax Benefits(defined in the tax sharing agreement) in cash and instead willcarry forward any such amounts to offset future Crown Tax Liability (defined inthe tax sharing agreement);

 

·              the Company is allowed to deduct both cash-payand pay-in-kind, or PIK, interest due to Hallmark Cards in calculatingtax-sharing payments;

 

·              the conversion of the HCC Debt pursuant to theRecapitalization is not deemed the payment of interest expense to HallmarkCards;

 

·              cancellation of indebtedness income resulting fromthe Recapitalization will be excluded from the calculation of tax sharingpayments for the 2010 tax year; and

 

·              any amounts related to taxes owed to Hallmark Cardsprior to December 31, 2009, was included in the HCC Debt.

 

**Selected Historical ConsolidatedFinancial Data of Crown Media Holdings**

 

In the table below, we provide selected historicalcondensed consolidated financial and other data of Crown Media Holdings and itssubsidiaries. The following selected condensed consolidated statement ofoperations data for three and six months ended June 30, 2009 and 2010, arederived from the unaudited financial statements of Crown Media Holdings and itssubsidiaries. Ratings and subscriber information also are unaudited. This datashould be read together with the condensed consolidated financial statementsand related notes included elsewhere in this Form 10-Q.

 
| ** **                                        | ** ** | **Three Months Ended June 30,** | ** ** | **Percent** | ** ** | **Six Months Ended June 30,** | ** ** | **Percent** | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|-------------|------------|------------------------------------|------------|-------------|------------|
| ** **                                        | ** ** | **2009**                             | ** ** | **2010**    | ** ** | **Change**                         | ** ** | **2009**    | ** ** | **2010** | ** ** | **Change** | ** ** |
| Revenues:                                         |       |                                 |       |        |       |                               |       |        |       |   |   |   |   |
| Subscriber fees                                   |       | $                                    | 15,860     |        | $          | 15,872                             |       | 0           | %          | $ | 31,155 |   | $ | 32,866 |   | 5 | % |
| Advertising                                       |       | 51,921                               |       | 49,826      |       | -4                                 | %          | 107,215     |       | 101,136 |   | -6 | % |
| Sublicense fees and other revenue                 |       | 401                                  |       | 11          |       | -97                                | %          | 764         |       | 85 |   | -89 | % |
| Total revenues                                    |       | 68,182                               |       | 65,709      |       | -4                                 | %          | 139,134     |       | 134,087 |   | -4 | % |
| Cost of Services:                                 |       |                                 |       |        |       |                               |       |        |       |   |   |   |   |
| Programming costs                                 |       | 31,301                               |       | 30,214      |       | -3                                 | %          | 63,516      |       | 59,371 |   | -7 | % |
| Operating costs                                   |       | 4,488                                |       | 2,713       |       | -40                                | %          | 8,500       |       | 5,410 |   | -36 | % |
| Total cost of services                            |       | 35,789                               |       | 32,927      |       | -8                                 | %          | 72,016      |       | 64,781 |   | -10 | % |
| Selling, general and administrative expense       |       | 11,195                               |       | 12,642      |       | 13                                 | %          | 23,759      |       | 25,053 |   | 5 | % |
| Marketing expense                                 |       | 842                                  |       | 464         |       | -45                                | %          | 5,617       |       | 1,437 |   | -74 | % |
| Loss from sale of film assets                     |       | —                               |       | 155         |       | 100                                | %          | —      |       | 155 |   | 100 | % |
| Income before interest and income tax expense     |       | 20,356                               |       | 19,521      |       | -4                                 | %          | 37,742      |       | 42,661 |   | 13 | % |
| Interest expense                                  |       | (25,678                              | )          | (25,606     | )          | 0                                  | %          | (50,515     | )          | (51,070 | ) | 1 | % |
| Income tax expense                                |       | —                               |       | (2,897      | )          | 100                                | %          | —      |       | (2,897 | ) | 100 | % |
| Net loss                                          |       | $                                    | (5,322     | )           | $          | (8,982                             | )          | 69          | %          | $ | (12,773 | ) | $ | (11,306 | ) | -11 | % |
|                                              |       |                                 |       |        |       |                               |       |        |       |   |   |   |   |
| **Other Data:**                                   |       |                                 |       |        |       |                               |       |        |       |   |   |   |   |
| Net cash provided by operating activities         |       | $                                    | 13,767     |        | $          | 21,017                             |       | 53          | %          | $ | 13,382 |   | $ | 28,788 |   | 115 | % |
| Net cash used in investing activities             |       | $                                    | (344       | )           | $          | (715                               | )          | 108         | %          | $ | (648 | ) | $ | (1,112 | ) | 72 | % |
| Net cash used in financing activities             |       | $                                    | (11,905    | )           | $          | (18,725                            | )          | 57          | %          | $ | (8,644 | ) | $ | (19,940 | ) | 131 | % |
| Total domestic day household ratings (1)(3)       |       | 0.541                                |       | 0.392       |       | -28                                | %          | 0.588       |       | 0.445 |   | -24 | % |
| Total domestic primetime household ratings (2)(3) |       | 0.871                                |       | 0.662       |       | -24                                | %          | 1.016       |       | 0.738 |   | -27 | % |
| Subscribers at period end                         |       | 86,228                               |       | 89,780      |       | 4                                  | %          | 86,228      |       | 89,780 |   | 4 | % |

 

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

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

(3)  These Nielsen ratings are for the time period April 1through June 30 and January 1 through June 30.

 

***Results of Operations***

 

*Three Months Ended June 30,2009, Compared to Three Months Ended June 30, 2010*

 

*Revenue. *Our revenue, comprised primarily of subscriber andadvertising fees, decreased $2.5 million or 3% in 2010 over 2009. Our subscriber fee revenue remained constant.  The amount of subscriber acquisition fees that was recorded as a reduction ofsubscriber fee revenue was approximately $651,000 and $526,000 for 2009 and2010, respectively. The increase in subscriber revenue due to smallcontractual rate increases and significant growth in Hallmark Movie Channelsubscribers was wholly offset by theaccounting treatment of subscriber revenue for one multiple systems operator.

 

The $2.1 million or 4% decrease in advertising revenueis primarily due to declines in viewer ratings across demographiccategories for 2010 compared to 2009. The ratings decline reduced the revenuefrom all inventory, including inventory used to satisfy deficiencies inaudience delivery.  Audience deficiencyunit revenue decreased $3.9 million from contra-revenue of $3.0 million for2009, to contra-revenue of $6.9 million for the same period in 2010 as a resultof such ratings declines, leading to a corresponding decrease in revenuerecognized by the Company. CPM rates in the second quarter of 2010 increased byapproximately 5% over the same period of 2009, thereby increasingrevenues.  However, the increase in CPMrates was more than offset by the decline in ratings which reduced the value ofthe Company’s inventory.

 

Webelieve that changes to our program schedule in 2009 and through the secondquarter of 2010, along with increased competition (including the availabilityof high definition distribution by competitors), contributed to a decline inratings on the Hallmark Channel. From 2005 until early 2009, our programmingschedule did not change significantly. Beginning in 2008, a number of programsthat had previously received strong ratings began to experience ratingsdeclines, and we placed television series in certain timeslots instead ofmovies or original productions.  Also, anumber of programs in the schedule provided strong household ratingsperformance but less effective delivery of our key demographic, women age 25-54.  In 2009, we began to introduce new contentinto the schedule with the objective of increasing the delivery of women25-54.  The schedule changes likelyresulted in some viewer confusion, resulting in lower ratings.  We will continue to focus on programacquisitions, original program production and schedule changes that areintended to improve both the viewer ratings and the demographic delivery of theHallmark Channel.

 

Thefact that Hallmark Channel was not broadcast in high definition may have had anegative impact on ratings in 2009.  Of thetop 44 advertising supported cable networks with a 0.4 household rating orhigher in prime time, only six of those networks (including Hallmark Channel)were not offered in high definition.  Ofthose six networks, three experienced double-digit ratings decreases in 2009compared to 2008 and three experienced single digit increases.  In 2009, 33% of viewers with access to highdefinition programming services tuned to those high definition services first.  The growth in popularity of high definitionprogramming is expected to continue in 2010

 

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andbeyond, and these high definition trends were part of our decision to launchHallmark Channel in high definition in February 2010.

 

In2009, competition within the cable television industry increasedsignificantly.  The number of cablenetworks investing in original programming increased 74% in 2009 compared to2008, and, for the full year 2009, acquired (non-original) programmingrepresented only 33% of prime time cable programming. The increase in cablenetworks’ investment in original programming continues in 2010, and we believeit continues to negatively impact our ratings. Although Hallmark Channel continues to invest in original programming,our increase in investment for original content did not match the growth of themarket or many of our competitors.  Theimpact of the programming competition is heightened by the continued growth oftime-shifting digital video recording devices, or DVR’s. With the proliferationof these devices, viewers are able to increase their access to the new,compelling content.

 

Forthe three months ended June 30, 2010, Nielsen ranked the Hallmark Channel23rd in total day viewership with a 0.392 householdrating and 23rd in primetime with a 0.662 household ratingamong the 78 cable channels in the United States market.

 

*Cost of services.*Cost of services as a percent of revenue decreased to 50% in 2010 ascompared to 52% in 2009. This decrease results primarily from the effects ofthe 3% decrease in programming costs, discussed below, offset in part by the 4%decrease in advertising revenue discussed above.

 

Programmingcosts decreased $1.1 million or 3% from 2009. During 2009 and through thesecond quarter of 2010, except for Martha Stewart programming, we did not enterinto any significant new third party license agreements. As a result, expiringprogram rights and the related amortization were not replaced in full withassets and amortization from newer license agreements. At this time, we do notexpect significant program acquisitions for the rest of 2010.

 

Operatingcosts for 2010 decreased $1.8million over 2009. The Company’s bad debt expense was $271,000 for 2009, ascompared to $6,000 for 2010.  Thedecrease in bad debt expense is primarily due to certain advertising customersexperiencing cash flow problems under generally poor economic conditions during2009 and being unable to make timely payments. Additionally, salary andseverance expense decreased $1.1 million due to terminations of employment andtransponder and uplink expense decreased $364,000 due to contract termination.

 

Wemay incur additional costs subsequent to June 30, 2010, to obtain highdefinition versions of certain of our programming.

 

*Selling, general andadministrative expense.* Ourselling, general and administrative expense for 2010 increased $1.5 millionover 2009. Salary and severance expense decreased $3.4 million primarily due toterminations of employment in 2009. Additionally, commission expense increased$592,000 due to meeting quarterly advertising revenue expectations. Researchexpense increased $1.3 million due to the receipt of ratings for the Hallmark MovieChannel. Benefits expense increased $1.6 million due to an increase in bonusexpense and an increase in insurance premiums.  Additionally, the Company recorded $1.0 million of debt issuance costsin conjunction with the Recapitalization.

 

*Marketing expense*.  Ourmarketing expense decreased 45% in the second quarter of 2010 versus the secondquarter of 2009. The Company decreased its marketing spend in 2010 in part dueto lower than expected advertising revenue and planned 2010 cost cutting measures,but is also waiting to allocate marketing resources towards the third quarterlaunch of the Martha Stewart programming. Marketing expenses are expected toincrease during the third quarter of 2010 to promote the Hallmark Channel’sprogramming schedule, including the recently acquired Martha Stewart Livingproductions.

 

*Loss from sale of film assets*. In June 2010, the Company concluded that payments for residualsand participations, which are liabilities from the Company’s December 2006sale of its film assets, would occur generally sooner than originally estimatedin December 2006 and December 2009 based upon a request for paymentreceived in July 2010.  Accordingly,the Company increased the carrying amount of the liability by $155,000 and

 

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recognized a corresponding loss from sale of film assetsin the accompanying statement of operations.

 

*Interest expense. *Interestexpense remained constant period over period.  The principal balance under our credit facility was $20.3 million atJune 30, 2009, and $0 at June 30, 2010. Interest rates on our 2001, 2005 and2006 notes decreased from 6.19% at June 30, 2009, to 5.29% at June 29, 2010.The benefit of these rate decreases was offset by a higher principal balance onthe Senior Secured Note, resulting in interest expense for 2010 being nearlythe same as for 2009.

 

*Income tax expense*. For tax purposes, theRecapitalization generated cancellation of debt income which is currentlyestimated at approximately $200.0 million. Accordingly, the Company is expected to generate federal and statetaxable income for both regular tax and alternative minimum tax (“AMT”)purposes.  For regular tax purposes, thisincome will be fully offset by net operating loss carryforwards.  However, for federal AMT purposes, losscarryforwards can be used against AMT income but are limited to 90% of AMTincome.  As a result, the Company hasrecorded an income tax expense of $2.9 million for the estimated AMT in itsconsolidated statements of operations as it is not likely that any benefit ofthis AMT as a credit carryforward will be realized.

 

*Six Months Ended June 30, 2009,Compared to Six Months Ended June 30, 2010*

 

*Revenue. *Our revenue, comprised primarily of subscriber andadvertising fees, decreased $5.1 million or 4% in 2010 over 2009. Our subscriber fee revenue increased $1.7 million or 5%.  The amount of subscriber acquisition fees that was recorded as a reduction ofsubscriber fee revenue was approximately $1.3 million and $1.1 million for 2009and 2010, respectively. Subscriber revenue increased in 2010 primarily due to smallcontractual rate increases and significant growth in Hallmark Movie Channelsubscribers.

 

The $6.1 million or 6% decrease in advertising revenueis primarily due to declines in viewer ratings across demographiccategories for 2010 compared to 2009. For the six months ended June 30, 2010,Nielsen ranked the Hallmark Channel 24th in total dayviewership with a 0.445 household rating and 23rd in primetimewith a 0.738 household rating among the 78 cable channels in the United Statesmarket. The ratings decline reduced the revenue from all inventory, includinginventory used to satisfy deficiencies in audience delivery.  Audience deficiency unit revenue decreased$6.4 million from contra-revenue of $4.9 million for 2009, to contra-revenue of$11.2 million for the same period in 2010 as a result of such ratings declines,leading to a corresponding decrease in revenue recognized by the Company.

 

*Cost of services.*Cost of services as a percent of revenue decreased to 48% in 2010 ascompared to 52% in 2009. This decrease results primarily from the effects ofthe $4.1 million or 7% decrease in programming costs, discussed below, offsetin part by the 6% decrease in advertising revenue discussed above.

 

Operatingcosts for 2010 decreased $3.1million over 2009 due in part to the $861,000 decrease in bad debt expense. TheCompany’s bad debt expense was $893,000 for 2009, as compared to $32,000 for2010.  The decrease in bad debt expenseis primarily due to certain advertising customers experiencing cash flowproblems under generally poor economic conditions during 2009 and being unableto make timely payments. Additionally, salary and termination expense decreased$1.3 million and playback and transponder expense decreased $630,000 due toterminations of employment and standard definition provider contracts in 2009.

 

*Selling, general and administrative expense.* Our selling, general and administrativeexpense for 2010 increased $1.5 million over 2009.  Salary and severance expense decreased $3.8million primarily due to terminations of employment in 2009. Additionally,commission expense increased $390,000 due to meeting quarterly advertisingrevenue expectations. Research expense increased $1.4 million due to thereceipt of ratings for the Hallmark Movie Channel. Benefits expense increased$2.2 million due to an increase in bonus expense and an increase in insurancepremiums.   Additionally, the Companyrecorded $1.0 million of debt issuance costs in conjunction with theRecapitalization.

 

*Marketing expense*.  Our marketing expense decreased74% in 2010 versus 2009. During 2009, the Company had one significant marketingpromotion in January 2009 centered on the original movie, “Taking a Chance onLove.” The Company did not have a significant marketing promotion in the firstquarter of 2010.

 

*Interest expense. *Interestexpense remained constant period over period.

 

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**Liquidity and Capital Resources**

 

During the six months ended June 30, 2009, our cashprovided by operating activities was $13.4 million as compared to $28.8 millionfor the six months ended June 30, 2010.**The Company’s net loss for the six months ended June 30, 2010, decreased$1.5 million to $11.3 million from $12.8 million for the six months ended June30, 2009. Our depreciation and amortization expense for the six months endedJune 30, 2010 decreased $4.3 million to $62.0 million from $66.3 million in2009.  The Company made programmingpayments of $73.2 million and $67.8 million during the six months ended June30, 2009 and 2010, respectively.

 

Cash used in investing activities was $648,000 and $1.1million during the six months ended June 30, 2009 and 2010, respectively.During the six months ended June 30, 2009 and 2010, we purchased property andequipment of $194,000 and $600,000, respectively. During the six months endedJune 30, 2009 and 2010, the Company paid $454,000 and $512,000, respectively,to the buyer of the international business for amounts due under the terms ofthe sale agreement, primarily for reimbursement of transponder lease payments.The related liability was recognized in 2005 as part of the sale of ourinternational business.

 

Cash used in financing activities was $8.6 million and$19.9 million for the six months ended June 30, 2009 and 2010. We borrowed$18.1 million and $0 under our credit facility to supplement the cashrequirements of our operating and investing activities during the six monthsended June 30, 2009 and 2010, respectively. We repaid principal of $26.3million and $1.0 million under our bank credit facility during the six monthsended June 30, 2009 and 2010, respectively. Also, during the second quarter of 2010, pursuant to provisions of theRecapitalization, the Company sequestered $15.0 million, which is nowrestricted to the payment of the NICC preferred interest on or before December31, 2010.  The Company has since beenable to increase the amount of these restricted funds to $20.0 million at July31, 2010.

 

TheCompany expects to make a cash payment for amounts due through third quarter of2010 on December 15, 2010, for tax liabilities incurred under the tax sharingagreement as amended. The Company may also have to make cash payments toHallmark Cards during 2011 under the amended tax sharing agreement.

 

*Cash Flows*

 

Asof June 30, 2010, the Company had $18.2 million in cash and cash equivalents onhand.  Also available to the Company wasthe full $30.0 million bank credit facility which expires June 30, 2011.  Day-to-day cash disbursement requirementshave typically been satisfied with cash on hand and operating cash receiptssupplemented with the borrowing capacity available under the bank creditfacility and, prior to the Recapitalization, forbearance by Hallmark Cards andits affiliates.

 

TheCompany’s management anticipates that the principal uses of cash during thetwelve month period ending June 30, 2011, will include the payment of operatingexpenses, accounts payable and accrued expenses, programming costs, andinterest of approximately $30.0 million to $35.0 million due under the New Debtissued in the Recapitalization.  Subjectto the legal availability of funds and approval by the Company’s board ofdirectors, the Company may also pay approximately $13.0 million for cashdividends on Preferred Stock during the six months ending June 30, 2011; at theoption of the Company’s board of directors, such dividends, if any, may be paidin the form of additional shares of Preferred Stock.

 

Increasesin the Company’s audience deficiency liability during the six month periodsended June 30, 2009, and June 30, 2010, contributed $4.9 million and $11.1million, respectively, to cash flows from operating activities (reflected aspart of the changes in accounts payable, accrued and other liabilities in theaccompanying condensed consolidated statements of cash flows included in Part Iof this report).  At June 30, 2010, theCompany’s audience deficiency liability was $29.0 million, an amount equivalentto 13.0% of advertising revenue for the year ended December 31, 2009.  Settlement of any portion of this liabilitywill not require the direct use of cash because it is the Company’s policy tosettle in kind.  However, such settlement

 

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requiresthe use of advertising spots that otherwise may be sold for cash.  Accordingly, any decrease in this liabilitywill indirectly require the use of cash with little or no corresponding effecton reported advertising revenue.

 

AtJune 30, 2010, the Company also had an additional $15.0 million of cash, theuse of which is restricted to payment of the $25.0 million company obligated,mandatorily redeemable preferred interest on December 31, 2010.  As of July 31, 2010, the Company hadincreased such restricted cash to $20.0 million.  The Company believes that it will be able tofund all, or substantially all, of the remaining $5.0 million with cashprovided by operating activities.

 

**RiskFactors and Forward-Looking Statements**

 

The discussion set forth inthis Form 10-Q contains statements concerning potential future events. Suchforward-looking statements are based on assumptions by Crown Media 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 differ materially from those anticipated by suchforward-looking statements.

 

Among the factors that couldcause actual results to differ materially are those discussed in this Reportbelow and in the Company’s filings with the Securities and Exchange Commission,including the Risk Factors stated in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2009, and this Report. Such Risk Factorsinclude, but are not limited to, the following: competition for distribution of channels, viewers, advertisers and theacquisition of programming; fluctuations in the availability of programming;fluctuations in demand for programming which we air on our channels; ourability to address our liquidity needs; our incurrence of losses; and oursubstantial indebtedness affecting our financial condition and results.

 

**Available Information**

 

**We will make available free of chargethrough our website, www.hallmarkchannel.com, the 2009 Annual Report on Form10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, andamendments 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 of Business Conduct and Ethics,which is applicable to all of our employees, including our senior financialofficers. Requests for a copy of this code should be addressed to the GeneralCounsel at 12700 Ventura Boulevard, Studio City, California  91604.**

 

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

 

We only invest in instruments that meet high credit andquality standards, as specified in our investment policy guidelines. Theseinstruments, like all fixed income instruments, are subject to interest raterisk. The fixed income portfolio will decline in value if interest ratesincrease. If market interest rates were to increase immediately and uniformlyby 10% from levels as of June 30, 2010, the decline of the fair value of thefixed income portfolio would not be material.

 

As of June 30, 2010, our cash, cash equivalents andshort-term investments had a fair value of $33.2 million (including restrictedcash) and were invested in cash and short-term commercial paper. The primarypurpose of these investing activities has been to preserve principal until thecash is required to fund operations and to fund the $25.0 mandatorilyredeemable preferred interest amount payable in December 2010. Consequently,the size of this

 

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portfolio fluctuates significantly as cash is providedby and used in our business.

 

The value of certain investments in this portfolio canbe impacted by the risk of adverse changes in securities and economic marketsand interest rate fluctuations. For the three and six  months ended June 30, 2010, the impact ofinterest rate fluctuations, changed business prospects and all other factorsdid not have a material impact on the fair value of this portfolio, or on ourincome derived from this portfolio.

 

We have not used derivative financial instruments forspeculative purposes. As of June 30, 2010, we are not hedged or otherwiseprotected against risks associated with any of our investing or financingactivities.

 

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

 

We are exposed to market risk, including changes tointerest rates. To reduce the volatility relating to these exposures, we mayenter into various derivative investment transactions in the near term pursuantto our investment and risk management policies and procedures in areas such ashedging and counterparty exposure practices. We have not used derivatives forspeculative purposes.

 

If we use risk management control policies, there willbe inherent risks that may only be partially offset by our hedging programsshould there be any unfavorable movements in interest rates or equityinvestment prices.

 

Theestimated exposure discussed below is intended to measure the maximum amount wecould lose from adverse market movements in interest rates and equityinvestment prices, given a specified confidence level, over a given period oftime.  Loss is defined in the value atrisk estimation as fair market value loss.

 

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

 

Our material interest bearing assets consisted of cashequivalents and short-term investments. The balance of our interest bearingassets was $33.2 million (including restricted cash), or 5% of total assets, asof June 30, 2010. Our material liabilities subject to interest rate riskconsisted of our bank credit facility, our old note and interest payable toHCC, and our old notes and interest payable to HCC. The balance of thoseliabilities was $0, or 0% of total liabilities, as of June 30, 2010. Netinterest expense for the three and six months ended June 30, 2010, was $25.6million, or 39%, and $51.1 million, or 38%, of our total revenue, respectively.Our net interest expense for these liabilities is sensitive to changes in thegeneral level of interest rates, primarily U.S. and LIBOR interest rates. Inthis regard, changes in U.S. and LIBOR (“Eurodollar”) interest rates affect thefair value of interest bearing liabilities.

 

If market interest rates were to increase or decrease by1% from the rates discussed in Notes 4 and 5 to the financial statements as ofJune 30, 2010, our interest expense for the three and six months would changeby $852,000 and $1.7 million, respectively. See Notes 4 and 5 to the UnauditedCondensed Consolidated Financial Statements contained in Part I, Item 1 above.

 

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

 

***a.  Disclosure Controls andProcedures***

 

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

 

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***b.  Changes in Internal Controlover Financial Reporting***

 

Therewas no change in the Company’s internal control over financial reporting thatoccurred during the quarter ended June 30, 2010, that materially affected, orwas reasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**PART II.  OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

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

 

**Item 1A.  Risk Factors**

 

***Changes inprogramming may cause temporary or long-term ratings declines.***

 

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

 

We anticipate making changes to our programming.  These program changes may result at leastinitially in reductions in the ratings delivery of the Channel, but our plan isthat, over time, these changes will increase our revenue through the deliveryof a more targeted demographic and attraction of higher CPM advertisers.  We must successfully implement theprogramming changes with an increase in ratings, which is uncertain, orotherwise address the decrease in ratings in order to maintain or increase ouradvertising revenues, to maintain subscriber fees and to maintain or improveour cash flow from operations.

 

**Item 5.  Other Information**

 

On August 10, 2010, the Company appointed MichaelHarmon, age 48, as interim Chief Financial Officer of the Company, effectiveAugust 23, 2010.  Mr. Harmon has served as Vice President and Controllerof the Company since March 2003.  Mr. Harmon was Controller of the Companyfrom June 2000 to March 2003 and, prior to that, Director from January 1997 toJune 2000.

 

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**Item 6.  *Exhibits***

 

**INDEX TO EXHIBITS**

 
| **Exhibit Number** | ** ** | **Exhibit Title**                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|--------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.4                |       | Agreement  and Plan of Merger of Crown Media Holdings, Inc. and Hallmark Entertainment  Investments Co., dated as of February 26, 2010 (previously filed as an  exhibit to our Schedule 14C Information Statement filed on May 21, 2010 and  incorporated herein by reference).                                                                                                                                                                                            |
| 2.5                |       | Agreement  and Plan of Merger of Crown Media Holdings, Inc. and Hallmark Entertainment  Holdings, Inc., dated as of February 26, 2010 (previously filed as an exhibit  to our Schedule 14C Information Statement filed on May 21, 2010 and  incorporated herein by reference).                                                                                                                                                                                             |
| 3.1                |       | Amended and Restated Certificate of Incorporation  (previously filed as Exhibit 3.1 to our Registration Statement on Form S-1/A  (Amendment No. 2), Commission File No. 333-95573, and incorporated herein by  reference).                                                                                                                                                                                                                                                 |
| 3.2                |       | Amendment to the Amended and Restated Certificate of  Incorporation (previously filed as Exhibit 3.2 to our Quarterly Report on  Form 10-Q filed on July 31, 2001 (File No. 000-30700; Film No. 1693331) and  incorporated herein by reference).                                                                                                                                                                                                                           |
| 3.3                |       | Amended and Restated By-Laws (previously filed as  Exhibit 3.2 to our Registration Statement on Form S-1/A (Amendment No. 3),  Commission File No. 333-95573, and incorporated herein by reference).                                                                                                                                                                                                                                                                       |
| 3.4                |       | Second  Amended and Restated Certificate of Incorporation of Crown Media Holdings  (previously filed as an exhibit to our Schedule 14C Information Statement  filed on May 21, 2010 and incorporated herein by reference).                                                                                                                                                                                                                                                 |
| 3.5                |       | Certificate  of Designation, Powers, Preferences, Qualifications, Limitations,  Restrictions and Relative Rights of Series A Convertible Preferred Stock of  Crown Media Holdings, Inc. (previously filed as an exhibit to our Schedule  14C Information Statement filed on May 21, 2010 and incorporated herein by  reference).                                                                                                                                           |
| 3.6                |       | Proposed  form of Third Amended and Restated Certificate of Incorporation of Crown  Media Holdings, Inc. (previously filed as Exhibit 3.3 to our Current  Report on Form 8-K filed on March 1, 2010 and incorporated herein by  reference).                                                                                                                                                                                                                           |
| 10.1               |       | Amendment No. 16, dated as of March 2, 2010, to  the Credit, Security, Guaranty and Pledge Agreement, dated as of August 31, 2001  among Crown Media Holdings, Inc. as Borrower, the Guarantors named therein,  and JP Morgan Chase Bank as Administrative Agent and as Issuing Bank (previously  filed as Exhibit 10.26 to our Annual Report on Form 10-K filed on March  4, 2010 and incorporated herein by reference).                                        |
| 10.2               |       | Amendment No. 17, dated as of June 29, 2010, to  the Credit, Security, Guaranty and Pledge Agreement, dated as of August 31,  2001 among Crown Media Holdings, Inc. as Borrower, the Guarantors named  therein, and JP Morgan Chase Bank as Administrative Agent and as Issuing  Bank.                                                                                                                                                                                |
| 10.3               |       | Waiver to the Trademark License Extension Agreement  (Hallmark Channel and Hallmark Movie Channel) dated March 3, 2010, by and  between Hallmark Licensing Inc. and Crown Media United States, LLC (previously  filed as Exhibit 10.46 to our Annual Report on Form 10-K filed on March  4, 2010 and incorporated herein by reference).                                                                                                                               |
| 10.4               |       | Intercompany Services Extension Agreement, dated as of  January 1, 2010, by and between Hallmark Cards, Incorporated and Crown Media  Holdings, Inc. (previously filed as Exhibit 10.58 to our  Annual Report on Form 10-K filed on March 4, 2010 and incorporated herein by  reference).                                                                                                                                                                             |
| 10.5               |       | Master Recapitalization Agreement by and among Hallmark  Cards, Incorporated, H C Crown Corp., Hallmark Entertainment Holdings, Inc.,  Crown Media Holdings, Inc., Crown Media United States, LLC, and The  Subsidiaries of Crown Media Holdings, Inc. Listed as Guarantors on the Credit  Facility, dated as of February 26, 2010 (previously filed as an exhibit to  our Schedule 14C Information Statement filed on May 21, 2010 and incorporated herein by reference). |
| 10.6               |       | Credit Agreement, dated June 29, 2010, Among Crown  Media Holdings, Inc. as Borrower and HC Crown Corp., as Lender and Each of  the Credit Parties Identified on the Signature Pages                                                                                                                                                                                                                                                                                       |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |

 

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|   |   | Hereto (previously filed as an exhibit to our Schedule  14C Information Statement filed on May 21, 2010 and  incorporated herein by reference).                                                                                                                                              |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.7   |   | Stockholders Agreement, dated June 29, 2010, by and  among H C Crown Corp., Hallmark Cards, Incorporated and Crown Media Holdings,  Inc. (previously filed as an exhibit to our Schedule 14C Information  Statement filed on May 21, 2010 and  incorporated herein by reference).            |
| 10.8   |   | Registration Rights Agreement, dated June 29, 2010,  among H C Crown Corp., any Other HEIC Stockholder and Crown Media Holdings,  Inc. (previously filed as an exhibit to our Schedule 14C Information  Statement filed on May 21, 2010 and  incorporated herein by reference).              |
| 10.9   |   | Amendment No. 2 to Federal Income Tax Sharing  Agreement, dated June 29, 2010, between Hallmark Cards, Incorporated and  Crown Media Holdings, Inc. (previously filed as an exhibit to our Schedule  14C Information Statement filed on May 21, 2010 and  incorporated herein by reference). |
| 10.10  |   | Amendment by letter dated March 19, 2010 to Master  Recapitalization Agreement.                                                                                                                                                                                                              |
| 10.11  |   | Security Agreement, dated June 29, 2010, between the  Company and HCC.                                                                                                                                                                                                                       |
| 10.12  |   | Pledge Agreement, dated June 29, 2010, between the  Company and HCC.                                                                                                                                                                                                                         |
| 10.13  |   | Trademark  License Extension Agreement (Hallmark Channel) dated June 29, 2010 by and  between Hallmark Licensing Inc. and Crown Media United States, LLC.                                                                                                                                    |
| 10.14  |   | Trademark  License Extension Agreement (Hallmark Movie Channel) dated June 29, 2010 by  and between Hallmark Licensing Inc. and Crown Media United States, LLC.                                                                                                                              |
| 31.1   |   | Rule  13a-14(a) Certification executed by the Company’s Chief Executive Officer.                                                                                                                                                                                                        |
| 31.2   |   | Rule  13a-14(a) Certification executed by the Company’s Executive Vice President  and Chief Financial Officer.                                                                                                                                                                          |
| 32     |   | Section  1350 Certifications.                                                                                                                                                                                                                                                                |

 

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*Management contract 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  MEDIA HOLDINGS, INC. |                  |      |                         |
|------------|-----------------------------|-----------------------|-----------|------------------------------|
|       |                        |                  |      |                         |
| ** ** | **Signature**               | ** **            | **Title** | ** **                   | **Date** | ** ** |
|       |                        |                  |      |                         |   |   |
|       | By:                         | /s/ WILLIAM J. ABBOTT |      | Principal Executive  Officer |   | August 12, 2010 |   |
|       |                        |                  |      |                         |   |   |   |
|       |                        | William J. Abbott     |      |                         |   |   |   |
|       |                        |                  |      |                         |   |   |
|       | By:                         | /s/ BRIAN C. STEWART  |      | Principal  Financial and     |   | August 12, 2010 |   |
|       |                        |                  |      | Accounting Officer           |   |   |   |
|       |                        | Brian C. Stewart      |      |                         |   |   |   |

 

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