UNITED
STATES SECURITIES AND EXCHANGE COMMISSION





Washington,
D.C. 20549





Form
10-Q





(Mark
One)


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


OF
THE SECURITIES EXCHANGE ACT OF 1934





For
the quarterly period ended September 30, 2009





or





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


OF
THE SECURITIES EXCHANGE ACT OF 1934





For
the transition period
from                    to                    .





Commission
File Number: 000-30700





Crown
Media Holdings, Inc.


(Exact
Name of Registrant as Specified in Its Charter)





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





12700
Ventura Boulevard,


Suite
200


Studio
City, California  91604


(Address
of Principal Executive Offices and Zip Code)





(818)
755-2400


(Registrant’s
Telephone Number, Including Area Code)





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


if
Changed Since Last Report.)





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





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





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


Large
      accelerated filer [  ]
            Accelerated
      filer [ X ]





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








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





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














TABLE
OF CONTENTS





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








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




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







PART
I. FINANCIAL INFORMATION





Item
1.  Financial
Statements (Unaudited)








CROWN
MEDIA HOLDINGS, INC. AND SUBSIDIARIES


UNAUDITED
CONDENSED CONSOLIDATED BALANCE SHEETS


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





As
      of December 31, 2008
                
                
                As
      of September 30,
                  2009ASSETSCash
      and cash
      equivalents
                
                $
                2,714
                
                
                $
                8,359Accounts
      receivable, less allowance for doubtful accounts of
                  $294
      and $322,
      respectively
                
                
                66,510
                
                
                
                57,488Program
      license
      fees
                
                
                105,936
                
                
                
                110,051Prepaid
      and other
      assets
                
                
                11,722
                
                
                
                6,821Total
      current
      assets
                
                
                186,882
                
                
                
                182,719Program
      license
      fees
                
                
                214,207
                
                
                
                194,726Property
      and equipment,
      net
                
                
                15,392
                
                
                
                13,689Goodwill
                
                
                314,033
                
                
                
                314,033Prepaid
      and other
      assets
                
                
                8,831
                
                
                
                6,106Total
      assets
                
                $
                739,345
                
                
                $
                711,273
































See accompanying notes to unaudited
condensed consolidated financial statements.








CROWN
MEDIA HOLDINGS, INC. AND SUBSIDIARIES


UNAUDITED
CONDENSED CONSOLIDATED BALANCE SHEETS


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


(continued)





As
      of December 31,
                  2008
                
                
                As
      of September 30,
                  2009LIABILITIES
      AND STOCKHOLDERS’ DEFICITLIABILITIES:Accounts
      payable and accrued
      liabilities
                
                $
                23,992
                
                
                $
                15,728Audience
      deficiency reserve
      liability
                
                
                11,505
                
                
                
                17,281License
      fees
      payable
                
                
                128,638
                
                
                
                113,108Payables
      to Hallmark Cards
      affiliates
                
                
                14,799
                
                
                
                19,970Payables
      to National Interfaith Cable
      Coalition
                
                
                2,849
                
                
                
                2,727Credit
      facility and interest
      payable
                
                
                29
                
                
                
                2,516Notes
      and interest payable to Hallmark Cards affiliates
                
                
                3,987
                
                
                
                340,727Total
      current
      liabilities
                
                
                185,799
                
                
                
                512,057Accrued
      liabilities
                
                
                28,857
                
                
                
                25,936License
      fees
      payable
                
                
                112,451
                
                
                
                105,606Payables
      to National Interfaith Cable
      Coalition
                
                
                2,504
                
                
                
                -Credit
      facility
                
                
                28,570
                
                
                
                -Notes
      payable to Hallmark Cards
      affiliates
                
                
                340,697
                
                
                
                -Senior
      secured note to HC Crown, including accrued interest
                
                
                686,578
                
                
                
                740,083Company
      obligated mandatorily redeemable preferred
                  interest
                
                
                20,822
                
                
                
                22,382Total
      liabilities
                
                
                1,406,278
                
                
                
                1,406,064COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS'
      DEFICIT:Class
      A common stock, $.01 par value; 200,000,000 shares authorized; 74,117,654
      shares issued and outstanding as of December 31, 2008 and September 30,
      2009, respectively
                
                
                741
                
                
                
                741Class
      B common stock, $.01 par value; 120,000,000 shares
                  authorized;
      30,670,422 shares issued and outstanding as of December 31, 2008 and
      September 30, 2009, respectively
                
                
                307
                
                
                
                307Paid-in
      capital
                
                
                1,465,293
                
                
                
                1,460,400Accumulated
      deficit
                
                
                (2,133,274
                )
                
                
                (2,156,239
                )Total
      stockholders'
      deficit
                
                
                (666,933
                )
                
                
                (694,791
                )Total
      liabilities and stockholders'
      deficit
                
                $
                739,345
                
                
                $
                711,273





See
accompanying notes to unaudited condensed consolidated financial
statements.








CROWN
MEDIA HOLDINGS, INC. AND SUBSIDIARIES


UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
LOSS


(In thousands, except per share
data)














Three
      Months Ended
                    September
      30,
                  
                  
                  Nine
      Months Ended
                    September
      30,2008
                  
                  
                  2009
                  
                  
                  2008
                  
                  
                  2009Revenue:Subscriber
      fees
                  
                  $
                  14,240
                  
                  
                  $
                  15,998
                  
                  
                  $
                  42,672
                  
                  
                  $
                  47,153Advertising
                  
                  
                  49,950
                  
                  
                  
                  46,296
                  
                  
                  
                  162,836
                  
                  
                  
                  153,177Advertising
      by Hallmark Cards
                  
                  
                  -
                  
                  
                  
                  191
                  
                  
                  
                  157
                  
                  
                  
                  525Other
      revenue
                  
                  
                  292
                  
                  
                  
                  334
                  
                  
                  
                  901
                  
                  
                  
                  1,098Total
      revenue, net
                  
                  
                  64,482
                  
                  
                  
                  62,819
                  
                  
                  
                  206,566
                  
                  
                  
                  201,953Cost
      of Services:Programming
      costsAffiliates
                  
                  
                  245
                  
                  
                  
                  315
                  
                  
                  
                  529
                  
                  
                  
                  914Non-affiliates
                  
                  
                  36,408
                  
                  
                  
                  31,365
                  
                  
                  
                  107,170
                  
                  
                  
                  94,282Other
      costs of services
                  
                  
                  2,459
                  
                  
                  
                  3,405
                  
                  
                  
                  9,522
                  
                  
                  
                  11,905Total
      cost of services
                  
                  
                  39,112
                  
                  
                  
                  35,085
                  
                  
                  
                  117,221
                  
                  
                  
                  107,101Selling,
      general and administrative expense (exclusive of depreciation and
      amortization expense shown separately below)
                  
                  
                  12,640
                  
                  
                  
                  12,208
                  
                  
                  
                  37,966
                  
                  
                  
                  35,000Marketing
      expense
                  
                  
                  4,633
                  
                  
                  
                  339
                  
                  
                  
                  13,091
                  
                  
                  
                  5,956Depreciation
      and amortization expense
                  
                  
                  506
                  
                  
                  
                  495
                  
                  
                  
                  1,430
                  
                  
                  
                  1,462Income
      from operations
                  
                  
                  7,591
                  
                  
                  
                  14,692
                  
                  
                  
                  36,858
                  
                  
                  
                  52,434Interest
      income
                  
                  
                  187
                  
                  
                  
                  115
                  
                  
                  
                  552
                  
                  
                  
                  375Interest
      expense
                  
                  
                  (25,641
                  )
                  
                  
                  (24,999
                  )
                  
                  
                  (75,912
                  )
                  
                  
                  (75,774
                  )Net
      loss and comprehensive loss
                  
                  $
                  (17,863
                  )
                  
                  $
                  (10,192
                  )
                  
                  $
                  (38,502
                  )
                  
                  $
                  (22,965
                  )Weighted
      average number of Class A and Class B shares outstanding, basic
      and diluted
                  
                  
                  104,788
                  
                  
                  
                  104,788
                  
                  
                  
                  104,772
                  
                  
                  
                  104,788Net
      loss per share, basic and diluted
                  
                  $
                  (0.17
                  )
                  
                  $
                  (0.10
                  )
                  
                  $
                  (0.37
                  )
                  
                  $
                  (0.22
                  )





See
accompanying notes to unaudited condensed consolidated financial
statements.











CROWN
MEDIA HOLDINGS, INC. AND SUBSIDIARIES


UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(In
thousands)





Nine
      Months Ended September 30,2008
                    
                    
                    2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                    
                    $
                    (38,502
                    )
                    
                    $
                    (22,965
                    )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Depreciation
      and amortization
                    
                    
                    111,738
                    
                    
                    
                    99,319Accretion
      on company obligated mandatorily redeemable preferred
    interest
                    
                    
                    1,665
                    
                    
                    
                    1,560Provision
      for allowance for doubtful accounts
                    
                    
                    43
                    
                    
                    
                    1,128Residuals
      and participations
                    
                    
                    (1,052
                    )
                    
                    
                    -Impairment
      of film asset
                    
                    
                    176
                    
                    
                    
                    -Stock-based
      compensation (benefit)
                    
                    
                    1,650
                    
                    
                    
                    (550
                    )Changes
      in operating assets and liabilities:Decrease
      in accounts receivable
                    
                    
                    12,846
                    
                    
                    
                    7,894Additions
      to program license fees
                    
                    
                    (135,893
                    )
                    
                    
                    (79,829
                    )(Increase)
      decrease in prepaid and other assets
                    
                    
                    (8,622
                    )
                    
                    
                    4,964Decrease
      in accounts payable, accrued and other liabilities
                    
                    
                    (16,998
                    )
                    
                    
                    (5,538
                    )Increase
      in interest payable
                    
                    
                    66,700
                    
                    
                    
                    49,481Increase
      (decrease) in license fees payable
                    
                    
                    46,335
                    
                    
                    
                    (22,375
                    )Increase
      in payables to affiliates
                    
                    
                    1,493
                    
                    
                    
                    278Net
      cash provided by operating activities
                    
                    
                    41,579
                    
                    
                    
                    33,367CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of property and equipment
                    
                    
                    (1,772
                    )
                    
                    
                    (371
                    )Payments
      to buyer of international business
                    
                    
                    (2,597
                    )
                    
                    
                    (691
                    )Net
      cash used in investing activities.
                    
                    
                    (4,369
                    )
                    
                    
                    (1,062
                    )CASH
      FLOWS FROM FINANCING ACTIVITIES:Borrowings
      under the credit facility
                    
                    
                    18,761
                    
                    
                    
                    18,062Principal
      payments on the credit facility
                    
                    
                    (53,100
                    )
                    
                    
                    (44,121
                    )Principal
      payments on capital lease obligations
                    
                    
                    (547
                    )
                    
                    
                    (601
                    )Net
      cash used in financing activities
                    
                    
                    (34,886
                    )
                    
                    
                    (26,660
                    )Net
      increase in cash and cash equivalents
                    
                    
                    2,324
                    
                    
                    
                    5,645Cash
      and cash equivalents, beginning of period
                    
                    
                    1,974
                    
                    
                    
                    2,714Cash
      and cash equivalents, end of period
                    
                    $
                    4,298
                    
                    
                    $
                    8,359Supplemental
      disclosure of cash and non-cash activities:Interest
      paid
                    
                    $
                    3,882
                    
                    
                    $
                    22,022Tax
      sharing payment from Hallmark Cards applied to
                      note
      payable to Hallmark Cards
                    
                    $
                    15,488
                    
                    
                    $
                    -Tax
      sharing amount due to Hallmark
      Cards
                    
                    $
                    -
                    
                    
                    $
                    4,893Reclassification
      of Redeemable Common Stock to common stock
                      and
      paid-in
      capital
                    
                    $
                    32,765
                    
                    
                    $
                    -Interest
      payable converted to principal on note payable
                      to
      Hallmark Card affiliates
                    
                    $
                    24,747
                    
                    
                    $
                    -





See
accompanying notes to unaudited condensed consolidated financial
statements.








CROWN
MEDIA HOLDINGS, INC. AND SUBSIDIARIES


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


For
the Three and Nine Months Ended September 30, 2008 and 2009








1.
Business and Organization





Organization





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





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





Liquidity







As of
September 30, 2009, the Company had $8.4 million in cash and cash equivalents on
hand and $42.5 million of current borrowing capacity under the bank credit
facility.  Day-to-day cash disbursement requirements have typically
been satisfied with cash on hand and operating cash receipts supplemented with
the borrowing capacity available under the bank credit facility and forbearance
by Hallmark Cards and its affiliates.  The Company’s management
anticipates that the principal uses of cash up to May 1, 2010, will include the
payment of operating expenses, accounts payable and accrued expenses,
programming costs, interest and repayment of principal under the bank credit
facility and interest of approximately $8.0 million to $12.0 million due under
certain notes to the Hallmark Cards affiliates from October 1, 2009, through May
1, 2010.  The amounts outstanding under the bank credit agreement and
those notes are due May 1, 2010 as discussed below.




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




Another
significant aspect of the Company’s liquidity is the deferral of payments on
obligations owed to Hallmark Cards and its subsidiaries. Under the Amended and
Restated Waiver Agreement as amended with Hallmark Cards and its affiliates (the
“Waiver Agreement”), the deferred payments under such obligations are extended
to May 1, 2010.  These obligations comprised $340.7 million at
September 30, 2009.  An additional $740.1 million (10.25% Senior
Secured Note) of principal and interest outstanding at September 30, 2009,
payable to a Hallmark Cards’ affiliate in August 2011, is also subject to the
Waiver Agreement until May 1, 2010.  Interest amounts related to the
10.25% note will be added to principal through February 5, 2010. The Hallmark
affiliate has indicated that it will not extend the Waiver Agreement beyond May
1, 2010.




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




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




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




The
sufficiency of the existing sources of liquidity to fund the Company’s
operations is dependent upon maintaining subscriber and advertising revenue at
or near the amount of such revenue for the nine months ended September 30, 2009.
A significant decline in the popularity of the Channels, a further economic
decline in the advertising market, an increase in program acquisition costs, an
increase in competition or other adverse changes in operating conditions could
negatively impact the Company’s liquidity and its ability to fund the current
level of operations.  For the first three quarters, lower viewership
ratings in 2009 as compared to 2008 for the Company's programming on the
Hallmark Channel resulted in an increase in audience deficiency units owed to
advertisers, thereby reducing revenues and cash flows.  Since the
second quarter of 2008, the Company has also experienced a softening of
advertising rates in the direct response and general rate scatter market because
of the national recession.  Subsequent to the first quarter of 2008,
the rates for the Company's advertising spots in the scatter market and direct
response advertising were lower than 2007 levels.  These market
conditions have continued in 2009, with rates lower in the third quarter of 2009
and the first nine months of 2009 when compared to the same periods in 2008. The
Company expects continued lower rates through 2009 and into 2010. In response to
these market conditions, the Company has implemented certain cost containment
measures for 2009, and has a limited number of additional, contingent cost
cutting measures that can be implemented in the remainder of 2009 depending on
market conditions.




The
Company is currently unable to meet its obligations which come due on and after
May 1, 2010.  A default on the obligations due on May 1, 2010 would
also result in a default under the Company’s 10.25% Senior Secured Note. The
Company anticipates that prior to May 1, 2010, it will be necessary to extend,
refinance or restructure (i) the bank credit facility and (ii) the promissory
notes payable to affiliates of Hallmark Cards. As part of a combination of
actions and in order to obtain additional funding, the Company may consider
various alternatives, including restructuring of the debt if possible,
refinancing the bank credit facility, raising additional capital through the
issuance of equity or debt securities, or other strategic alternatives. If the
current adverse credit market conditions continue, a restructuring or
refinancing could be difficult to achieve and if achieved could include changes
to existing interest rates and other provisions within the current debt
arrangements. These changes may have a negative impact on future operating
results and cash flows.




As
discussed in Note 6, the Hallmark Cards' affiliate has proposed a
recapitalization of the Company's obligations.  There can be no
assurance that the Company will accept and consummate this proposal, with or
without modification. Further, there can be no assurance that the Company will
ever consummate a refinancing or recapitalization.







2.
Summary of Significant Accounting Policies and Estimates





Interim
Financial Statements





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





Basis
of Presentation





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





The
preparation of financial statements in accordance with generally accepted
accounting principles requires the consideration of events or transactions that
occur after the balance sheet date but before the financial statements are
issued. Depending on the nature of the subsequent event, financial statement
recognition or disclosure of the subsequent event is
required.  Subsequent events have been evaluated through the time of
filing of the Company’s Form 10-Q Report on November 5, 2009, which represents
the date the unaudited condensed consolidated financial statements were
issued.





Use
of Estimates





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





Allowance
for Doubtful Accounts





The
allowance for doubtful accounts is based upon the Company’s assessment of
probable loss related to uncollectible accounts receivable.  The
Company uses a number of factors in determining the allowance, including, among
other things, collection trends. The Company’s bad debt expense was $235,000 and
$1.1 million for the three and nine months ended September 30, 2009,
respectively. The Company’s bad debt expense was $38,000 and $43,000 for the
three and nine months ended September 30, 2008, respectively.





Fair
Value of Financial Instruments







Financial
Accounting Standards Board (“FASB”) Accounting Standards Codification (the
“ASC”) Topic 820, Fair Value
Measurements and Disclosures, provides guidance which defines fair value,
establishes a framework for measuring fair value and specifies disclosures about
fair value measurements.  On January 1, 2008 we adopted that portion
of the standard that relates to those nonfinancial assets and liabilities
which are recognized or disclosed at fair value on a recurring basis (that
is, at least annually).  On January 1, 2009, subject to the FASB’s delayed
implementation, we adopted the remaining provisions of the standard.  After
adoption, we now determine fair value as an exit price, representing the price
that would be received to sell an asset or paid to transfer a liability in
an orderly transaction between market participants.







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








Net
Loss per Share





Basic net
loss per share is computed by dividing the net loss for the period by the
weighted average number of common shares outstanding during the period. Diluted
net loss per share is computed based on the weighted average number of common
shares and potentially dilutive common shares outstanding. The calculation of
diluted net loss per share excludes potential common shares if the effect would
be antidilutive. Potential common shares consist of incremental common shares
issuable upon the exercise of stock options. Approximately 341,000 stock options
for each of the three and nine months ended September 30, 2008, have been
excluded from the calculations of earnings per share because their effect would
have been antidilutive. Approximately 88,000 stock options for each of the three
and nine months ended September 30, 2009, have been excluded from the
calculations of earnings per share because their effect would have been
antidilutive.





Concentration
of Credit Risk





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





Four and
five of our distributors each accounted for more than 10% of our consolidated
subscriber revenue for the three months ended September 30, 2008 and 2009, and
together accounted for a total of 68% and 76% of consolidated subscriber revenue
during the three months ended September 30, 2008 and 2009,
respectively.  Three of our distributors each accounted for
approximately 15% or more of our consolidated subscribers for both the three
months ended September 30, 2008 and 2009, respectively, and accounted for 61% of
our subscribers during both the three months ended September 30, 2008 and 2009,
respectively.





Four and
five of our distributors each accounted for more than 10% of our consolidated
subscriber revenue for both the nine months ended September 30, 2008 and 2009,
and together accounted for a total of 68% and 76% of consolidated subscriber
revenue during the nine months ended September 30, 2008 and 2009,
respectively.  Three of our distributors each accounted for
approximately 15% or more of our consolidated subscribers for both the nine
months ended September 30, 2008 and 2009, respectively, and accounted for 61%
our subscribers during both the nine months ended September 30, 2008 and 2009,
respectively.





Recently
Issued Accounting Pronouncements







The
FASB’s Accounting Standards Codification is effective for all interim and annual
financial statements issued after September 15, 2009.  The ASC is now
the single official source of authoritative, nongovernmental generally accepted
accounting principles (GAAP) in the United States.  The historical
GAAP hierarchy was eliminated and the ASC became the only level of authoritative
GAAP, other than guidance issued by the Securities and Exchange
Commission.  Our accounting policies were not affected by the
conversion to the ASC.  However, we have conformed references to
specific accounting standards in these notes to unaudited condensed consolidated
financial statements to the appropriate section of the ASC.




In August
2009, the FASB issued Accounting Standards Update No. 2009-05 Fair Value Measurements and
Disclosures (ASC Topic 820) - Measuring Liabilities at Fair
Value (ASC Update 2009-05). This update provides amendments to reduce
potential ambiguity in financial reporting when measuring the fair value of
liabilities. Among other provisions, this update provides clarification that in
circumstances in which a quoted price in an active market for the identical
liability is not available, a reporting entity is required to measure fair value
using one or more of the valuation techniques described in ASC Update 2009-05.
The Company will adopt ASC Update 2009-05 prospectively from October 1,
2009.  We have not determined the impact, if any, that this update may
have on our financial statements.





In
October 2009, the FASB issued Accounting Standards Update, 2009-13, Revenue
Recognition (ASC Topic 605): Multiple Deliverable Revenue
Arrangements – A Consensus of the FASB Emerging Issues Task Force. This
update provides application guidance on whether multiple deliverables exist, how
the deliverables should be separated and how the consideration should be
allocated to one or more units of accounting. This update establishes a selling
price hierarchy for determining the selling price of a deliverable. The selling
price used for each deliverable will be based on vendor-specific objective
evidence, if available, third-party evidence if vendor-specific objective
evidence is not available, or estimated selling price if neither vendor-specific
or third-party evidence is available. The Company will be required to apply this
guidance prospectively for revenue arrangements entered into or materially
modified after January 1, 2011; however, earlier application is permitted. The
Company has not determined the impact that this update may have on its financial
statements.








3.
Program License Fees





Program
license fees are comprised of the following:





As of December 31,
                
                
                As of September 30,2008
                
                
                2009(In
      thousands)Program
      license fees —
      non-affiliates
                
                $
                576,779
                
                
                $
                623,076Program
      license fees — Hallmark Cards affiliates
                
                
                10,967
                
                
                
                12,467Program
      license fees, at
      cost
                
                
                587,746
                
                
                
                635,543Accumulated
      amortization
                
                
                (267,603
                )
                
                
                (330,766
                )Program
      license fees,
      net
                
                $
                320,143
                
                
                $
                304,777





At
December 31, 2008, and September 30, 2009, $7.6 million and $3.5 million,
respectively, of program license fees were included in prepaid and other assets
on the accompanying condensed consolidated balance sheets as the Company made
payments for the program license fees prior to commencement of the respective
license periods.





License
fees payable are comprised of the following:





As of December 31,
                
                
                As of September 30,2008
                
                
                2009(In
      thousands)License
      fees payable —
      non-affiliates
                
                $
                231,218
                
                
                $
                208,201License
      fees payable — Hallmark Cards affiliates
                
                
                9,871
                
                
                
                10,513Total
      license fees
      payable
                
                
                241,089
                
                
                
                218,714Less
      current
      maturities
                
                
                (128,638
                )
                
                
                (113,108
                )Long-term
      license fees
      payable
                
                $
                112,451
                
                
                $
                105,606








4.
Credit Facility








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





The
Company had at September 30, 2009, $42.5 million of unused revolving credit
capacity. The Company’s ability to borrow additional amounts under the credit
facility is not limited or restricted.





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





At
December 31, 2008, and September 30, 2009, the Company had outstanding
borrowings under the credit facility of $28.6 million and $2.5 million,
respectively, and there were no letters of credit outstanding. At December 31,
2008, the outstanding balance bore interest at the Eurodollar rate (a 2.02%
weighted average rate). At September 30, 2009, the outstanding balance bore
interest at the Eurodollar rate (a 2.51% weighted average rate). Interest
expense on borrowings under the credit facility for each of the three months
ended September 30, 2008 and 2009, was $389,000 and $53,000, respectively.
Interest expense on borrowings under the credit facility for each of the nine
months ended September 30, 2008 and 2009, was $1.8 million and $342,000,
respectively.





Covenants





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








5.
Related Party Long-Term Obligations





Waiver
and Standby Purchase





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




·
            Note
      and interest payable to HC Crown, dated December 14, 2001, in the original
      principal amount of $75.0 million, payable to HC Crown. (Total amount
      outstanding at December 31, 2008, and September 30, 2009, including
      accrued interest was $109.8 million and $108.6 million, respectively. See
      Note and Interest
      Payable to HC Crownbelow.)




·
            $70.0
      million note and interest payable to Hallmark Cards affiliate, dated as of
      March 21, 2006, arising out of the sale to Crown Media Holdings of the
      Hallmark Entertainment film library. (Total amount outstanding at December
      31, 2008, and September 30, 2009, including accrued interest was
      $62.7 million and $62.0 million, respectively. See Note and Interest Payable to
      Hallmark Cards Affiliatebelow.)






·
            10.25%
      senior secured note, dated August 5, 2003, in the initial accreted value
      of $400.0 million, payable to HC Crown.  (Total amount
      outstanding at December 31, 2008, and September 30, 2009, including
      accrued interest was $686.6 million and $740.1 million, respectively. See
      Senior Secured Notebelow.)




·
            Note
      and interest payable to Hallmark Cards affiliate, dated as of October 1,
      2005, in the principal amount of $132.8 million. (Total amount outstanding
      at December 31, 2008, and September 30, 2009, including accrued interest
      was $172.1 million and $170.1 million, respectively. See Note and Interest Payable to
      Hallmark Cards Affiliatebelow.)






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






·
            Any
      and all amounts due and owing to Hallmark Cards pursuant to the Tax
      Sharing Agreement (Total amount outstanding at September 30, 2009, was
      $4.9 million.).




Interest
will continue to accrue on these obligations during the Waiver
Period.  The Waiver Agreement also contains certain covenants,
including but not limited to (1) our covenant not to take any action that
would prohibit us from being included as a member of Hallmark Cards consolidated
federal tax group, (2) compliance with obligations in the loan documents
for the bank credit facility and (3) commercially reasonable efforts to
refinance the obligations subject to the Waiver Period.  Pursuant to
the Waiver Agreement, the Company must make prepayments on the outstanding debt
from 100% of any “Excess Cash Flow” during the Waiver Period.  There
was no Excess Cash Flow for the first, second or third quarters of 2009. For the
nine months ended September 30, 2009, the Company repaid $26.1 million of
principal under the credit facility and $20.6 million of interest due to
Hallmark Cards affiliates, which amounts would otherwise be Excess Cash
Flow.




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




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







Hallmark
Guarantee; Interest and Fee Reductions





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





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





The above
mentioned credit support provided by Hallmark Cards resulted in reductions in
the interest rate and commitment fees under the credit facility; however, we
agreed to pay and have paid an amount equal to the reductions in the
interest rate and commitment fees to Hallmark Cards.  Prior to April
1, 2009, we paid 2.25% and 0.375% to Hallmark Cards, representing the reductions
in the interest rate and commitment fees, respectively. On April 1, 2009, as
noted in Note 4, the interest rate and commitment fees under the renewed credit
facility increased and we began paying Hallmark Cards a smaller reduction amount
of the interest rate and commitment fees equal to 0.75% and 0.125%.





Senior
Secured Note





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





In
accordance with the Waiver Agreement, cash payments are not required until
August 5, 2010 (which is the first payment date after May 1, 2010). The
principal amount of the senior secured note accretes at 10.25% per annum,
compounding semi-annually, to February 5, 2010.  From that date,
interest at 10.25% per annum is scheduled to be payable semi-annually in arrears
on the accreted value of the senior note to HC Crown on August 5 and February 5
of each year until maturity.  The note matures on August 5, 2011,
and is pre-payable without penalty. At December 31, 2008, and September 30,
2009, $686.6 million and $740.1 million, respectively, of principal and interest
were included in the senior note payable in the accompanying consolidated
balance sheets. The note purchase agreement for the senior note provides that if
there is an event of default with respect to any other indebtedness in excess of
$5.0 million, the accreted value and any accrued and unpaid interest on the
senior note would become due and payable. The note purchase agreement for the
senior note contains certain restrictive covenants which, among other things,
prevent the Company from incurring any additional indebtedness, purchasing or
otherwise acquiring shares of the Company’s stock, investing in other parties
and incurring liens on the Company’s assets.  As a fee for the
issuance of the notes, the Company paid $3.0 million to HC Crown, which was
initially capitalized and is being amortized as additional interest expense over
the term of the note payable.





Note
and Interest Payable to HC Crown





On
December 14, 2001, the Company executed a $75.0 million promissory note with HC
Crown.  Pursuant to the Waiver Agreement, the note is payable in full
on May 1, 2010 (although the maturity date of the note is December 31, 2009).
Under the Waiver Agreement, accrued interest on this 2001 Note was added to
principal through November 15, 2008.  Commencing November 16, 2008,
interest is payable in cash, quarterly in arrears five days after the end of
each calendar quarter. This note is subordinate to the bank credit facility. The
rate of interest under this note is currently LIBOR plus 5% per annum (9.05% and
5.60% at December 31, 2008, and September 30, 2009, respectively). At December
31, 2008, and September 30, 2009, $108.6 million, is reported as note payable to
Hallmark Cards affiliate and $1.3 million and $0, respectively, are reported as
interest payable to Hallmark Cards affiliate on the accompanying condensed
consolidated balance sheet. Interest of $1.3 million was paid on January 5,
2009, interest of $1.7 million was paid on April 6, 2009, interest of $1.7
million was paid on July 6, 2009, and interest of $1.6 million was paid on
September 30, 2009.





Note
and Interest Payable to Hallmark Cards Affiliate





On
October 1, 2005, the Company converted approximately $132.8 million of its
license fees payable to Hallmark affiliates to a promissory note.  The
rate of interest under this note is currently LIBOR plus 5% per annum (9.05% and
5.60% at December 31, 2008, and September 30, 2009, respectively). Pursuant to
the Waiver Agreement, the promissory note is payable in full on May 1, 2010
(although the maturity date of the note is December 31, 2009).  Under
the Waiver Agreement, accrued interest on this 2005 Note was added to principal
through November 15, 2008.  Commencing November 16, 2008, interest is
payable in cash, quarterly in arrears five days after the end of each calendar
quarter. At December 31, 2008, and September 30, 2009, $170.1 million is
reported as note payable to Hallmark Cards affiliate and $2.0 million and $0,
respectively, are reported as interest payable to Hallmark Cards affiliate on
the accompanying condensed consolidated balance sheet. Interest of $2.0 million
was paid on January 5, 2009, interest of $2.7 million was paid on April 6, 2009,
interest of $2.7 million was paid on July 6, 2009, and interest of $2.4 million
was paid on September 30, 2009.





Note
and Interest Payable to Hallmark Cards Affiliate





On March
21, 2006, the Company converted approximately $70.4 million of its payable to a
Hallmark Cards affiliate to a promissory note. The rate of interest under this
note is currently LIBOR plus 5% per annum (9.05% and 5.60% at December 31, 2008,
and September 30, 2009, respectively). Pursuant to the Waiver Agreement, the
promissory note is payable in full on May 1, 2010 (although the maturity date of
the note is December 31, 2009). Under the Waiver Agreement, accrued interest on
this 2006 Note was added to principal through November 15,
2008.  Commencing November 16, 2008, interest is payable in cash,
quarterly in arrears five days after the end of each calendar quarter. At
December 31, 2008, and September 30, 2009, $62.0 million is reported as note
payable to Hallmark Cards affiliates and $717,000 and $0, respectively, are
reported as interest payable to Hallmark Cards affiliate on the accompanying
condensed consolidated balance sheet. Interest of $717,000 was paid on January
5, 2009, interest of $996,000 was paid on April 6, 2009, interest of $971,000
was paid on July 6, 2009, and interest of $887,000 was paid on September 30,
2009.








Interest
Paid to HC Crown Related to the Credit Facility





Interest
expense paid to HC Crown in connection with the credit facility was $241,000 for
the three months ended September 30, 2008, and $15,000 for the three months
ended September 30, 2009.  Interest expense paid to HC Crown in
connection with the credit facility was $953,000 for the nine months ended
September 30, 2008, and $1.0 million for the nine months ended September 30,
2009.








Related
Party Note Obligations
 
 The
aggregate maturities of related party notes for each of the five years
subsequent to September 30, 2009, are as follows:
 
 Payments
      Due by PeriodTotal
                                      
                                      
                                      
                                      2010
                                      
                                      
                                      
                                      2011
                                      
                                      
                                      2012
                                      
                                      
                                      2013
                                      
                                      
                                      2014(In
      thousands)Note
      and interest payable to HC Crown,
                                        with
      principal deferred until  May 1, 2010
                                      
                                      $
                                      108,611
                                      
                                      
                                      $
                                      108,611
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -10.25
      % Senior secured note to HC Crown,
                                        including
      accrued interest, due August 5, 2011
                                      
                                      
                                      740,083
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      740,083
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -Note
      and interest payable to Hallmark Cards affiliate
                                        with
      principal deferred until May 1, 2010
                                      
                                      
                                      170,109
                                      
                                      
                                      
                                      170,109
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -Note
      and interest payable to Hallmark Cards affiliate
                                        with
      principal deferred until May 1, 2010
                                      
                                      
                                      62,007
                                      
                                      
                                      
                                      62,007
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -$
                                      1,080,810
                                      
                                      
                                      $
                                      340,727
                                      
                                      
                                      $
                                      740,083
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -


6.
Related Party Transactions





Recapitalization
Proposal





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





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





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





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





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





There can
be no assurance that the Company will accept and consummate this Proposal, with
or without modification. The Proposal was filed with the Securities and Exchange
Commission by the Company in a May 28, 2009 Form 8-K Report and by
Hallmark Cards in an amendment to a Schedule 13D concerning the
Company.





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





For
information on the lawsuit brought in July 2009 with respect to the Proposal,
see Note 11, Commitments and Contingencies.





Tax Sharing
Agreement





Overview





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





The
Company received $5.3 million, which was offset during the third quarter of 2008
against debt owed under the tax sharing agreement with Hallmark Cards ($15.5
million for the nine months ended September 30, 2008). The Company recorded a
$1.2 million reduction to the payable to Hallmark Cards affiliates during the
third quarter of 2009 under the tax sharing agreement ($4.9 million payable for
the nine months ended September 30, 2009). All payments received from Hallmark
Cards or otherwise credited against amounts owed by Crown Media Holdings to any
member of the Hallmark Cards consolidated group, all pursuant to the tax sharing
agreement, have been recorded as paid-in capital.





Services
Agreement with Hallmark Cards





Hallmark
Cards provides various support services to the Company under a 2003 agreement,
the most recent renewal of which expires December 31, 2009.  The
Company plans to request a renewal of this agreement on similar terms to the
current agreement. Such services include tax, risk management, health safety,
environmental, insurance, legal, treasury, human resources, cash management
services and real estate consulting services.  In exchange, the
Company is obligated to pay Hallmark Cards a fee, plus out-of-pocket expenses
and third party fees, in arrears on the last business day of each quarter. Fees
for Hallmark Cards’ services were $541,000 for 2008 and are scheduled to be
$455,000 for 2009. With the concurrence of Hallmark Cards, the Company deferred
payment of fees for services provided through September 2008. Commencing October
2008, the Company has paid the required monthly fees, amounting to $135,000
during the three months ended December 31, 2008, $127,000 during the three
months ended September 30, 2009, and $341,000 during the nine months ended
September 30, 2009.





At
December 31, 2008, and September 30, 2009, non-interest bearing unpaid accrued
service fees and unreimbursed expenses of $14.8 million and $15.1 million,
respectively, were included in payable to affiliates on the accompanying
consolidated balance sheets. For the year ended December 31, 2008, and the nine
months ended September 30, 2009, related out-of-pocket expenses and third party
fees were $1.1 million and $278,000, respectively.





Trademark
License Agreement





Crown
Media United States has a trademark license agreement with Hallmark Licensing,
Inc. for use of the “Hallmark” mark for the Hallmark Channel and for the
Hallmark Movie Channels.  In September 2009, Hallmark Cards extended
the trademark license agreements for the Hallmark Channel and the Hallmark Movie
Channels to September 1, 2010. The Company is not required to pay any fees under
the trademark license agreements.





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








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





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





Under the
company agreement, the members agreed that if during any year ending after
January 1, 2005 and on or prior to December 31, 2009, Crown Media
United States has Federal taxable income (with possible adjustments) in excess
of $10.0 million, and the preferred interest has not been redeemed, Crown Media
United States will redeem the preferred interest in an amount equal to the
lesser of: (i) such excess Federal taxable income; (ii) $5.0 million; or (iii)
the amount equal to the preferred liquidation preference on the date of
redemption.  Crown Media United States may voluntarily redeem the
preferred interest at any time; however, it is obligated to do so no later than
December 31, 2010. Because of the mandatory redemption provisions, this equity
instrument is reflected as a liability in the accompanying consolidated balance
sheets. Notwithstanding provisions of the Tax Sharing Agreement, the Company
believes that it will not have Federal taxable income in 2009. Accordingly, the
accreted amount of this obligation is classified among other than current
liabilities as of December 31, 2008, and September 20, 2009.




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





During
the three months ended September 30, 2008 and 2009, Crown Media United States
paid NICC $0 and $40,000, respectively, under the terms of the Modification
Agreement and one programming agreement. During the nine months ended September
30, 2008 and 2009, Crown Media United States paid NICC $6.4 million and $4.6
million, respectively, under the terms of the Modification Agreement and one
programming agreement.








8.
Share-Based Compensation





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





The
Company recorded $649,000 and $2.4 million of compensation expense associated
with the Employment and Performance restricted stock units (“RSUs”) during the
three and nine months ended September 30, 2008, respectively, which have been
included in selling, general and administrative expense on the accompanying
condensed consolidated statements of operations. The Company recorded $134,000
of compensation expense and $303,000 of compensation benefit associated with the
Employment and Performance RSUs during the three and nine months ended September
30, 2009, respectively, which have been included in selling, general and
administrative expense on the accompanying condensed consolidated statements of
operations. The Company recorded these RSUs at fair value during each
period.





The
Company issued cash settlements related to the RSUs of $3.8 million during the
year ended December 31, 2008, and $1.5 million during the nine months ended
September 30, 2009.





At
December 31, 2008, the CEO’s share appreciation rights (“SARs”) were valued at
$440,000 using the $2.85 closing price of a share of our common stock on
December 31, 2008. At September 30, 2009, these SARs were valued at $0 as the
related CEO resigned on May 4, 2009. The Company recorded $42,000 and $0 in
compensation benefit related to SARs for the three months ended September 30,
2008 and 2009, respectively, on our condensed consolidated statement of
operations as a component of selling, general and administrative
expense.  The Company recorded $730,000 and $247,000 in compensation
benefit related to SARs for the nine months ended September 30, 2008 and 2009,
respectively, on our condensed consolidated statement of operations as a
component of selling, general and administrative expense.  The SARs
were recorded in accounts payable and accrued liabilities on the accompanying
condensed consolidated balance sheet at December 31, 2008.







9.  Resignation
Agreements, Long Term Incentive Plan and Employee Terminations





Resignation
Agreements





The
individual then serving as the Company’s chief executive officer resigned May
31, 2009.  Pursuant to the resignation agreement, in June 2009 the
Company paid this individual $2.5 million, an amount representing the present
value of the salary and bonus that otherwise would have been paid to him from
June 1, 2009 through October 2, 2010, the scheduled expiration of his employment
contract.  The Company was obligated to pay this individual a
transaction bonus if a change in control of the Company occurred on or before
August 29, 2009.  The Company is obligated to provide him office
space, an assistant and payment of COBRA insurance benefits for periods that
expire at various times through May 31, 2010.





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




Long
Term Incentive Compensation Agreements





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





Employee
Terminations





In August
2009, the Company terminated the employment of certain
individuals.  The Company recorded severance expense of approximately
$1.2 million during the third quarter of 2009 as part of selling, general and
administrative expenses.





10.
Fair Value





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








December
      31, 2008
                
                
                September
      30, 2009Carrying
                
                
                Significant
      Unobservable
                  Inputs
                  (Level
      3)
                  Fair
                
                
                Carrying
                
                
                Significant
      Unobservable
                  Inputs
                  (Level
      3)
                  FairAmount
                
                
                Value
                
                
                Amount
                
                
                Value(In
      thousands)Senior
      secured note to HC Crown,including
      accrued interest
                
                $
                686,578
                
                
                $
                599,683
                
                
                $
                740,083
                
                
                $
                724,613Note
      and interest payable to HC Crown
                
                
                109,837
                
                
                
                86,544
                
                
                
                108,611
                
                
                
                104,101Note
      and interest payable to Hallmark Cards
                  Affiliate
                
                
                62,724
                
                
                
                49,422
                
                
                
                62,007
                
                
                
                59,448Note
      and interest payable to Hallmark Cards
                  Affiliate
                
                
                172,077
                
                
                
                135,584
                
                
                
                170,109
                
                
                
                163,089Company
      obligated mandatorily redeemablepreferred
      interest
                
                
                20,822
                
                
                
                17,430
                
                
                
                22,382
                
                
                
                19,200








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





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





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





Accounts
payable and receivable are carried at reasonable estimates of their fair values
because of the short-term nature of these instruments. Long-term license fees
payable are also considered carried at reasonable estimates of their fair value.
Interest rates on borrowings under the bank credit facility are for relatively
short periods and variable. Therefore, the fair value of this debt is not
significantly affected by fluctuations in interest rates.  The credit
spread in debt is fixed, but the market credit spread will
fluctuate.





Estimates
of the fair value of the Company’s financial instruments are presented in the
tables above. As a result of recent market conditions, the Company has financial
instruments for which limited or no observable market data is available. Fair
value measurements for these instruments are included in Level 3 of the fair
value hierarchy of ASC Topic 820. These fair value measurements are based
primarily upon the Company’s own estimates and are often based on its current
pricing policy, the current economic and competitive environment, the
characteristics of the instrument, credit and interest rate risks, and other
such factors. Therefore, the results cannot be determined with precision, cannot
be substantiated by comparison to quoted prices in active markets, and may not
be realized in an immediate settlement of the liability. Additionally, there are
inherent uncertainties in any fair value measurement technique, and changes in
the underlying assumptions used, including discount rates, liquidity risks, and
estimates of future cash flows, could significantly affect the fair value
measurement amounts.





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








11.
Commitments and Contingencies





Lawsuit





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





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





The
Company is unable to predict the outcome of the legal proceeding discussed in
this Note. The plaintiff does not seek monetary damages from the Company or
other named defendants. However, if the plaintiff’s request for relief is
granted, the Company will be unable to consummate the recapitalization described
in the Proposal. Legal fees to defend the proceeding described in this Note are
being expensed as incurred.





12.
Subsequent Event





At
November 5, 2009, the Company believes that it will be necessary in the first
quarter of 2010 to record a charge to cost of services of approximately $4.0
million to $5.0 million. This relates to the Company’s planned launch of a high
definition version of the Hallmark Channel in February 2010.








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





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





Description
of Business and Overview





Current
Business





We own
and operate the Channels. With 87.7 million subscribers (as provided by Nielsen
Research) in the United States at September 30, 2009, the Hallmark Channel is
the 38th most
widely distributed advertising-supported cable channel in the United States. At
December 31, 2008, the Hallmark Channel was the 38th most
widely distributed advertising-supported cable channel in the United States with
85.5 million subscribers (as provided by Nielsen Research). For the third
quarter of 2009, the Hallmark Channel finished the quarter as the 18th highest
rated advertising-supported cable channel for total day ratings and the 17th highest
rated advertising-supported cable channel in prime time as measured by Nielsen
Research.These
viewer ratings represent a decline that started earlier in 2009. See “Results of
Operations – Three Months Ended September 30, 2008 compared to Three Months
Ended September 30, 2009 – Revenue” for more information on
ratings.





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





At
September 30, 2009, the Hallmark Movie Channel was distributed to over 24.9
million subscribers, an increase of nearly 10.4 million subscribers from 14.5
million at December 31, 2008. As of October 15, 2009, the Hallmark Movie Channel
was distributed in the nation’s top 30 demographic measurement areas (DMA’s).
This increase in distribution, particularly in these key markets, and a greater
number of advertising spots has contributed to improved Hallmark Movie Channel
revenue in the first three quarters of 2009 and should continue to do so through
the remainder of the year.





Current
Challenges and Developments





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




We have
completed our 2009/2010 upfront sales process.  In this year’s
process, we entered agreements with major advertising firms representing
approximately 41% of our advertising inventory for the last quarter of 2009 and
the first three quarters of 2010.  This inventory was sold at CPMs
(i.e., advertising rates per thousand viewers) approximately 1.6% lower than the
inventory sold in the 2008/2009 upfront.  In the 2008/2009 upfront
sales process, we entered agreements for approximately 51% of our advertising
inventory for the last quarter of 2008 and the first three quarters of
2009.  We held more advertising inventory from the 2009/2010 upfront
than the 2008/2009 upfront, for use in the general scatter market, because of
lower CPMs offered by some advertisers in the 2009/2010 upfront.




Advertisers
with upfront contracts have an option to terminate their contracts, as well as
an option to expand the amount of inventory purchased under the contracts.
During the twelve months period ended September 30, 2009, advertisers canceled
approximately 13% of the inventory covered by such contracts.  In
prior years, cancellations of upfront contracts were unusual.




The
Company intends to sell the balance of the 2009/2010 general rate inventory in
the calendar year upfront and scatter marketplace. The Company sold the balance
of the 2008/2009 general rate inventory, including that resulting from the
cancellations, in the scatter market. Continued weakness in the economy has
resulted generally in lower demand and lower rates for our inventory of ad spots
available for the scatter market and lower revenue from direct response
advertising when comparing the third quarter of 2009 to the third quarter of
2008 and comparing the first three quarters of 2009 to the first three quarters
of 2008. Notwithstanding the relatively higher CPMs negotiated in the 2008/2009
upfront sales period versus the 2007/2008 upfront sales period, our advertising
revenue for the nine months ended September 30, 2009, decreased relative to the
nine months ended September 30, 2008, primarily because of lower viewer ratings
and also because of lower rates in the scatter market. With the shortfall in
achieving viewership commitments, our liability for audience deficiency units
has increased significantly since December 31, 2008.




Following
the upfront period, sales of our general rate, direct response and
paid-programming inventory are made closer to the timing of the actual
advertisement.  We have historically seen significant increases in
rates on these remaining advertising sales over the rates obtained from our
upfront sales.  During the fourth quarter of 2008 and the first three
quarters of 2009, rates for this scatter market and direct response advertising
decreased when compared to the same periods in the prior year, although still at
levels in excess of our 2008/2009 upfront sales rates.  Accordingly
for the 2008/2009 upfront period, while we still saw increases in rates on that
portion of our advertising sales from the upfront, this was offset by decreases
in rates on the remaining advertising inventory related to scatter and direct
response sales.







The
scatter rates in the first three quarters of 2009 were higher by approximately
the following percentages than the upfront rates for those
quarters:  45% for the first quarter of 2009; 40% for the second
quarter of 2009; and 46% for the third quarter of 2009.




Distribution
agreements are important because they affect our number of subscribers, which in
turn have a major impact on our subscriber fees, the number of persons viewing
our programming, and the rates charged for advertising. The long-term
distribution challenge is renewing our distribution arrangements with the
multiple system operators as they expire on favorable terms. Our major
distribution agreements have terms which expire at various times from December
31, 2009, through December 2023, inclusive of renewal options. Agreements
representing approximately 12% of our total Hallmark Channel subscriber base
expire between the date of this Report and December 31, 2009. Agreements
representing an additional 5% of our subscribers will expire during
2010.




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




We expect
to continue experiencing increases in our bad debt expense during the remainder
of 2009 and into 2010 because of the economic downturn. Such increased expense
is expected to result from certain customers, primarily advertisers, which will
experience cash flow problems in this adverse economic environment.





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




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




We plan
to launch a high definition version of the Hallmark Channel in February
2010.  The Company’s management estimates that the costs for this
launch will be approximately $5.0 million to $7.0 million.  This
estimate is subject to change based upon several factors. The Company may also
incur additional costs including the cost of converting certain television
series to high definition.  The launch of a high definition version
will further the Company’s efforts to maintain competitiveness.




Revenue
from Continuing Operations





Our
revenue consists of subscriber fees and advertising fees.








Subscriber
Fees





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





•
            the
      degree of competition in the
market;





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





•
            the
      packaging arrangements for the channel;
and





•
            length
      of the contract term and other commercial
terms.





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





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





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





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








Advertising







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





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





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





Our
channels are broadcast 24 hours per day.  The revenue contribution of
Hallmark Movie Channel has been small relative to that of Hallmark
Channel.  The Hallmark Movie Channel has not been the subject of
ratings measurement by Nielsen Media Research. However, as currently planned,
the Hallmark Movie Channel will have Nielsen ratings commencing in the second
quarter of 2010, and we will sell advertising inventory for the Hallmark Movie
Channel commencing in that quarter based on a price per unit of audience
measurement.





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





Cost
of Services





Our cost
of services consists primarily of the amortization of program license fees; the
cost of signal distribution; and the cost of promotional segments that are aired
between programs. Although we expect our 2009 expenses for bad debts and
severance payments to exceed 2008 levels, we expect our total cost of service to
decrease in 2009 compared to 2008 because of reduced amortization expense
associated with program license fees.  See the discussion of
programming costs in “Results of Operations” below. See also discussion of
operating costs in “Results of Operations” below for an anticipated increase in
the operating costs for the first quarter of 2010 due to the costs of launching
a high definition version of the Hallmark Channel.





Critical
Accounting Policies, Judgments and Estimates





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





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








Effects
of Transactions with Related and Certain Other Parties





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





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











Selected
Historical Consolidated Financial Data of Crown Media Holdings





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





Percent
      Change
                
                
                
                
                
                
                
                
                Percent
      ChangeThree
      Months Ended September 30,
                
                
                2009
      vs.
                
                
                Nine
      Months Ended September 30,
                
                
                2009
      vs.2008
                
                
                2009
                
                
                2008
                
                
                2008
                
                
                2009
                
                
                2008Revenue:Subscriber
      fees
                
                $
                14,240
                
                
                $
                15,998
                
                
                
                12
                %
                
                $
                42,672
                
                
                $
                47,153
                
                
                
                11
                %Advertising
                
                
                49,950
                
                
                
                46,487
                
                
                
                -7
                %
                
                
                162,993
                
                
                
                153,702
                
                
                
                -6
                %Other
      revenue
                
                
                292
                
                
                
                334
                
                
                
                14
                %
                
                
                901
                
                
                
                1,098
                
                
                
                22
                %Total
      revenue
                
                
                64,482
                
                
                
                62,819
                
                
                
                -3
                %
                
                
                206,566
                
                
                
                201,953
                
                
                
                -2
                %Cost
      of Services:Programming
      costs
                
                
                36,653
                
                
                
                31,680
                
                
                
                -14
                %
                
                
                107,699
                
                
                
                95,196
                
                
                
                -12
                %Operating
      costs
                
                
                2,459
                
                
                
                3,405
                
                
                
                38
                %
                
                
                9,522
                
                
                
                11,905
                
                
                
                25
                %Total
      cost of services
                
                
                39,112
                
                
                
                35,085
                
                
                
                -10
                %
                
                
                117,221
                
                
                
                107,101
                
                
                
                -9
                %Selling,
      general and administrative expense
                
                
                13,146
                
                
                
                12,703
                
                
                
                -3
                %
                
                
                39,396
                
                
                
                36,462
                
                
                
                -7
                %Marketing
      expense
                
                
                4,633
                
                
                
                339
                
                
                
                -93
                %
                
                
                13,091
                
                
                
                5,956
                
                
                
                -55
                %Income
      from operationsbefore
      interest expense
                
                
                7,591
                
                
                
                14,692
                
                
                
                94
                %
                
                
                36,858
                
                
                
                52,434
                
                
                
                42
                %Interest
      expense
                
                
                (25,454
                )
                
                
                (24,884
                )
                
                
                -2
                %
                
                
                (75,360
                )
                
                
                (75,399
                )
                
                
                0
                %Net
      loss
                
                $
                (17,863
                )
                
                $
                (10,192
                )
                
                
                -43
                %
                
                $
                (38,502
                )
                
                $
                (22,965
                )
                
                
                -40
                %Other
      Data:Net
      cash provided by operating activities
                
                $
                24,580
                
                
                $
                19,985
                
                
                
                -19
                %
                
                $
                41,579
                
                
                $
                33,367
                
                
                
                -20
                %Net
      cash used in investing activities
                
                $
                (1,083
                )
                
                $
                (414
                )
                
                
                -62
                %
                
                $
                (4,369
                )
                
                $
                (1,062
                )
                
                
                -76
                %Net
      cash used in financing activities
                
                $
                (19,476
                )
                
                $
                (18,016
                )
                
                
                -7
                %
                
                $
                (34,886
                )
                
                $
                (26,660
                )
                
                
                -24
                %Total
      domestic day household ratings (1)(3)
                
                
                0.657
                
                
                
                0.537
                
                
                
                -18
                %
                
                
                0.689
                
                
                
                0.571
                
                
                
                -17
                %Total
      domestic primetime household ratings (2)(3)
                
                
                1.115
                
                
                
                0.899
                
                
                
                -19
                %
                
                
                1.128
                
                
                
                0.976
                
                
                
                -13
                %Subscribers
      at period end
                
                
                84,761
                
                
                
                87,717
                
                
                
                3
                %
                
                
                84,761
                
                
                
                87,717
                
                
                
                3
                %(1) Total
      day is the time period measured from the time each day the broadcast of
      commercially sponsoredprogramming
      commences to the time such commercially sponsored programming
      ends.(2) Primetime
      is defined as 8:00 - 11:00 P.M. in the United States.(3) These
      Nielsen ratings are for the time period July 1 through September 30 and
      January 1 through September 30, respectively.








Results
of Operations




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







Revenue.Our
revenue from continuing operations, comprised primarily of subscriber fees and
advertising, decreased $1.7 million or 3% in 2009 over 2008. Our subscriber fee
revenue increased $1.8 million or 12%.  The amount of subscriber
acquisition fees that was recorded as a reduction of subscriber fee revenue
declined from $702,000 for the three months ended September 30, 2008, to
$651,000 in 2009. Subscriber revenue increased primarily due to an increase in
distribution because of the addition of subscribers in 2009 with some of the
Company’s distributors and small contractual rate increases.





Charter
Communications filed for a Chapter 11 bankruptcy in March 2009. There is a risk
in a bankruptcy of a distributor that a sale of some of the systems under
bankruptcy to other distributors may result in a decline of subscriber revenue.
This risk is diminished significantly in the case of Charter Communications
which has stated that it expects to emerge soon from Chapter 11. Charter
Communications has indicated in its press releases that it has received
authorization from the bankruptcy court to pay in the normal course trade
creditor balances which were incurred prior to the bankruptcy filing and that
Charter Communications is authorized to transact business in the ordinary course
of business and as such has been paying its trade creditors in full for balances
incurred after the bankruptcy filing in the normal course.  On October
15, 2009, Charter Communications announced that the bankruptcy court indicated
that it would confirm Charter Communications’ pre-arranged joint plan of
reorganization and issue a confirmation order in the next several
weeks.





The $3.5
million or 7% decrease in advertising revenue is primarily due to declines in
viewer ratings across demographic categories in the third quarter of 2009
compared to the third quarter of 2008. Audience deficiency reserve revenue
decreased $1.8 million from revenue of $951,000 for the three months ending
September 30, 2008, to contra-revenue of $842,000 for the same period in 2009,
leading to a corresponding decrease in revenue recognized by the Company. A
number of changes to our program schedule were implemented in second and third
quarters of 2009, including the replacement of programs that had appeared in the
schedule for a number of years, as well as a shift in scheduling strategy to
more specifically target the demographic group of women 25-54.  This
strategy included the placement of television series in certain timeslots,
instead of movies or original productions. These changes have caused a
disruption to established viewing patterns of our audience resulting in declines
in household ratings, but over time are intended to increase our delivery of
viewers in this target demographic category.





In the
later half of the fourth quarter, we will implement our traditional Holiday
schedule, including an expanded block of Holiday-themed movies from noon to
midnight each weekday.  This additional emphasis on our most
successful programming genre (Holiday-themed movies) is intended to increase our
audience of women ages 25 to 54, and provide promotional information on our
post-Holiday schedule to this important audience.  In 2010, we will
continue to refine our schedule in an attempt to optimize our women 25 to 54
viewership, and launch original series intended to increase this viewing
audience and increase the CPM’s we charge advertisers.  At this time,
we expect advertising revenue to improve marginally in the fourth quarter of
2009 as compared to the third quarter of 2009, consistent with our historically
strong ratings for our Holiday programming.





The
decrease in advertising revenue also reflects slightly lower scatter rates in
the third quarter of 2009 compared to the third quarter of 2008, and lower
direct response advertising revenue based on lower programming rates and lower
viewer responses in the third quarter of 2009 than in the third quarter of
2008.  As indicated under “Current Challenges and Developments” above,
we continue to experience a softening of advertising rates due to economic
conditions.





For the
three months ended September 30, 2009, Nielsen ranked the Hallmark Channel
18th
in total day viewership with a 0.537 household rating and 17th in
primetime with a 0.899 household rating among the 76 cable channels in the
United States market.  We believe that these ratings declines are due
primarily to the changes to our programming schedule described
above.





Cost of
services.Cost of services as a percent of revenue decreased
to 56% in 2009 as compared to 61% in 2008. This decrease results primarily from
the effects of the 14% decrease in programming costs, discussed below, offset in
part by the 7% decrease in advertising revenue discussed above.





Programming
costs decreased $5.0 million or 14% from the three months ended September 30,
2008. In the second and third quarters of 2008, we entered into agreements to
amend significant programming agreements which added programs and deferred
certain payments for programming content to periods beyond 2008. Some of the
agreements resulted in the extension of related program licenses to cover
slightly longer periods of availability, the deferral of expected delivery of
certain programming and the deferral of certain payments primarily from 2008
until 2009. Upon the amendment of the agreements, we prospectively changed the
amortization of program license fees for any changes in the period of expected
usage and/or changes in license fees.  The effects of these amendments
on 2008 amortization were not significant.Additionally, we
returned our exclusivity rights to one title, which resulted in a lower asset
and liability balance.  During the first quarter of 2009, we also
entered into amendments to some of our original programming agreements which
extended the current license period to those titles, and thus, resulted in lower
amortization in the third quarter of 2009 compared to the third quarter of
2008.  Additionally, we have not entered into any significant new
third party license agreements since the fourth quarter of 2008, so expiring
program rights and the related amortization have not been replaced in full with
assets and amortization from newer license agreements.





Operating
costs for the three months ended September 30, 2009, increased $946,000 over
2008. During the third quarter of 2008, the Company recorded $1.1 million
negative amortization of film assets related to a change in estimate of the
Company’s residual and participation liability using information that became
available during the third quarter of 2008. The Company’s bad debt expense was
$235,000 for the three months ended September 30, 2009, compared to $38,000 for
the three months ended September 30, 2008.  The increase in bad debt
expense is due to certain advertising customers experiencing cash flow problems
under current economic conditions.  The Company will continue to
monitor cash collections as part of estimating this expense and expects that
this expense may continue at higher levels in 2009 than in 2008.  The
Company’s management expects that approximately $4.0 million to $5.0 million of
the estimated costs of launching a high definition version of the Hallmark
Channel in February 2010 (estimated costs of $5.0 million to $7.0 million) will
be an additional expense in operating costs for the first quarter of
2010.





Selling, general and administrative
expense.Our selling, general and administrative expense decreased
$443,000 or 3%.  The Company recorded $1.2 million of severance
expense associated with the termination of 15 employees in August 2009. Legal
fees expense also increased $451,000 primarily related to the shareholder
lawsuit and the recapitalization proposal described in Notes 6 and 11 to the
unaudited consolidated financial statements in this Report. The increases were
offset by decreases in the bonus and RSU related expenses. Bonus expense
decreased $1.5 million quarter over quarter. Additionally, the Company recorded
$649,000 of compensation expense associated with RSUs during the three months
ended September 30, 2008, as compared to $134,000 of compensation expense
associated with RSUs for the three months ended September 30, 2009. See Note 8
to the unaudited condensed consolidated financial statements in this
Report.





Marketing
expense.  Our marketing expense decreased 93%. The Company had
one marketing promotion for “A Gunfighter’s Pledge” in July 2008, which was a
large, national off-air campaign.  In addition to radio, television, print
and online advertising, we executed a multi-market event to drive press coverage
and viewer awareness. As part of our contingency cost reduction efforts,
promotional and marketing efforts were reduced overall during the 2009 quarter
compared to the third quarter of 2008.




Interest
expense.Interest expense for the three months ended September
30, 2009, decreased $570,000 compared to the three months ended September 30,
2008. The principal balance under our credit facility was $35.2 million at
September 30, 2008, and $2.5 million at September 30, 2009. The interest rate on
our bank credit facility decreased from 4.45% at September 30, 2008, to 2.5% at
September 30, 2009. Interest rates on our 2001, 2005 and 2006 notes decreased
from 7.79% at September 30, 2008, to 5.60% at September 30, 2009. The benefit of
these rate decreases was offset in part by a higher principal balance on the
Senior Secured Note.










Nine
Months Ended September 30, 2008 Compared to Nine Months Ended September 30,
2009







Revenue.Our
revenue from continuing operations, comprised primarily of subscriber and
advertising fees, decreased $4.6 million or 2% in 2009 over 2008. Our subscriber
fee revenue increased $4.5 million or 11%.  The amount of subscriber
acquisition fees that was recorded as a reduction of subscriber fee revenue was
approximately $2.0 million for both the nine months ended September 30, 2008 and
2009. The primary reason for the increase in subscriber fees in the nine months
ended September 30, 2009 was the same as those stated above for subscriber fee
revenue for the three months ended September 30, 2009.





The $9.3
million or 6% decrease in advertising revenue is primarily due to declines in
viewer ratings across demographic categories for the first nine months of 2009
compared 2008. Audience deficiency unit revenue decreased $6.9 million from
revenue of $1.2 million for the nine months ending September 30, 2008, to
contra-revenue of $5.7 million for the same period in 2009, leading to a
corresponding decrease in revenue recognized by the Company.  Please
see the discussion above related to the decrease in advertising revenue for the
three months ended September 30, 2009 for additional information on the ratings.
The decrease in advertising revenue also reflects lower scatter rates and direct
response advertising revenue during the first three quarters of 2009 compared to
2008 because of the effects of the national recession on the advertising market.
An offsetting factor was an increase in the number of available general/scatter
rate advertising spots. In response to the lower advertising revenue, starting
in the third quarter of 2008, we reduced the amount of time allotted to on-air,
self-promotion and increased the time available for paid
advertising.





For the
nine months ended September 30, 2009, Nielsen ranked the Hallmark Channel
15th
in total day viewership with a 0.571 household rating and 12th in
primetime with a 0.976 household rating among the 76 cable channels in the
United States market. These ratings declined primarily due to recent changes to
our programming schedule.





Cost of
services.Cost of services as a percent of revenue decreased
to 53% in 2009 as compared to 57% in 2008. This decrease results primarily from
the effects of the 12% decrease in programming costs, discussed below, offset in
part by the 6% decrease in advertising revenue discussed above.





Programming
costs decreased $12.5 million or 12% from the nine months ended September 30,
2008. See the discussion of programming costs for the three months ended
September 30, 2009 above as to the primary reason for this
decrease.





Operating
costs for the nine months ended September 30, 2009, increased $2.4 million over
2008 primarily due to the $1.1 million increase in bad debt expense and the
$912,000 of severance expense recorded in May 2009 related to one executive’s
resignation. The Company’s bad debt expense was $1.1 million for the nine months
ended September 30, 2009, as compared to $42,000 for the nine months ended
September 30, 2008. See the discussion above on the bad debt expense for the
third quarter of 2009 for additional information.





Selling, general and administrative
expense.Our selling, general and administrative expense decreased $2.9
million or 7%.  The Company recorded $2.5 million of severance expense
associated with the resignation of its President on May 31, 2009. The Company
also recorded $1.2 million of severance expense associated with the termination
of 15 employees in August 2009. Legal fees expense also increased $587,000
primarily related to the shareholder lawsuit and the recapitalization proposal
described in Notes 6 and 11 to the unaudited consolidated financial statements
in this Report. These increases in expense were offset by decreases in the
bonus, commission, travel, communication, and RSU related expenses. Bonus and
commission expenses decreased $3.3 million period over period. Travel and
communication events related expenses decreased approximately $1.0 million
period over period. Additionally, the Company recorded $2.4 million of
compensation expense associated with RSUs during the nine months ended September
30, 2008, as compared to $303,000 of compensation benefit associated with RSUs
for the nine months ended September 30, 2009. See Note 8 to the unaudited
condensed consolidated financial statements in this Report.





Marketing
expense.  Our marketing expense decreased 55%. The Company had
three marketing promotions in the first three quarters of 2008: “The Good Witch”
in January 2008, “Bridal Fever” in February 2008, and “A Gunfighter’s Pledge” in
July 2008. The Company had one significant marketing promotion in January 2009
centered around the original movie, “Taking a Chance on Love.” As part of our
contingency cost reduction efforts, promotional and marketing efforts were
reduced overall during the 2009 compared to 2008.




Interest
expense.The principal balance under our credit facility was
$35.2 million at September 30, 2008, and $2.5 million at September 30, 2009. The
interest rate on our bank credit facility decreased from 4.45% at September 30,
2008, to 2.5% at September 30, 2009. Interest rates on our 2001, 2005 and 2006
notes decreased from 7.79% at September 30, 2008, to 5.60% at September 30,
2009. The benefit of these rate decreases was offset by a higher principal
balance on the Senior Secured Note, resulting in interest expense for the first
three quarters of 2009 being nearly the same as for the first three quarters of
2008.










Liquidity
and Capital Resources





During
the nine months ended September 30, 2008, our operating activities provided
$41.6 million of cash compared to $33.4 million in 2009.The Company’s net loss
for the nine months ended September 30, 2009, decreased $15.5 million to $23.0
million from $38.5 million for the nine months ended September 30, 2008. Our
depreciation and amortization expense for the nine months ended September 30,
2009, decreased $12.4 million to $99.3 million from $111.7 million in
2008.  Due to contract amendments mentioned above under programming
costs, we reduced programming amortization expense, but those adjustments did
not change the cash payment terms.  Additionally, certain amendments
to programming agreements moved cash payments from 2008 to 2009, resulting in
higher programming cash payments and lower cash from operations in 2009 compared
to 2008.  Pursuant to the Waiver Agreement, the Company paid $20.6
million for interest on the 2001, 2005 and 2006 Notes that accrued from November
16, 2008, through September 30, 2009, while no such interest payments were made
in the prior year period.





Cash used
in investing activities was $4.4 million and $1.1 million for the nine months
ended September 30, 2008 and 2009, respectively. During the nine months ended
September 30, 2008 and 2009, the Company paid $2.6 million and $691,000,
respectively, to the buyer of the international business (sold in April 2005)
for amounts due under the terms of the sale agreement, primarily for
reimbursement of transponder lease payments. During the nine months ended
September 30, 2008 and 2009, the Company purchased property and equipment
of  $1.8 million and $371,000, respectively.





Cash used
in financing activities was $34.9 million and $26.7 million for the nine months
ended September 30, 2008 and 2009, respectively. We borrowed $18.8 million and
$18.1 million under our credit facility to supplement the cash requirements of
our operating and investing activities during the nine months ended September
30, 2008 and 2009, respectively. We repaid principal of $53.1 million and $44.1
million under our bank credit facility during the nine months ended September
30, 2008 and 2009, respectively.








Cash
Flows








As of
September 30, 2009, the Company had $8.4 million in cash and cash equivalents on
hand and $42.5 million of current borrowing capacity under the bank credit
facility.  Day-to-day cash disbursement requirements have typically
been satisfied with cash on hand and operating cash receipts supplemented with
the borrowing capacity available under the bank credit facility and forbearance
by Hallmark Cards and its affiliates.  The Company’s management
anticipates that the principal uses of cash up to May 1, 2010, will include the
payment of operating expenses, accounts payable and accrued expenses,
programming costs, interest and repayment of principal under the bank credit
facility and interest of approximately $8.0 million to $12.0 million due under
certain notes to the Hallmark Cards affiliates from October 1, 2009, through May
1, 2010.  The amounts outstanding under the bank credit agreement and
those notes are due May 1, 2010 as discussed below.




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




Another
significant aspect of the Company’s liquidity is the deferral of payments on
obligations owed to Hallmark Cards and its subsidiaries. Under the Amended and
Restated Waiver Agreement as amended with Hallmark Cards and its affiliates (the
“Waiver Agreement”), the deferred payments under such obligations are extended
to May 1, 2010.  These obligations comprised $340.7 million at
September 30, 2009.  An additional $740.1 million (10.25% Senior
Secured Note) of principal and interest outstanding at September 30, 2009,
payable to a Hallmark Cards’ affiliate in August 2011, is also subject to the
Waiver Agreement until May 1, 2010.  Interest amounts related to the
10.25% note will be added to principal through February 5, 2010. The Hallmark
affiliate has indicated that it will not extend the Waiver Agreement beyond May
1, 2010.




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




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




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




The
sufficiency of the existing sources of liquidity to fund the Company’s
operations is dependent upon maintaining subscriber and advertising revenue at
or near the amount of such revenue for the nine months ended September 30, 2009.
A significant decline in the popularity of the Channels, a further economic
decline in the advertising market, an increase in program acquisition costs, an
increase in competition or other adverse changes in operating conditions could
negatively impact the Company’s liquidity and its ability to fund the current
level of operations.  For the first three quarters, lower viewership
ratings in 2009 as compared to 2008 for the Company's programming on the
Hallmark Channel resulted in an increase in audience deficiency units owed to
advertisers.  Since the second quarter of 2008, the Company has also
experienced a softening of advertising rates in the direct response and general
rate scatter market because of the national recession.  Subsequent to
the first quarter of 2008, the rates for the Company's advertising spots in the
scatter market and direct response advertising were lower than 2007
levels.  These market conditions have continued in 2009, with rates
lower in the third quarter of 2009 and the first nine months of 2009 when
compared to the same periods in 2008. The Company expects continued lower rates
through 2009 and into 2010. In response to these market conditions, the Company
has implemented certain cost containment measures for 2009, and has a limited
number of additional, contingent cost cutting measures that can be implemented
in the remainder of 2009 depending on market conditions.




The
Company is currently unable to meet its obligations which come due on and after
May 1, 2010.  A default on the obligations due on May 1, 2010 would
also result in a default under the Company’s 10.25% Senior Secured Note. The
Company anticipates that prior to May 1, 2010, it will be necessary to extend,
refinance or restructure (i) the bank credit facility and (ii) the promissory
notes payable to affiliates of Hallmark Cards. As part of a combination of
actions and in order to obtain additional funding, the Company may consider
various alternatives, including restructuring of the debt if possible,
refinancing the bank credit facility, raising additional capital through the
issuance of equity or debt securities, or other strategic alternatives. If the
current adverse credit market conditions continue, a restructuring or
refinancing could be difficult to achieve and if achieved could include changes
to existing interest rates and other provisions within the current debt
arrangements. These changes may have a negative impact on future operating
results and cash flows.




As
discussed in Note 6, the Hallmark Cards' affiliate has proposed a
recapitalization of the Company's obligations.  There can be no
assurance that the Company will accept and consummate this proposal, with or
without modification. Further, there can be no assurance that the Company will
ever consummate a refinancing or recapitalization.













Risk
Factors and Forward-Looking Statements





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





Among the
factors that could cause actual results to differ materially are those discussed
in this Report below and in the Company’s filings with the Securities and
Exchange Commission, including the Risk Factors stated in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008, the Company’s
Quarterly Report on Form 10-Q for the quarter ended June 30, 3009, and this
Report. Such Risk Factors include, but are not limited to, the
following:  competition for distribution of channels, viewers,
advertisers and the acquisition of programming; fluctuations in the availability
of programming; fluctuations in demand for programming which we air on our
channels; our ability to address our liquidity needs; our incurrence of losses;
and our substantial indebtedness affecting our financial condition and
results.





Available
Information







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





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





Item
3.  Quantitative and
Qualitative Disclosures About Market Risk





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





As of
September 30, 2009, our cash, cash equivalents and short-term investments had a
fair value of $8.4 million and were invested in cash and short-term commercial
paper. The primary purpose of these investing activities has been to preserve
principal until the cash is required to fund operations. Consequently, the size
of this portfolio fluctuates significantly as cash is provided by and used in
our business.





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





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








We
are exposed to market risk.





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





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





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





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





Our
material interest bearing assets consisted of cash equivalents and short-term
investments. The balance of our interest bearing assets was $8.4 million, or 1%
of total assets, as of September 30, 2009. Our material liabilities subject to
interest rate risk consisted of our bank credit facility, our note and interest
payable to HC Crown, and our notes and interest payable to Hallmark Cards
affiliates. The balance of those liabilities was $343.2 million, or 24% of total
liabilities, as of September 30, 2009. Net interest expense for the three months
ended September 30, 2009, was $24.9 million, 40%, of our total revenue. Net
interest expense for the nine months ended September 30, 2009, was $75.4
million, 37%, of our total revenue.  Our net interest expense for
these liabilities is sensitive to changes in the general level of interest
rates, primarily U.S. and LIBOR interest rates. In this regard, changes in U.S.
and LIBOR (“Eurodollar”) interest rates affect the fair value of interest
bearing liabilities.




If market
interest rates were to increase or decrease by 1% from the rates discussed in
Notes 4 and 5 to the financial statements as of September 30, 2009, our interest
expense for the three and nine months would change by $892,000 and $2.8 million,
respectively. See Notes 4 and 5.




Item
4.  Controls and
Procedures.





a.  Disclosure
Controls and Procedures





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





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





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





PART
II.  OTHER INFORMATION





Item
1.  Legal Proceedings





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





Item
1A.  Risk Factors





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





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





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








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





Our 2009
annual meeting of stockholders was held on July 23, 2009, and was temporarily
adjourned until July 30, 2009.  The following proposals were voted
upon at the meeting on July 30, 2009, with the following number of votes cast
for, against or withheld:





Proposal 1: Election
of Directors








Name
              
              Number of Votes For
              
              
              Votes For as a Percent of Votes
      Eligible
              
              
              Votes WithheldWilliam
      J. Abbott
              
              
              367,649,294
              
              
              
              96.54
              %
              
              
              6,372,864Dwight
      C. Arn
              
              
              367,644,911
              
              
              
              96.54
              
              
              
              6,377,247Robert
      C. Bloss
              
              
              367,503,397
              
              
              
              96.50
              
              
              
              6,518,761William
      Cella
              
              
              368,944,755
              
              
              
              96.88
              
              
              
              5,077,403Glenn
      Curtis
              
              
              367,665,389
              
              
              
              96.55
              
              
              
              6,356,769Steve
      Doyal
              
              
              367,649,117
              
              
              
              96.54
              
              
              
              6,373,041Brian
      E. Gardner
              
              
              366,929,588
              
              
              
              96.35
              
              
              
              7,092,570Herbert
      A.Granath
              
              
              368,946,473
              
              
              
              96.88
              
              
              
              5,075,685Donald
      J. Hall, Jr.
              
              
              367,635,471
              
              
              
              96.54
              
              
              
              6,386,687Irvine
      O. Hockaday, Jr.
              
              
              367,600,487
              
              
              
              96.53
              
              
              
              6,421,671A.
      Drue Jennings
              
              
              368,901,736
              
              
              
              96.87
              
              
              
              5,120,422Peter
      A. Lund
              
              
              367,667,583
              
              
              
              96.55
              
              
              
              6,354,575Brad
      R. Moore
              
              
              368,946,026
              
              
              
              96.88
              
              
              
              5,076,132Deanne
      R. Stedem
              
              
              367,500,519
              
              
              
              96.50
              
              
              
              6,521,639








Item
6.  Exhibits





INDEX
TO EXHIBITS





Exhibit
      Number
            Exhibit
      Title3.1
            Amended
      and Restated Certificate of Incorporation (previously filed as Exhibit 3.1
      to our Registration Statement on Form S-1/A (Amendment No. 2), Commission
      File No. 333-95573, and incorporated herein by
  reference).3.2
            Amendment
      to the Amended and Restated Certificate of Incorporation (previously filed
      as Exhibit 3.2 to our Quarterly Report on Form 10-Q filed on July 31, 2001
      (File No. 000-30700; Film No. 1693331) and incorporated herein by
      reference).3.3
            Amended
      and Restated By-Laws (previously filed as Exhibit 3.2 to our Registration
      Statement on Form S-1/A (Amendment No. 3), Commission File No. 333-95573,
      and incorporated herein by reference).10.1
            Trademark
      License Extension Agreement (Hallmark Movie Channel) dated August 15, 2009
      by and between Hallmark Licensing Inc. and Crown Media United States,
      LLC.10.2
            Trademark
      License Extension Agreement (Hallmark Channel) dated August 15, 2009 by
      and between Hallmark Licensing Inc. and Crown Media United States,
      LLC.10.3*
            Employment
      Agreement, dated as of June 15, 2009, by and between Crown Media Holdings,
      Inc. and Edward Georger.31.1
            Rule
      13a-14(a) Certification executed by the Company's Chief Executive
      Officer.31.2
            Rule
      13a-14(a) Certification executed by the Company's Executive Vice President
      and Chief Financial Officer.32
            Section
      1350 Certifications.





__________





*Management
contract or compensating plan or arrangement.











SIGNATURES








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





CROWN MEDIA HOLDINGS,
INC.





Signature
            Title
            DateBy:               /s/
      WILLIAM J. ABBOTT
            Principal
      Executive
              Officer
            November
      5, 2009William
      J. AbbottBy:             /s/
      BRIAN C. STEWART
            Principal
              Financial
      and
            November
      5, 2009Brian
      C. Stewart
            Accounting
      Officer