Table of Contents

 

 

 

**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

**Form 10-Q**

 

**(Mark One)**

 

**x                                        ****QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGEACT OF 1934**

 

**For the quarterly period ended September 30,2008**

 

**or**

 

**o                                         ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACTOF 1934**

** **

**For the transition periodfrom                    to                    .**

 

**Commission File Number: 000-30700**

 

**Crown Media Holdings, Inc.**

(Exact Name of Registrant as Specified in ItsCharter)

 

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

 

**12700 Ventura Boulevard,**

**Suite 200**

**Studio City, California  91604**

(Address of Principal Executive Offices and ZipCode)

 

**(818) 755-2400**

(Registrant’s Telephone Number, Including AreaCode)

 

 

(Former Name, Former Address, and Former FiscalYear,

if Changed Since Last Report.)

 

Indicate by check markwhether the registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes  x     No o

 

Indicate by check mark whether the registrant isa large accelerated filer, an accelerated filer, a non-accelerated filer or asmaller reporting company.  Seedefinition of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 ofthe Exchange Act. (Check one):

 

Large accelerated filer o                    Acceleratedfiler x

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

 

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

 

As of November 3,2008, the number of shares of Class A Common Stock, $.01 par valueoutstanding was 74,117,654, and the number of shares of Class B CommonStock, $.01 par value, outstanding was 30,670,422.

 

 

 

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**TABLE OF CONTENTS**

 
| ** **       | ** **                                                                                                                                          | **Page** |
|------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------|----------|
| **PART I**  | **Financial Information**                                                                                                                           |     |
|             |                                                                                                                                                |     |
| Item 1           | Financial Statements  (Unaudited)                                                                                                                   | 3        |
|             | CROWN MEDIA HOLDINGS, INC.  AND SUBSIDIARIES                                                                                                        |     |
|             | Condensed Consolidated  Balance Sheets — December 31, 2007 andSeptember 30, 2008 (Unaudited)                                         | 3        |
|             | Condensed Consolidated  Statements of Operations and Comprehensive Loss (Unaudited)  - Three and Nine Months Ended September 30, 2007 and 2008 | 5        |
|             | Condensed  Consolidated Statements of Cash Flows (Unaudited)  - Nine Months Ended September 30, 2007 and 2008                                  | 6        |
|             | Notes to  Unaudited Condensed Consolidated Financial Statements                                                                                     | 7        |
|             |                                                                                                                                                |     |
| Item 2           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                         | 23       |
|             |                                                                                                                                                |     |
| Item 3           | Quantitative  and Qualitative Disclosures About Market Risk                                                                                         | 33       |
|             |                                                                                                                                                |     |
| Item 4           | Controls and  Procedures                                                                                                                            | 34       |
|             |                                                                                                                                                |     |
| **PART II** | **Other Information**                                                                                                                               | 34       |
|             |                                                                                                                                                |     |
| Item 1A          | Risk Factors                                                                                                                                        | 34       |
|             |                                                                                                                                                |     |
| Item 6           | Exhibits                                                                                                                                            | 35       |
|             |                                                                                                                                                |     |
| Signatures       | 36                                                                                                                                                  |

 

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

* *

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

* *

**PART I. FINANCIALINFORMATION**

** **

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

 

**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED BALANCE SHEETS**

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

** **
| ** **                                                                                  | ** ** | **As of December 31,** | ** ** | **As of September 30,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                  | ** ** | **2007**                              | ** ** | **2008**                               | ** ** |
| ASSETS                                                                                      |       |                                  |       |                                   |       |
|                                                                                        |       |                                  |       |                                   |       |
| Cash and cash equivalents                                                                   |       | $                                     | 1,974      |                                   | $          | 4,298 |   |
| Accounts receivable, less  allowance for doubtful accounts of  $242  and $261, respectively |       | 68,603                                |       | 55,715                                 |       |
| Program license fees —  affiliates                                                     |       | 166                                   |       | 1,055                                  |       |
| Program license fees —  non-affiliates                                                 |       | 119,523                               |       | 92,077                                 |       |
| Prepaid and other assets                                                                    |       | 4,478                                 |       | 4,021                                  |       |
| Prepaid program license fee  assets                                                         |       | 8,361                                 |       | 15,657                                 |       |
| Total current assets                                                                        |       | 203,105                               |       | 172,823                                |       |
|                                                                                        |       |                                  |       |                                   |       |
| Program license fees —  affiliates                                                     |       | 653                                   |       | 8,107                                  |       |
| Program license fees —  non-affiliates                                                 |       | 129,268                               |       | 176,564                                |       |
| Subscriber acquisition fees,  net                                                           |       | 3,333                                 |       | 3,984                                  |       |
| Property and equipment, net                                                                 |       | 15,962                                |       | 15,942                                 |       |
| Goodwill                                                                                    |       | 314,033                               |       | 314,033                                |       |
| Prepaid and other assets                                                                    |       | 9,887                                 |       | 7,739                                  |       |
| Total assets                                                                                |       | $                                     | 676,241    |                                   | $          | 699,192 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATEDBALANCE SHEETS**

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

**(continued)**

 
| ** **                                                                                                                                                                                                                                                                           | ** ** | **As of December 31,** | ** ** | **As of September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                           | ** ** | **2007**                              | ** ** | **2008**                               | ** ** |
|                                                                                                                                                                                                                                                                                 |       |                                  |       |                                   |       |
| LIABILITIES AND STOCKHOLDERS’  DEFICIT                                                                                                                                                                                                                                          |       |                                  |       |                                   |       |
|                                                                                                                                                                                                                                                                                 |       |                                  |       |                                   |       |
| LIABILITIES:                                                                                                                                                                                                                                                                         |       |                                  |       |                                   |       |
| Accounts payable and accrued  liabilities                                                                                                                                                                                                                                            |       | $                                     | 25,255     |                                   | $          | 19,961 |   |
| Audience deficiency reserve  liability                                                                                                                                                                                                                                               |       | 15,620                                |       | 14,438                                 |       |
| Accrued restricted stock units                                                                                                                                                                                                                                                       |       | 4,609                                 |       | 3,141                                  |       |
| License fees payable to  affiliates                                                                                                                                                                                                                                                  |       | 1,628                                 |       | 1,408                                  |       |
| License fees payable to  non-affiliates                                                                                                                                                                                                                                              |       | 107,749                               |       | 115,697                                |       |
| Payables to affiliates                                                                                                                                                                                                                                                               |       | 18,951                                |       | 17,253                                 |       |
| Credit facility and interest  payable                                                                                                                                                                                                                                                |       | 19,583                                |       | 35,215                                 |       |
| Note and interest payable to  Hallmark Cards                                                                                                                                                                                                                                         |       | —                                |       | 5,915                                  |       |
| Other current liabilities                                                                                                                                                                                                                                                            |       | 5,979                                 |       | 3,813                                  |       |
| Total current liabilities                                                                                                                                                                                                                                                            |       | 199,374                               |       | 216,841                                |       |
| Accrued liabilities                                                                                                                                                                                                                                                                  |       | 18,056                                |       | 15,345                                 |       |
| License fees payable to  affiliates                                                                                                                                                                                                                                                  |       | —                                |       | 7,923                                  |       |
| License fees payable to  non-affiliates                                                                                                                                                                                                                                              |       | 56,521                                |       | 87,207                                 |       |
| Payables to affiliates                                                                                                                                                                                                                                                               |       | 4,041                                 |       | 1,869                                  |       |
| Credit facility                                                                                                                                                                                                                                                                      |       | 50,000                                |       | —                                 |       |
| Note and interest payable to HC  Crown                                                                                                                                                                                                                                               |       | 101,360                               |       | 107,449                                |       |
| Note and interest payable to  Hallmark Cards affiliate                                                                                                                                                                                                                               |       | 57,868                                |       | 61,338                                 |       |
| Senior secured note to HC  Crown, including accrued interest                                                                                                                                                                                                                         |       | 621,266                               |       | 669,682                                |       |
| Note and interest payable to  Hallmark Cards affiliate                                                                                                                                                                                                                               |       | 158,753                               |       | 168,273                                |       |
| Note and interest payable to  Hallmark Cards                                                                                                                                                                                                                                         |       | 22,075                                |       | —                                 |       |
| Company obligated mandatorily  redeemable preferred  interest                                                                                                                                                                                                                        |       | 18,690                                |       | 20,355                                 |       |
| Other liabilities                                                                                                                                                                                                                                                                    |       | 19,232                                |       | 16,920                                 |       |
| Obligation to NICC for the repurchase of  Class A common stock, extinguished without cash on January 2, 2008,  per the agreement, $.01 par value;  4,357,066 and 0 shares issued and  outstanding  as of December 31, 2007 and September 30, 2008,  respectively |       | 32,765                                |       | —                                 |       |
| Total liabilities                                                                                                                                                                                                                                                                    |       | 1,360,001                             |       | 1,373,202                              |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                                                                                                                                        |       |                                  |       |                                   |       |
| STOCKHOLDERS’ DEFICIT:                                                                                                                                                                                                                                                          |       |                                  |       |                                   |       |
| Class A common stock,  $.01 par value; 200,000,000 shares authorized; 69,760,588 and 74,117,654  shares issued and outstanding as of December 31, 2007 and  September 30, 2008,  respectively                                                                         |       | 698                                   |       | 741                                    |       |
| Class B common stock,  $.01 par value; 120,000,000 shares  authorized;  30,670,422 shares issued and outstanding as of December 31, 2007 and  September 30, 2008                                                                                                      |       | 307                                   |       | 307                                    |       |
| Paid-in capital                                                                                                                                                                                                                                                                      |       | 1,411,291                             |       | 1,459,500                              |       |
| Accumulated deficit                                                                                                                                                                                                                                                                  |       | (2,096,056                            | )          | (2,134,558                             | )          |
| Total stockholders’ deficit                                                                                                                                                                                                                                                     |       | (683,760                              | )          | (674,010                               | )          |
| Total liabilities and  stockholders’ deficit                                                                                                                                                                                                                                    |       | $                                     | 676,241    |                                   | $          | 699,192 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS ANDCOMPREHENSIVE LOSS**

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

 
| ** **                                                                                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2007**                                             | ** ** | **2008**                                            | ** ** | **2007** | ** ** | **2008** | ** ** |
| Revenue:                                                                                         |       |                                                 |       |                                                |       |   |   |   |   |
| Subscriber fees                                                                                  |       | $                                                    | 7,389      |                                                | $          | 14,240 |   | $ | 21,391 |   | $ | 42,672 |   |
| Advertising                                                                                      |       | 47,819                                               |       | 49,950                                              |       | 142,750 |   | 162,836 |   |
| Advertising by Hallmark Cards                                                                    |       | —                                               |       | —                                              |       | 390 |   | 157 |   |
| Other revenue                                                                                    |       | 104                                                  |       | 292                                                 |       | 260 |   | 901 |   |
| Total revenue, net                                                                               |       | 55,312                                               |       | 64,482                                              |       | 164,791 |   | 206,566 |   |
| Cost of Services:                                                                                |       |                                                 |       |                                                |       |   |   |   |   |
| Programming costs                                                                                |       |                                                 |       |                                                |       |   |   |   |   |
| Affiliates                                                                                       |       | 11,247                                               |       | 842                                                 |       | 21,149 |   | 1,777 |   |
| Non-affiliates                                                                                   |       | 35,148                                               |       | 35,811                                              |       | 103,327 |   | 105,922 |   |
| Amortization of film assets                                                                      |       | (4,739                                               | )          | (1,148                                              | )          | (5,260 | ) | (1,148 | ) |
| Subscriber acquisition fee  amortization expense                                                 |       | 7,048                                                |       | —                                              |       | 22,728 |   | — |   |
| Amortization of capital lease  obligation                                                        |       | 289                                                  |       | 289                                                 |       | 868 |   | 868 |   |
| Other costs of services                                                                          |       | 2,933                                                |       | 3,318                                               |       | 8,193 |   | 9,802 |   |
| Total cost of services                                                                           |       | 51,926                                               |       | 39,112                                              |       | 151,005 |   | 117,221 |   |
| Selling, general and  administrative expense                                                     |       | 11,578                                               |       | 12,640                                              |       | 39,828 |   | 37,966 |   |
| Marketing expense                                                                                |       | 3,565                                                |       | 4,633                                               |       | 11,850 |   | 13,091 |   |
| Depreciation and amortization  expense                                                           |       | 377                                                  |       | 506                                                 |       | 1,270 |   | 1,430 |   |
| (Loss) income from operations                                                                    |       | (12,134                                              | )          | 7,591                                               |       | (39,162 | ) | 36,858 |   |
| Interest income                                                                                  |       | 343                                                  |       | 23                                                  |       | 1,087 |   | 1,225 |   |
| Interest expense                                                                                 |       | (26,086                                              | )          | (25,477                                             | )          | (83,672 | ) | (76,585 | ) |
| Net loss and comprehensive  loss                                                                 |       | $                                                    | (37,877    | )                                                   | $          | (17,863 | ) | $ | (121,747 | ) | $ | (38,502 | ) |
| Weighted average number of  Class A and Class B shares  outstanding, basic and diluted |       | 104,788                                              |       | 104,788                                             |       | 104,788 |   | 104,772 |   |
| Net loss per share, basic and  diluted                                                           |       | $                                                    | (0.36      | )                                                   | $          | (0.17 | ) | $ | (1.16 | ) | $ | (0.37 | ) |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**UNAUDITED CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

** **
| ** **                                                                                                                                                  | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                                                                                  | ** ** | **2007**                                                | ** ** | **2008** | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                                                                                                      | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Net loss                                                                                                                                                    |       | $                                                       | (121,747   | ) | $ | (38,502 | ) |
| Adjustments to reconcile net  loss to net cash used in operating activities:                                                                                |       |                                                    |       |   |   |
| Depreciation and amortization                                                                                                                               |       | 153,195                                                 |       | 111,738 |   |
| Accretion on company obligated  mandatorily redeemable preferred interest                                                                                   |       | 1,655                                                   |       | 1,665 |   |
| Provision for allowance for  doubtful accounts                                                                                                              |       | 95                                                      |       | 43 |   |
| Residuals and participations                                                                                                                                |       | (5,260                                                  | )          | (1,052 | ) |
| Impairment of film asset                                                                                                                                    |       | —                                                  |       | 176 |   |
| Loss on sale of property and  equipment                                                                                                                     |       | 36                                                      |       | — |   |
| Stock-based compensation                                                                                                                                    |       | 5,671                                                   |       | 1,650 |   |
| Changes in operating assets  and liabilities:                                                                                                               |       |                                                    |       |   |   |
| (Increase) decrease in  accounts receivable                                                                                                                 |       | (870                                                    | )          | 12,846 |   |
| Additions to program license  fees                                                                                                                          |       | (101,576                                                | )          | (135,893 | ) |
| Deletions (additions) to  subscriber acquisition fees                                                                                                       |       | 858                                                     |       | (2,693 | ) |
| Increase in prepaid and other  assets                                                                                                                       |       | (1,124                                                  | )          | (5,929 | ) |
| Decrease in accounts payable,  accrued and other liabilities                                                                                                |       | (1,561                                                  | )          | (12,343 | ) |
| Increase in interest payable                                                                                                                                |       | 70,915                                                  |       | 66,700 |   |
| (Decrease) increase in  subscriber acquisition fees payable                                                                                                 |       | (1,206                                                  | )          | 1,183 |   |
| Increase in license fees  payable to affiliates                                                                                                             |       | 1,635                                                   |       | 7,702 |   |
| (Decrease) increase in license  fees payable to non-affiliates                                                                                              |       | (5,208                                                  | )          | 38,633 |   |
| Increase (decrease) in  payables to affiliates                                                                                                              |       | 1,723                                                   |       | (3,870 | ) |
| Decrease in deferred revenue                                                                                                                                |       | —                                                  |       | (475 | ) |
| Net cash (used in) provided by  operating activities                                                                                                        |       | (2,769                                                  | )          | 41,579 |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                                                                                                      |       |                                                    |       |   |   |
| Purchases of property and  equipment                                                                                                                        |       | (970                                                    | )          | (1,772 | ) |
| Payments to buyer of  international business                                                                                                                |       | (3,028                                                  | )          | (2,597 | ) |
| Proceeds from disposition of  property and equipment                                                                                                        |       | 3                                                       |       | — |   |
| Net cash used in investing  activities                                                                                                                      |       | (3,995                                                  | )          | (4,369 | ) |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                                                                                                      |       |                                                    |       |   |   |
| Borrowings under the credit  facility                                                                                                                       |       | 7,145                                                   |       | 18,761 |   |
| Principal payments on the  credit facility                                                                                                                  |       | (13,845                                                 | )          | (53,100 | ) |
| Principal payments on capital  lease obligations                                                                                                            |       | (498                                                    | )          | (547 | ) |
| Net cash used in financing  activities                                                                                                                      |       | (7,198                                                  | )          | (34,886 | ) |
| Net (decrease) increase in  cash and cash equivalents                                                                                                       |       | (13,962                                                 | )          | 2,324 |   |
| Cash and cash equivalents,  beginning of period                                                                                                             |       | 13,965                                                  |       | 1,974 |   |
| Cash and cash equivalents, end  of period                                                                                                                   |       | $                                                       | 3          |   | $ | 4,298 |   |
|                                                                                                                                                        |       |                                                    |       |   |   |
| Supplemental disclosure of  cash and non-cash activities:                                                                                                   |       |                                                    |       |   |   |
| Interest paid                                                                                                                                               |       | $                                                       | 6,721      |   | $ | 3,882 |   |
| Reclassification of additional  paid-in capital for obligation to return amounts  previously received as capital contributions  under tax sharing agreement |       | $                                                       | 25,192     |   | $ | — |   |
| Tax sharing payment from  Hallmark Cards applied to  note  payable to Hallmark Cards                                                                        |       | $                                                       | 6,510      |   | $ | 15,488 |   |
| Reclassification 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                                                                      |       | $                                                       | 18,778     |   | $ | 24,747 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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**CROWN MEDIA HOLDINGS, INC. ANDSUBSIDIARIES**

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**For the Three and Nine MonthsEnded September 30, 2007 and 2008**

 

**1. Business and Organization**

 

***Organization***

 

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

 

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

 

***Liquidity***

*** ***

As of September 30,2008, the Company had $4.3 million in cash and cash equivalents on hand and$14.8 million of current borrowing capacity under the bank creditfacility.  Day-to-day cash disbursementrequirements have typically been satisfied with cash on hand and operating cashreceipts supplemented with the borrowing capacity available under the bankcredit facility and forbearance by Hallmark Cards and its affiliates.

 

Operating activities for the year ended December 31, 2007, yieldedpositive cash flow as have the nine months ended September 30, 2008.  However, there can be no assurance that theCompany’s operating activities will continue to generate positive cash flow.

 

The Company’s principal sources of funds are cash onhand, cash generated by operations and amounts available under the Company’srevolving bank credit facility through May 31, 2009.  Another significant aspect of the Company’sliquidity is the deferral of payments on obligations owed to Hallmark Cards andits subsidiaries.  In March 2008,the Company and Hallmark Cards entered into an Amended and Restated WaiverAgreement which changed the maturity date of three obligations and deferredpayments under certain obligations. Under an amendment in October 2008, the deferred payments underthese obligations were extended to October 1, 2009. However, under theWaiver Agreement, interest on the 2001, 2005 and 2006 Notes that accrues from November 16,2008, through December 31, 2008,  ispayable in cash in January 2009; subsequent quarterly accrued interest ispayable in cash 5 days after each quarterly period.  See Note 6 Related Party Long-TermObligations – Waiver and Standby Purchase Agreement.

 

The Waiver Agreement requires that Excess Cash Flow asdefined in the Waiver Agreement be used to make payments due under the bankcredit facility or to pay obligations subject to the Waiver Agreement.  The Company has budgeted and anticipates thatit will have substantial Excess Cash Flow for the year ended December 31,2008 and that this amount will be used to make a reduction in the bank creditfacility during the first quarter of 2009. See Note 6.  However, theexistence and amounts of any Excess Cash Flow depend on the Company’s resultsand cash flow for the remainder of 2008.

 

The Company may incur a tax liability to HallmarkCards in 2009 pursuant to the Tax Sharing Agreement that could result in a cashamount being payable to Hallmark Cards in the second quarter of 2009 unlessHallmark Cards agrees to defer any such tax liability. Additionally, we expectto repay the remaining balance under the Tax Note before its due date of July 27,2009, through non-cash sources. See Note 7 Related Party Transactions – TaxSharing Agreement.

 

The Company believesthat cash on hand, cash generated by operations, and borrowing availabilityunder its bank credit facility through May 31, 2009, when combined withthe deferral of any required payments on related-party debt and relatedinterest described under the Waiver Agreement, and, if necessary, HallmarkCards’ purchase of any outstanding indebtedness under the bank credit facilityin May 2009 as described 

 

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below, will besufficient to fund the Company’s operations and enable the Company to meet itsliquidity needs through October 1, 2009.

 

InMarch 2008, the bank credit facility’s was extended to May 31, 2009,and the bank’s lending commitment was reduced to $50.0 million on September 30,2008, at which time the Company owed $35.2 million on the facility. The bank’scommitment will decrease further to $45.0 million on March 31, 2009.  Such decrease was made in accordance with theMarch 2008 amendment to the bank credit facility.  The Company plans to use cash flows fromoperations to reduce outstanding borrowings under the facility and expects thiscash flow to be sufficient to maintain outstanding borrowings under thecommitment levels throughout the remaining term of the facility.  Accordingly, the Company’s ability to complywith the scheduled reduction in the Bank credit facility and to pay any amountsoutstanding upon the maturity is highly dependent upon the Company’s ability togenerate sufficient cash flows from operations between September 30, 2008,and May 31, 2009.  See Note 5 CreditFacility.

 

The Company willendeavor to extend or refinance the bank credit facility prior to or upon itsmaturity.  Any such extension orrefinancing could require the continuation of a letter of credit from HallmarkCards in support of the bank credit facility or other steps by the Company and,thus, is not assured.  Upon maturity of the credit facility on May 31, 2009,if the facility has not been paid in full, renewed or replaced (1) JPMorgan Chase Bank, N.A., would have the right to draw down onHallmark Cards’ irrevocable letter of credit or (2) Hallmark Cards couldpurchase the interest of the lending bank in the facility.  In either case, Hallmark Cards would have allthe obligations and rights of the lending bank under the bank credit facilityand could demand payment of outstanding amounts at any time after October 1,2009 under the terms of the Waiver Agreement. Upon maturity of the credit facility on May 31, 2009, if not paidin full, renewed or replaced, the lending bank could forego drawing down on Hallmark Cards irrevocable letter ofcredit and, alternatively, foreclose on the Company’s assets. Suchforeclosure proceedings would adversely affect our ability to continue ouroperations. However, prior to any such possible foreclosure, if the Company hadnot secured a refinancing of the credit facility or alternative financing, theCompany would require Hallmark Cards to exercise its option, pursuant to theterms of the Waiver Agreement, to purchase all of the outstanding indebtednessunder the credit facility. The amount purchased would then be subject to termsof the Waiver Agreement.

 

The sufficiency of the existing sources of liquidity to fund theCompany’s operations is dependent upon maintaining subscriber revenue at orabove the amount of such revenue for the nine months ended September 30,2008, and continuing growth in advertising revenue. A significant decline inthe popularity of the Hallmark Channel, a significant economic decline in theadvertising market, an increase in program acquisition costs, an increase incompetition or other adverse changes in operating conditions could negativelyimpact the Company’s liquidity and its ability to fund the current level ofoperations.  During the second and thirdquarters of 2008 the Company experienced a softening of advertising rates inthe direct response and scatter market. Despite the significant decline in economic conditions nationally, andwithin the advertising industry, these conditions did not materially impact theCompany’s ability to fund current and expected levels of cash needed foroperations.  The Company expects thissoftening to continue through at least the second quarter of 2009, but,similarly, does not currently expect these changing market conditions tomaterially impact the Company’s ability to pay its obligations as they becomedue.

 

       The Company’s long-term obligations include notes payable toHallmark Cards or affiliates of Hallmark Cards which are the subject of theWaiver Agreement.  These obligationsinclude Notes issued in 2001, 2005 and 2006 which mature on December 31,2009, and amounts currently due under these notes at September 30, 2008,are $337.0 million Additionally, at September 30,2008, non-interest bearing unpaid accrued service fees and unreimbursedexpenses of $14.8 million were included in payable to affiliates on theaccompanying condensed consolidated balance sheet.

 

Because of the Company’spossible inability to meet its obligations when they come due on and after October 1,2009 and through December 31, 2009, the Company anticipates that prior to October 1,2009, it will be necessary to either extend or refinance (i) the bankcredit facility and (ii) the promissory notes payable to affiliates ofHallmark Cards. As part of a combination of actions and in order to obtainadditional funding, the Company may consider various alternatives, includingrefinancing the bank credit facility, raising 

 

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additional capitalthrough the issuance of equity or debt securities, or other strategicalternatives. If the current credit market conditions continue, a refinancingcould be difficult.

 

Upon maturity of thebank credit facility on May 31, 2009, the Company will not have acomparable credit facility.  In thatcase, the Company would be solely dependent upon day-to-day operating cashreceipts to meets its cash requirements.

 

***Transactions with NICC***

 

On October 28, 2007, NICC purportedly exercisedthe Put Right, described below in Note 8, by making formal demand that theCompany purchase all of the 4,357,066 shares of Class A common stock ownedby NICC.  The Company subsequentlyinformed NICC that exercise of the Put Right constituted a breach of a bindingagreement in September 2007 whereby NICC agreed not to exercise the PutRight.

 

NICC proposed that its purchase demand be settled on January 4,2008.  If the Company repurchased theshares as requested, the settlement amount would have been $32.8 million, basedon the 30-day average closing price from October 8, 2007 through November 16,2007, inclusive.

 

Asmore fully described below in Note 8, the Company and NICC signed theModification Agreement on January 2, 2008 whereby the Company’s obligationunder the Put Right was immediately extinguished.  The Modification Agreement also resolved arelated dispute with respect to expiration or survival of a prior provisionwhich would have required the Company to pay NICC $15.0 million upon a changein control of the Company.  Pursuant tothe Modification Agreement, the Company will pay NICC a total of $3.8 millionin equal installments of $1.3 million on each January 20 of 2008, 2009 and2010.  In addition, the Company willprovide NICC with two-hours of broadcast time each Sunday morning during 2008and 2009 at no cost to NICC. We estimate the value of the broadcast time to be$1.5 million.  Its discounted value wasrecorded as deferred revenue at December 31, 2007 and will be amortized torevenue ratably over NICC’s two year use. The Company is also obligated to payNICC an estimated $3.7 million in quarterly installments at the rate of 6% ofthe outstanding liquidation preference of the CMUS preferred interest owned byVISN Management Corp. (“VISN”), a wholly-owned subsidiary of NICC, through December 31,2010.

 

NICC has made a claim stemmingfrom certain provisions in the 2005 NICC Agreement that had not previously beenresolved. The Company has conducted extensive negotiations with NICC on thisissue and expects to sign a final settlement during the fourth quarter of2008.  The Company expects that as a result of this settlement, NICC willreceive full ownership of “The Note,” a Hallmark Channel original moviecurrently co-owned by NICC and the Company with the Company maintaining certainbroadcast rights on its Channels.  In expectation of such settlement, theCompany recognized settlement expense of approximately $500,000 during thethird quarter of 2008.

 

***Classification of Redeemable Common Stock***

*** ***

At December 31,2007, the Company classified 4,357,066 shares of Class A common stock and$32.8 million associated with the purported exercise of the Put Right referredto above as redeemable common stock. The shares and related amount werereclassified to common stock and paid-in capital on January 2, 2008, inconnection with the NICC Modification Agreement discussed above and in Note 8.

 

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

 

***InterimFinancial Statements***

 

In the opinion ofmanagement, the accompanying condensed consolidated balance sheets and relatedinterim condensed consolidated statements of operations and cash flows includeall adjustments, consisting of normal recurring items necessary for their fairpresentation in conformity with accounting principles generally accepted in theUnited States. Interim results are not necessarily indicative of results for afull year. These condensed 

 

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consolidated financial statements should be read in conjunction withthe audited consolidated financial statements and the notes to those statementsfor the year ended December 31, 2007, included in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2007.

 

***Basis of Presentation***

*** ***

Thecondensed consolidated financial statements include the consolidated accountsof Crown Media Holdings, including those of its wholly owned subsidiaries. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

 

***Net Loss per Share***

 

Basicnet loss per share is computed by dividing the net loss for the period by theweighted average number of common shares outstanding during the period. Dilutednet loss per share is computed based on the weighted average number of commonshares and potentially dilutive common shares outstanding. The calculation ofdiluted net loss per share excludes potential common shares if the effect wouldbe antidilutive. Potential common shares consist of incremental common sharesissuable upon the exercise of stock options. Approximately 356,000 and 341,000stock options for the three and nine months ended September 30, 2007 and2008, respectively, have been excluded from the calculations of loss per sharebecause their effect would have been anti-dilutive.

 

The 4,357,066 shares related toNICC’s purported exercise of the Put Right have been excluded from thedetermination of weighted average shares outstanding through January 1,2008.

 

***Concentration of Credit Risk***

*** ***

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

 

Five and four of our distributors each accounted for more than 10% ofour consolidated subscriber revenue for both the three months ended September 30,2007 and 2008, and together accounted for a total of 93% and 68% ofconsolidated subscriber revenue for those periods, respectively.  Four and three of our distributors eachaccounted for more than 15% of our subscribers for the three months ended September 30,2007 and 2008, and together accounted for 77% and 61% of our subscribers onthose dates, respectively.

 

Five and four of our distributors each accounted for more than 10% ofour consolidated subscriber revenue for both the nine months ended September 30,2007 and 2008, and together accounted for a total of 92% and 68% ofconsolidated subscriber revenue for those periods, respectively.  Four and three of our distributors eachaccounted for more than 15% of our subscribers for the nine months ended September 30,2007 and 2008, and together accounted for 77% and 61% of our subscribers onthose dates, respectively.

 

***Reclassifications***

 

Certain reclassifications havebeen made to conform the prior period’s financial information to the currentpresentation.

 

The Company is a co-owner of “TheNote,” which the Company intends to transfer to NICC during the fourthquarter of 2008.  The portion of the filmasset retained by the Company will be reclassified as a program license feeasset upon execution of an agreement with NICC. See Note 10, Commitments and Contingencies, below.

 

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***Recently Issued Accounting Pronouncements***

*** ***

In September 2006, the FASB issued Statement ofFinancial Accounting Standards No. 157 (“SFAS 157”), *Fair Value Measurements,* in order toestablish a single definition of fair value and a framework for measuring fairvalue in generally accepted accounting principles that is intended to result inincreased consistency and comparability in fair value measurements.SFAS 157 also expands disclosures about fair value measurements, with theintention of improving the quality of information provided to users offinancial statements. The standard applies whenever other authoritativeliterature requires (or permits) certain assets or liabilities to be measuredat fair value, but does not expand the use of fair value.

 

SFAS 157 was originally effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those years with early adoption permitted. In early2008, the FASB issued Staff Position (FSP) FAS-157-2, which delayed by oneyear, the effective date of SFAS 157 for all non-financial assets andnon-financial liabilities, except those that are recognized or disclosed atfair value in the financial statements on a recurring basis (at leastannually). The delay pertains to items including, but not limited to,non-financial assets and non-financial liabilities initially measured at fairvalue in a business combination, reporting units measured at fair value in thefirst step of evaluating goodwill for impairment under SFAS 142, *Goodwill and Other Intangible Assets*, indefinite-livedintangible assets measured at fair value for impairment assessment under SFAS142, and long-lived assets measured at fair value for impairment assessmentunder SFAS 144, *Accounting for theImpairment or Disposal of Long-Lived Assets*. The Company adopted theportion of SFAS 157 that has not been delayed by FSP FAS-157-2 as of January 1,2008, and plans to adopt the balance of its provisions as of January 1,2009.

 

The Company does not have balance sheet items carriedat fair value on a recurring basis (to which SFAS 157 applies in2008) such as derivative financial instruments which are valued primarilybased on quoted prices in active or brokered markets for identical as well assimilar assets and liabilities. Significant balance sheet items which aresubject to non-recurring fair value measurements (to which SFAS 157 willapply in 2009) consist of goodwill, property and equipment, and subscriberacquisition fees. The adoption of SFAS 157 in 2008 has had no effect onthe measurement of the Company’s financial assets and liabilities. The Companyis continuing to evaluate the impact the standard will have on thedetermination of fair value related to non-financial assets and non-financialliabilities in post-2008 years.

 

In February 2007, the FASB issued Statement ofFinancial Accounting Standards No. 159 (“SFAS 159”), *Establishing the Fair Value Option for FinancialAssets and Liabilities*. The FASB has issued SFAS 159 to permitall entities to elect, at specified election dates, to measure eligiblefinancial instruments at fair value. An entity shall report unrealized gainsand losses on items for which the fair value option has been elected inearnings at each subsequent reporting date, and recognize upfront costs andfees related to those items in earnings as incurred and not deferred.SFAS 159 applies to fiscal years beginning after November 15, 2007,with early adoption permitted for an entity that has also elected to apply theprovisions of SFAS 157. An entity is prohibited from retrospectivelyapplying SFAS 159, unless it chooses early adoption. SFAS 159 alsoapplies to eligible items existing at November 15, 2007 (or early adoptiondate). The Company adopted SFAS 159 effective January 1, 2008.  The Company has not elected to measureeligible financial instruments at fair value. Accordingly, SFAS 159 hashad no effect on the Company’s condensed consolidated balance sheets or resultsof operations.

 

In April 2008, the FASB issued FASB Staff Position (“FSP”) No. 142-3,*Determination of the Useful Life of IntangibleAssets* (“FSP 142-3”). FSP 142-3 amends the factors to be consideredin developing renewal or extension assumptions used to determine the usefullife of intangible assets under SFAS No. 142, *Goodwill andOther Intangible Assets*. Its intent is to improve the consistencybetween the useful life of an intangible asset and the period of expected cashflows used to measure its fair value. This FSP is effective for us on January 1,2009. The Company is still in the process of evaluating the impact FSP 142-3,but does not expect it to have a material impact on its condensed consolidatedbalance sheets or results of operations.

 

The FASB issued Statement of Financial Accounting Standards No. 162(“SFAS 162”), *The Hierarchy of GenerallyAccepted Accounting Principles,*in May 2008.  This Statement identifies the sources ofaccounting principles and the framework for selecting the principles to be usedin the preparation of financial statements of nongovernmental entities that arepresented in conformity with generally accepted accounting principles (GAAP) in

 

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the United States(the GAAP hierarchy).  This Statement will become effective 60 daysfollowing the SEC’s approval of the Public Company Accounting Oversight Boardamendments to AU Section 411, The Meaning of Present Fairly in ConformityWith Generally Accepted Accounting Principles.  The Company does notexpect that the adoption of this statement will have a material effect on theCompany’s condensed consolidated financial statements.

 

In October 2008, the FASB issued Staff Position No. FAS157-3, *Determining the Fair Value of a Financial AssetWhen the Market for That Asset is Not Active* (“FSP 157-3”).  FSP157-3 clarifies the application of SFAS 157, which the Company adopted as of January 1,2008, in cases where a market is not active.  The Company has notelected to measure eligible financial instruments at fair value. The Company isstill in the process of evaluating the impact FSP 157-3, but does not expect itto have a material impact on our condensed consolidated financial statements.

 

**3. Subscriber Acquisition Fees**

 

Subscriberacquisition fees are comprised of the following:

 
| ** **                            | ** ** | **As of December 31,** | ** ** | **As of September 30,** | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| ** **                            | ** ** | **2007**                              | ** ** | **2008**                               | ** ** |
| ** **                            | ** ** | **(In thousands)**               | ** ** |
| Subscriber acquisition fees,  at cost |       | $                                     | 9,837      |                                   | $          | 11,530 |   |
| Accumulated amortization              |       | (6,504                                | )          | (7,546                                 | )          |
| Subscriber acquisition fees,  net     |       | $                                     | 3,333      |                                   | $          | 3,984 |   |

 

*Of the net balance at September 30,2008, the Company expects $4.0 million will be recognized as a reduction ofsubscriber fee revenue in future periods.*

* *

As of December 31,2007, and September 30, 2008, the condensed consolidated balance sheetsalso reflect subscriber acquisition fees payable of $29,000 and $1.2 million,respectively, as a component of accounts payable and accrued liabilities. Forthe three months ended September 30, 2007 and 2008, the Company made cashpayments of $250,000 and $0, respectively, relating to current subscriberacquisition fee obligations. For the nine months ended September 30, 2007and 2008, the Company made cash payments of $348,000 and $1.5 million,respectively, relating to current subscriber acquisition fee obligations.

 

**4. Program License Fees**

 

Programlicense fees are comprised of the following:

 
| ** **                                                 | ** ** | **As of December 31,** | ** ** | **As of September 30,** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                              | ** ** | **2008**                               | ** ** |
| ** **                                                 | ** ** | **(In thousands)**               | ** ** |
| Program license fees—RHI  Entertainment  Distribution |       | $                                     | 244,920    |                                   | $          | 275,327 |   |
| Program license fees—NICC                             |       | 197                                   |       | 180                                    |       |
| Program license fees—Hallmark  Cards affiliates       |       | 918                                   |       | 9,818                                  |       |
| Program license fees—other  non-affiliates            |       | 297,816                               |       | 267,572                                |       |
| Program license fees, at cost                              |       | 543,851                               |       | 552,897                                |       |
| Accumulated amortization                                   |       | (294,241                              | )          | (275,094                               | )          |
| Program license fees, net                                  |       | $                                     | 249,610    |                                   | $          | 277,803 |   |

 

At December 31,2007, and September 30, 2008, respectively, an additional $8.4 million and$15.7 million of program license fees were included in prepaid program licensefee assets on the accompanying condensed consolidated balance sheets as theCompany made payments for the program license fees prior to commencement of thelicense period.

 

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Licensefees payable are comprised of the following:

 
| ** **                                                | ** ** | **As of December 31,** | ** ** | **As of September 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| ** **                                                | ** ** | **2007**                              | ** ** | **2008**                               | ** ** |
| ** **                                                | ** ** | **(In thousands)**               | ** ** |
| License fees payable—RHI Entertainment  Distribution |       | $                                     | 21,427     |                                   | $          | 59,284 |   |
| License fees payable—NICC                            |       | 1,078                                 |       | 358                                    |       |
| License fees payable—Hallmark  Cards affiliates      |       | 550                                   |       | 8,973                                  |       |
| License fees payable—other  non-affiliates           |       | 142,843                               |       | 143,620                                |       |
| Total license fees payable                                |       | 165,898                               |       | 212,235                                |       |
| Less current maturities                                   |       | (109,377                              | )          | (117,105                               | )          |
| Long-term license fees payable                            |       | $                                     | 56,521     |                                   | $          | 95,130 |   |

 

**5. Credit Facility**

 

ByAmendment No. 14 in March 2008, the maturity date of the bank creditfacility was extended to May 31, 2009. Under this Amendment, the amounts available under this facility havebeen, and will continue to be, reduced from $130.0 million as follows:

 
| **Date**                | ** ** | **Revolving Credit Commitment** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|
| March 10, 2008     |       | $                                         | 90,000,000 |   |
| June 30, 2008      |       | $                                         | 60,000,000 |   |
| September 30, 2008 |       | $                                         | 50,000,000 |   |
| March 31, 2009     |       | $                                         | 45,000,000 |   |
| May 31, 2009       |       | -0                                        | -          |

 

TheCompany had at September 30, 2008, $14.8 million of unused revolvingcredit capacity. Other than with respect to the scheduled decreases inborrowing capacity described above, the Company’s ability to borrow additionalamounts under the credit facility is not limited or restricted.  The Company and the lending banks originallyentered into the facility in 2001 and have subsequently amended the terms of thisfacility, with the most recent amendment dated as of March 10, 2008.  The facility is guaranteed by the Company’ssubsidiaries and is secured by all tangible and intangible property of CrownMedia Holdings and its subsidiaries.

 

Eachborrowing under the bank credit facility bears interest at a Eurodollar rate oran alternate base rate as the Company may request at the time ofborrowing.  The Eurodollar rate is basedon the London interbank market for Eurodollars, and remains in effect for thetime period of the loan ranging from one, two, three, six or twelvemonths.  The alternate rate is based uponthe prime rate of JP Morgan Chase Bank, a certificate of deposit rate or theFederal Funds effective rate, which is adjusted whenever the rates change.  The Company is required to pay a commitmentfee of 0.15% per annum of the committed, but not outstanding, amounts under therevolving credit facility, payable in quarterly installments.

 

At December 31, 2007, and September 30,2008, the Company had outstanding borrowings of $69.5 million and $35.2 million,respectively, under the credit facility and there were no letters of creditoutstanding. At December 31, 2007, $69.5 million of the outstandingbalance bore interest at the Eurodollar rate (5.60% at December 31, 2007)and $0 bore interest at the JP Morgan Chase Bank prime rate. Under the creditfacility, $1.1 million bore interest at the JP Morgan Chase Bank prime rate of7.75% for three days during September 2007. At September 30, 2008,$35.2 million of the outstanding balance bore interest at the Eurodollar rate(4.45% at September 30, 2008) and $0 bore interest at the JP Morgan ChaseBank prime rate. Under the credit facility, $1.3 million bore interest at theJP Morgan Chase Bank prime rate (7.25%) for five days during January 2008,$5.8 million bore such interest at 7.25% for four days in January 2008,$2.6 million bore such interest at 6.50% for six days in January 2008,$362,000 bore such interest at 6.00% for six days in January and February 2008,$387,000 bore such interest at 6.00% for six days in January and February 2008,$6.8 million bore such interest at 6.00% for six days in February 2008,and $1.6 million bore such interest at 6.00% for four days in February 2008. Interest expense on borrowings under the creditfacility for each of the three months ended September 30, 2007 and 2008,was $1.4 million and $389,000, 

 

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respectively. Interest expense on borrowingsunder the credit facility for each of the nine months ended September 30,2007 and 2008, was $4.3 million and $1.8 million, respectively.

 

***Covenants***

 

The credit facility, as amended, contains affirmative and negativecovenants.  The Notes to ConsolidatedFinancial Statements included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2007, contain a detailed description ofthese covenants. The Company was in compliance with these covenants at September 30,2008.

 

**6. Related Party Long-TermObligations**

 

***Waiver and Standby Purchase Agreement***

 

On March 10, 2008, the Company, Hallmark Cards and affiliates ofHallmark Cards who hold obligations of the Company entered into an Amended andRestated Waiver and Standby Purchase Agreement, which was most recently amendedon October 30, 2008 to extend the waiver period (the “Waiver Agreement”).  The Waiver Agreement replaced a previousversion of the Waiver and Standby Purchase Agreement dated March 21, 2006as amended through October 2007. The Waiver Agreement as amended extends to October 1, 2009 theperiod during which the Hallmark Cards and its affiliates will defer thepayment of obligations listed below.  TheMarch 2008 agreement also included the following changes:  The annual addition of interest to principalon the obligations described below (except the 10.25% Note continues to addinterest semi-annually to the principal); the extension of the maturity datesof three notes (the 2001, 2005 and 2006 notes mentioned below) to December 31,2009; fixing the interest rate of these three notes to a rate of LIBOR plus 5%,adjusted quarterly; the accrual and addition to principal of interest through November 15,2008 on these three notes; a requirement that interest on these three noteswill be payable in cash, quarterly in arrears five days after the end of eachcalendar quarter commencing November 16, 2008; and a change to thedefinition of Excess Cash Flow.  Asrevised, the Waiver Agreement defers all payments due on any of the followingobligations (the “Subject Obligations”) and, except as noted above, payment ofinterest thereon until October 1, 2009, or an earlier date as describedbelow as the waiver termination date, whereupon all of these amounts becomeimmediately 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, 2007, and  September 30, 2008, including accrued interest was $101.4 million and  $107.4 million, respectively. See *Note and Interest  Payable to HC Crown*below.)                                                                    |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| · | $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, 2007, and September 30, 2008, including  accrued interest was $57.9 million and $61.3 million, respectively. See *Note and Interest Payable to Hallmark Cards Affiliate*below.) |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| · | 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, 2007, and  September 30, 2008, including accrued interest was $621.3 million and  $669.7 million, respectively. See *Senior Secured Note*below.)                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| · | 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, 2007, and September 30, 2008,  including accrued interest was $158.8 million and $168.3 million,  respectively. See *Note and Interest  Payable to Hallmark Cards Affiliate*below.)                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| · | Note and interest  payable to Hallmark Cards in the amount of $33.1 million, dated as of  July 27, 2007. (Total amount outstanding at December 31, 2007, and  September 30, 2008,                                                                                                                                                                                                                                          |

 

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|   | including accrued  interest was $22.1 million and $5.9 million, respectively. See *Tax Note*below.)                                                                                                                                                                                                                                                 |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                |
| · | 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 letter of credit 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. |

 

Hallmark Cards has agreed that it will not accelerate the maturity ofany of the foregoing obligations or initiate collection proceedings during theWaiver Period. Interest will continue to accrue on these obligations during theWaiver Period and will be payable as indicated above. The Company will continueto pay interest on the bank credit facility during the Waiver Period.

 

The waiver termination date is October 1, 2009, or earlier uponoccurrence of any of the following events: (a) the Company fails to pay any principal or interest, regardlessof amount, due on any indebtedness to unrelated parties with an aggregateprincipal amount in excess of $5.0 million or any other event or conditionoccurs that results in any such indebtedness becoming due prior to itsscheduled maturity, provided that the waiver will not terminate if the Companyreduces the principal amount of such indebtedness to $5.0 million or lesswithin five business days of a written notice of termination from HallmarkCards; (b) certain bankruptcy events occur; (c) the Company defaultsin its payment of licensing fees under the Second Amended and Restated ProgramLicense Agreement with RHI Entertainment Distribution (formerly known asHallmark Entertainment Distribution at which time it was a wholly-ownedsubsidiary of Hallmark Cards); (d) a representation and warranty of theCompany in the Waiver Agreement is false or misleading in any material respect;(e) the Company fails to pay interest on the bank credit facilitydescribed above to the extent that Hallmark Cards has purchased all or aportion of the indebtedness thereunder or to perform any covenants in theWaiver Agreement; or (f) the security agreements granted to the Hallmarkparties shall not remain perfected.

 

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

 

The Waiver Agreement does not limit any existing rights of HallmarkCards or its affiliates to offset amounts owed to us under the Hallmark Tax SharingAgreement or as otherwise agreed by us against these obligations.  Additionally, during the Waiver Period,Hallmark Cards is permitted to offset future tax benefits it realizes pursuantto the Tax Sharing Agreement, first against accrued and unpaid interest andthen to the unpaid principal balance of the Tax Note until the earlier of suchtime as the balance reaches zero or the maturity date of the Tax Note.

 

Pursuant to the Waiver Agreement, the Company must make prepayments onthe outstanding debt from 100% of any “Excess Cash Flow” during the WaiverPeriod.   “Excess Cash Flow” is definedas 1) the net proceeds of any debt or equity financings; 2) the net cashproceeds from the sale, transfer or release by the Company of assets outsidethe ordinary course of business; and 3) if positive, the consolidated net cash flow from operations calculated in thesame manner (and subject to the same restrictions on selling, general andadministrative expenses, capital expenditures and similar items) as “Cash FlowBefore Interest, Taxes (including tax sharing payments) and Principal” as setforth in the Crown Media Holdings 2008 budget as approved by the Board ofDirectors of Crown Media Holdings and provided to the Hallmark parties. For2009, the restrictions will be those contained in the 2009 budget to beapproved by the Board of Directors of Crown Media Holdings and reasonablyacceptable to the Hallmark parties.  Anysuch Excess Cash Flow for 2008 will be used, within one business day of thedetermination of the amount (anticipated to be in the first quarter of 2009),to repay amounts outstanding under the bank credit facility; any Excess CashFlow for 2008 remaining after such a payment would be applied to the SubjectObligations listed above.  We expect thatthere will be Excess Cash Flow sufficient to make a payment on the bank creditfacility but not for payments to reduce the Subject Obligations.  See Note 1 Business and Organization —Liquidity for additional information on the Excess Cash Flow for 2008.  Similarly, any such Excess Cash Flow for 2009will be payable to Hallmark Cards or its affiliates in the first quarter of2010.

 

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Additionally, the Waiver Agreement contains thefollowing covenants:  (1) compliancewith obligations in the loan documents for the bank credit facility; (2) executionof additional documents as necessary to implement the waiver agreement; (3) commerciallyreasonable efforts to refinance the obligations subject to the Waiver Period aslisted above; and (4) ratification of the security interests granted tothe Hallmark affiliates in personal property of the Company.

 

***Hallmark Letterof Credit***

 

Concurrentwith the execution of Amendment No. 14, the existing Hallmark Cards’support letter of credit was reissued by JP.Morgan in the face amount of $90.0million and with an expiration date of June 10, 2009.  On July 1, 2008, the face amount was reducedto $60.0 million, the amount of the bank revolving credit commitment. On October 1,2008, the face amount was reduced to $50.0 million, the amount of the bankrevolving credit commitment.

 

***Senior SecuredNote***

 

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’soutstanding trust preferred securities, and the balance of the proceeds, afterexpenses, was used to reduce amounts outstanding under its bank credit facility.

 

Inaccordance with the Waiver Agreement, cash payments are not required until October 1,2009. The principal amount of the senior secured note accretes at 10.25% perannum, compounding semi-annually, to $596.6 million at August 5,2007.  From that date, interest at 10.25%per annum was scheduled to be payable semi-annually on the accreted value ofthe senior note to HC Crown, but now interest accrued after October 1,2009, will be payable semi-annually in arrears on August 5 and February 5of each year until maturity.  The notematures on August 5, 2011, and is pre-payable without penalty. At December 31,2007, and September 30, 2008, $621.3 million and $669.7 million,respectively, of principal and interest were included in the senior notepayable in the accompanying condensed consolidated balance sheets. The notepurchase agreement for the senior note contains certain restrictive covenantswhich, among other things, prevent the Company from incurring any additionalindebtedness, 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, theCompany paid $3.0 million to HC Crown, which was initially capitalized and isbeing amortized as additional interest expense over the term of the notepayable.

 

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

 

On December 14,2001, the Company executed a $75.0 million promissory note with HC Crown.  Due to the Waiver Agreement, the note is notdue until December 31, 2009. Under the Waiver Agreement, interest on this2001 Note accrues and is added to principal through November 15,2008.  Commencing November 16, 2008,interest will be payable in cash, quarterly in arrears five days after the endof each calendar quarter. This note is subordinate to the bank credit facility.The rate of interest under this note was equal to LIBOR plus 3% and iscurrently LIBOR plus 5% per annum pursuant to the March 2008 amendment tothe Waiver Agreement. At December 31, 2007, and September 30, 2008,borrowings under the note were $93.5 million and $101.3 million, respectively.Accrued interest on the note of $7.9 million and $6.1 million are included innote and interest payable to HC Crown on the accompanying condensed consolidatedbalance sheets as of December 31, 2007, and September 30, 2008,respectively. At December 31, 2007, $93.5 million of the outstandingbalance bore interest at the Eurodollar rates of 8.23%. At September 30,2008, $101.3 million of the outstanding balance bore interest at the Eurodollarrates of 7.79%. At December 31, 2007, and September 30, 2008, $101.4million and $107.4 million, respectively, are each reported as note andinterest payable to HC Crown on the accompanying condensed consolidated balancesheets.

 

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

 

On October 1, 2005, the Company convertedapproximately $132.8 million of its license fees payable to Hallmark affiliatesto a promissory note.  The rate ofinterest under this note was equal to LIBOR plus 3% and is currently LIBOR plus5% per annum pursuant to the March 2008 amendment to the Waiver AgreementPursuant to the Waiver Agreement, the promissory note is payable in full on December 31,2009.  Under the Waiver Agreement,interest on this 2005 Note accrues and is added to principal through November 15,2008.  Commencing November 

 

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16, 2008, interest will be payable in cash, quarterly in arrears fivedays after the end of each calendar quarter. At December 31, 2007, and September 30,2008, borrowings under the note were $146.4 million and $158.8 million,respectively. Accrued interest on the note of $12.4 million and $9.5 million isincluded in note and interest payable to Hallmark Cards affiliate on theaccompanying condensed consolidated balance sheets as of December 31,2007, and September 30, 2008, respectively. At December 31, 2007,$146.4 million of the outstanding balance bore interest at the Eurodollar ratesof 8.23%. At September 30, 2008, $158.8 million of the outstanding balancebore interest at the Eurodollar rates of 7.79%. At December 31, 2007, and September 30,2008, $158.8 million and $168.3 million, respectively, are each reported asnote and interest payable to Hallmark Cards affiliate in the accompanyingcondensed consolidated balance sheets.

 

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

 

On March 21,2006, the Company converted approximately $70.4 million of its payable to aHallmark Cards affiliate to a promissory note. The rate of interest under thisnote was equal to LIBOR plus 3% and is currently LIBOR plus 5% per annumpursuant to the March 2008 amendment to the Waiver Agreement. Pursuant tothe Waiver Agreement, the promissory note is payable in full on December 31,2009. Under the Waiver Agreement, interest on this 2006 Note accrues and isadded to principal through November 15, 2008.  Commencing November 16, 2008, interestwill be payable in cash, quarterly in arrears five days after the end of eachcalendar quarter. At December 31, 2007, and September 30, 2008,borrowings under the note were $53.4 million and $57.9 million, respectively.Accrued interest on the note of $4.5 million and $3.5 million is included innote and interest payable to Hallmark Cards affiliate on the accompanyingcondensed consolidated balance sheet as of December 31, 2007, and September 30,2008, respectively. At December 31, 2007, $53.4 million of the outstandingbalance bore interest at the Eurodollar rates of 8.23%.  At September 30, 2008, $57.9 million ofthe outstanding balance bore interest at the Eurodollar rates of 7.79%.  At December 31, 2007, and September 30,2008, $57.9 million and $61.3 million, respectively, are each reported as noteand interest payable to Hallmark Cards affiliate in the accompanying condensedconsolidated balance sheets.

 

***Tax Note***

 

On July 27, 2007, the Company replaced a payableto Hallmark Cards under the Tax Sharing Agreement with a $33.1 millionpromissory note payable to Hallmark Cards due in July 2009 with interestat LIBOR plus 3% per annum (the “Tax Note”). The Tax Note may be prepaid in whole or in part with no penalty.  The Company is not required to make any cashpayments prior to maturity. Until the Tax Note and related interest is paid infull, Hallmark Cards will offset any future tax benefits it realizes pursuantto the Tax Sharing Agreement, first against accrued and unpaid interest andthen against the unpaid principal balance. In September 2007, HallmarkCards offset $6.5 million against $508,000 of accrued and unpaid interest and$6.0 million of unpaid principal. Additionally, in September 2007, theCompany recorded an additional $85,000 charge to interest expense related tothe receipt of an invoice for the actual amount owed in regard to the return oftax benefits under the Tax Sharing Agreement. In December 2007, HallmarkCards offset $5.7 million against $571,000 of accrued and unpaid interest and$5.1 million of unpaid principal. In March 2008, Hallmark Cards offset$5.1 million against $429,000 of accrued and unpaid interest and $4.6 millionof unpaid principal. In June 2008, Hallmark Cards offset $5.1 millionagainst $233,000 of accrued and unpaid interest and $4.8 million of unpaidprincipal. In September 2008, Hallmark Cards offset $5.3 million against$164,000 of accrued and unpaid interest and $5.2 million of unpaid principal.

 

On April 14, 2008, the Internal Revenue Service refunded to HallmarkCards a portion of the interest previously paid in connection with thedisallowance of certain net operating losses. In July 2008, Hallmark Cards notified the Company that they hadreduced the Company’s indebtedness as of April 14, 2008, under the TaxNote by $1.5 million in consideration of the Company’s applicable portion ofsuch refund. Accordingly, the Company reduced interest expense during the threemonths ended June 30, 2008.

 

At December 31,2007, and September 30, 2008, interest was paid to the respective balancesheet dates. At December 31, 2007, $22.1 million of the outstandingbalance bore interest at the Eurodollar rates of 8.23%.  At September 30, 2008, $5.9 million ofthe outstanding balance bore interest at the Eurodollar rates of 5.79%.  At December 31, 2007, and September 30,2008, borrowings under the note were $22.1 million and $5.9 million,respectively, and are each reported as note and interest payable to HallmarkCards in the accompanying condensed consolidated balance sheets.

 

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The Tax Note and all payments thereunder aresubordinated to the bank credit facility extended to the Company by JP MorganChase Bank.

 

***Interest Paid to HC Crown***

 

Interestexpense paid to HC Crown was $457,000 for the three months ended September 30,2007, and $241,000 for the three months ended September 30, 2008. Interestexpense paid to HC Crown was $1.4 million for the nine months ended September 30,2007, and $953,000 for the nine months ended September 30, 2008.

 

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

 

Theaggregate maturities of related party long-term debt for each of the five yearssubsequent to September 30, 2008, are as follows:

** **
| ** **                                                                                       | ** ** | **Payments Due by Period** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                       | ** ** | **Total**                                 | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** |
| ** **                                                                                       | ** ** | **(In thousands)**                   | ** ** |
| Note and interest payable to HC Crown, with  principal due December 31, 2009                |       | $                                         | 107,449    |   | $ | — |   | $ | 107,449 |   | $ | — |   | $ | — |   | $ | — |   |
| 10.25 % Senior secured note to HC Crown, including  accrued interest, due August 5, 2011    |       | 669,682                                   |       | — |   | — |   | — |   | 669,682 |   | — |   |
| Note and interest payable to Hallmark Cards  affiliate with principal due December 31, 2009 |       | 168,273                                   |       | — |   | 168,273 |   | — |   | — |   | — |   |
| Note and interest payable to Hallmark Cards  affiliate with principal due December 31, 2009 |       | 61,338                                    |       | — |   | 61,338 |   | — |   | — |   | — |   |
| Note and interest payable to Hallmark Cards due  July 27, 2009                              |       | 5,915                                     |       | — |   | 5,915 |   | — |   | — |   | — |   |
|                                                                                             |       | $                                         | 1,012,657  |   | $ | — |   | $ | 342,975 |   | $ | — |   | $ | 669,682 |   | $ | — |   |

 

In addition to amounts in the table, any Excess Cash Flow for 2008 and2009 as defined in the Waiver Agreement must be paid on bank debt or theSubject Obligations, and any tax liability under the Tax Sharing Agreement mustbe paid in cash to Hallmark Cards, unless Hallmark Cards defers such requiredpayment.

 

**7. Related Party Transactions**

 

***Tax Sharing Agreement***

 

*Overview*

 

On March 11, 2003,Crown Media Holdings became a member of Hallmark Cards consolidated federal taxgroup and entered into a federal tax sharing agreement with Hallmark Cards (the“tax sharing agreement”). Hallmark Cards includes Crown Media Holdings in itsconsolidated federal income tax return. Accordingly, Hallmark Cards has benefited from past tax losses and maybenefit from future federal tax losses, which may be generated by Crown MediaHoldings.  Based on the tax sharingagreement, Hallmark Cards has agreed to pay Crown Media Holdings all of thebenefits realized by Hallmark Cards as a result of including Crown MediaHoldings in its consolidated income tax return. These benefits are estimated and paid 75% in cash on a quarterly basisand the balance when Crown Media Holdings becomes a federal taxpayer.  A final true-up calculation is completedwithin 15 days after Hallmark Cards files its consolidated federal income taxreturn for the year.  Pursuant to thetrue-up calculation, Crown Media Holdings is obligated to reimburse HallmarkCards the amount that any estimated payments have exceeded the actual benefitrealized by Hallmark Cards and Hallmark Cards is obligated to pay Crown MediaHoldings the amount that any actual benefit exceeds the estimatedpayments.  Under the tax sharingagreement, at Hallmark Cards’ option, the non-interest bearing balance of the25% in federal tax benefits may be applied as 

 

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an offset against anyamounts owed by Crown Media Holdings to any member of the Hallmark Cardsconsolidated group under any loan, line of credit or other payable, subject tolimitations under any loan indentures or contracts restricting such offsets.

 

The Company received $6.5 and $5.3 million (includingthe $6.5 million offset against the Tax Note during the third quarter of 2007and the $5.3 million offset against the Tax Note during the third quarter of2008) under the Tax Sharing Agreement during three months ended September 30,2007 and 2008, respectively. The Company received $6.5 and $15.5 million(including the $6.5 million offset against the Tax Note during 2007 and the$15.5 million offset against the Tax Note during 2008) under the Tax SharingAgreement during nine months ended September 30, 2007 and 2008,respectively. Any payments received from Hallmark Cards or credited againstamounts owed by Crown Media Holdings to any member of the Hallmark Cardsconsolidated group under the tax sharing agreements are recorded as an additionto paid-in capital.

 

*Accounting for Uncertainty inIncome Taxes*

 

Under FASBInterpretation No. 48, *Accounting for Uncertaintyin Income Taxes* (“FIN 48”), if the probability for sustaining a taxposition is at least more likely than not, then the tax position is warrantedand recognition should be at the highest amount which is greater than 50%likely of being realized upon ultimate settlement. At September 30, 2008,the total amount of unrecognized tax benefits for uncertain tax positions was$0. The Company recognizes interest and penalties related to uncertain taxpositions in income tax expense.  As ofthe date of adoption and on September 30, 2008, we have no accruedinterest related to uncertain tax positions.

 

By virtue of itsinclusion in Hallmark Cards consolidated tax returns, the Company is subject toexamination by the Internal Revenue Service for periods subsequent to March 10,2003. Further, net operating loss carryforwards (“NOL’s”) are subject toexamination in the year they are utilized regardless of whether the tax year inwhich they were generated has been closed by statute.  The amount subject to disallowance is limitedto the NOL utilized.  Accordingly, theCompany is subject to examination for NOL’s generated prior to March 11,2003 if and when such NOL’s are utilized in future tax returns.

 

The  Company files  state  tax returns  in  major jurisdictions such as California, Colorado  and  New York,  and  has also been included in the combined state tax returns of Hallmark orHallmark Entertainment Holdings, Inc. The state returns are generallysubject to examination for years after 2003.

 

***Services Agreement with Hallmark Cards***

 

The Company has an intercompany services agreementwith Hallmark Cards, which was entered into in 2003 for a term of three yearsand then extended for additional years through December 31, 2009.  Under the agreement, Hallmark Cards providesCrown Media Holdings with tax, risk management, health safety, environmental,insurance, legal, treasury and cash management services and real estateconsulting services.  Under theagreement, the Company agreed to pay Hallmark Cards $546,000 in 2007 and$541,000 in 2008 for these services, plus out-of-pocket expenses and thirdparty fees, payable in arrears on the last business day of each quarter. However, the Company has not paid these amountswith concurrence of Hallmark Cards.

 

For the year ended December 31,2007, Crown Media Holdings had accrued $546,000 under the agreement. For thethree and nine months ended September 30, 2008, the Company has accrued$135,000 and $406,000 under the agreement. At December 31, 2007, and September 30,2008, non-interest bearing unpaid accrued service fees and unreimbursedexpenses of $13.3 million and $14.8 million, respectively, were included inpayable to affiliates on the accompanying consolidated balance sheets. At December 31,2007, and September 30, 2008, out-of-pocket expenses and third party feeswere $1.2 million and $1.1 million, respectively.

 

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***“Hallmark Hall of Fame”Programming License Agreement***

 

In May 2008, CrownMedia United States entered into an agreement with Hallmark Hall of FameProductions, Inc. to license 58 “Hallmark Hall of Fame” movies, consistingof 16 contemporary Hallmark Hall of Fame titles (i.e., produced from 2003 to2008) and 42 older titles, for exhibition on the Hallmark Channel and HallmarkMovie Channel.  These titles are licensedfor ten year windows, with windows commencing at various times between 2007 and2010, depending on availability.  Thisagreement makes the Hallmark Channel and Hallmark Movie Channel the exclusivehome for these movies.  The total licensefee for these movies is $17.2 million and is payable in equal monthlyinstallments over each movie’s 10 year exhibition window.

 

The Company aired one titleduring 2007 and has recorded $550,000 as a license fee payable to affiliaterelated to this title at December 31, 2007. Windows opened for additionaltitles in the amount of $800,000 and $8.9 million during the three and ninemonths ending September 30, 2008.

 

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

 

VISNowns a $25.0 million company obligated mandatorily redeemable preferredmembership interest in Crown Media United States (the “preferred interest”)issued in connection with an investment by the Company in Crown Media UnitedStates. On November 13, 1998, the Company, Vision Group, VISN and HensonCable Networks, Inc. signed an amended and restated company agreementgoverning 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, December 1,2005 (the “December 2005 NICC Settlement Agreement”) and January 2,2008.

 

Underthe 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 hasFederal taxable income (with possible adjustments) in excess of $10.0 million,and the preferred interest has not been redeemed, Crown Media United Stateswill redeem the preferred interest in an amount equal to the lesser of: (i) suchexcess Federal taxable income; (ii) $5.0 million; or (iii) the amountequal to the preferred liquidation preference on the date of redemption.  Crown Media United States may voluntarilyredeem the preferred interest at any time; however, it is obligated to do so nolater than December 31, 2010. Due to the mandatory redemption provision ofthe preferred interest, on July 1, 2003, the preferred interest wasremeasured at fair value and reclassified to non-current liabilities inaccordance with the provisions of *Statement of FinancialAccounting Standards  No. 150:Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity (as amended)* (“*SFAS 150*”).

 

During the three monthsended September 30, 2007, and 2008, Crown Media United States paid NICC$4.0 million and $0, respectively, related to the company agreement as amended.During the nine months ended September 30, 2007, and 2008, Crown MediaUnited States paid NICC $15.3 million and $6.4 million, respectively, related tothe company agreement as amended.

 

**9. Share-Based Compensation**

 

The Company recorded$784,000 and $649,000 of compensation expense associated with the Employmentand Performance RSUs during the three month periods ended September 30,2007 and 2008, respectively, and has included such amounts in selling, generaland administrative expense on the accompanying condensed consolidatedstatements of operations and comprehensive loss. The Company recorded $4.2million and $2.4 million of compensation expense associated with the Employmentand Performance RSUs during the nine month periods ended September 30,2007 and 2008, respectively, and has included such amounts in selling, generaland administrative expense on the accompanying condensed consolidated statementsof operations and comprehensive loss.

 

The Company issued cashsettlements of $1.5 million during the year ended December 31, 2007. Additionally, following the December 2007death of one of the members of the Company’s Board of Directors, the Company settled5,820 vested RSUs for approximately $35,000 in cash in January 2008.

 

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Sixty-five percent of the Achieved Performance RSUs (that portion ofthe Performance RSUs that were earned based on meeting the plan’s performancecriteria – “Achieved Performance RSUs”) granted in 2006 became fully vested in March 2008after all major distribution agreements were renewed. In a second vesting, 65%to 135% (“the Modifier”) of the Achieved Performance RSUs (less the AchievedPerformance RSUs previously vested) will vest on December 31, 2008, basedupon a formula using subscriber revenue achieved for a specified time period.

 

 The Compensation Committee ofthe Board of Directors has the discretion to increase or decrease the Modifierby 20% and also may extend the deadlines for satisfaction of the vestingconditions.  In order to be eligible forvesting and settlement of the Achieved Performance RSUs, the individual holdingthem must either be employed at the time of the first vesting or have beenterminated without cause within 90 days of a vesting date.

 

On March 13, 2008, the Compensation Committee determined that thefirst vesting of the 2006 Performance RSUs would be paid out in accordance withthe vesting criteria as if all the major distribution agreements had beenrenewed prior to each agreement’s expiration date, and accordingly, 100% of thefirst vesting of the Performance RSUs were deemed Achieved PerformanceRSUs.  The settlement of 571,578 vestedunits valued at approximately $3.3 million was paid on April 4, 2008.

 

In August 2008, the Company issued cash settlements of $397,000related to the vesting of the 2005 Employment RSUs.  The Company also issued cash settlements of$151,000 related to the vesting of the 2005, 2006 and 2007 Board of DirectorsRSUs. Additionally, the Company granted 52,129 RSUs in August 2008 tomembers of its Board of Directors who were not employees of the Company orHallmark Cards and its subsidiaries. These RSUs are part of the compensation of directors consisting of thegrant annually of RSUs valued at $40,000.

 

In August 2008, 255,000 of the 2005 Performance RSUs expired, asthe stock price targets were not met as required in the agreement, whichterminated in August 2008.

 

At December 31, 2007, theCEO’s SARs were valued at $4.6 million based on that day’s $6.50 per shareclosing stock price of our common stock. At September 30, 2008, the CEO’sSARs were valued at $1.4 million based on that day’s $5.03 per share closingstock price of our common stock. The Company recorded $358,000 incompensation expense and $42,000 in compensation benefit related to SARs forthe three months ended September 30, 2007 and 2008, respectively, on ourcondensed consolidated statement of operations and comprehensive loss as acomponent of selling, general and administrative expense.  The Company recorded $1.4 million incompensation expense and $730,000 in compensation benefit related to SARs forthe nine months ended September 30, 2007 and 2008, respectively, on ourcondensed consolidated statement of operations and comprehensive loss as acomponent of selling, general and administrative expense.  The SARs of $1.4 million and $697,000 havebeen recorded in accounts payable and accrued liabilities on the accompanyingcondensed consolidated balance sheets at December 31, 2007, and September 30,2008, respectively.

 

**10. Commitments and Contingencies**

 

In thenormal course of business, the Company has entered into agreements that commitit to make cash payments in future periods with respect to non-cancelableleases and programming contracts.

 

On July 27, 2007, a lawsuit was brought against Crown MediaHoldings, Inc. and our former Chief Financial Officer, William Aliber, inthe U.S. District Court for the Northern District of Illinois.  The plaintiff, Robert Lieblang, claims tohave purchased our common shares on the market from August 31, 2005 to April 13,2006 and to have sold those shares in April 2006 and in August 2006.  The plaintiff alleges that he relied to hisdetriment on allegedly false and misleading statements by the defendantsregarding the possible sale of Crown Media Holdings.  We announced the exploration of strategicalternatives including the possibility of selling the Company in August 2005;in April 2006, we announced the termination of an extensive review ofstrategic alternatives including a possible sale.  Plaintiff alleges claims under Section 10(b) ofthe Securities Exchange Act (and Rule 10b-5), the Illinois Consumer FraudAct and common law fraud.  The complaintseeks compensatory damages of approximately $2.0 million plus interest and $6.0million in punitive damages.  The Companyhas retained counsel to defend Mr. Aliber and the Company and hassubmitted the claims to an insurer under an insurance policy. The insurer ispaying 

 

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costs of thislawsuit, subject to certain reservations or exclusions. Prior to December 31,2007, the Company had incurred legal expense equal to its deductible of$500,000 under its insurance policy. In January 2008, the court ruledagainst the defendant’s motion to dismiss the lawsuit, although the court’sruling also narrowed the securities law claims to purchases after a certaindate in 2006**.**

 

NICC has made a claim stemmingfrom certain provisions in the 2005 NICC Agreement that had not previously beenresolved. The Company has conducted extensive negotiations with NICC on thisissue and expects to sign a final settlement during the fourth quarter of2008.  The Company expects that as a result of this settlement, NICC willreceive full ownership of “The Note,” a Hallmark Channel original moviecurrently co-owned by NICC and the Company with the Company maintaining certainbroadcast rights on its Channels.  In expectation of such settlement, theCompany has recognized settlement expense of approximately $500,000 during thethird quarter of 2008.

 

**11.  Residual and Participation Liabilities**

 

During the second quarter of 2007, the Company reducedits estimate of a residual and participation liability related to the Company’suse of the film assets prior to the sale to RHI for $521,000 less than it hadoriginally accrued.  Therefore, theCompany recognized negative amortization of film assets in this amount duringthis time period.

 

During the third quarter of 2007, the Companycompleted an analysis of its residual and participation liability, related tothe Company’s licenses of the film assets prior to the sale to RHI.  Using new information that became availableduring this time period, the Company more accurately estimated amounts due andmade payments on certain obligations, as well as analyze and determinepotential amounts due for exploitation of the films during the applicable period.  The Company determined that it needed toreduce its liability by $4.7 million, and thus, recorded a negativeamortization of film assets in this amount during this time period.

 

The Company also completed an analysis during thethird quarter of 2008 of its residual and participation liability, related tothe Company’s licenses of the film assets prior to the sale to RHI.  Using new information that became availableduring this time period, the Company determined that it needed to reduce itsliability by $1.1 million, and thus, recorded a negative amortization of filmassets in this amount during this time period.

 

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

 

The following discussion andanalysis of the Company’s financial condition and results of operations shouldbe read in conjunction with “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

**Description of Business andOverview**

 

*CurrentBusiness*

 

Crown Media Holdings, Inc.(“Crown Media Holdings,” “Crown Media” or the “Company”), through itssubsidiary, owns and operates pay television channels (the “Hallmark Channel”and the “Hallmark Movie Channel,” each singularly the “channel” or collectivelythe “Channels”) dedicated to high-quality entertainment programming for adultsand families, in the United States.

 

With 84.8 million subscribers (as provided by Nielsen Research) in theUnited States at September 30, 2008, the Hallmark Channel is the 38thmost widely distributed advertising-supported cable channel in the UnitedStates. For the third quarter of 2008, the Hallmark Channel finished thequarter as the 10th highest rated advertising-supported cablechannel for total day ratings and the 9th highest rated advertising-supportedcable channel in prime time as measured by Nielsen Research.

 

We launched our second 24-hour linear channel, the Hallmark MovieChannel, during the first quarter of 2005. Programming on the Hallmark Movie Channel consists of movies and mini-series.The Hallmark Movie Channel generated advertising revenue in 2007 and hasgenerated subscriber fees and advertising revenue in 2008. As distributioncontinues to expand, the financial contribution of the Hallmark Movie Channelmay grow, including increases in advertising and subscription revenue. TheHallmark Movie Channel is operated through Crown Media Holdings’ existinginfrastructure at a small incremental cost. In April 2008, we began distributing the Hallmark Movie Channel HDin high definition format, which has resulted in additional costs, but isexpected to result in subscriber growth for the Hallmark Movie Channel.

 

Our Annual Report on Form 10-K for the year ended December 31,2007, in Item 2, summarizes information regarding principal real propertyleases.  The leases for the New York Cityoffice and the Greenwood Village, Colorado office have been extended fromexpirations in 2009 to 2016****for the NewYork City office and from expiration in 2008 to 2013 for the GreenwoodVillage office.

 

*Current Challenges and Developments*

 

The Company facesnumerous operating challenges. Among them are maintaining and increasingadvertising sales revenue, maintaining and expanding the distribution of theChannels, broadening viewership demographics, and increasing viewershipratings.

 

We have recentlycompleted the 2008 upfront marketing process during which we entered into dealswith major advertising firms for approximately 50% of our advertising inventoryfor the last quarter of 2008 and first three quarters of 2009.  The deals for these inventory units providethe Company with modestly higher CPMs than the inventory guaranteed in the 2007upfront. The balance of the inventory will be sold in the scatter market.Continued weakness in the economy could result in lower demand and pricing forour inventory, and limit our ability to continue to grow advertising revenue athistorical rates.  See “Results ofOperations – Three Months Ended September 30, 2007 Compared to ThreeMonths Ended September 30, 2008 – Revenue” for additional information onadvertising revenues.

 

Distribution agreementsare important because they affect our number of subscribers, which in turn hasa major impact on our subscriber fees, the number of persons viewing ourprogramming, and the rates charged for advertising. The long-term distributionchallenges are renewing our distribution arrangements with the multiple systemoperators as they expire on favorable terms. Our major distribution agreements have 

 

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terms which expire at various times from December 31,2008, through, with options to renew, December 2023.

 

Since January 1,2007, through April 2008, the Company has renewed its agreements with seven majordistributors, accounting for 95% of our subscriber baseat September 30, 2008.  Each renewalagreement has a multi-year term.The March 2007agreement with EchoStar Communication Corporation provided for a repositioningof the Hallmark Channel on the DISH Network, resulting in an addition ofapproximately 6.4 million Nielsen subscribers in May 2007. It furtherprovided for carrying the Hallmark Movie Channel on a package of the DISHNetwork, increasing distribution of that Channel by more than 4.0 millionsubscribers. In May 2007, we executed a renewal of our distribution agreementwith the National Cable Television Cooperative (“NCTC”). Under the terms of therenewal, we continue to be available to NCTC’s 1,100 member companies. In November 2007,we executed a renewal agreement with Comcast Corporation, providing Comcastwith rights to distribute the Hallmark Channel, the Hallmark Movie Channel andthe Hallmark Movie Channel HD.  In thefirst quarter of 2008, we renewed distribution agreements with Time WarnerCable and DirecTV for multi-year distribution of the Hallmark Channel. In April 2008,we renewed our distribution agreement with Cablevision Systems, which was thefinal major distribution agreement which originally expired in 2007. Therenewal agreement covers the Hallmark Channel as well as the StandardDefinition and High Definition versions of the Hallmark Movie Channel,resulting in an increase in distribution of the Hallmark Movie Channel of morethan 2 million subscribers.

 

In September, 2008, we renewed our distribution agreement with CharterCommunications Inc.  Under the agreement,Charter continues to deliver the Hallmark Channel and the Hallmark MovieChannel to approximately 4.4 million subscribers.

 

Our agreements withmajor distributors contain “most favored nations” clauses.  These clauses typically provide that, in theevent we enter into an agreement with another distributor on more favorableterms, these terms must be offered to the distributor, subject to variousexceptions and conditions.  These clausescover matters such as subscriber fees, launch support, local advertising timeand other financial and operating provisions. We take these provisions into account when renewing agreements.

 

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

 

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

 

Three factors havecontributed to the ratings of the Hallmark Channel: acquired series and movies,original productions and marketing and promotional efforts. Certain acquiredseries have consistently delivered strong ratings across all day-parts.Original productions are our most high profile programs and generate theHallmark Channel’s highest ratings. Their ratings success is of significanthelp to our distribution and advertising sales teams in selling the HallmarkChannel. The Company typically incurs additional marketing and promotionalexpenses surrounding original productions and certain acquired movies.

 

Historically, Nielsen cable television ratings werebased on viewing of networks’ programming content.  Beginning in the fourth quarter of 2007,Nielsen began measuring and providing performance data based on viewing ofcommercial content as well as programming content.  The new ratings information also includesdata on viewing of program content through digital recording devices (*i.e.,* DVR’s), if that viewing occurs within three days ofthe program’s air date.  From the beginningof the fourth quarter of 2007 through the second quarter of 2008, weexperienced a decrease in viewers of approximately 5% under the new ratingsmeasurement system. We have factored the new rating information into ouradvertising rates, and at this time we do not expect a significant impact fromthe new rating information on our net advertising rates.

 

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At September 30, 2008, the Hallmark Movie Channelwas distributed to over 6.8 million subscribers, an increase of nearly 600,000subscribers from June 30, 2008. This increase in distribution has and will continue to improve theCompany’s ability to generate advertising revenue from the Hallmark MovieChannel in 2008.

 

**Revenue from Continuing Operations**

 

*Our revenueconsists of subscriber fees and advertising.*

* *

*SubscriberFees*

 

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

 

Rates we receive per subscriber vary with changes inthe following factors, among others:

 

                                                ·              The level of sophistication anddegree of competition in the market;

 

                                                ·              The relative position in themarket of the distributor and the popularity of the channel;

 

                                                ·              The packaging arrangements for thechannel; and

 

                                                ·              Other commercial terms and lengthof the contract term.

 

We are in continuous negotiations with our existingdistributors to increase our subscriber base in order to enhance ouradvertising results.

 

#### *Advertising*

####  

Our advertising rates are generally calculated on thebasis of an agreed upon price per unit of audience measurement in return for aguaranteed commitment to the advertiser. We commit to provide advertiserscertain rating levels in connection with their advertising. Advertising ratesmay vary by time of year due to seasonal changes in television viewership.Revenue is recorded net of estimated delivery shortfalls, which are usuallysettled by providing the advertiser additional advertising time. The remainderof the revenue is recognized as the “make-good” advertising time is delivered.

 

**Cost of Services**

 

Our cost ofservices consists primarily of the amortization of program license fees,subscriber acquisition fee expense, the cost of signal distribution, and thecost of promotional segments that are aired between programs. We expect cost ofservices to decrease in 2008 as compared to 2007 as subscriber acquisition feeexpense is, and will continue to be, zero in 2008, based primarily upondistribution agreements renewed in 2007 and to date in 2008.

 

**Critical Accounting Policies, Judgments and Estimates**

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States requires Crown Media Holdings to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements and 

 

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the reported amounts of revenue and expensesduring the reporting period. Actual results could differ from those estimates.

 

For further information regarding our criticalaccounting policies, judgments and estimates, please see the Notes to UnauditedCondensed Consolidated Financial Statements contained in Item 1 of this Reportand “Critical Accounting Policies, Judgments and Estimates” in Item 7 of theCompany’s Annual Report on Form 10-K as filed with the SEC for the year endedDecember 31, 2007.

 

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

 

In 2008 and in prior years, we entered into a number of significanttransactions with Hallmark Cards and its subsidiaries. These transactionsinclude, among other things, programming, trademark licenses, administrativeservices, a line of credit, a tax sharing agreement, the issuance of fourpromissory notes and a waiver agreement. For information regarding suchtransactions and transactions with other related parties, please see “Effectsof Transactions with Related and Certain Other Parties” in Item 7 of theCompany’s Annual Report on Form 10-K as filed with the SEC for the yearended December 31, 2007. Also, please see Notes 6, 7 and 8 of Notes toUnaudited Condensed Consolidated Financial Statements contained in Item 1 ofthis Report.

 

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

##  

In the table below, we provideselected historical condensed consolidated financial and other data of CrownMedia Holdings and its subsidiaries. The following selected condensedconsolidated statement of operations data for three and nine months ended September 30,2007 and 2008, are derived from the unaudited financial statements of CrownMedia Holdings and its subsidiaries. Ratings and subscriber information isunaudited. This data should be read together with the condensed consolidatedfinancial statements and related notes included elsewhere in this Form 10-Q.

 
| ** **                                             | ** ** | ** **                                               | ** ** | ** ** | ** ** | **Percent  Change**                                     | ** ** | ** **   | ** ** | ** ** | ** ** | **Percent** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------------|------------|------------|------------|---------------------------------------------------------|------------|--------------|------------|------------|------------|-------------|------------|
| ** **                                             | ** ** | ** **                                               | ** ** | ** ** | ** ** | **2008**                                                | ** ** | ** **   | ** ** | ** ** | ** ** | **Change**  | ** ** |
| ** **                                             | ** ** | **Three Months Ended September 30,** | ** ** | **vs.**    | ** ** | **Nine Months Ended September 30,** | ** ** | **2008 vs.** | ** ** |
| ** **                                             | ** ** | **2007**                                                 | ** ** | **2008**   | ** ** | **2007**                                                | ** ** | **2007**     | ** ** | **2008**   | ** ** | **2007**    | ** ** |
| Revenue:                                               |       |                                                     |       |       |       |                                                    |       |         |       |       |       |        |       |
| Subscriber fees                                        |       | $                                                        | 7,389      |       | $          | 14,240                                                  |       | 93           | %          | $          | 21,391     |        | $          | 42,672 |   | 99 | % |
| Advertising                                            |       | 47,819                                                   |       | 49,950     |       | 4                                                       | %          | 143,140      |       | 162,993    |       | 14          | %          |
| Other revenue                                          |       | 104                                                      |       | 292        |       | 181                                                     | %          | 260          |       | 901        |       | 247         | %          |
| Total revenue                                          |       | 55,312                                                   |       | 64,482     |       | 17                                                      | %          | 164,791      |       | 206,566    |       | 25          | %          |
| Cost of Services:                                      |       |                                                     |       |       |       |                                                    |       |         |       |       |       |        |       |
| Programming costs                                      |       | 46,395                                                   |       | 36,653     |       | -21                                                     | %          | 124,476      |       | 107,699    |       | -13         | %          |
| Subscriber acquisition fee amortization                |       | 7,048                                                    |       | 0          |       | -100                                                    | %          | 22,728       |       | 0          |       | -100        | %          |
| Operating costs                                        |       | (1,517                                                   | )          | 2,459      |       | -262                                                    | %          | 3,801        |       | 9,522      |       | 151         | %          |
| Total cost of services                                 |       | 51,926                                                   |       | 39,112     |       | -25                                                     | %          | 151,005      |       | 117,221    |       | -22         | %          |
| Selling, general and administrative expense            |       | 11,955                                                   |       | 13,146     |       | 10                                                      | %          | 41,098       |       | 39,396     |       | -4          | %          |
| Marketing expense                                      |       | 3,565                                                    |       | 4,633      |       | 30                                                      | %          | 11,850       |       | 13,091     |       | 10          | %          |
| (Loss) income from operations before interest  expense |       | (12,134                                                  | )          | 7,591      |       | -163                                                    | %          | (39,162      | )          | 36,858     |       | -194        | %          |
| Interest expense                                       |       | (25,743                                                  | )          | (25,454    | )          | -1                                                      | %          | (82,585      | )          | (75,360    | )          | -9          | %          |
| Net loss                                               |       | $                                                        | (37,877    | )          | $          | (17,863                                                 | )          | -53          | %          | $          | (121,747   | )           | $          | (38,502 | ) | -68 | % |
|                                                   |       |                                                     |       |       |       |                                                    |       |         |       |       |       |        |       |
| **Other Data:**                                        |       |                                                     |       |       |       |                                                    |       |         |       |       |       |        |       |
| Net cash (used in) provided by operating activities    |       | $                                                        | 5,368      |       | $          | 24,580                                                  |       | 358          | %          | $          | (2,769     | )           | $          | 41,579 |   | -1602 | % |
| Capital expenditures                                   |       | $                                                        | (387       | )          | $          | (505                                                    | )          | 30           | %          | $          | (970       | )           | $          | (1,772 | ) | 83 | % |
| Net cash used in investing activities                  |       | $                                                        | (1,428     | )          | $          | (1,083                                                  | )          | -24          | %          | $          | (3,995     | )           | $          | (4,369 | ) | 9 | % |
| Net cash used in financing activities                  |       | $                                                        | (10,870    | )          | $          | (19,476                                                 | )          | 79           | %          | $          | (7,198     | )           | $          | (34,886 | ) | 385 | % |
| Total domestic day household ratings (1)(3)            |       | 0.710                                                    |       | 0.657      |       | -7                                                      | %          | 0.700        |       | 0.689      |       | -2          | %          |
| Total domestic primetime household ratings (2)(3)      |       | 1.137                                                    |       | 1.115      |       | -2                                                      | %          | 1.129        |       | 1.128      |       | 0           | %          |
| Subscribers at period end                              |       | 84,535                                                   |       | 84,761     |       | 0                                                       | %          | 84,535       |       | 84,761     |       | 0           | %          |
|                                                        |            |                                                          |            |            |            |                                                         |            |              |            |            |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

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

(3)  TheseNielsen ratings are for the time period July 1 through September 30 andJanuary 1 through September 30, respectively.

 

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

### ** **

#### *ThreeMonths Ended September 30, 2007 Compared to Three Months Ended September 30,2008*

####  

*Revenue. *Our revenue from continuing operations,comprised of subscriber fees and advertising, increased 17% to $64.5 millionfor the three months ended September 30, 2008. Our 93% increase to $14.2 million in subscriberfee revenue for the three months ended September 30, 2008, was a result ofhigher net effective rates on average, primarily due to increases in thenumber of paying subscribers from renewed distribution agreements andreductions in subscriber acquisition fees netted against gross subscriberrevenue.  We anticipate that these samefactors will result in substantial increases in subscriber fees during theremainder of 2008, compared to the corresponding period in 2007; subscriberrevenue growth beyond 2008 will be limited. Subscriberacquisition fee expense recorded as a reduction of revenue was $1.9 million forthe three months ended September 30, 2007, and $702,000 for the comparableperiod in 2008. The number of paying subscribers at September 30, 2008,when compared to September 30, 2007, has increased as a result ofpreviously amended distribution agreements.

 

The increase in advertising revenue to $50.0million for the three months ended September 30, 2008, compared to $47.8million for the three months ended September 30, 2007, reflects anincrease in advertising rates. The number of advertisers was 438 at September 30,2008, as compared to 448 at September 30, 2007. In addition,approximately $450,000 of the increase in advertising revenue is due toadvertising on the Hallmark Movie Channel.

 

We have experienced in the second and third quarters of 2008 asoftening of advertising rates in the scatter and direct response markets,primarily due to deteriorating economic conditions.  There have also been a limited number ofcancellations by advertisers as permitted by their contracts.  We expect this softening to continue in thefourth quarter of 2008 and possibly the first two quarters of 2009.  This decrease in rates has resulted in loweradvertising revenues in the third quarter of 2008 compared to the secondquarter of 2008, in excess of a normal decline in advertising revenue typicallyexperienced by us between the second and third quarters. In response to thelower advertising rates, starting in the third quarter of 2008 we haveeliminated some on-air promotions of our programs in order to have moreadvertising inventory available for sale.

 

As a result of the economic conditions, we expect a slowing in thegrowth of our advertising revenues for the remaining quarter in 2008 and thefirst and second quarters of 2009 when compared to the same quarters in theprior year.  Nevertheless, we stillexpect advertising revenues for those quarters to be higher percentage-wise, inthe single digit range, than those revenues in the same period of the prioryear.  If economic conditions improve inthe second half of 2009, we would expect to benefit from that improvement andpossibly have again double digit growth in advertising revenues.  Our expectations are supported, in part, byadvertising revenues which we receive from our clients in the packaged goods,discount retail, pharmaceuticals and entertainment industries.  A majority of our advertising clients are inthese areas which have not had to date the significant downturn in ad dollarslike the automotive and financial sectors.

 

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Among the 73 ad-supported cable channels in the United States market,the Hallmark Channel ranked 10th intotal day with a 0.657 household rating for the three months ending September 30,2008 and 9th for primetime with a 1.115 household ratingfor the same period based on Nielsen ratings.  Although we had an increase in distribution to the Nielsen Universe of5% in the third quarter of 2008 versus the third quarter of 2007, our householdratings were virtually even (or down slightly) for the third quarter of 2008compared to the third quarter of 2007. We believe that the reasons for this circumstance include significantsample adjustments to viewers in determining ratings, the 2008 Summer Olympics,and a shift of viewers to cable news channels during the unprecedented mediacoverage of the national elections and the economic crisis.   We do notexpect these temporary events to impact our overall ratings for the balance of2008.

 

*Cost ofservices. *Cost ofservices as a percent of revenue decreased to 61% in 2008, as compared to 94%in 2007. This decrease results from the combined effects of the 17% increase inrevenue, discussed above, and the 100% decrease in subscriber amortization feeamortization expense discussed below.

 

Total programming costs for the three months ended September 30,2008, decreased 21% following the December 31, 2007, expiration of ourprogramming agreement with NICC and because of the Company’s effort to monitorcosts. This was offset in part by the Company licensing Hallmark Hall of Famemovies under a new 2008 agreement with Hallmark Cards that provides 10-yearexhibition windows for all licensed films. During the third quarter of 2008, weentered into amendments to two significant programming agreements which addedprogramming and deferred payments of certain programming costs to periodsbeyond 2008.

 

        Subscriber acquisition feeamortization expense results from subscriber acquisition costs incurredpreviously by us and amortized over the remaining life of the relevantdistribution agreement. Subscriber acquisition fee amortization expensedecreased 100% as all of the expense was net against revenue during threemonths ended September 30, 2008. The Company’s three largest affiliationagreements became fully amortized during the fourth quarter of 2007.

 

During the third quarter of 2007, the Company recorded$4.7 million negative amortization of film assets related to a change inestimate of the Company’s residual and participation liability resulting froman analysis of the Company’s third-party licenses and use of the film assetsprior to the sale to RHI using information that became available during thethird quarter of 2007. During the third quarter of 2008, the Company recorded$1.1 million negative amortization of film assets related to a change inestimate of the Company’s residual and participation liability usinginformation that became available during the third quarter of 2008.

 

*Selling,general and administrative expense.* Our selling, general and administrativeexpense increased 10% quarter over quarter. This increase is primarily due to the increase in salary and benefitsexpense for officers and employees and an increase in settlement expenserelated to the potential NICC settlement.

 

*Marketing expense*.  Our marketing expense increased 30% due toincreased media costs and increased promotional activities in the third quarterof 2008 as compared to the third quarter of 2007. The Company had one marketingpromotion for “Avenging Angel” in July 2007. The Company also had onemarketing promotion for “A Gunfighter’s Pledge” in July 2008. A “Gunfighter’sPledge” had a larger national off-air campaign than the one executed in2007.  In addition to radio, television, print and online advertising, weexecuted a multi-market event to drive press coverage and viewer awareness.

 

*Interestexpense. *Interest expense for the three months ended September 30,2008, decreased $289,000 compared to the three months ended September 30,2007.  The principal balance of ourcredit facility went from $54.5 million at June 30, 2008, to $35.2 millionat September 30, 2008 (the balance decreased from $91.7 million at June 30,2007, to $80.9 million at September 30, 2007) and a decrease in the bankcredit facility interest rate from 5.88% at September 30, 2007, to 4.45%at September 30, 2008, offset in part by higher principal balances on fourof the five notes payable to Hallmark Cards affiliates.

 

#### *NineMonths Ended September 30, 2007 Compared to Nine Months Ended September 30,2008*

####  

*Revenue. *Our revenue from continuing operations,comprised of subscriber fees and advertising, increased 25% 

 

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to $206.6 million forthe nine months ended September 30, 2008. Our subscriber fee revenue for the nine months ended September 30,2008, increased $42.7 million or 99%, as a result of higher net effective rateson average, primarily due to increases in the number of payingsubscribers from renewed distribution agreements and reductions in subscriberacquisition fees netted against gross subscriber revenue.  Subscriberacquisition fee expense recorded as a reduction of revenue was $4.8 million forthe nine months ended September 30, 2007, and $2.0 million for thecomparable period in 2008. The number of paying subscribers has increased as aresult of previously amended distribution agreements.

 

The increase in advertisingrevenue to $163.0 million for the nine months ended September 30, 2008,compared to $143.1 million for the nine months ended September 30, 2007,reflects an increase in advertising rates. In addition, approximately $2.5million of the increase in advertising revenue is due to advertising on theHallmark Movie Channel.

 

Among the 73 ad-supported cable channels in the UnitedStates market, the Hallmark Channel ranked 11th in total day with a0.689 household rating for the nine months ending September 30, 2008 and 9thfor primetime with a 0.700 household rating for the same period based onNielsen ratings.

 

*Cost ofservices. *Cost ofservices as a percent of revenue decreased to 57% in 2008, as compared to 92%in 2007. This decrease results from the combined effects of the 25% increase inrevenue, discussed above, and the 100% decrease in subscriber amortization feeamortization expense discussed below.

 

Total programming costs for the nine months ended September 30,2008, decreased 13% following the December 31, 2007, expiration of ourprogramming agreement with NICC and because of the Company’s effort to monitorcosts. This was offset in part by the Company licensing Hallmark Hall of Famemovies under a new 2008 agreement with Hallmark Cards that provides 10-yearexhibition windows for all licensed films.

 

        Subscriber acquisition feeamortization expense results from subscriber acquisition costs incurredpreviously by us and amortized over the remaining life of the relevantdistribution agreement. Subscriber acquisition fee amortization expensedecreased 100% as all of the expense was net against revenue during nine monthsended September 30, 2008. The Company’s three largest affiliationagreements became fully amortized during the fourth quarter of 2007.

 

During the second quarter of 2007, the Company reducedits estimate of a residual and participation liability for $521,000 less thanit had originally accrued for it in conjunction with the sale of its filmlibrary.  During the third quarter of2007, the Company recorded $4.7 million negative amortization of film assetsrelated to a change in estimate of the Company’s residual and participationliability resulting from an analysis of the Company’s third-party licenses anduse of the film assets prior to the sale to RHI using information that becameavailable during the third quarter of 2007. During the third quarter of 2008,the Company recorded $1.1 million negative amortization of film assets relatedto a change in estimate of the Company’s residual and participation liabilityusing information that became available during the third quarter of 2008.

 

*Selling,general and administrative expense.* Our selling, general and administrativeexpense decreased 4% period over period. This decrease is primarily due to the $1.8 million decrease and $2.1million decrease of our expense related to the RSU liability and SAR liability,respectively. This decrease was partially offset by increases in salary,research, and communication expenses and an increase in settlement expenserelated to the potential NICC settlement described in Note 10 of Notes toUnaudited Condensed Consolidated Financial Statements in this Report.

 

*Marketing expense*.  Our marketing expense increased 10% due toincreased media costs and increased promotional activities in 2008 as comparedto 2007. The Company had three marketing promotions in the first nine months of2007: “Love is a Four Letter Word” in February 2007, “A Stranger’s Heart”in May 2007, and “Avenging Angel” in July 2007. The Company also hadthree marketing promotions in 2008: “The Good Witch” in January 2008, “BridalFever” in February 2008, and “A Gunfighter’s Pledge” in July 2008. A “Gunfighter’sPledge” had a larger national off-air campaign than the one executed in thethird quarter of 2007as discussed above.

 

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*Interestexpense. *Interestexpense for the nine months ended September 30, 2008, decreased $7.2million compared to the nine months ended September 30, 2007.   The principal balance of our credit facilitywent from $69.6 million at December 31, 2007, to $35.2 million at September 30,2008 (the balance decreased from $87.6 million at December 31, 2006 to$80.9 million at September 30, 2007) and a decrease in the bank creditfacility interest rate from 5.88% at September 30, 2007, to 4.45% at September 30,2008, offset in part by higher principal balances on four of the five notespayable to Hallmark Cards affiliates. Additionally, on April 14, 2008, the Tax Note was credited $1.5million, which represented the Company’s share of an IRS interest refund thatHallmark Cards received. This refund of interest reduced the balance of the TaxNote. During the nine months ended September 30, 2007, the Companyrecorded $7.9 million of interest expense related to the Tax Note.

 

## **Liquidityand Capital Resources**

##  

During the nine months ended September 30,2008 our operating activities provided $41.6 million of cash.  During the comparable period in 2007, ouroperating activities consumed $2.8 million of cash.** The most significant contribution to thisfavorable change of $44.3 million was theincrease in operating cash receipts from $178.3 million to $220.0 millionduring the nine months ended September 30, 2007 and 2008, respectively.Additionally, the Company’s net loss for the nine months ended September 30,2008, decreased $83.2 million to $38.5 million from $121.7 million for the ninemonths ended September 30, 2007.

 

Cash used in investingactivities was $4.0 million and $4.4 million for the nine months ended September 30,2007 and 2008, respectively. During the nine months ended September 30,2007 and 2008, the Company purchased property and equipment of $970,000 and$1.8 million, respectively. During the nine months ended September 30,2007, the Company paid $3.0 million to the buyer of the international business.During the nine months ended September 30, 2008, the Company paid $2.6million to the buyer of the international business. In accordance withthe terms of the sale of the international business, the Company is obligatedto reimburse the buyer for payments on certain lease arrangements, which wereassumed by the buyer, at or about the same time the buyer is obligated to paythe lessor.

 

Cash used in financingactivities was $7.2 million and $34.9 million for the nine months ended September 30,2007 and 2008, respectively. We borrowed $7.1 million and $18.8 million underour credit facility to supplement the cash requirements of our operating andinvesting activities during the nine months ended September 30, 2007 and2008, respectively. We repaid principal of $13.8 million and $56.1 millionunder our credit facility during the nine months ended September 30, 2007and 2008, respectively.

 

*Cash Flows*

 

*To October 1, 2009*

 

As of September 30,2008, the Company had $4.3 million in cash and cash equivalents on hand and$14.8 million of current borrowing capacity under the bank creditfacility.  Day-to-day cash disbursementrequirements have typically been satisfied with cash on hand and operating cashreceipts supplemented with the borrowing capacity available under the bank creditfacility and forbearance by Hallmark Cards and its affiliates.

 

Operating activities for the year ended December 31, 2007, yieldedpositive cash flow as have the nine months ended September 30, 2008.  However, there can be no assurance that theCompany’s operating activities will continue to generate positive cash flow. 

 

The Company’s principal sources of funds are cash onhand, cash generated by operations and amounts available under the Company’srevolving bank credit facility through May 31, 2009.  Another significant aspect of the Company’sliquidity is the deferral of payments on obligations owed to Hallmark Cards andits subsidiaries.  In March 2008,the Company and Hallmark Cards entered into an Amended and Restated WaiverAgreement which changed the maturity date of three obligations and deferredpayments under certain obligations.  However,under the Waiver Agreement, interest on the 2001, 2005 and 2006 Notes thataccrues from November 16, 2008, through December 31, 2008,  is payable in cash in January 2009;subsequent quarterly accrued interest is payable in cash 5 days after eachquarterly period.  Under an amendment in October 2008,the deferred payments under these obligations were extended to October 1,2009.  See Note 6 Related Party Long-TermObligations – Waiver and Standby Purchase Agreement.

 

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InMarch 2008, the bank credit facility was extended to May 31, 2009,and the bank’s lending commitment was reduced to $90.0 million. By its terms,the Bank’s lending commitment was reduced to $60.0 million on June 30,2008.  This commitment decreased to $50.0million on September 30, 2008, at which time the Company owed $35.2million on the facility. The bank’s commitment will decrease further to $45.0million on March 31, 2009.  Suchdecreases were made in accordance with the March 2008 amendment to thebank credit facility.  The Company plansto use cash flows from operations to reduce outstanding borrowings under thefacility and expects this cash flow to be sufficient to maintain outstandingborrowings under the commitment levels throughout the term of thefacility.  Accordingly, the Company’sability to comply with the scheduled reduction in the Bank credit facility andto pay any amounts outstanding upon the maturity is highly dependent upon theCompany’s ability to generate sufficient cash flows from operations between September 30,2008, and May 31, 2009.  See Note 5Credit Facility.

 

The Waiver Agreement requires that Excess Cash Flow as defined in theWaiver Agreement be used to make payments due under the bank credit facility orto pay obligations subject to the Waiver Agreement.  The Company has budgeted and anticipates thatit will have substantial Excess Cash Flow for the year ended December 31,2008 and that this amount will be used to make a reduction in the bank creditfacility during the first quarter of 2009. See Note 6.  However, theexistence and amounts of any Excess Cash Flow depend on the Company’s resultsand cash flow for the remainder of  2008,with its attendant risks, and is not assured.

 

In prior years, the Company’s Tax Sharing Agreementwith Hallmark Cards has also been a source of cash from financing activities.More recently, benefits to the Company under the tax sharing agreement havebeen used to reduce amounts owed to Hallmark Cards and its affiliates under theTax Note.  The Company may incur a taxliability to Hallmark Cards in 2009 pursuant to the Tax Sharing Agreement inpart because accrued unpaid interest on the Company’s 10.25% Senior SecuredNote with HC Crown Corp. is not deducted in determining tax benefits and taxliabilities under that Agreement.  Thiscould result in a cash amount being payable to Hallmark Cards in the secondquarter of 2009 unless Hallmark Cards agrees to defer any such taxliability.  See Note 7 Related PartyTransactions – Tax Sharing Agreement.

 

The Company’s recurringnet loss situation necessitates that we continue to monitor and control allareas of expenses, including programming, marketing and distribution.  The Company anticipates that its principaluses of cash during the next twelve months will continue to include the paymentof operating expenses, accounts payable and accrued expenses, license fees forprogramming, interest and repayment of principal under its bank credit facilityincluding the use of Excess Cash Flow as required by the Waiver Agreement,interest under certain notes payable to Hallmark Cards affiliates and paymentsunder the Tax Sharing Agreement with Hallmark Cards.

 

The Company willendeavor to extend or refinance the bank credit facility prior to or upon itsmaturity.  Any such extension orrefinancing could require the continuation of a letter of credit from HallmarkCards in support of the bank credit facility or other steps by the Company and,thus, is not assured.  Upon maturity of the credit facility on May 31, 2009,if the facility has not been paid in full, renewed or replaced (1) JPMorgan Chase Bank, N.A., would have the right to draw down onHallmark Cards’ irrevocable letter of credit or (2) Hallmark Cards couldpurchase the interest of the lending bank in the facility.  In either case, Hallmark Cards would have allthe obligations and rights of the lending bank under the bank credit facilityand could demand payment of outstanding amounts at any time after October 1,2009 under the terms of the Waiver Agreement. Upon maturity of the credit facility on May 31, 2009, if not paidin full, renewed or replaced, the lending bank could forego drawing down on Hallmark Cards irrevocable letter ofcredit and, alternatively, foreclose on the Company’s assets. Suchforeclosure proceedings would adversely affect our ability to continue ouroperations. However, prior to any such possible foreclosure, if the Company hadnot secured a refinancing of the credit facility or alternative financing, theCompany would require Hallmark Cards to exercise its option, pursuant to theterms of the Waiver Agreement, to purchase all of the outstanding indebtednessunder the credit facility. The amount purchased would then be subject to termsof the Waiver Agreement.

 

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The Company believesthat cash on hand, cash generated by operations, and borrowing availabilityunder its bank credit facility through May 31, 2009, when combined withthe deferral of any required payments on related-party debt and relatedinterest described under the Waiver Agreement, and, if necessary, HallmarkCards’ purchase of any outstanding indebtedness under the bank credit facilityin May 2009 as described above, will be sufficient to fund the Company’soperations and enable the Company to meet its liquidity needs through October 1,2009.

 

The sufficiency of the existing sources of liquidity to fund theCompany’s operations is dependent upon maintaining subscriber revenue at orabove the amount of such revenue for the nine months ended September 30,2008, and continuing growth in advertising revenue. A significant decline inthe popularity of the Hallmark Channel, a significant economic decline in theadvertising market, an increase in program acquisition costs, an increase incompetition or other adverse changes in operating conditions could negativelyimpact the Company’s liquidity and its ability to fund the current level ofoperations.  During the second and thirdquarters of 2008 the Company experienced a softening of advertising rates inthe direct response and scatter market. Despite the significant decline in economic conditions nationally, andwithin the advertising industry, these conditions did not materially impact theCompany’s ability to fund current and expected levels of cash needed foroperations.  The Company expects thissoftening to continue through at least the second quarter of 2009, but,similarly, does not currently expect these changing market conditions tomaterially impact the Company’s ability to fund its operations.

 

*On or After October 1, 2009*

 

TheCompany’s long-term obligations include notes payable to Hallmark Cards oraffiliates of Hallmark Cards which are the subject of the WaiverAgreement.  These obligations includeNotes issued in 2001, 2005 and 2006 which mature on December 31,2009.  See Note 6.  Amounts currently due under these notes at September 30,2008, are $107.4 million, $168.3 million and $61.3 million, respectively. TheTax Note in the current amount of $5.9 million matures on July 27, 2009.Additionally, at September 30, 2008,non-interest bearing unpaid accrued service fees and unreimbursed expenses of$14.8 million were included in payable to affiliates on the accompanyingcondensed consolidated balance sheet.  Another long-term obligation concern is VISN’sownership of the $25.0 million company obligated mandatorily redeemablepreferred membership interest in Crown Media United States that is redeemableno later than December 31, 2010. See Note 8 Company Obligated Mandatory Redeemable Preferred Interest andNICC License Agreement.

 

Because of the Company’spossible inability to meet its obligations when they come due on and after October 1,2009 and through December 31, 2009, the Company anticipates that prior to October 1,2009, it will be necessary to either extend or refinance (i) the bankcredit facility and (ii) the promissory notes payable to affiliates ofHallmark Cards. As part of a combination of actions and in order to obtainadditional funding, the Company may consider various alternatives, includingrefinancing the bank credit facility, raising additional capital through theissuance of equity or debt securities, or other strategic alternatives. If thecurrent credit market conditions continue, a refinancing could be difficult.

 

Upon maturity of thebank credit facility on May 31, 2009, the Company will not have acomparable credit facility unless the bank credit facility is extended, renewedor replaced.  In that case, the Companywould be solely dependent upon day-to-day operating cash receipts to meets itscash requirements.

 

***Bank Credit Facility, Hallmark Notes, andTax Sharing Agreement***

 

For informationregarding our Bank Credit Facility, Hallmark Notes and Tax Sharing Agreement,please see “Bank Credit Facility, Hallmark Notes, and Tax Sharing Agreement” ofthe Company’s Annual Report on Form 10-K as filed with the SEC for theyear ended December 31, 2007. Also, please see Notes 5, 6 and 7 ofNotes to Unaudited Condensed Consolidated Financial Statements contained inItem 1 of this Report.

 

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

##  

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

 

Among the factors that could cause actual resultsto differ materially are those discussed in this Report below and in theCompany’s filings with the Securities and Exchange Commission, including theRisk Factors stated in the Company’s Annual Report on Form 10-K for theyear ended December 31, 2007. Such Risk Factors include, but are notlimited to, the following:  competitionfor distribution of channels, viewers, advertisers and the acquisition ofprogramming; fluctuations in the availability of programming; fluctuations indemand for programming which we air on our channels; our ability to address ourliquidity needs; our incurrence of losses; and our substantial indebtednessaffecting our financial condition and results.

 

### **Available Information**

### ** **

**We will makeavailable free of charge through our website, www.hallmarkchannel.com, theAnnual Report, 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 weelectronically file or furnish such material with the Securities and ExchangeCommission.**

 

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

 

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

 

We only invest in instrumentsthat meet high credit and quality standards, as specified in our investmentpolicy guidelines. These instruments, like all fixed income instruments, aresubject to interest rate risk. The fixed income portfolio will decline in valueif interest rates increase. If market interest rates were to increase immediatelyand uniformly by 10% from levels as of September 30, 2008, the decline ofthe fair value of the fixed income portfolio would not be material.

 

As of September 30, 2008,our cash, cash equivalents and short-term investments had a fair value of $4.3and were invested in cash and short-term commercial paper. The primary purposeof these investing activities has been to preserve principal until the cash isrequired to fund operations. Consequently, the size of this portfoliofluctuates significantly as cash is provided by and used in our business.

 

The value of certain investmentsin this portfolio can be impacted by the risk of adverse changes in securitiesand economic markets and interest rate fluctuations. For the three and ninemonths ended September 30, 2008, the impact of interest rate fluctuations,changed business prospects and all other factors did not have a material impacton the fair value of this portfolio, or on our income derived from thisportfolio.

 

We have not used derivativefinancial instruments for speculative purposes. As of September 30, 2008,we are not hedged or otherwise protected against risks associated with any ofour 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 theseexposures, we may enter into various derivative investment transactions in thenear term pursuant to our investment and risk management policies andprocedures in areas such as hedging and counterparty exposure practices. We 

 

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have not and will not use derivatives forspeculative purposes.

 

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

 

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

 

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

 

Ourmaterial interest bearing assets consisted of cash equivalents and short-terminvestments. The balance of our interest bearing assets was $4.3 million, or lessthan 1% of total assets, as of September 30, 2008. Our materialliabilities subject to interest rate risk consisted of our bank creditfacility, our note and interest payable to HC Crown, and our notes and interestpayable to Hallmark Cards affiliates. The balance of those liabilities was$378.2 million, or 28% of total liabilities, as of September 30, 2008. Netinterest expense for the three and nine months ended September 30, 2008,was $25.5 million, 40%, of our total revenue and $75.4 million, 37%, of ourtotal revenue, respectively. Our net interest expense of these liabilities issensitive to changes in the general level of interest rates, primarily U.S. andLIBOR interest rates. In this regard, changes in U.S. and LIBOR (“Eurodollar”)interest rates affect the fair value of interest bearing liabilities.

 

Ifmarket interest rates were to increase or decrease by 1% from levels as of September 30,2008, our interest expense for the three and nine months would changecorrespondingly by $961,000 and $3.0 million, respectively.

 

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

 

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

 

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

 

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

 

There was no change in the Company’s internal control over financialreporting that occurred during the quarter ended September 30, 2008, thatmaterially affected, or was reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

**PART II.  OTHER INFORMATION**

 

**Item 1A.  Risk Factors**

 

The following is an additional risk factor concerning our business as aresult of current economic conditions in the United States.

 

***Current difficult conditions in the financial servicesmarkets may materially and adversely impact our business.***

 

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      Dramatic declines in the values of, among other things, variousderivative instruments, credit default swaps and the housing market during theprior year, with falling home prices and increasing foreclosures andunemployment, have resulted in significant write-downs of asset values byfinancial institutions, including government-sponsored entities and majorcommercial and investment banks.  Manylenders and institutional investors have reduced, and in some cases, ceased toprovide funding to borrowers, including other financial institutions.  This market turmoil and tightening of credithave led to an increased level of commercial and consumer delinquencies, lackof consumer confidence, increased market volatility and possibly a reduction ofbusiness activity generally.  Acontinuation of these conditions could have, among other things, the followingpotential negative effects:  A reductionin spending by consumers and generally advertisers, which could reduce ournumber of subscribers, advertising rates and thereby also our revenues; anincrease in bad debts or the reserve for bad debts; making more difficult orunlikely a refinancing or replacement of our outstanding indebtedness, whetherthe bank credit facility or any indebtedness owed to Hallmark Cards and itssubsidiaries; and exposure to increased interest expense to the extent that anyrefinanced debt could be at a higher cost.

 

**Item 6.  *Exhibits***

 

**INDEX TO EXHIBITS**

 
| **Exhibit Number** | ** ** | **Exhibit Title**                                                                                                                                                                                                                                                    |
|-------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                                                                                                                                                                                      |
| 3.1                     |       | Amended and Restated  Certificate of Incorporation (previously filed as Exhibit 3.1 to our  Registration Statement on Form S-1/A (Amendment No. 2), Commission  File No. 333-95573, and incorporated herein by reference).                            |
| 3.2                     |       | Amendment to the Amended and  Restated Certificate of Incorporation (previously filed as Exhibit 3.2  to our Quarterly Report on Form 10-Q filed on July 31, 2001 (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                    |       | Amendment No. 2 to Amended and Restated Waiver  and Standby Purchase Agreement dated October 30, 2008, by and between  Hallmark Cards Incorporated and Crown Media Holdings, Inc.                                                                          |
| 10.2                    |       | Lease Agreement, dated September 8, 2008, by  and between Paramount Group, Inc., 1325 Avenue of the Americas, L.P.,  and Crown Media United States, LLC.                                                                                                        |
| 10.3                    |       | Guaranty Commitment, dated as of September 2,  2008, by and between Hallmark Cards, Incorporated and Crown Media United  States, LLC.                                                                                                                                |
| 31.1                    |       | Rule 13a-14(a) Certification executed by  the Company’s Chief Executive Officer.                                                                                                                                                                           |
| 31.2                    |       | Rule 13a-14(a) Certification executed by  the Company’s Executive Vice President and Chief Financial Officer.                                                                                                                                              |
| 32                      |       | Section 1350 Certifications.                                                                                                                                                                                                                                         |

 

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**SIGNATURES**

 

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

 
| CROWN  MEDIA HOLDINGS, INC.                      |                  |               |
|--------------------------------------------------|-----------------------|--------------------|
| ** **                                       | ** **            | ** **         | ** ** | ** ** |
| **Signature**                                    | ** **            | **Title**          | ** ** | **Date** |
|                                             |                  |               |   |   |
| By:                                         | /s/ HENRY S. SCHLEIFF |               | Principal Executive |   | November 6, 2008 |
|                                             |                  | Officer            |   |   |
|      Henry  S. Schleiff |                  |               |   |   |
|                                             |                  |               |   |   |
| By:                                         | /s/ BRIAN C. STEWART  |               | Principal |   | November 6, 2008 |
|                                             |                  | Financial and      |   |   |
|    Brian C. Stewart               |                  | Accounting Officer |   |   |

 

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