Back to GetFilings.com

Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended June 30, 2002

or

For the transition period from             to           .

Commission File Number: 000-30700

Crown Media Holdings, Inc.
(Exact Name of Registrant as Specified in Its Charter)

6430 S. Fiddlers Green Circle,
Suite 500,
Greenwood Village, Colorado 80111
(Address of Principal Executive Offices and Zip Code)

(303) 220-7990
(Registrant’s Telephone Number, Including Area Code)

(Former Name, Former Address, and Former Fiscal Year,
if Changed Since Last Report.)

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

As of August 2, 2002, the number of shares of Class A Common Stock, $.01 par value outstanding was 73,670,775, and the number of shares of Class B Common Stock, $.01 par value, outstanding was 30,670,422.

Table of Contents

TABLE OF CONTENTS

2

Table of Contents

     The discussion set forth in this Form 10-Q contains statements concerning potential future events. Such forward-looking statements are based on assumptions by Crown Media Holdings, Inc.’s (“Crown Media Holdings” or the “Company”) management, as of the date of this Form 10-Q, including assumptions about risks and uncertainties faced by Crown Media Holdings. Readers can identify these forward-looking statements by their use of such verbs as “expects,” “anticipates,” “believes,” or similar verbs or conjugations of such verbs. If any of management’s assumptions prove incorrect or should unanticipated circumstances arise, Crown Media Holdings’ actual results, levels of activity, performance, or achievements could materially differ from those anticipated by such forward-looking statements. Among the factors that could cause actual results to differ materially are those discussed in this Form 10-Q under the heading “Forward-Looking Statements and Risk Factors.” Crown Media Holdings will not update any forward-looking statements contained in this Form 10-Q to reflect future events or developments.

     In this Form 10-Q the terms “we,” “us” and “our” refer to Crown Media Holdings, and, unless the context requires otherwise, Crown Media International, LLC (“Crown Media International”), Crown Media United States, LLC (“Crown Media United States”), Crown Media Distribution, LLC (“Crown Media Distribution”), Crown Entertainment Limited (“Crown Entertainment”), Crown Media Trust (“Crown Media Trust”), and H&H Programming — Asia, L.L.C. (“H&H Programming — Asia”), subsidiaries of Crown Media Holdings that operate our businesses. The term “common stock” refers to our Class A common stock and Class B common stock, unless the context requires otherwise.

     The names Hallmark, Hallmark Entertainment, TOTAL CHOICE and other product or service names are trademarks or registered trademarks of their owners.

3

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)

The accompanying notes are an integral part of these consolidated balance sheets.

4

Table of Contents

CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands, except per share amounts)

The accompanying notes are an integral part of these
consolidated statements of operations and comprehensive loss.

5

Table of Contents

CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

The accompanying notes are an integral part of these
consolidated statements of cash flows.

6

Table of Contents

CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Three and Six Months Ended June 30, 2001 and 2002

1. Business and Organization

Organization

     Crown Media Holdings, Inc. (“Crown Media Holdings” or the “Company”), through its subsidiaries, owns and operates pay television channels dedicated to high quality, broad appeal, entertainment programming, in the United States and in various countries throughout the world. Internationally, the Hallmark Channel is operated and distributed in approximately 110 countries by Crown Media International, which commenced operations as a Delaware corporation in June 1995, and in the United Kingdom by Crown Entertainment. Domestically, the Hallmark Channel is operated and distributed by Crown Media United States, which commenced operations as a limited liability company in July 1995. Significant investors in Crown Media Holdings include Hallmark Entertainment Holdings, Inc. (“Hallmark Entertainment Holdings”), a subsidiary of Hallmark Cards, Incorporated (“Hallmark Cards”), Liberty Media Corp. (“Liberty Media”), the National Interfaith Cable Coalition (“NICC”), J.P. Morgan Partners (BHCA), L. P. (“J.P. Morgan”), and DirecTV Enterprises, Inc. (“DirecTV”).

     Crown Media International’s 50% interest in H&H Programming — Asia, which operated The Kermit Channel until December 2000, was treated as an equity investment until March 15, 2001, in Crown Media Holdings’ consolidated financial statements. On March 15, 2001, Crown Media Holdings acquired from The Jim Henson Company, Inc. (“The Jim Henson Company”) the remaining 22.5% common interests in Crown Media United States and the remaining 50% interest in H&H Programming — Asia that the Company did not previously own. In consideration for these ownership interests, the Company issued approximately 5.4 million shares of its Class A common stock, with a then market value of approximately $85.8 million, to The Jim Henson Company. The acquisition was recorded at fair value using purchase accounting as of March 15, 2001.

Liquidity

     In connection with the Company’s growth strategy, the Company expects that it will continue to make significant investments in programming, distribution and technology. The Company’s principal sources of funds are expected to be cash generated from operations, cash on hand and available borrowings under the Company’s JP Morgan Chase credit facility and the HC Crown Corporation (“HC Crown”) line of credit. Crown Media Holdings and/or its subsidiaries have a limited ability to incur additional debt due to certain provisions contained in the Company’s credit agreement and indenture governing the Company’s preferred securities. The Company’s principal uses of funds are expected to be the payment of operating expenses (including but not limited to licensing programming from third parties), working capital, capital expenditure requirements, and debt service payments.

     The Company’s financial position and operations changed significantly during 2001. Substantial revenue producing assets were acquired through the issuance of debt and stock and funds available under the Company’s credit facility. In August 2001, the Company issued $80.1 million of common stock for additional carriage on a U.S. pay television distributor. In September 2001, the Company acquired approximately 700 films for $592.0 million in common stock and assumption of $220.0 million of debt. The expectation is that these additional assets will provide substantial revenue for the foreseeable future. These acquisitions and the Company’s continuing use of cash in operations required several new financings during 2001. In September 2001, the Company established a bank credit facility of $285.0 million, which was subsequently increased in December 2001, to $320.0 million. In December 2001, the Company also issued $265.0 million of preferred securities in a private placement transaction. As of June 30, 2002, the Company had a $5.3 million cash balance, $76.5 million undrawn balance under the bank credit facility and $75.0 million available under the HC Crown line of credit. The Company believes that this available credit, together with cash generated from operations and cash on-hand, will be sufficient for its liquidity needs through at least June 30, 2003.

2. Summary of Significant Accounting Policies

Principles of Consolidation

     The consolidated financial statements include the consolidated accounts of Crown Media Holdings and those of its wholly owned and majority-owned and controlled subsidiaries. Investments in entities that are not majority-owned and controlled by Crown Media Holdings are accounted for under the equity method. All significant intercompany balances and transactions have been eliminated in consolidation.

7

Table of Contents

Cash and Cash Equivalents

     Crown Media Holdings considers all highly liquid financial instruments purchased with an initial maturity of three months or less to be cash equivalents. The carrying value of Crown Media Holdings’ cash equivalents approximates cost at each balance sheet date.

Restricted Cash

     Restricted cash includes amounts deposited to secure letters of credit in accordance with certain lease agreements.

Subscriber Acquisition Fees

     Crown Media United States has distribution agreements with eight of the top nine largest (based on number of subscribers) United States pay television distributors. These distributors carry the Hallmark Channel on some of their cable, satellite, terrestrial television, or satellite master antenna television systems. Crown Media United States is obligated to pay subscriber acquisition fees if certain subscriber levels are met as defined in certain of these agreements, or in order to obtain carriage of the Hallmark Channel by those distributors.

     Subscriber acquisition fees are amortized over the life of the distribution agreements as a reduction of subscriber fees revenue. If the amortization expense exceeds the revenue recognized on a per distributor basis, the amortization is included as a component of operating expense. Crown Media Holdings assesses the recoverability of these costs periodically and whenever events or changes in distributor relationships occur or other indicators would suggest an impairment.

     Subscriber acquisition fees are comprised of the following:

     As of December 31, 2001, and June 30, 2002, the consolidated balance sheets also reflected subscriber acquisition fees payable of $28.3 million and $13.7 million, respectively. For the three months ended June 30, 2001 and 2002, Crown Media United States made cash payments of $7.2 million and $6.3 million, respectively, reducing subscriber acquisition fees payable. For the six months ended June 30, 2001 and 2002, Crown Media United States made cash payments of $7.2 million and $20.4, respectively. Additionally, $80.1 million of common stock was issued in exchange for distribution rights during 2001 (see Note 7).

Program License Fees

     Program license fees are payable in connection with the acquisition of the rights to air programs acquired from others. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 63, Financial Reporting by Broadcasters, program rights are deferred and then amortized on a straight-line basis over their license periods (the “airing windows”) or anticipated usage, whichever is shorter. At the inception of these contracts and periodically thereafter, Crown Media Holdings evaluates the recoverability of these costs versus the revenues directly associated with the programming and related expenses. Where an evaluation indicates that a programming contract will ultimately result in a loss, additional amortization is provided to currently recognize that loss.

     SFAS No. 63 also requires an entity providing programming to report an asset and liability for the rights licensed under a programming agreement only when the license period begins and when certain other defined requirements are met.

8

Table of Contents

Subtitling and Dubbing

     Subtitling and dubbing costs represent costs incurred to prepare programming for airing in international markets. These costs are capitalized as incurred and are amortized over the shorter of the program’s airing window for programming licensed from unaffiliated third-parties, the program’s estimated life (in the case of programming licensed from Hallmark Entertainment Distribution and the Company’s film assets) or 10 years. Accumulated amortization related to subtitling and dubbing as of December 31, 2001, and June 30, 2002, was $4.9 million and $5.5 million, respectively.

Capitalized Leases

     Noncancellable leases, which meet the criteria of capital leases, are capitalized as assets and amortized over the lease term.

Property and Equipment

     Property and equipment are recorded at cost. Depreciation of property and equipment are provided by the straight-line method over the estimated useful lives of the respective assets, ranging from three to eight years. Leasehold improvements are amortized over the life of the lease. When property is sold or otherwise disposed of, the cost and related accumulated depreciation and amortization are removed from the accounts and any resulting gain or loss is included in income. The costs of normal maintenance and repairs are charged to expense when incurred.

Accounting for Trust Preferred Securities

     Crown Media Holdings formed a special-purpose entity, Crown Media Trust, in December 2001. Crown Media Trust issued units of preferred securities and loaned the proceeds from its sales to Crown Media Holdings. This loan was designed so that interest and principal payments match the dividend and any redemption requirements on the preferred securities issued by Crown Media Trust. Interest received by Crown Media Trust from Crown Media Holdings funds distributions to the investors of the preferred securities.

     Crown Media Holdings owns 100% of the common equity in Crown Media Trust. The preferred securities include terms that allow the holder to earn a return above the stated dividend rate on the securities under certain conditions. Based on fair value calculations using discounted cash flows and Black-Scholes models, a portion of the preferred securities have been allocated and classified in Crown Media Holdings’ balance sheet as guaranteed preferred beneficial interest in Crown Media Trust’s debentures (mezzanine minority interest) and a portion has been classified as convertible debt. Issuance costs related to the guaranteed preferred beneficial interest portion were netted against the guaranteed preferred beneficial interest and accreted as additional minority interest in earnings. Issuance costs related to the convertible debt portion were recorded as a “deferred debt issuance costs” asset and are currently amortized as additional interest expense, using the effective interest method. See Note 6 for additional discussion of the terms and related accounting for the preferred securities and Crown Media Holdings’ related subordinated debentures.

     Crown Media Holdings is aware of recent accounting exposure drafts, which may cause the Company to reclassify its guaranteed preferred beneficial interest in Crown Media Trust’s debentures as convertible debt if these drafts are adopted. Changing the classification of the Company’s preferred securities from guaranteed preferred beneficial interest to convertible debt could significantly impact the presentation of the Company’s financial statements, although the Company does not expect this change to significantly impact its financial position.

Revenue Recognition

     Subscriber fees from pay television distributors are recognized as revenue when an agreement is executed, programming is provided, price is determinable, and collectibility is reasonably assured. Subscriber fees from pay television distributors are recorded net of amortization of subscriber acquisition costs.

     Crown Media Holdings adopted Emerging Issues Task Force (“EITF”) Issue No. 00-25, Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor’s Products (“EITF No. 00-25”) on January 1, 2001, which was codified in EITF Issue No. 01-9 (“EITF No. 01-9”), Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products). EITF No. 01-9 clarifies the income statement classification of costs incurred by a vendor in connection with the reseller’s purchase or promotion of the vendor’s products. Under EITF No. 01-9 certain cooperative advertising and product placement costs previously classified as selling expenses are to be reflected as a reduction of revenues earned from that activity.

     Advertising revenues are recognized as earned in the period in which the advertising commercials or infomercials are telecast. If uncertainty as to the collectibility of this revenue exists, the revenue is recognized on a cash basis. Advertising revenues are recorded net of agency commissions and estimated advertising deficiency reserves.

9

Table of Contents

     Advertising revenue and expenses in barter transactions are recorded at the fair value of the advertising to be provided, which is generally the value in the negotiated barter contract. The fair value is determined based upon Crown Media Holdings’ historical practice of receiving cash for similar advertisements from buyers unrelated to the other party in the current barter transaction. When the barter advertising revenue does not meet the requirements of EITF No. 99-17, Accounting for Advertising Barter Transactions, no revenue is recognized. For the three months ended June 30, 2001 and 2002, revenue from advertising barter transactions equaled the corresponding barter expenses and were $431,000 and $207,000, respectively, and were included as a component of both advertising revenue and marketing expenses in the accompanying consolidated statements of operations. For the six months ended June 30, 2001 and 2002, these amounts were $928,000 and $320,000, respectively.

     Revenue from program licensing agreements is recognized when the film is available for exhibition by the licensee, the license fee is known, collectibility is reasonably assured and the cost of each film is known or reasonably determinable. Payments received from licensees prior to the availability of a film are recorded as deferred revenue.

     Revenues from foreign sources for the three months ended June 30, 2001 and 2002, represented 63% and 53% respectively, of total revenue. Revenues from foreign sources for the six months ended June 30, 2001 and 2002, represented 63% and 49% respectively, of total revenue. Such revenues, generally denominated in United States dollars, were primarily from sales to customers in Argentina, Australia, India, Malaysia, Mexico, Philippines, Poland, Singapore, South Africa, South Korea, Taiwan, and the United Kingdom, during all periods presented.

Cost of Services

     Cost of services includes programming distribution expenses and amortization of program license fees, subtitling and dubbing, and the film assets.

Film Assets

     The Company amortizes its film assets based on recognized revenue in the case of sales to third parties, using projections of sales to third parties for 10 years in determining the amortization amount for any sale to a third party, and based on a 10-year amortization for anticipated internal use of the film assets. The Company’s projections regarding sales to third parties and anticipated internal use are based on the history of each film and similar films, sales and marketing plans, and other factors, all of which require significant judgment by management. The 10-year period used for sales to third parties and internal use commences on the date of acquisition and is the same time period used by an initial, external valuation of the Company’s film assets at the time of acquisition. The film assets are also reviewed by the Company for impairment whenever events or changes in circumstances indicate that the carrying amount of any such asset may not be recoverable. At least annually, the Company is required by its debt covenants to have a valuation expert perform a valuation of the film assets and the film assets as a whole will be written-down to their fair values if necessary.

     Crown Media Holdings adopted Statement of Position 00-2, Accounting by Producers and Distributors of Films (“SOP 00-2”) on September 28, 2001, in conjunction with the purchase of the film assets. SOP 00-2 requires advertising costs for theatrical and television product to be expensed as incurred and all film costs to be classified in the balance sheet as non-current assets.

Goodwill and Other Intangibles

     In July 2001, the FASB issued SFAS No. 141, Business Combinations (“SFAS No. 141”) and No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”), which were adopted by Crown Media Holdings on January 1, 2002. These standards prohibit the prospective use of pooling-of-interests accounting and require companies to cease amortizing goodwill and certain intangible assets with an indefinite useful life created by business combinations accounted for using the purchase method of accounting. Instead, goodwill and intangible assets deemed to have an indefinite useful life are subject to an annual review for impairment. Crown Media Holdings ceased amortizing goodwill, including goodwill included in the carrying value of certain investments accounted for under the equity method of accounting. Additionally, during the first quarter of 2002, an external valuation expert reviewed the carrying value of Crown Media Holdings’ goodwill and certain intangible assets for impairment, finding that an impairment was not necessary. The Company performed an internal review of the carrying value of its goodwill and certain intangible assets for impairment in the second quarter of 2002, also finding that an impairment was not necessary.

     If the Company had not recorded the amortization of its goodwill in prior periods, the results of operations would have changed.

10

Table of Contents

     These changes are reflected in the following table:

Taxes on Income

     Income taxes are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in Crown Media Holdings’ consolidated financial statements or tax returns. In estimating future tax consequences, Crown Media Holdings generally considers all expected future events other than changes in the tax law or rates. Crown Media Holdings records a valuation allowance against future tax benefits if it is determined that the benefit will, more likely than not, be realized in future periods. As of December 31, 2001, and June 30, 2002, the valuation allowance was $16.0 million and $56.8 million, respectively.

Comprehensive Loss

     Crown Media Holdings reports all changes in equity that result from transactions and other economic events other than transactions with owners in their capacity as owners as comprehensive income (loss). No tax benefit has been provided on the foreign currency translation loss or the gain (loss) on the fair value of the derivative components for any period.

Translation of Foreign Currency

     The balance sheets and statements of operations of certain Crown Media Holdings’ foreign subsidiaries are measured using local currency as the functional currency. Revenues, expenses and cash flows of such subsidiaries are translated into United States dollars at the average exchange rates prevailing during the period. Assets and liabilities are translated at the rates of exchange at the balance sheet date. Translation gains and losses are deferred as a component of stockholders’ equity. Aggregate foreign currency transaction gains and losses are included in determining net income.

Net Loss Per Share

     Basic net loss per share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed based on the weighted average number of common shares and potentially dilutive common shares outstanding. The calculation of diluted net loss per share excludes potential common shares if the effect is antidilutive. Potential common shares consist of incremental common shares issuable upon the exercise of stock options. Approximately 5.7 million stock options for the three and six months ended June 30, 2001, and approximately 8.1 million stock options for the three and six months ended June 30, 2002, have been excluded from the calculations on the statements of operations because their effect would have been antidilutive. Additionally, 10.1 million contingent appreciation certificates have also been excluded for the three and six months ended June 30, 2002, as their effect would have been antidilutive. Accordingly, diluted loss per share equals basic loss per share.

11

Table of Contents

Stock-Based Compensation

     SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to account for stock-based compensation plans using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including Financial Accounting Standards Board (“FASB”) Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB No. 25, issued in March 2000. Accordingly, compensation cost for stock options issued to employees is measured as the excess, if any, of the quoted market price of the Company’s stock at the date of the grant over the amount an employee must pay to acquire the stock.

Derivative Financial Instruments

     On January 1, 2001, the Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. The standard requires the recognition of all derivative instruments on the balance sheet as either assets or liabilities measured at fair value. Changes in fair value are recognized immediately in earnings unless the derivatives qualify as hedges of future cash flows. Changes in the fair value of the derivatives components of the private placement transaction are recognized immediately in earnings.

     For derivatives qualifying as hedges of future cash flows, the effective portion of changes in fair value is recorded as a component of other comprehensive income (loss) and recognized in earnings when the hedged transaction is recognized in earnings. Any ineffective portion (representing the extent that the change in fair value of the hedges does not completely offset the change in the anticipated net payments being hedged) is recognized in earnings as it occurs. There was no cumulative effect recognized for adopting this accounting change.

     The Company formally designates and documents each financial instrument as a hedge of a specific underlying exposure as well as the risk management objectives and strategies for entering into the hedge transaction upon inception. The Company also formally assesses upon inception, and quarterly thereafter, whether the financial instruments used in hedging transactions are effective in offsetting changes in the fair value or cash flows of the hedged items.

     The Company uses a derivative financial instrument, primarily a forward foreign exchange contract, to reduce the exposure of adverse effects of fluctuating foreign currency exchange rates. This contract, which has been designated as a cash flow hedge, was entered into primarily to hedge an affiliate payable denominated in a foreign currency, which has a maturity of less than one year. The unrecognized income (loss) on the revaluation of forward currency contracts will be recognized in cost of sales upon expiration of the contract. Throughout 2001 and through June 30, 2002, the Company entered into this contract with a counterparty that is a major financial institution, and accordingly, the Company believes that the risk of counterparty nonperformance is remote. The amount of the ineffectiveness of the derivative, recorded in the consolidated statements of operations for the three and six months ended June 30, 2002, was not significant.

     See Note 6 for a discussion of the derivative liability related to the private placement transaction.

Use of Estimates

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

Concentration of Credit Risk

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

Fair Value

     The carrying amounts of financial instruments, including amounts payable and receivable, are reasonable estimates of their fair values because of their short-term nature. The fair values of the above were estimated using the current rates at which loans would be made to Crown Media Holdings for similar remaining maturities.

12

Table of Contents

Interim Financial Statements

     In the opinion of management, the accompanying balance sheets and related interim statements of operations and cash flows, include all adjustments, consisting only of normal recurring items, as well as the accounting changes to adopt SFAS No. 133, SFAS No. 141, and SFAS No. 142, Goodwill and Other Intangible Assets, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Actual results may differ from these estimates. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis and financial statements and notes thereto included in the Crown Media Holdings, Inc. 2001 Annual Report on Form 10-K.

Recently Issued Accounting Pronouncements

     In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which provides clarifications of certain implementation issues within SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, along with additional guidance on the accounting for the impairment or disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121 and applies to all long-lived assets (including discontinued operations) and consequently amends APB No. 30, Reporting the Effects of Disposal of a Segment of Business. SFAS No. 144 develops one accounting model for long-lived assets that are to be disposed of by sale, as well as addresses the principal implementation issues. SFAS No. 144 requires that entities measure long-lived assets that are to be disposed of by sale at the lower of book value or fair value less cost to sell. That requirement eliminates APB No. 30’s requirement that discontinued operations be measured at net realizable value or that entities include under “discontinued operations” in the financial statements amounts for operating losses that have not yet occurred. Crown Media Holdings adopted SFAS No. 144 on January 1, 2002, and its adoption did not have a significant impact on the Company’s consolidated financial statements.

     In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which is effective for restructurings initiated after December 31, 2002. SFAS No. 146 supercedes EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) and requires companies to record exit costs and employee termination benefits only after such costs have been incurred and their fair values can be measured. To the extent that the Company enters into plans to restructure the business in the future, SFAS No. 146 will have a significant effect on the Company’s consolidated financial statements.

Reclassifications

     Certain reclassifications have been made to conform prior periods’ data to the current presentation. These reclassifications have no effect on reported net loss.

3. Program license fees

     Program license fees are comprised of the following:

13

Table of Contents

     License fees payable are comprised of the following:

4. Property and Equipment

     Property and equipment are comprised of the following:

     Depreciation and amortization expense totaled $2.4 million and $3.6 million, respectively, for the three months ended June 30, 2001 and 2002. Depreciation and amortization expense totaled $6.1 million and $7.0 million, respectively, for the six months ended June 30, 2001 and 2002.

     On April 1, 2002, Crown Media United States entered into a satellite transponder service agreement with SES Americom, Inc. Once the equipment is launched in 2004, Crown Media United States has committed to lease a combined uplink and transponder space segment under this long-term lease agreement. In accordance with SFAS No. 13, Accounting for Leases, the lease will be capitalized upon launch of the satellite, and an estimated $20.0 million asset and corresponding liability will be recorded.

5. Investments in and Advances to Unconsolidated Entities

Investment in H&H Programming — Asia

     Each of Crown Media International and The Jim Henson Company held a 50% interest in H&H Programming — Asia through March 15, 2001. Crown Media Holdings’ investment in H&H Programming — Asia was reflected in the consolidated financial statements using the equity method of accounting until March 15, 2001, the date of the acquisition of the remaining 50% interest (see Note 1), at which time it became a consolidated subsidiary. Crown Media Holdings’ equity in the net loss of H&H Programming — Asia was $655,000 for the two and one half months ended March 15, 2001.

     Crown Media Holdings’ investment in H&H Programming — Asia, through the date of the acquisition, exceeded the underlying equity in the net assets of H&H Programming — Asia as of the date of the investment. The goodwill and other intangibles were amortized over 10 years through December 31, 2001.

     For the two and one half months ended March 15, 2001, Crown Media International made contributions of $707,000 to H&H Programming — Asia, which were recorded net of cash acquired from the acquisition of the remaining 50% interest in H&H Programming — Asia.

Investment in Crown Media United States

     Crown Media Holdings’ investment in Crown Media United States, through the date of the reorganization (see Note 1), exceeded the underlying equity in the net assets of Crown Media United States as of the date of the investment. This goodwill was amortized over 20 years through December 31, 2001.

     On March 15, 2001, Crown Media Holdings acquired the remaining 22.5% common interests in Crown Media United States and 50% interest in H&H Programming — Asia for $85.8 million (see Note 1).

14

Table of Contents

6. Credit Facility and Private Placement

Credit Facility

     In connection with the completion of the purchase of the film assets, Crown Media Holdings entered into a credit agreement with a syndicate of banks, led by JP Morgan Chase Bank, under which the banks have extended to Crown Media Holdings, as amended in December 2001, a five-year $320.0 million secured credit facility. On the accompanying consolidated balance sheet at December 31, 2001, outstanding amounts of $111.9 million were included as a current liability (including interest of approximately $936,000), because this amount was required to be paid on January 7, 2002, from the proceeds of the issuance of the preferred securities, and $151.4 million was included as a long-term liability. At June 30, 2002, an outstanding amount of $243.5 million was included as a long-term liability as the entire balance is due in 2006. This loan is guaranteed by Crown Media Holdings’ subsidiaries and is secured by all tangible and intangible property of Crown Media Holdings and its subsidiaries. A portion of the borrowings under the credit facility were used to pay $120.0 million of debt assumed as part of the consideration for acquiring the Crown Media Library and to repay $84.2 million outstanding under a $150.0 million line of credit provided by HC Crown. At June 30, 2002, the balance available to Crown Media Holdings for general working capital purposes under the credit facility is $76.5 million. JP Morgan Chase Bank and J.P. Morgan Partners (BHCA) L.P., a significant stockholder of Crown Media Holdings, are both affiliates of J.P. Morgan Chase & Co.

     The bank credit facility encompasses a term loan of $100.0 million and a revolving line of credit of $220.0 million, up to $20.0 million of which can be letters of credit issued at the request of Crown Media Holdings. Each loan (which includes the term loans and any revolving credit loans) bears interest at a Eurodollar rate or an alternate base rate as Crown Media Holdings may request in accordance with the credit agreement. The Eurodollar rate is based on the London interbank market for Eurodollars, and remains in effect for the time period of the loan ranging from one, two, three, six or twelve months. The alternate rate is based upon the prime rate of JP Morgan Chase Bank, a certificate of deposit rate or the Federal Funds effective rate, which is adjusted whenever the rate changes. Crown Media Holdings is required to pay a commitment fee of 0.5% per annum of the committed, but not outstanding, amounts under the revolving credit facility, payable in quarterly installments. The credit facility contains a number of affirmative and negative covenants. In addition, the aggregate principal amount of all outstanding revolving credit loans and term loans as well as letters of credit available under the credit facility must not exceed the amount of the Library Credit then in effect. The Library Credit is defined as 50% of the most recent valuation of the Crown Media Library, which is required to be delivered after the end of each quarter. This valuation of the Crown Media Library is based upon the net present value of future cash flows expected to be generated by sales of film licenses. Currently, the library credit is in excess of the maximum amount of the credit facility.

     Since the inception of the credit facility, Crown Media Holdings has elected the monthly Eurodollar rate. Amounts under the revolver had accrued interest at rates from 5.0% to 5.59% and amounts under the term loan had accrued interest at rates from 5.11% to 5.59% for 2001. Amounts under the revolver have accrued interest at rates from 4.73% to 5.14% and amounts under the term loan have accrued interest at rates from 4.84% to 5.11% for the six months ended June 30, 2002. Interest expense on borrowing from the credit facility for the three and six months ended June 30, 2002, was $2.8 million and $5.1 million, respectively. At December 31, 2001, and June 30, 2002, accrued interest of $936,000 and $625,000, respectively, was reflected in the current portion of the JP Morgan Chase credit facility and accrued interest on the accompanying consolidated balance sheet.

     Future contractual maturities of principal are as follows:

Private Placement

     On December 17, 2001, Crown Media Holdings completed a $265.0 million private placement to a group of institutional investors. Under the terms of the private placement, Crown Media Holdings issued units to the investors, each unit consisted of one preferred security of Crown Media Trust, and one contingent appreciation certificate, issued by Crown Media Holdings.

15

Table of Contents

     The additional financing allowed Crown Media Holdings to reduce the amount outstanding under its JP Morgan Chase bank credit facility by $111.6 million. The $111.6 million was placed into an escrow account until it was paid on January 7, 2002. Additionally, the Company used a portion of the proceeds of the private placement to repay $70.6 million under lines of credit provided by HC Crown and $69.4 million of amounts payable to Hallmark Entertainment Distribution pursuant to certain program license agreements held by subsidiaries of Crown Media Holdings.

     Each preferred security has a stated liquidation amount of $1,000, and each contingent appreciation certificate entitles the holder to receive cash, or at the holder’s option, purchase approximately 38.3 shares of the Company’s Class A common stock at a price of $13.07 per share, subject to adjustment. Crown Media Trust issued the preferred securities to Crown Media Holdings in exchange for 6.75% Subordinated Debentures from Crown Media Holdings due 2007. Crown Media Holdings pays interest on the debentures at the same rate and at the same time as Crown Media Trust is required to make distributions on the preferred securities. Crown Media Holdings has guaranteed, on a subordinated basis, Crown Media Trust’s obligations under the preferred securities.

     Distributions on the preferred securities are cumulative, payable quarterly in arrears, and accumulate from the date of issuance at the annual rate of 6.75% of the $1,000 liquidation amount. In the event of a liquidation, the holders of the preferred securities are entitled to receive, together with any prior distributions, an amount equal to their initial investment of $1,000 plus any accumulated and unpaid distributions.

     The contingent appreciation certificates issued by Crown Media Holdings will expire on March 15, 2008. On or after the occurrence of certain defined purchase or liquidation events, the holders will be entitled, at their option, (i) to a cash payment for a minimum return amount on the original cost of the unit, or (ii) to purchase approximately 38.3 shares of Class A common stock per unit at a price initially equal to $13.07, subject to adjustment, calculated on the date Crown Media Trust redeems or purchases the preferred securities. The minimum return amount means the amount, when added to the liquidation amount and all cash distributions on the preferred securities, which yields an internal rate of return of 14.0% to 18.0%, depending on the date of redemption or purchase. The maximum return amount means the amount, when added to the liquidation amount and all cash distribution on the preferred securities, which yields an internal rate of return of 25%. The contingent appreciation certificates, if fully exercised for stock, would represent approximately 10.1 million shares of the Company’s Class A common stock.

     On or after December 15, 2003, Crown Media Holdings will have the right to redeem any and all of the outstanding debentures at a redemption price equal to 100% of the aggregate principal amount of the debentures, together with any accrued and unpaid interest thereon. Currently, the Company expects to redeem the debentures on December 15, 2004, and is accreting its convertible debt and guaranteed preferred beneficial interest to the amount expected to be paid, either in cash or common stock, in satisfaction of the minimum return, at an internal rate of return of 14%, assuming a redemption date of December 15, 2004. In the event of a change of control, the Company must either exercise its right to redeem all or offer to purchase any and all of the outstanding debentures at a price equal to 110% of the aggregate principal amount of the debentures, together with any accrued and unpaid interest thereon.

     The financing was recorded at $265.0 million and required the allocation of fair value to the various components based on the terms of the private placement agreement. Crown Media Holdings calculated the guaranteed preferred beneficial interest portion of the preferred securities using an internal rate of return analysis (cumulative present value of expected future cash flows) on the preferred securities. The carrying value of the guaranteed preferred beneficial interest as determined on December 17, 2001, was $197.7 million, on December 31, 2001, was $199.0 million, and on June 30, 2002, was $208.9 million, net of offering costs.

     Crown Media Holdings calculated the initial value of the contingent appreciation certificate portion of the preferred securities by using Black-Scholes models and by using a combination of put and call options that would provide the same future payout as the convertible debt portion. The resulting value of the contingent appreciation certificates, net of embedded derivatives, was $43.5 million on December 17, 2001, $43.7 million as of December 31, 2001, and $45.5 million as of June 30, 2002, which has been classified as convertible debt on the accompanying consolidated balance sheets. The transaction also resulted in a net derivative liability on December 17, 2001, of $12.1 million, on December 31, 2001, of $12.5 million, and on June 30, 2002, of $7.1 million.

     The following table summarizes the transaction at the transaction date, as of December 31, 2001, and as of June 30, 2002. The summary also reflects the allocation of transaction costs between the various components of the financing.

16

Table of Contents