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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

(Mark One)

For the quarterly period ended June 30, 2003

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 225,
Greenwood Village, Colorado 80111
(Address of Principal Executive Offices and Zip Code)

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

6430 S. Fiddlers Green Circle,
Suite 500,
Greenwood Village, Colorado 80111

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [X] No [ ]

As of August 6, 2003, the number of shares of Class A Common Stock, $.01 par value outstanding was 73,794,606, and the number of shares of Class B Common Stock, $.01 par value, outstanding was 30,670,422.

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     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 “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 “Crown Media Holdings,” “we,” “us” and “our” refer to Crown Media Holdings, and, unless the context requires otherwise, subsidiaries of Crown Media Holdings that operate our businesses, 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”) . 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.

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.

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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.

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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.

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CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Three and Six Months Ended June 30, 2002 and 2003

1. Business and Organization

Organization

     Crown Media Holdings, Inc. (“Crown Media Holdings” or the “Company”), which was incorporated in the state of Delaware in December 1999, through its subsidiaries, owns and operates pay television channels dedicated to high quality, entertainment programming for adults and families in the United States and in various countries throughout the world. The international operations of the Hallmark Channel are operated by Crown Media International LLC (“Crown Media International”) and, in the United Kingdom, by Crown Entertainment Limited (“Crown Entertainment”). Crown Media International commenced its operations outside the United States in 1995. Domestically, the Hallmark Channel is operated and distributed by Crown Media United States LLC (“Crown Media United States”). Crown Media International acquired an interest in Crown Media United States in 1998 and as a result of several transactions Crown Media Holdings owned 100% of the common interests of Crown Media United States by March 2001. Significant investors in Crown Media Holdings include: Hallmark Entertainment Investments Co. (“Hallmark Entertainment Investments”); Hallmark Entertainment Holdings, Inc., a subsidiary of Hallmark Cards, Incorporated (“Hallmark Cards”); Liberty Media Corporation (“Liberty Media”) and J.P. Morgan Partners (BHCA), LP (“J.P. Morgan”), each through their investments in Hallmark Entertainment Investments; VISN Management Corporation, a for-profit subsidiary of the National Interfaith Cable Coalition; and Hughes Electronics Corporation.

Liquidity

     In connection with the Company’s growth strategy, the Company expects to continue making investments in programming and distribution during the remainder of 2003. Programming expenditures for the remainder of 2003 are expected to be in the range of $40.0 million to $50.0 million, and cash payments for subscriber acquisition fees for the remainder of 2003 are expected to be $25.0 million to $35.0 million. Through June 30, 2003 the Company has expended $42.6 million for programming and $24.2 million for subscriber acquisition fees. If necessary, the Company believes it has discretion to reduce some of this anticipated spending. The Company’s principal uses of funds during the remainder of 2003 are expected to be the payment of operating expenses, payments for licensing of programming from third parties and subscriber acquisition fees, and interest payments under its bank credit facility.

     On August 5, 2003, Crown Media Holdings repurchased all of the preferred securities of Crown Media Trust and related contingent appreciation certificates issued by the Company. The securities were repurchased for approximately $329.1 million, including approximately $2.4 million of cash distributions on the preferred securities through August 5, 2003. Funds for this repurchase were obtained from the proceeds of a $400.0 million 10.25% senior unsecured discount note issued to HC Crown Corp., a subsidiary of Hallmark Cards. After the payment of certain expenses for the issuance including a fee of $3.0 million to HC Crown, the Company used the balance of the proceeds of the note, approximately $67.4 million, to pay principal, interest, and prepayment penalties on its bank revolving credit loans. The Company will avoid approximately $72.0 million in cash interest payments over the next 4 years due to this repurchase and refinancing.

     Through June 30, 2003, Crown Media Holdings had borrowed $75.0 million under the line of credit with HC Crown, which is the full amount available under that line of credit, to pay scheduled subscriber acquisition fee payments, marketing costs and programming fees accrued at the end of the previous year and to support the cash needs of its current operations. Because of the pay down on the bank credit facility on August 5, 2003, the Company has available funds under the bank credit facility of approximately $67.3 million. Prior to the paydown, the Company had borrowed the full amount available under the bank credit facility of $320.0 million. The Company’s principal sources of funds are currently cash inflows from operations, cash on hand, periodic cash inflows expected under the tax sharing agreement with Hallmark Cards and amounts available for borrowing under its bank credit facility. In addition, as of August 5, 2003, $32.0 million had been received under the tax sharing agreement and the Company expects that the remaining payments under the tax sharing agreement in 2003 will be approximately $15.0 million. The Company also believes that since the tax sharing agreement is with the Company’s largest shareholder, there is a potential that future tax sharing payments could become available to the Company at an earlier date.

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     The Company projects that advertising revenue and licensing fees will increase in 2003, and that certain operating expenses will continue to decrease as a result of the reorganization begun in the fourth quarter of 2002. Considering these projected revenues and reduced expenditures, the Company believes that cash flow from its operations, cash on hand, remaining availability under its credit facility and payments anticipated under the tax sharing agreement will be sufficient to meet its liquidity needs through at least June 2004. However, any decline in the popularity of the Hallmark Channel, any significant future modifications to the Company’s distribution agreements, an economic decline in the advertising market, an unexpected increase in competition or other adverse operating conditions will impact the Company’s ability to achieve its projected operating results. If the projected operating results are not achieved, the Company may need to obtain additional funding. In any event, in order to provide more liquidity, Crown Media Holdings may consider pursuing alternatives to raise additional cash, which could include the issuance of additional equity or debt securities. There can be no assurance, however, that additional funding will be available, if at all, on terms acceptable to the Company. Any new debt financing would require the agreement of existing lenders, including HC Crown.

2.     Summary of Significant Accounting Policies

Principles of Consolidation

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

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 fair 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. Under certain of these agreements, Crown Media United States is obligated to pay subscriber acquisition fees if defined subscriber levels are met, 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 excess amortization is included as a component of cost of services. Crown Media Holdings assesses the recoverability of these costs periodically and whenever events or changes in distributor relationships occur or other indicators would suggest impairment.

     Subscriber acquisition fees are comprised of the following:

     As of December 31, 2002 and June 30, 2003, the consolidated balance sheets also reflected subscriber acquisition fees payable of $48.6 million and $25.5 million, respectively. For the three months ended June 30, 2002 and 2003, Crown Media United States made cash payments of $6.3 million and $12.8 million, respectively, reducing subscriber acquisition fees payable. For the six months ended June 30, 2002 and 2003, Crown Media United States made cash payments of $20.4 million and $24.2 million, respectively, reducing subscriber acquisition fees payable.

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     On November 7, 2002, the Company entered into an amendment of a distribution agreement with a large distributor in the United States. The amendment extended the distribution agreement for two years to December 31, 2007, and provided for the payment of a substantial cash amount in settlement of the “most favored nation” clauses in regard to the terms of an agreement with DirecTV in 2001 and for additional full-time subscribers to the Hallmark Channel. The Company paid a portion of the amount upon execution and will make monthly cash payments through December 2003 for the balance. The Company may also be required to pay substantial marketing support payments, if subscribers exceed the final commitment number, through December 31, 2004. In addition, if the distributor achieves the final commitment level of subscribers, subscriber fees will not apply to subscribers above a specified number. The amendment also contains a “most favored nation” provision relating to other distribution agreements.

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 generally deferred and then amortized on a straight-line basis over their license periods (the “airing windows”) or anticipated usage. At the inception of these contracts and periodically thereafter, Crown Media Holdings evaluates the recoverability of these costs compared to the estimated future 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.

Subtitling and Dubbing

     Subtitling and dubbing 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 or the program’s estimated life (in the case of programming licensed from Hallmark Entertainment Distribution and the Company’s film assets). Beginning in 2003, subtitling and dubbing costs related to programming licensed from Hallmark Entertainment Distribution are being amortized over a maximum period of 3 years. Amortization expense for subtitling and dubbing costs was $1.3 million and $1.2 million for the three months ended June 30, 2002 and 2003, respectively. Amortization expense for subtitling and dubbing costs was $2.4 million and $2.3 million for the six months ended June 30, 2002 and 2003, 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 is provided using 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 preferred securities in Crown Media Trust’s name to investors in a private placement and loaned the proceeds to Crown Media Holdings. This loan was designed so that interest and principal payments matched 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 funded distributions to the holders of the preferred securities.

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     Crown Media Holdings owned 100% of the common equity in Crown Media Trust. The preferred securities included terms that allowed 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 proceeds from the preferred securities was allocated and classified in Crown Media Holdings’ balance sheet as guaranteed preferred beneficial interest in Crown Media Trust’s debentures and a portion was 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 expense in earnings. Issuance costs related to the convertible debt portion were recorded as a deferred debt issuance costs asset and were amortized as additional interest expense, using the effective interest method. See Note 6, Credit Facility and Private Placement, for additional discussion of the terms for the preferred securities and Crown Media Holdings’ related subordinated debentures and see Note 9, Subsequent Events, for information on the August 5, 2003, repurchase of all of the preferred securities by Crown Media Holdings.

Revenue Recognition

     Subscriber fees from pay television distributors are recognized as revenue when an agreement is executed, programming is provided, the price is determinable, and collectibility is reasonably assured. Subscriber fees from pay television distributors are recorded net of amortization of subscriber acquisition costs in accordance with Emerging Issues Task Force (“EITF”) No. 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products). Subscriber acquisition fee expense is recorded to the extent that the amortization of subscriber acquisition costs exceed the related revenue earned from the pay television distributor.

     Certain revenue from pay television distributors and film license agreements is recognized in accordance with EITF No. 00-21, Revenue Arrangements with Multiple Deliverables. Under EITF No. 00-21, revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: the delivered item has value to the customer on a standalone basis; there is objective and reliable evidence of the fair value of the undelivered item; and delivery or performance of the undelivered item is considered probable and substantially in the control of the vendor.

     Advertising revenues are recognized as earned in the period in which the advertising is 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.

     Advertising revenue and expenses in barter transactions are recorded at the fair value of the advertising to be provided. The fair value is determined based upon amounts paid in cash for similar advertisements from buyers unrelated to the other party in the 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, 2002, revenue from advertising barter transactions of $207,000 and the corresponding barter expenses were included in marketing expenses in the accompanying consolidated statements of operations. No barter revenue or related expenses were recorded for the three months ended June 30, 2003. For the six months ended June 30, 2002 and 2003, revenue from advertising barter transactions of $320,000 and $94,000, respectively, and the corresponding barter expenses were included in marketing expenses in the accompanying consolidated statements of operations.

     Revenue from film asset licensing agreements is recognized when an agreement is executed, the film is available for exhibition by the licensee, the license fee is fixed or reasonably determinable, 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, 2002 and 2003, represented 53% and 47% respectively, of total revenue. Revenues from foreign sources for the six months ended June 30, 2002 and 2003, represented 49% and 46% respectively, of total revenue. Such revenues, generally denominated in United States dollars, were primarily from sales to customers in Australia, Malaysia, Mexico, Norway, Poland, Singapore, South Africa, South Korea, Spain, Sweden, Taiwan, and the United Kingdom, during all periods presented.

     The Company is in discussions with a primary pay television distributor in Spain who has attempted to terminate an existing distribution agreement with the Hallmark Channel. The outcome can not be predicted.

Cost of Services

     Cost of services includes signal distribution expenses, depreciation of the Network Operations Center and amortization of the capital lease for uplink and transponder space, amortization of program license fees, subtitling and dubbing amortization and costs, subscriber acquisition amortization and costs, and amortization of film assets.

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Film Assets

     The Company amortizes its film assets using the individual-film-forecast-computation method over a maximum period of 10 years, which amortizes such assets in the same ratio that current period actual revenue bears to estimated unrecognized ultimate revenues as of the beginning of the current fiscal year for sales to third parties and internal usage. 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 in the initial, external valuation of the Company’s film assets at the time of acquisition. The Company also reviews the film assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. If the carrying value of the individual film assets exceeds the fair value, the film assets are written-down to their fair values. At least annually, the Company is required by the covenants in its credit facility to have a outside valuation expert perform a valuation of the film assets. These valuations supported the Company’s determination that the estimated fair value of the film assets as of December 31, 2002, exceeded the carrying value. Amortization expense for the film library was $5.5 million and $6.8 million for the three months ended June 30, 2002 and 2003, respectively. Amortization expense for the film library was $12.7 million and $13.6 million for the six months ended June 30, 2002 and 2003, respectively.

Goodwill

     In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards 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 required companies to cease amortizing goodwill and certain intangible assets with indefinite useful lives acquired or created through business combinations accounted for using the purchase method of accounting. Instead, goodwill and intangible assets deemed to have indefinite useful lives are subject to an annual review for impairment. Crown Media Holdings ceased amortizing goodwill effective January 1, 2002. Valuation experts evaluated the carrying value of the Company’s goodwill for impairment upon implementation of SFAS No. 142 and at November 30, 2002, which the Company has selected as its annual goodwill impairment review date. These evaluations support the Company’s determination that the estimated fair value of goodwill currently is not less than its carrying value.

Taxes on Income

     Income taxes are accounted for using an asset and liability method that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and net operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to be applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company reduces deferred tax assets by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized.

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 accumulated other comprehensive income. Foreign currency transaction gains and losses are included in determining net loss for the period.

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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 and restricted stock units. Approximately 1.7 million stock options for the three and six months ended June 30, 2003, approximately 8.1 million stock options for the three and six months ended June 30, 2002, and approximately 2.1 million restricted stock units for the three and six months ended June 30, 2003, have been excluded from the calculations of earnings per share because their effect would have been antidilutive. Additionally, 10.1 million contingent appreciation certificates issued in conjunction with the private placement have also been excluded from the calculations of earnings per share for the three and six months ended June 30, 2002 and 2003, as their effect would have been antidilutive.

Stock-Based Compensation, Employee Incentives and Retention

     The Company accounts for its stock-based employee compensation plan using the intrinsic value method under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. 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. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of SFAS No. 123. SFAS No. 148 requires certain additional disclosures related to stock-based compensation plans. 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’s Board of Directors approved in April 2003 actions to provide additional incentives to and encourage retention of its employees. Crown Media Holdings’ then outstanding stock options held by employees had exercise prices significantly above the current market value of its Class A common stock. The Company made an exchange offer in May 2003 to senior management and vice presidents, totaling approximately 55 persons, to exchange their options for restricted stock units (“RSUs”). The exchange ratio was one RSU for every 2.5 options for shares of the Company’s Class A common stock. Each RSU, upon vesting, represents the right to receive one share of Class A common stock or the value of the share in cash at the time of vesting. The Company’s Board may determine at its discretion whether the payment is made in common stock or cash. The RSUs vest annually over three years. In the exchange offer, a total of 5,126,732 options were exchanged for 2,050,693 RSUs in May 2003. As a result of the exchange offer, Crown Media Holdings is recording non-cash compensation expense based on the fair value of its common stock on the date of grant of the RSUs over the vesting period of the RSUs. As of June 30, 2003, the Company had recorded $317,288 of compensation expense. Options for 279,254 shares of common stock that were not exchanged are subject to variable plan accounting in which compensation is remeasured at each reporting date until the options are exercised, expire unexercised or are forfeited. No compensation expense was recorded related to the unexchanged options for the three and six months ended June 30, 2003, as the price of the Company’s Class A common stock on June 30, 2003, was less than the strike price of the underlying unexchanged options. It is currently believed that the Board of Directors will elect to settle the RSU awards in common stock. If the Board of Directors ultimately decides to settle the RSU awards in cash, variable plan accounting will be required.

     In addition, Crown Media Holdings’ Board of Directors vested the stock options of all employees below the vice-president level who held options at the end of May 2003 and granted them a right to receive a future cash payment of $1.00 for each outstanding option held by the employee. The immediate vesting of the employees’ stock options created a new measurement date which requires the Company record stock compensation expense, if any, for the excess of the Company’s stock price on the measurement date over the underlying stock options’ strike price. Since the price of the Company’s Class A common stock on the measurement date was less than the strike price of all of the stock options owned by the employees, no compensation expense was recorded. The June 2004 cash payment is contingent upon employment through that period and is based upon options for a total of 344,386 shares of our Class A common stock. As a result, we are recording related compensation expense from June 2003 through May 2004 as compensation is earned. As of June 30, 2003, we had recorded $29,000 of compensation expense related to this grant.

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     Had compensation costs for these plans been determined consistent with SFAS 123, Crown Media Holdings’ net loss and loss per share would have been increased to the following pro forma amounts for the three and six months ended June 30, 2002 and 2003:

Pro Forma Effects
(In thousands, except per share amounts)

     For purposes of this pro forma presentation, the fair value of each option grant was estimated at the date of grant using a Black-Scholes model with the following weighted-average assumptions for grants during the three and six months ended June 30, 2002. No options were granted during the three and six months ended June 30, 2003.

Derivative Financial Instruments

     The Company has adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”), 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. The Company discontinues hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting the cash flows of the hedged item, the derivative expires or is sold, terminated or exercised, or the derivative is no longer designated as a hedging instrument. Changes in the fair value of the contingent appreciation certificates in the private placement transaction are recognized immediately in earnings. See Note 6 for a discussion of the derivative liability related to the private placement transaction.

     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.

     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 was a party to a forward foreign exchange contract in 2002, which was entered into to reduce the exposure to the adverse effects of fluctuating foreign currency exchange rates. This contract, which was designated as a cash flow hedge, was entered into to hedge a payable denominated in a foreign currency, which had a maturity of less than one year. The foreign exchange contract was settled at maturity and the net loss was reclassified to earnings during 2002.

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.

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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.

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, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States. Interim results are not necessarily indicative of results for a full year. 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. 2002 Annual Report on Form 10-K.

Reclassifications

     Certain reclassifications have been made to conform prior periods’ data to the current presentation.

Recently Issued Accounting Pronouncements

     In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and is effective at the beginning of the first interim period beginning after June 15, 2003. For financial instruments created before the issuance date, transition shall be achieved by reporting the cumulative effect of a change in an accounting principle by initially measuring the financial instruments at fair value. For mandatorily redeemable financial instruments, “dividends” and other amounts paid or accrued prior to reclassification of the instrument as a liability shall not be reclassified as interest cost upon transition. Restatement of financial statements for earlier years presented is not permitted.

     In accordance with SFAS No. 150, Crown Media Holdings, Inc. reclassified its guaranteed preferred interest in Crown Media Trust’s debentures and its preferred minority interest as liabilities as of July 1, 2003. On August 5, 2003, Crown Media Holdings repurchased all of the preferred securities of Crown Media Trust and related contingent appreciation certificates issued by the Company for approximately $329.1 million, including approximately $2.4 million of cash distributions on the preferred securities through August 5, 2003. As of June 30, 2003, the balances of the private placement components were $236.2 million of guaranteed preferred beneficial interests, $50.8 million of convertible debt, $2.0 million of net derivative liability and $1.8 million of debt issuance costs asset, respectively.

3.     Reorganization

     On October 7, 2002, the Company announced its intention to reorganize its operations in order to concentrate its efforts on the Hallmark Channel in the U.S. and in its more successful international markets. The Company completed decentralizing many oversight and non-technical support functions formerly located in the Company’s U.S. based offices and has transferred those responsibilities to regional staff. In Latin America the Company entered into an agreement with a local distribution partner, Pramer S.C.A., who is now responsible for the day-to-day operations of the Hallmark Channel in this region. By April 2003, the Company’s workforce was reduced by approximately 30% or 130 positions.

     The Company recorded a reorganization charge of $28.8 million during the fourth quarter of 2002. This charge was comprised of a charge of $5.5 million for severance costs and charges of $23.3 million related to exit costs for satellite, transponder and facility leases.

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     The following table displays the activity and balances of the reorganization accrual account from October 7, 2002, to June 30, 2003, which has been included in accounts payable and accrued liabilities in the accompanying consolidated balance sheets.

     Deductions reflect total cash payments of $8.5 million through June 30, 2003, representing termination benefits and satellite and transponder contractual obligations. Additions reflect accretion through June 30, 2003, of $420,000 representing accretion on our satellite, transponder and facility lease obligations.

4.     Program license fees

     Program license fees are comprised of the following:

     Programming costs for the three months ended June 30, 2002 and 2003, were $22.2 million and $24.1 million, respectively. Programming costs for the six months ended June 30, 2002 and 2003, were $46.0 million and $47.5 million, respectively. Amortization of program license fees, included as a component of programming cost, was $22.0 million and $22.5 million for the three months ended June 30, 2002 and 2003. Amortization of program license fees, included as a component of programming cost, was $45.3 million and $46.3 million for the six months ended June 30, 2002 and 2003.

     License fees payable are comprised of the following:

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5.     Property and Equipment

     Property and equipment are comprised of the following:

     Depreciation and amortization expense related to property and equipment totaled $3.0 million and $2.9 million for the three months ended June 30, 2002 and 2003, respectively. Depreciation and amortization expense related to property and equipment totaled $5.2 million and $5.7 million for the six months ended June 30, 2002 and 2003, respectively. Software and other intangible assets have been included in prepaids and other in the accompanying consolidated balance sheets. Amortization expense related to software and other intangibles was $200,000 and $600,000, respectively, for the three months ended June 30, 2002 and 2003. Amortization expense related to software and other intangibles was $600,000 and $1.4 million, respectively, for the six months ended June 30, 2002 and 2003.

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, a five-year $320.0 million secured credit facility. At June 30, 2003, Crown Media Holdings had borrowed all funds available under the credit facility. The entire balance is due in 2006 and, therefore, is classified as a long-term liability in the accompanying consolidated balance sheets. 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.

     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.

     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 for the three and six months ended June 30, 2002, was $2.8 million and $5.1 million, respectively. Amounts under the revolver have accrued interest at rates from 4.06% to 4.44% and amounts under the term loan have accrued interest at rates from 4.06% to 4.42% for the six months ended June 30, 2003. Interest expense for the three and six months ended June 30, 2003, was $3.5 million and $7.0 million, respectively. At December 31, 2002, and June 30, 2003, accrued interest of $596,000 and $308,000, respectively, was reflected in the current portion of the credit facility in the accompanying consolidated balance sheets.

     See Note 9, Subsequent Events, below for information on the August 5, 2003, repayment of approximately $67.4 million of bank revolving credit loans, interest and prepayment penalties.

Private Placement