UNITED STATES SECURITIES AND
EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)

x                           ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

or

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

For the transition period from               to              .

Commission File Number: 000-30700

Crown Media Holdings, Inc.

(Exact Name of Registrant as Specified in Its Charter)

12700 Ventura Boulevard,
Suite 200,
Studio City, California  91604

(Address of Principal Executive Offices and Zip Code)

(818) 755-2400

(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:  Class A Common Stock, $0.01 par value

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 for 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 o  No x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of June 30, 2004, the last business day of the registrant’s most recently completed second fiscal quarter, was $79,368,767.

As of May 1, 2005, the number of shares of Class A Common Stock, $.01 par value outstanding was 73,863,037, and the number of shares of Class B Common Stock, $.01 par value, outstanding was 30,670,422.

DOCUMENTS INCORPORATED BY REFERENCE

NONE.

TABLE OF CONTENTS

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In this Annual Report on Form 10-K the terms “Crown Media Holdings” or the “Company,” refer to Crown Media Holdings, Inc. and, unless the context requires otherwise, subsidiaries of Crown Media Holdings that operate or have operated our businesses, Crown Media United States, LLC (“Crown Media United States”), Crown Media Distribution, LLC (“Crown Media Distribution”), Crown Media Trust (“Crown Media Trust”) and, until completion of the sale of our international business in April, 2005. Crown Media International, LLC (“Crown Media International”) and Crown Entertainment Limited (“Crown Entertainment”). 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

ITEM 1.                Description of Business

Company Overview

We own and operate pay television channels, known as the Hallmark Channel, dedicated to high-quality, entertainment programming for adults and families.

On February 23, 2005, we announced entering into a definitive agreement for the sale of our international business including the outstanding capital stock of Crown Media International and Crown Entertainment Ltd., the sale of certain international rights in our library of film assets and the broadcast facility in Denver, Colorado, and we closed this transaction on April 26, 2005. Please see “Overview—Sale of International Business” in Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operation. Following the sale of the Company’s international business, the principal executive office of the Company is now located in Studio City, California.

As a network, we offer compelling stories, masterfully written, directed and produced with talented actors. We believe that with the programming we own (the “Crown Media Library,” the “Library” or the “film assets”), together with the programming we license from Hallmark Entertainment Distribution and third parties, we have established the Hallmark Channel internationally and in the United States as destinations for viewers seeking high-quality, entertainment for adults and families, and as attractive outlets for advertisers seeking to target these viewers. We have distribution agreements with leading pay television distributors in each of our markets. The following table shows for our Channels: our programming sources, selected pay television distributors and the total number of our subscribers as of December 31, 2004.

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As of February 28, 2005, our total number of subscribers had increased to approximately 127.9 million of which 67.8 million are subscribers to our domestic channel and 60.1 million are subscribers to our international channel. At April 30, 2005, our total subscribers to the Hallmark Channel in the United States were 67.9 million. We view a “subscriber” as a household that receives, on a full or part-time basis, the Hallmark Channel on a program tier of a distributor. We determine our domestic subscribers from subscriber numbers reported by Nielsen Media Research. Our number of subscribers outside the United States are based on monthly reports received from cable, satellite and other distributors around the world which are licensed to distribute the Hallmark Channel. To our knowledge, the distributors of our Channel outside the United States use the same definition for subscribers. Subscribers include both viewers who pay a monthly fee for the tier programming and so-called “promotional” subscribers who are given free access to the tier by the distributor for a limited time with the hope that they will eventually choose to subscribe and pay for the tier. For a more detailed description of our Channels, see “—Channels—The Hallmark Channel—United States” and “—Channels—The Hallmark Channel—International.”

Programming acquired from third parties has been an important part of our Channels as we continually develop and refine our programming strategy. Our domestic and international Channels have also benefited from the volume and availability of programming in our Film Library. Our Channels further have enjoyed the benefits of long-term program agreements with Hallmark Entertainment Distribution, which generally provide access to the Hallmark Entertainment Distribution library titles and to new production and first-run presentations controlled by Hallmark Entertainment Distribution. Our Film Library and the programming that we have access to through our program license agreements with Hallmark Entertainment Distribution consist of some of the most highly rated made-for-television movies, based on A.C. Nielson ratings. These programs have also won numerous Emmy Awards, Golden Globe Awards and Peabody Awards.

We have distribution agreements with pay television distributors in each of our markets. We currently distribute our domestic Channel through approximately 4,800 cable systems and communities and satellite providers. By the end of 2004, we had agreements with Adelphia, Cablevision, Charter, Comcast, Cox, DirecTV, EchoStar, Insight, the National Cable Television Cooperative and Time Warner for the distribution of our Channel in the United States. The preceding providers account for more than 88% of all pay cable and television subscribers in the United States as of December 31, 2004. Internationally, these included British Sky Broadcasting (“BSkyB”), Canal Digital, Home Entertainment, Measat, Multichoice, PCTV and Sky Italy. BSkyB accounted for 13% of our consolidated revenue and 33% of our international revenue for the year ended December 31, 2004. No individual pay television distributor or advertiser accounted for 10% of our domestic revenue and 15% of our consolidated subscribers for the year ended December 31, 2004.

Through Crown Media Distribution, we exploit the Film Library to the extent not used by our Channel. We license the use of Library films and programming to third parties in the United States including terrestrial broadcasters in return for license fees and, prior to the International Sale, we licensed films and programs around the world.

We license the trademark “Hallmark” for use on our Channels pursuant to certain trademark license agreements with Hallmark Cards, Incorporated (“Hallmark Cards”). We believe that the use of this trademark is extremely important for our domestic Channel due to the substantial name recognition and favorable characteristics associated with the name in the United States. For further information concerning these trademark license agreements, see Part III—Item 13. Certain Relationships and Related Transactions—Hallmark Trademark License Agreements.

Information concerning revenue, operating losses and identifiable assets attributable to each of our domestic and international pay television programming services and our distribution of films may be found in Note 23 of Notes to Consolidated Financial Statements in this Report.

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Development of Business

Crown Media Holdings, Inc., 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, prior to the sale of its international business, in approximately 152 countries throughout the world. Significant investors in Crown Media Holdings include Hallmark Entertainment Investments Co., a subsidiary of Hallmark Cards, 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 international operations of the Hallmark Channel are operated by Crown Media International and, in the United Kingdom, by Crown Entertainment Limited. 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. 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.

Hallmark Cards controls the Company through its ownership of more than 80% of the equity interests in Hallmark Entertainment Investments and its control over the voting of our Class A and Class B common stock held by Hallmark Entertainment Investments. See also the description of the Hallmark Entertainment Investments Co. Stockholders Agreement in Item 13 below and Item 12 below regarding beneficial ownership of our securities.

Industry Overview

The pay television industry is comprised primarily of program suppliers, pay television channel providers and pay television distributors. Program suppliers, from whom we acquire or license a portion of our programming, include many of the major production studios and other independent production companies and independent owners of programming. These program suppliers create, develop and finance the production of, or control rights to, movies, television miniseries, series and other programming. Due to our acquisition of the Crown Media Library, we are a program supplier. Program suppliers generate revenue by licensing their programming to broadcasters and video distributors (pay television channel providers) around the world. These licenses are typically specific by territory and are limited to a certain number of showings within specified periods of time.

We are also a pay television channel provider. Pay television channel providers include all channel providers (except over-the-air broadcasters) and major U.S. networks. Pay television channel providers often produce programming and acquire or license programming from program suppliers and generally package the programming according to an overriding theme and brand strategy. Pay television providers and distributors generally restrict viewership through security encryption devices that limit viewership to paying subscribers. Pay television channel providers compete with each other for distribution and to attract viewers and advertisers. Pay television providers generally target audiences with a certain demographic composition, so that they can then sell advertising to advertisers seeking to reach the providers’ demographic audiences.

Pay television distributors own and operate the platforms used to deliver channels to subscribers. These distributors use several different technologies to reach their subscribers as described below. Distributors attempt to create a mix of channels that will be attractive to their subscriber population in an attempt to gain new subscribers and to reduce subscriber turnover. Distributors have different levels of service for subscribers, with each service level containing some different channels. More recently, distributors, particularly in the U.S., have begun to offer additional broadband services such as Internet access, telephony and video-on-demand over their systems.

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As a result of the recently increased competition for limited analog channel space in the United States and increased use of the digital cable capacity for new broadband services, pay television channel providers are often required to pay subscriber acquisition fees to pay television distributors for carriage on their systems. These subscriber acquisition fees are paid to television distributors on a per subscriber basis and generally in advance of any receipt of subscriber fee revenue from such pay television distributors.

Distribution Platforms

Four major distribution platforms are currently used to transmit programming. First, cable television systems use coaxial or fiber optic cable to transmit multiple channels between a central facility, known as a headend, and the individual subscriber’s television set. Second, analog and digital satellite broadcast systems (such as direct-to-home or “DTH”) use satellite transponders to broadcast television programming to individual dwellings with satellite reception equipment, including a dish and a decoder. Third, digital terrestrial television broadcasters (“DTT”) typically broadcast locally or through regional or national ground-based transmission networks. In general, such broadcasters use landline, microwave or satellite transmission systems to distribute programming to terrestrial transmission facilities for broadcast directly to viewers’ homes. Finally, channels can also be distributed through satellite master antenna television (“SMATV”). SMATV is used primarily for buildings, such as apartments and hotels that receive programming from satellites by means of a single antenna that is connected to the buildings’ headend. The television signals are then distributed to individual units in the building by cable.

Sources of Revenue

Subscriber Fees

Pay television customers subscribe to basic services by paying monthly fees for basic channels to pay television distributors. The customers can also subscribe to additional packages of premium or pay-per-view services upon payment of additional fees. Primarily in international markets, pay television distributors generally pay a fee per subscriber for all or some subscribers to channel providers. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Advertising Revenue

The advertising market differs greatly around the world. In the United States, there is a growing sentiment among advertisers that advertising expenditures are shifting from broadcast television to cable television. In other parts of the world, the amount spent by advertisers on television varies according to the development of each country’s television market. In general, advertising expenditures are less in other countries than in the United States, both in terms of percentage of advertising expenditures as well as absolute dollars. Program ratings systems in many non-United States markets are growing rapidly, and as a result, advertisers are relying less on subscriber counts and more on empirical measurements when buying advertising time.

Television advertising is sold in a variety of formats. Many pay television channels rely largely upon the spot advertisement format. Spot advertisements are normally 30 seconds long and air during or between programs. They are often sold in packages of a certain number of spots or to deliver a certain number of viewers. An alternative to spot advertising is sponsorship, by which a company sponsors a program or selection of programs on a channel by applying their branding around the programming.

The ability of a television channel to generate advertising revenue largely depends on estimated or actual viewing levels, primarily based on ratings, and on advertising rates. Typically, in the United States and some other markets, independent ratings systems on which advertising sales can be based are well established and widely accepted within the industry. In addition, pay television channel providers and distributors may also provide estimated or actual subscriber information. Our U.S. Channel sells the

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majority of its advertising in the “up-front” season, generally in August, for the last quarter of the same year and the first three quarters of the following year. We hold back a small percentage of our inventory for audience deficiency units, “ADUs,” and sell the remainder in the spot market. ADUs are units of inventory that are made available to advertisers as compensation for inventory the advertiser purchased that ran in programs that under-delivered on the guaranteed ratings.

Historically, advertisers have spent more on advertising through traditional broadcast television than through pay television. We believe that as pay television continues to gain viewership relative to broadcast television, it should attract a larger percentage of the total available dollars spent on television advertising. Also, as pay television draws audience share from broadcast television, audience demographics become fragmented; and, as a result, advertisers are able to target groups of viewers with specific demographic profiles.

Since February 2002, paid commercial programming, “infomercials,” has been carried on our domestic Channel and, prior to the sale of our international business, on a limited basis in several international regional feeds of our international Channel.

Ratings

Among the 54 ad-supported cable channels in the United States market, the Hallmark Channel ranked 10^th in total day with a 0.6 household rating for the 2004 year and 14^th for prime time with a 0.871 household rating for the 2004 year, according to Nielsen Media Research. In 2003 among the 52 ad-supported cable channels in the United States market, the Hallmark Channel ranked 16^th in total day with a 0.503 household rating for the 2003 year and 22^nd for prime time with a 0.718 household rating for the 2003 year, according to Nielsen Media Research. Total day means the time period measured from the time each day the broadcast of commercially-sponsored programming commences to the time such commercially-sponsored programming ends. We believe that the key demographics for the Hallmark Channel are the viewers in the groups Adults 25-54 and Women 25-54.

Internationally, during 2004 the international Hallmark Channel ranked in the top five cable and satellite channels in the U.K. according to the Broadcaster Audience Research Board. In the U.K., the Channel enjoyed a strong and sustained increase in ratings over the past two years, increasing its television rating among adults in multi-channel homes by 13% from 2003 and its share, or percentage of viewing audience, among individuals in multi-channel homes by 18%. The Channel was the 9^th most watched commercial non-terrestrial channel in Poland according to AGB Polska in December 2004. The Channel ranked among the top ten multi-channel networks in Hungary according to AGB Hungary for the 2004 year.

Licensing Revenue

Program suppliers sell or license programming to broadcasters and video distributors (pay television channel providers) who pay a license fee for the right to exploit (air) the programming over a certain period in their program package. Our licensing of film assets is an important contributor to our revenues and, because the amortization of our film assets is a non-cash expense, also to our cash flow.

Channels

The Hallmark Channel—United States

Programming

Our domestic Channel offers a range of high quality, entertainment programming for adults and families including movies, miniseries, epics, historical dramas, romances, literary classics, and contemporary stories. Sources for programming on our domestic Channel include the Crown Media

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Library, programming licensed from Hallmark Entertainment Distribution, and programming licensed from third parties. Prior to the purchase of the Crown Media Library, we licensed substantially all of the titles in that library from Hallmark Entertainment Distribution.

Examples of programming from our Library and the Hallmark Entertainment library include, Larry McMurtry’s Lonesome Dove, 10th Kingdom, Neil Simon’s London Suite, Gulliver’s Travels, Dog of the Yukon: Call of the Wild and Larry McMurtry’s Dead Man’s Walk as well as programming previously shown as Hallmark Hall of Fame such as William Faulkner’s Old Man, Rose Hill, Sarah Plain and Tall and What the Deaf Man Heard. We benefit from these original Hallmark Entertainment productions, which are sometimes premiered and often aired on our domestic Channel. Examples of third party programming shown on our domestic Channel include the popular drama series M*A*S*H, Judging Amy, Magnum, P.I., Matlock, Touched By An Angel, Walker Texas Ranger, Rawhide, Dr. Quinn Medicine Woman, and Perry Mason. Other examples of our third party programming include acquired movies and miniseries such as Roots, North and South, The Thorn Birds and Shogun. Our license agreements with third parties typically provide for a license fee paid out over the term of the license for the right to exhibit a program in the United States within a specified period of time.

Distribution

Our domestic Channel ended 2004 with 64.6 million subscribers, an increase of 15% from 56.0 million at the 2003 year-end. We currently distribute our domestic Channel to approximately 70% of all United States pay television subscribers. The following table shows the approximate number of pay television households and domestic Channel subscribers for each of the eight largest pay television distributors, and all other pay television distributors as a group, in the United States as of December 31, 2004.

(1)          Source: Nielsen Code and The Nielsen Public U.E. December 2004.

Sources of Revenue

We derive our domestic Channel revenue primarily from subscriber fees and advertising sales. We charge our pay television distributors a monthly per subscriber fee for the right to broadcast our domestic Channel. Generally, these distribution agreements last from five to ten years, and sometimes include annual increases of both subscribers and per subscriber fees. A distribution agreement may also involve a payment by us for the establishment of the relationship or, together with or in lieu of any payment, the free carriage of our Channel to subscribers for a period of time and discounts or no fees if certain subscriber levels are achieved. Please see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, for information regarding subscriber fees. For the years ended December 31, 2002,

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2003, and 2004 revenue derived from subscriber fees for the domestic Channel were approximately $13.5 million, $6.6 million and $10.8 million, respectively.

We have advertising sales offices in New York, Los Angeles, Chicago, Atlanta and Detroit. In addition, we have made significant investments in programming, research, marketing and promotions, all specifically designed to support the sale of advertising time on our domestic Channel. For the years ended December 31, 2002, 2003, and 2004 revenue from the sale of advertising time on our domestic Channel were approximately $46.0 million, $77.6 million and $106.3 million, respectively.

Sales and Marketing

Our primary target demographics are women aged 25 to 54 and adults aged 25 to 54 and our secondary target is adults aged 18 to 49. Our programming is targeted to adults, but is generally appropriate for viewing by the entire family, which is important to viewers, advertisers and affiliates alike.

For over fifty years Hallmark has been a leader in high-quality original television production. The Hallmark Channel is the only home on cable television for the movies previously shown as Hallmark Hall of Fame, a selection of movies from an award-winning entertainment series. Much of the Hallmark Channel’s unique programming comes from Hallmark Entertainment, including Merlin, Alice in Wonderland and Dinotopia. Hallmark Entertainment original productions rank among the highest-rated programs on U.S. broadcast network television.

The power of the Hallmark brand and the quality of Hallmark Entertainment combine to:

·       provide our viewers with tangible evidence of our commitment to the best in entertainment for the entire family;

·       enhance our ability to attract advertising commitments and higher Cost-Per-Thousands (“CPM”) from the largest advertisers; and

·       provide a competitive advantage in negotiating long-term distribution agreements with pay television distributors.

Hallmark Movie Channel

In 2004, we launched our second domestic channel, the Hallmark Movie Channel, which is distributed on digital tiers or as part of packages of services. The Movie Channel features top-rated movies from over 3,000 hours of programming in the Crown Media Library. In addition, the Movie Channel showcases movies previously shown as Hallmark Hall of Fame and also features movies from sources other than Hallmark and the Crown Media Library.

The Hallmark Channel—International

As disclosed in this Report, we sold our international business to a third party on April 26, 2005. The following is a description of our international business conducted prior to such sale.

Overview

The international Channel commenced 2004 with 57.3 million subscribers and ended the year with 59.4 million subscribers, an increase of 4%. We distributed the international Channel to 17 geographic markets covering approximately 152 countries, dubbed or subtitled into 26 languages compared to 17 geographic markets covering approximately 116 countries, dubbed or subtitled into 26 languages as of December 31, 2003. Our markets included Asia Pacific, with approximately 20.5 million subscribers, Europe, Middle East and Africa, with more than 17.8 million subscribers, Latin America, with more than 11.8 million subscribers, and the United Kingdom, with more than 9.3 million subscribers.

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Programming

The international Channel offered a range of award-winning programming including made-for-television movies, miniseries, epics, historical dramas and series. We sought programming that was consistent with our programming theme: “great stories that stay with you.” The high quality, entertainment programming for adults and families that we offered was based on universal themes, included world-renowned actors and actresses, such as Sidney Poitier, Whoopi Goldberg, Anjelica Huston, and James Earl Jones and was often filmed in international locations.

Significant sources for our programming were the Crown Media Library and programming by Hallmark Entertainment, Inc. (“Hallmark Entertainment”), which was available to us through our program agreements. Prior to the purchase of the Crown Media Library, we licensed substantially all of the titles in that library from Hallmark Entertainment Distribution. We enjoyed access to new Hallmark Entertainment programming through an amended five-year program license agreement with Hallmark Entertainment Distribution. For more information regarding the program license agreements with Hallmark Entertainment Distribution, please see Part III below. Hallmark Entertainment provided family programming for audiences worldwide, generally delivering more than forty projects each year. We licensed for that same time period the remaining portion of the international Channel’s programming line-up from third parties. This third party programming was consistent with the themes and quality of the material we own or license from Hallmark Entertainment Distribution. We licensed programming from third party suppliers such as CBS Broadcast International, Southern Star Sales Limited, Granada International, Paramount Television, Minotaur Entertainment, NBC Universal Inc., Metro-Goldwyn-Mayer Studios Inc., Columbia Tri-Star International, Sony Pictures, ABA Plus and Warner Bros. Entertainment Inc.

During 2004, we aired third-party series such as Judging Amy, Law and Order, Sue Thomas F.B. Eye, Monk, E.R., Gilmour Girls, and The Guardian. We also aired third-party movies and mini-series including The Fourth Protocol, On Golden Pond, and Hawking.

Distribution

In the countries where we offered the international Channel, we distributed the Channel through a variety of distribution platforms, including cable, satellite broadcast systems, digital terrestrial television and satellite master antenna television. We distributed the Channel through distribution agreements with local pay television operators such as BSkyB, Canal Digital, Home Entertainment, Measat, Multichoice, PCTV and Sky Italy. Our distribution agreements with such operators generally lasted from two to five years. We had the capability to create and deliver our Channel to new platforms in a short period of time through our broadcast infrastructure based in Greenwood Village, Colorado. We had a strategic relationship with Pramer, S.C.A., which performed all day-to-day operations including program acquisitions, scheduling, marketing, advertising and affiliate sales, playback and uplink for our operations in Mexico, Central and South America.

We regularly reviewed existing and potential markets to assess their prospects. As the number of international Channel subscribers increased in a market, we assessed our ability to increase revenue or develop new revenue sources by subdividing the market through the addition of satellite signals to individual countries within that market as opportunities—particularly advertising—arose. When we subdivided a market, we were able to customize the Channel to appeal to a more specific audience. The delivery of the international Channel to more targeted audiences also increased the number of potential advertisers on the Channel by creating more targeted advertising opportunities for local or regional businesses in the markets in which we operate.

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The following chart shows the approximate number of television households and pay television households, as estimated by Kagan World Media (except where noted) at December 31, 2004, and the number of our international Channel subscribers at December 31, 2003 and 2004.

(1)             Total subscribers include promotional (free) subscribers at December 31, 2003, and December 31, 2004.

(2)             India includes Bangladesh, Brunei, Macau, Maldives, New Guinea, Pakistan, Republic of Palau, and Sri Lanka

(3)             Source: Zenith Optimedia.

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(4)             Middle East includes Armenia, Azerbaijan, Byelorussia, Estonia, Georgia, Kazakhstan, Kyrgystan, Latvia, Lithuania, Macedonia, Middle East, Republic of Moldova and Republic of Ukraine

(5)             Other Latin America includes Aruba, Bolivia, Caribbean, Costa Rica, Curacao, Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Jamaica, Nicaragua, Panama, Paraguay, Peru, and Uruguay

Sources of Revenue

Like most international pay television channels, we derived the majority of our international revenue from subscriber fees and, to a lesser extent, advertising sales. We generally charged our pay television distributors a fee per subscriber for the right to broadcast our international Channel. For the years ended December 31, 2002, 2003, and 2004 revenue derived from subscriber fees for the international Channel were approximately $54.4 million, $62.3 million, and $71.3 million, respectively.

We also derived revenue from the sale of advertising time on our international Channel. We generated revenue directly from advertisers as well as from our pay television distributors under distribution agreements that provided for a sharing of revenue from advertising. Advertising revenue from our international Channel was derived primarily from activities in a limited number of countries, including East Asia, Mexico, Poland, South Africa, the United Kingdom and certain countries in Latin America. For the years ended December 31, 2002, 2003, and 2004 revenue from the sale of advertising on our international Channel were $23.1 million, $20.5 million, and $22.8 million, respectively.

The Network Operations Center, which enabled us to control delivery of our Channels to our pay television distributors, allowed us to insert commercials into our programming from a central point. The Company had international sales offices in Buenos Aires, Hong Kong, London, Mumbai, Sydney and Taipei.

Sales and Marketing

Our international Channel focused its marketing efforts on maximizing our two revenue streams, distribution and advertising sales, in the individual markets in which the Channel was distributed. Our international Channel’s marketing efforts varied by market depending on the maturity of the local television industry, the level of distribution of our Channel and the potential for the sale of advertising.

In markets where our international Channel is not carried by all the pay television distributors, marketing efforts were primarily directed toward potential new distributors. These efforts included advertising in trade publications and participating in industry trade shows as well as direct mail and public relations campaigns. In these markets, efforts were also made to market the Channel to potential viewers to drive consumer demand for carriage of the Channel by local affiliates.

In markets where our international Channel has obtained substantial distribution or has exclusive agreements with primary distributors, marketing efforts were primarily directed toward maintaining subscribers and viewership. Our efforts in these markets were primarily directed toward a target of adults 25 to 54. These efforts often included traditional marketing campaigns consisting of on-air promotion; print, billboard, cross-channels, radio and television advertising and sometimes these efforts were partially funded by our pay television distributors in each market. Additionally, we emphasized our unique relationship with our primary content supplier, Hallmark Entertainment Distribution, through the use of premier screening events, press tours with actors and actresses and viewer trips to movie sets. We also used our website to market and promote the Channel to consumers through schedule information, movie synopses, games and contests all of which are localized across the region. This was in addition to a comprehensive business to business website for our external customers such as journalists, affiliates and local agents.

In markets where we were developing our international Channel’s advertising business, marketing efforts were also directed toward potential advertisers. When marketing the Hallmark Channel to

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potential advertisers, we used local representation to target media planners and buyers and international advertisers.

Channel Operations

The programming department, and, prior to the international sale, programming departments at each of our regional offices or partners have been responsible for ensuring the consistent quality of the programming we offer. The programming, scheduling and acquisitions departments work in conjunction with the traffic department and creative services to create the distinctive appearance of our Channel. Some of these functions are outsourced on an as-needed basis.

The creation of our Channel begins with the acquisition of programming. Subsequent to the sale of the international business, we have approximately 640 titles in the Crown Media Library. In addition, we license programming from Hallmark Entertainment Distribution and other program suppliers. Our staff or third parties review and summarize all potential programming to ensure compliance with our quality and content standards. Prior to the international sale, the acquisitions staff in our regional offices licensed programming based on the amount of new programming required on the Channels. Each of the acquisitions offices worked together to leverage multi-channel acquisitions across many territories to reduce license fees, but remain sensitive to specific markets with targeted localized programming.

In most of our international markets, we customized the Hallmark Channel by dubbing or subtitling program elements into local languages. The decision to customize the Channel into local languages was based on local market practices, viewer preferences and cost considerations. Language preparation was coordinated in the regional offices in London and Hong Kong and by Pramer in Buenos Aires. Program language elements were typically shipped to the specific region to ensure that nuances in dialect of the particular language are captured. The language versions were then combined with the other programming elements.

The creation of on-air promotional segments “interstitials”, which are broadcast between the feature movies, miniseries and series, are typically outsourced to external vendors. Promotional segments were prepared in many languages for broadcast worldwide. These interstitials are intended to invite viewership, guide viewers to specific programming, and promote “brand awareness” for the Hallmark Channel.

The scheduling department creates the play list, which contains a list of daily programming. The scheduling department works with marketing personnel to continuously monitor the programming mix. The play list is then forwarded to the traffic department.

The traffic department inserts promotional segments and advertising into the play list and creates the daily log, which contains a detailed schedule of the stream of programming, commercials and promotional materials that will ultimately be viewed by the subscriber for each regional feed of the Hallmark Channel. The daily log, together with digital tapes that contain the corresponding programming, are then forwarded to either the Network Operations Center or, to the third party facility, which is performing the playback and uplink services for the feed. Digital tapes that contain the promotional segments are forwarded to either the Network Operations Center or to the third party origination and playback facility separately.

Channel Delivery

We deliver the daily log and digital tapes to the Network Operations Center (described below) or to a third party origination and playback facility for each market, where the programming, promotional and advertising elements are combined and compressed into a single signal, and transported to an uplink facility. The uplink facility then transmits the signal to the satellite transponder that covers the relevant geographic market, and the transponder reflects the signal back within its designated geographic area to

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head-end facilities and Direct-to-Home satellite services operated by pay television distributors who receive and decode our signal and transmit our Channel.

Prior to the international sale, we owned and operated the global Network Operations Center, which consists of 5,000 square feet at Greenwood Village, Colorado, which commenced operations in February 2001 and has the ability to perform origination and playback services for up to 32 programming Channels. The Network Operations Center is an efficient, state of the art broadcasting operation. The broadcast facility was included in the sale of our international business, and we continue to use the facility under a technical services agreement. See Notes 1 and 24 of our Notes to Consolidated Financial Statements in this Report for information on such sale and the technical services agreement.

The following chart summarizes for the United States Channel the distribution platforms through which we deliver our Channel, our primary pay television distributors, the language in which our Channel is broadcast, and the uplink and satellites we currently use to deliver our Channel. The second chart summarizes each of these matters for our international Channel prior to the sale of our international business.

The Hallmark Channel—United States

The contracts with the parties providing uplink, satellite and other services for the delivery of our Channel in the United States expire from 2005 through 2019. Such contracts may be terminated by the vendors prior to the expiration of the contracts under conditions that are customary to contracts of this type. Amounts payable under these contracts, as well as international contracts, are reflected in “Operating and Capital Leases” in the schedule of contractual commitments as of December 31, 2004 as shown in Item 7 below.

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The Hallmark Channel—International

The following contracts were assigned to the buyer of our international business effective April 26, 2005.

Film Distribution

Crown Media Distribution owns the Crown Media Library, consisting currently of United States rights to approximately 640 titles, and generates revenue from the film assets in the library by granting licenses to use the films to third parties. We are also using the films as programming for our television Channels and interactive uses.

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Crown Media Distribution oversees sales and distribution of the Crown Media Library to third-party licensees. Third-party licensees purchase available rights, which primarily include all forms of television and home video. Crown Media Distribution has a service agreement with Hallmark Entertainment, providing for services relating to the administration, distribution and other exploitation of the Crown Media Library, and directs the Hallmark Entertainment sales force worldwide in all sales matters pertaining to the Crown Media Library.

Competition

The pay television industry is highly competitive. Our Channels have competed for distribution, viewers and advertisers with other pay television channels, broadcast television channels and with other general forms of entertainment.

There are several sources of competition within our industry, each of which affects our business strategy. Our domestic Channel competes with other general entertainment programming from TNT, USA Network, A&E, the Discovery Channel, Lifetime, ABC Family and other similarly targeted channels. Our international Channel competed with general entertainment programming from AXN, I-SAT, Canal Fox, TNT, UK Gold and USA Network. We compete with these channels for viewers and advertising dollars based upon quality of programming, number of subscribers, ratings and subscriber demographics. We compete with all channels for carriage on cable and satellite systems that may have limited capacity.

Competition continues to intensify as the industry shifts from analog distribution to digital distribution. Many pay television distributors have upgraded their physical infrastructures to accommodate digital delivery, which provides significantly more channel capacity. We believe that it will take several years for the majority of current subscribers to convert to, and begin paying for, upgraded services. In an effort to accelerate the conversion, pay television distributors are attempting to place new channels on their digital tier as opposed to their limited, yet more widely distributed, analog tiers. Although competition for the remaining widely distributed analog channel space is still intense, as more and more subscribers are converted, the digital tier is expected to become the dominant platform.

Competitive Strengths

We have established a track record of providing high quality programming. We believe that our primary competitive strengths include the following:

Pay Television Channel Branded with the Well-Known Hallmark Name

Our Channel is branded with the Hallmark name. We believe that viewers and distributors associate the Hallmark brand with family values and high quality content and that our association with this brand facilitates our efforts to achieve increased distribution and to attract additional viewers that leads to higher ratings and advertising revenue.

Long-Term Distribution Contracts that Call for Increasing Subscriber Counts and Fees

At December 31, 2004, we had long-term distribution agreements with Adelphia, Cablevision, Charter, Comcast, Cox, DirecTV, EchoStar, and Time Warner in the United States, as well as a number of other distributors. The terms of our major distribution agreements generally provide for subscriber increases over time, although some provide for lower or no subscriber fees if certain levels of subscribers are achieved.

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A Library of Popular and Award-Winning Programming and Guaranteed Access through Long-Term Agreements to Other Similar Programming

Our Library gives us control over a significant amount of popular and award-winning programming that we can either air on our Channel or license in the United States to third parties. These titles provide us with a portion of our core programming, and by owning these titles, we have the flexibility to use them as needed to create the most effective program schedules. Owning these titles also eliminates the license fees we otherwise would have to pay for these titles and provides a revenue stream for us from licensing the titles to third parties. We have a five-year program agreement with Hallmark Entertainment ending December 31, 2005, that provides us with access to new quality productions, as well as to the titles in the Hallmark Entertainment Distribution library that we did not purchase. This program agreement will be automatically extended for an addition three year term if at that time Hallmark Entertainment Distribution’s parent company, Hallmark Entertainment LLC, owns at least 35% of the Company.

Experienced Management

Members of our senior management team have experience launching, promoting and operating channels both domestically and internationally. They have held senior positions at such companies as The Discovery Channel, Cable Satellite Public Affairs Network, the News Corporation, Telecommunications International, Inc., ABC, CBS Sports, Turner Network Television, MediaOne International, the Golf Channel and USA Networks.

Competitive Risks

One Channel Distributed Domestically

We operate one primary Channel in the United States. Many competitors have more than one channel and may also be diversified entertainment companies, giving them an advantage in dealing with distributors and advertisers. These companies are also able to leverage costs across multiple channels.

Entertainment Programming

Our programming is entertainment designed for adults and families and is intended to meet quality standards that are associated with the Hallmark trademark. Competitors may have more flexibility in programming.

Ratings Which Affect Advertising

Our ratings have improved substantially over the last two years. Nevertheless, our competitors include channels with more subscribers and higher ratings, which affects rates that we can charge for advertising.

Research

The research departments at the Company provide strategic and tactical guidance to decision-makers within the Company, as well as supplying information about the Channel to potential advertisers and affiliates. These departments provide data on the size and demographics of our audience and information about our audiences, competitors, markets and industry.

Currently, our Channel’s research department translates our overall business strategy into a cohesive research program. This information assists our executives to more effectively target, brand, promote, program, and better understand where opportunities lie, in order to increase our Channel’s market share.

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The research department has sophisticated ratings systems (Npower, PNF2 and Adviews) and competitive tracking database hardware and software. Trends and changes from these ratings systems are reported to top management for short and long-term strategic planning.

Our Channel’s performance is tracked through an internal tracking study established in July 2001, which is a monthly telephone survey conducted among a national probability sample of approximately 1,000 adults. The research department also subscribes to a number of other services, which are useful in obtaining information about viewers of our Channel.

Employees

We had 356 and 351 employees at December 31, 2003 and 2004, respectively. Subsequent to the sale of our international business in April 2005, we had 187 employees. Neither we nor any of our subsidiaries are parties to collective bargaining agreements. We believe that our relations with our employees are good. Substantially all of our domestic Channel’s employees work at our offices in Studio City, California and New York, New York.

Regulation

The operations of television channels in the United States are regulated. Within the United States, program access rules applicable to channel providers with ownership ties to pay television distributors may limit business combinations between these two types of companies.

Financial Information about Geographic Areas

Information concerning revenue and long-lived assets attributable to external customers, domestically and internationally, may be found in Note 22 of our Notes to Consolidated Financial Statements in this Report.

Risk Factors and Forward-Looking Statements

The discussion set forth in this Form 10-K contains statements concerning potential future events. Such forward-looking statements are based on assumptions by Crown Media Holdings management, as of the date of this Form 10-K 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 below in this Form 10-K. Crown Media Holdings will not update any forward-looking statements contained in this Form 10-K to reflect future events or developments.

If we do not successfully address the risks described below, our business, prospects, financial condition, results of operations or cash flow could be materially adversely affected. The trading price of our Class A common stock could decline because of any of these risks.

Risks Relating to Our Business

Our business has incurred net losses since inception and may continue to incur losses.

Both our international and domestic channels have a history of net losses and we expect to continue to report net losses for the foreseeable future. As of December 31, 2004, we had an accumulated deficit of approximately $1.3 billion, total stockholders’ equity of approximately $54.6 million, goodwill of approximately $314.0 million, and film assets of $599.0 million.

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We cannot assure you that we will achieve or sustain profitability. If we are not able to achieve or sustain profitability, the trading price of our Class A common stock may fall significantly. To diminish our losses and become profitable, we will need to substantially increase our revenue, particularly advertising and licensing revenue. This will require, among other things, increasing the distribution of our channels, attracting more viewers to our channels, attracting more advertisers, and increasing our advertising rates. Risks associated with these areas of our business are described below.

In addition, in order to accomplish these goals, the management of Crown Media Holdings continues to believe that it is necessary to increase subscribers and enhance our programming, which results in increased subscriber acquisition fees and higher costs for programming. Over the last four years, these actions have contributed to increased net losses for Crown Media Holdings.

Our substantial indebtedness could adversely affect our financial health, and the restrictions imposed by the terms of our debt instruments may severely limit our ability to plan for or respond to changes in our business.

We have a substantial amount of indebtedness. As of December 31, 2004, our total debt was $889.1 million and we had $12.1 million of cash and cash equivalents. In addition, as of March 31, 2005, we could borrow the remaining $10.0 million available borrowing under our bank credit facility to cover the negative cash flow resulting from our current operations. Subject to restrictions under our debt agreements, we may also seek equity or debt financing from time to time to cover our operating losses, to finance acquisitions or capital expenditures or for other purposes.

As a result of our level of debt and the terms of our debt instruments:

·       our vulnerability to adverse general economic conditions is heightened;

·       we will be required to dedicate a portion of our cash flow from operations to repayment of debt, limiting the availability of cash for other purposes;

·       we are and will continue to be limited by financial and other restrictive covenants in our ability to borrow additional funds, consummate asset sales, enter into transactions with affiliates or conduct mergers and acquisitions;

·       our flexibility in planning for, or reacting to, changes in our business and industry will be limited;

·       we are sensitive to fluctuations in interest rates; and

·       our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes may be impaired.

Our ability to meet our debt and other obligations and to reduce our total debt depends on our future operating performances and on economic, financial, competitive and other factors. There can be no assurance that our leverage and such restrictions will not materially and adversely affect our ability to finance our future operations or capital needs or to engage in other business activities.

We have increasing interest expense, which may impact our future operations.

High levels of interest expense could have negative effects on our future operations. Interest expense, which is net of interest income and includes amortization of debt issuance costs and interest expense on borrowings under our senior and demand notes and bank credit facility, increased substantially over the past year. The increase in interest expense in the past twelve months resulted from an increase in the average borrowings outstanding, due to cash generated from operations being insufficient to cover operating expenses and capital expenditures. A substantial portion of our cash flow from operations must be used to pay our interest expense and will not be available for other business purposes. In addition, we may need to incur additional indebtedness in the future. We cannot assure you that our business will

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generate sufficient cash flow or that future financings will be available to provide sufficient proceeds to meet our obligations or to service our total debt.

Our liquidity is dependent on external funds.

Because we currently operate at a loss and may have a negative cash flow, any unanticipated significant expense or any development that hampers our growth in revenue or decreases any of our revenue, would result in the need for additional external funds in order to continue operations. We have no arrangements for any external financings, whether debt or equity, and are not certain whether any such new external financing would be available on acceptable terms. Any new debt financing would require the cooperation and agreement of existing lenders.

Modification of any existing agreements with United States distributors could result in an increased obligation to pay subscriber acquisition fees.

Several of the Crown Media United States’ existing distribution agreements contain “most favored nations” clauses. These clauses typically provide that, in the event Crown Media United States enters into an agreement with another distributor on more favorable terms, these terms must be offered to the existing distributor, subject to certain exceptions and conditions. Distribution agreements which we may enter into in the future may also contain similar “most favored nation clauses.” In the past, Crown Media United States was asked to comply with such clauses and modify its distribution agreements with certain distributors after entering into new distribution agreements. Any claims under these clauses in the future could result in the payment of cash or the issuance of stock by us to our distributors and would negatively affect subscriber revenues; however, if our subscription base is increased as a result of such modification, it could result in higher advertising revenue.

If we are unable to obtain programming from third parties, we may be unable to increase our subscriber base.

We compete with other pay television channel providers to acquire programming. If we fail to continue to obtain programming on reasonable terms for any reason, including as a result of competition, we could be forced to incur additional costs to acquire such programming or look for alternative programming, which may hinder the growth of our subscriber base.

If our programming declines in popularity, our subscriber fees and advertising revenue could fall and the additional revenue we expect as a result of the acquisition of film assets from Hallmark Entertainment Distribution may be lower than we anticipate.

Our success depends partly upon unpredictable and volatile factors beyond our control, such as viewer preferences, competing programming and the availability of other entertainment activities. We may not be able to anticipate and react effectively to shifts in tastes and interests in our markets. In particular, our ability to react effectively may be limited by our obligation to license programming from Hallmark Entertainment Distribution, which has standards and contractual commitments to other parties that limit the types of programming that it will provide to us. Our competitors may have more flexible programming arrangements, as well as greater amounts of production, better distribution, and greater capital resources, and may be able to react more quickly to shifts in tastes and interests. As a result, we may be unable to maintain the commercial success of any of our current programming, or to generate sufficient demand and market acceptance for our new programming. A shift in viewer preferences in programming or alternative entertainment activities could also reduce the amount of revenue we anticipate receiving from licensing of our film assets and cause a decline in both advertising and subscriber fees revenue. The decline in revenue could hinder or prevent us from achieving profitability and could adversely affect the market price of our Class A common stock.

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We are currently dependent on Hallmark Entertainment to distribute and maximize licensing fees from the film assets.

Currently, we are dependent on Hallmark Entertainment, a related party, to distribute and license our film assets to third parties for us under a services agreement, which will expire on December 31, 2006. This arrangement reduces our control over the sales and distribution of the film assets and might delay our realization of the full revenue stream from the film assets. We and Hallmark Entertainment each have the right to terminate the service agreement on a yearly basis. If Hallmark Entertainment elects to terminate the agreement before we have established our own distribution network, we may not be able to establish our own or obtain alternative distribution services of equivalent quality or on terms as favorable to us. Termination of this services agreement could hinder our ability, at least in the short-term, to achieve the amount of additional revenue anticipated from these activities and could adversely affect the market price of our Class A common stock.

We may in due course develop our own distribution/sales network and hire employees to perform the services currently performed by Hallmark Entertainment under the service agreement. Our ability to do so is unproven and will require financial, operational and management resources. We may not be able to hire the number of employees, or employees who are sufficiently qualified, to perform these services, or do so in a cost efficient manner. If the cost to develop and maintain this employee base is greater, or if this process takes longer than anticipated, it could have a negative impact on the revenue we anticipate generating from the film assets.

If we are unable to increase our advertising revenue, we may be unable to achieve profitability.

Although it is expected over time that our advertising revenue will increase, if we fail to increase significantly our advertising revenue, we may be unable to achieve or sustain profitability or to expand our business. A failure to increase advertising revenue may be a result of any or all of the following: (i) we have a limited history of marketing and selling advertising time; (ii) we may be unable to identify, attract and retain experienced sales and marketing personnel with relevant experience for our U.S. channel; (iii) our sales and marketing organization may be unable to successfully compete against the significantly more extensive and well-funded sales and marketing operations of our current or potential competitors; (iv) the advancement of technologies such as Digital Video Recording may cause industry-wide changes concerning the frequency in which individuals are exposed to advertising on television; and/or (v) we will not be able to increase our advertising sales rate-card or may be required to run additional advertising spots which affect the availability of advertising inventory for future sales. Success in increasing our advertising revenue also depends upon the number and coverage of the distributors who carry our channels, our number of subscribers, and the viewership ratings for our programming.

Hallmark Entertainment Investments controls us and this control could create conflicts of interest or inhibit potential changes of control.

Hallmark Entertainment Investments controls all of our outstanding shares of Class B common stock and owns shares of our Class A common stock, representing in the aggregate approximately 95.8% of the outstanding voting power on all matters submitted to our stockholders. Hallmark Entertainment Holdings, a subsidiary of Hallmark Cards, controls the voting of all our shares held by Hallmark Entertainment Investments. Hallmark Entertainment Investments’ control could discourage others from initiating potential merger, takeover or other change of control transactions that may otherwise be beneficial to our business or holders of Class A common stock. As a result, the market price of our Class A common stock could suffer, and our business could suffer. Hallmark Entertainment Investments’ control relationship with us also could give rise to conflicts of interest in certain situations.

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Hallmark Entertainment Distribution may not deliver to us as many programs as it has historically delivered.

We currently acquire library programming, new productions and first-run presentations pursuant to our program license agreement with Hallmark Entertainment Distribution. However, Hallmark Entertainment Distribution is not required to deliver a specific minimum number of programs. We could be forced to develop and produce or acquire alternative programming if we no longer receive as many programs from Hallmark Entertainment Distribution as we have in prior years and, without adequate notice, this could negatively impact our ability to effectively program our Channel.

We could lose the right to use the name “Hallmark” because we have limited-duration trademark license agreements, which could harm our business.

We license the name “Hallmark” from Hallmark Licensing, Inc., a subsidiary of Hallmark Cards, for various uses, including the name of our domestic channel. This license will expire on September 1, 2005. If Hallmark Cards determines not to renew the trademark license agreements for any reason, including our failure to meet minimum programming thresholds dependent on programming provided by affiliates of Hallmark Cards or to comply with Hallmark Cards’ programming standards, we would be forced to significantly revise our business plan and operations, and could experience a significant erosion of our subscriber base and advertising revenue, particularly in the United States.

If our third-party suppliers fail to provide us with network infrastructure services on a timely basis, our costs could increase and our growth could be hindered.

We currently rely on third parties to supply key network infrastructure services, including uplink, playback, transmission and satellite services to certain of our markets, which are available only from limited sources. We have occasionally experienced delays and other problems in receiving communications equipment, services and facilities and may, in the future, be unable to obtain such services, equipment or facilities on the scale and within the time frames required by us on terms we find acceptable, or at all. If we are unable to obtain, or if we experience a delay in the delivery of, such services, we may be forced to incur significant unanticipated expenses to secure alternative third party suppliers or adjust our operations, which could hinder our growth and reduce our revenue and potential profitability.

If the Network Operations Center fails, or its operations are disrupted, our costs could increase and our growth could be hindered.

We are currently using the Network Operations Center for the origination and playback of signals for the Hallmark Channel. Like other single-point facilities, the Network Operations Center is subject to interruption from fire, tornadoes, lightning and other unexpected natural causes. Although there are redundant systems in place, equipment failure, employee misconduct or outside interference could also disrupt the Network Operations Center’s services. We currently have certain backup facilities for the domestic channel. Any significant interruption at the Network Operations Center affecting the distribution of our channel could have an adverse effect on our operating results and financial condition.

As part of the sale of the international business, the buyer of the business acquired the Network Operations Center, but we continue to use the Network Operations Center for the distribution of our domestic channel pursuant to a service agreement, and we depend upon the buyer in providing these services for our domestic Channel. Any significant interruption of such services affecting the distribution of our channels could have an adverse effect on our operating results and financial condition.

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If we are unable to retain key executives and other personnel, our growth could be inhibited and our business harmed.

Our success depends on the expertise and continued service of our executive officers and key employees of our subsidiaries. If we fail to attract, hire or retain the necessary personnel, or if we lose the services of our key executives, we may be unable to implement our business plan or keep pace with developing trends in our industry.

The amount of our goodwill, as well as our film costs, may hinder our ability to achieve profitability.

As a result of our acquisitions of all the common interests in Crown Media United States, we have generated a significant amount of goodwill. We ceased the amortization of this acquired goodwill, and we are required to periodically review whether the value of our goodwill has been impaired. If we are required to write down our goodwill, our results of operations, stockholders’ equity could be materially adversely affected.

We also have film costs relating to the amortization of the purchase price for the film assets that we use and license to others. These film costs are, and will continue to be, a significant component of our cost of services each quarter.

Our stock price may be volatile and could decline substantially.

The stock market has, from time to time, experienced extreme price and volume fluctuations. Many factors may cause the market price for our Class A common stock to decline, including:

·       our operating results failing to meet the expectations of securities analysts or investors in any quarter;

·       material announcements by us or our competitors;

·       governmental regulatory action;

·       technological innovations by competitors or competing technologies;

·       investor perceptions of our industry or prospects, or those of our customers; and

·       changes in general market conditions or economic trends.

Additionally, of the approximately 73.9 million shares of the Company’s outstanding Class A common stock, only 9.6 million shares (approximately 13%) are not held by affiliates of the Company. This stock ownership structure may also be a cause of volatility in the market price of the Company’s Class A common stock.

Risks Relating to Our Industry

The proposed change in television ratings in the United States could reduce our channel revenue and our ability to achieve profitability.

Our domestic advertising revenues are partially dependent on television ratings provided by Nielsen Media Research. Nielsen is currently modifying its ratings system by increasing its household sample size and plans to institute other changes in its audience measurement systems. Our ratings could either be positively or negatively affected by these changes, depending on the demographic characteristics of the households added to the Nielsen sample and the natures of the changes in the measurement systems.

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Competition could reduce our channel revenue and our ability to achieve profitability.

We operate in the pay television business, which is highly competitive. If we are unable to compete effectively with large diversified entertainment companies that have substantially greater resources than we have, our operating margins and market share could be reduced, and the growth of our business inhibited. In particular, we compete for distribution with other pay television channels and, when distribution is obtained, for viewers and advertisers with pay television channels, broadcast television networks, radio, the Internet and other media. We also compete, to varying degrees, with other leisure-time activities such as movie theaters, the Internet, radio, print media, electronic games and other alternative sources of entertainment and information. Future technological developments may affect competition within this business.

A continuing trend towards business combinations and alliances in the communications industries may create significant new competitors for us or intensify existing competition. Many of these combined entities have more than one channel and resources far greater than ours. These combined entities may provide bundled packages of programming, delivery and other services that compete directly with the products we offer.

We may need to reduce our prices or license additional programming to remain competitive, and we may be unable to sustain future pricing levels as competition increases. Our failure to achieve or sustain market acceptance of our programming at desired pricing levels could impair our ability to achieve profitability or positive cash flow, which would harm our business.

Distributors in the United States may attempt to pressure pay TV channels with lower viewership, such as our Channel, to accept decreasing amounts for subscriber fees, to pay higher subscriber acquisition fees or to allow carriage of the channel without the payment of subscriber fees. Factors that may lead to this pressure include the number of competing pay TV channels, the limited space available on services of distributors in the United States and the desire of distributors to maintain or reduce costs. Any reduction in subscriber fees revenue now or in the future could have a material impact on our ability to achieve profitability and cash flow.

New distribution technologies may fundamentally change the way we distribute our channels and could significantly decrease our revenue or require us to incur significant capital expenditures.

Our future success will depend, in part, on our ability to anticipate and adapt to technological changes and to offer, on a timely basis, services that meet customer demands and evolving industry standards. The pay television industry has been, and is likely to continue to be, subject to:

·       rapid and significant technological change, including continuing developments in technology which do not presently have widely accepted standards; and

·       frequent introductions of new services and alternative technologies, including new technologies for providing video services.

For example, the advent of digital technology is likely to accelerate the convergence of broadcast, telecommunications, Internet and other media and could result in material changes in the economics, regulations, intellectual property usage and technical platforms on which our business relies, including lower retail rates for video services. These changes could fundamentally affect the scale, source, and volatility of our revenue streams, cost structures, and profitability, and may require us to significantly change our operations.

We also rely in part on third parties for the development of, and access to, communications and network technology. As a result, we may be unable to obtain access to new technology on a timely basis or on satisfactory terms, which could harm our business and prospects.

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Moreover, the increased capacity of digital distribution platforms, including the introduction of digital terrestrial television, may reduce the competition for the right to carry channels and allow development of extra services at low incremental cost. These lower incremental costs could lower barriers to entry for competing channels, and place pressure on our operating margins and market position. In addition, a greater number of channels would likely increase competition among channels for viewers and advertisers, which could affect our ability to attract advertising and new distribution at desired pricing levels, and could therefore hinder or prevent the growth of our subscriber base.

If we fail to comply with applicable government regulations, our business could be harmed.

If, as a provider of television channels, we fail to comply with applicable present or future government regulations in the U.S., we could be prohibited from operating in the U.S. and could be subject to monetary fines, either of which would increase our operating costs, reduce our revenue and limit our ability to achieve profitability.

Moreover, broadcasting regulations are generally subject to periodic and on-going governmental review and legislative initiatives, which may, in the future, affect the nature of programming we are able to offer and the means by which it is distributed. The timing, scope or outcome of these reviews could be unfavorable to us, and any changes to current broadcasting legislation or regulations could require adjustments to our operations.

The Federal Communications Commission or Congress may enact requirements that cable program services be offered to subscribers on an “a la carte” basis, i.e. be made available for purchase separately and not as part of a package of services. Such requirements could result in a reduction in the total number of subscribers to our domestic program services and adversely affect advertising revenue.

Available Information

We will make available free of charge through our website, www.hallmarkchannel.com, this Annual 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 we electronically file or furnish such material with the Securities and Exchange Commission.

ITEM 2.                Properties

The following table provides certain summary information with respect to the principal real properties leased by the Company. We do not own any real property. The leases for these United States offices and facilities expire between March 2005 and June 2010. The Company believes the facilities, office space and other real properties leased are adequate for its current operations.

Hallmark Channel—United States

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Hallmark Channel—International

The following leases were assigned to the buyer of our international business effective April 26, 2005.

We own most of the equipment and furnishings used in our businesses, except for satellite transponders, which are leased. See Note 9 of Notes to Consolidated Financial Statements for information on our leasing of property and equipment.

Our film assets consist primarily of television movies and miniseries. The masters for these films are stored in vaults and laboratories with which we have access agreements.

ITEM 3.                Legal Proceedings

In May 2005, we received a letter from National Interfaith Cable Coalition, Inc. threatening litigation in regard to an Amendment dated February 22, 2001 to the Amended and Restated Company Agreement of Crown Media United States. The Amendment is described below under “Crown Media United States Amended and Restated Company Agreement” in Item 13, Certain Relationships and Related Transactions. The letter claims that, among other things, the Company and Hallmark Entertainment, Inc. have not honored their commitments relating to the production and financing of certain NICC and “faith and values” programming for broadcast on the Hallmark Channel in the United States. NICC alleges that we and HEI have materially breached the Amendment, causing substantial damages to NICC in an amount which exceeds $100.0 million. The letter further indicates that NICC intends to file litigation for breaches of the Amendment unless we agree, by June 1, 2005, to enter into a new, extended agreement with NICC for the production, promotion and funding of programming. We believe that the Company and HEI are in compliance with the Amendment. We cannot, however, predict whether the letter will result in litigation, an amendment or other resolution.

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

None.

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PART II

ITEM 5.                Market for Our Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our Class A common stock is listed on the Nasdaq National Market System under the ticker symbol “CRWN[E].” Set forth below are the high and low sales prices for our Class A common stock for each quarterly period in 2003 and 2004, as reported on the Nasdaq National Market System.

There is no established public trading market for our Class B common stock, of which 100% is owned by Hallmark Entertainment Investments Co.

Holders

As of May 1, 2005, there were approximately 72 record holders of our Class A common stock and one record holder of our Class B common stock.

Dividends

We have not paid any cash dividends on our common stock since inception. We anticipate that we will retain all of our earnings, if any, in the foreseeable future to finance the continued growth and expansion of our business, and we have no current intention to pay cash dividends. Our bank credit facility also prohibits our declaring or paying any cash dividends.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides as of December 31, 2004, information for our only equity compensation plan, which is the Amended and Restated 2000 Long Term Incentive Plan

Equity Compensation Plan Information