UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

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)

(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  o    No  ý

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

As of May 31, 2005, the number of shares of Class A Common Stock, $.01 par value outstanding was 73,869,641, and the number of shares of Class B Common Stock, $.01 par value, outstanding was 30,670,422.

TABLE OF CONTENTS

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In this Form 10-Q 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”), 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 and other product or service names are trademarks or registered trademarks of their owners.

PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements (Unaudited)

CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

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

See accompanying notes to unaudited condensed consolidated financial statements.

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CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

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

(continued)

See accompanying notes to unaudited condensed consolidated financial statements.

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CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND

COMPREHENSIVE LOSS

(In thousands, except per share data)

See accompanying notes to unaudited condensed consolidated financial statements.

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CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

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CROWN MEDIA HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Three Months Ended March 31, 2004 and 2005

1. Business and Organization

Organization

Crown Media Holdings, Inc. (“Crown Media Holdings,” “Crown Media” or the “Company”), through its subsidiaries, owns and operates pay television channels (collectively the “Hallmark Channel” or the “channel”) dedicated to high quality, entertainment programming for adults and families, in the United States and, prior to the sale of its international business, in various countries throughout the world. Domestically, the Hallmark Channel is operated and distributed by Crown Media United States, LLC (“Crown Media United States”). Significant investors in Crown Media Holdings include Hallmark Entertainment Investments Co. (“Hallmark Entertainment Investments”), a subsidiary of Hallmark Cards, Incorporated (“Hallmark Cards”), the National Interfaith Cable Coalition, Inc. (“NICC”), 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 were operated in the United Kingdom, by Crown Entertainment Limited (“Crown Entertainment”) and elsewhere by Crown Media International, LLC (“Crown Media International”). Crown Media International commenced its operations outside the United States in 1995.

Sale of the International Business

The Company sold its international business to a group of investors comprised of Equity Partners, 3i and U.K. executive David Elstein (collectively, the “buyer”) in a transaction that closed on April 26, 2005. The sale included the international versions of the Hallmark Channel distributed outside the United States, the international rights to over 580 titles in the Crown Media film library, and the network broadcast facility based in Denver, Colorado.  The sale price was $242.0 million, subject to certain purchase price adjustments relating to receivables acquired and working capital changes. Upon closing of the transaction, the Company received cash proceeds of approximately $209.3 million; such proceeds were net of approximately $12.7 million paid to the buyer for future services to be provided by the buyer under a services contract and $20.0 million related to certain accounts receivable not acquired by the buyer.  Within 45 days from the close of the transaction, the purchase price may be adjusted for certain minimum working capital considerations, guarantees and commitments, which we estimate will reduce the net cash proceeds by an additional $2.0 million in the aggregate. The Company agreed to pay the buyer approximately $24.1 million over a specified number of years to cover the fair value amount of certain obligations transferred with the international business. Proceeds from the transaction were used by Crown Media Holdings to reduce outstanding indebtedness under its bank credit facility and to pay transaction fees, restricted stock unit settlements, and employment contract terminations and severance for certain executives who were involved in the Company’s international business and not retained by the buyer.

Substantially all of the employees of the international business as well as the broadcast facility were retained by the buyer.  Subsequent to the sale, the Company has no continuing economic involvement with the operations of the international business.

Due to the delay in filing this quarterly report on Form 10-Q, the Company breached a report covenant of the bank credit facility. The Company obtained a waiver for such covenant violation, subject to the filing of this interim report on Form 10-Q prior to June 30, 2005.

Liquidity

As of March 31, 2005, the Company had $14.7 million in cash and cash equivalents on hand and $10.0 million available under its bank credit facility. As of March 31, 2005, the Company had borrowed $310.0 million under its bank credit facility, which has a maturity date of May 31, 2006. Upon the closing of the sale of the international business on April 26, 2005, the Company used the net proceeds to repay $195.0 million of borrowings under its

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bank credit facility and to pay $14.3 million for transaction fees, restricted stock unit settlements, and employment contract terminations and severance for certain executives who were involved in the Company’s international business and not retained by the buyer. However, subsequent to the close of the transaction, the Company borrowed $64.0 million under its credit facility to pay subscriber acquisition fees and license fees payable to affiliates. After these transactions were executed at May 31, 2005, the Company had outstanding borrowings under the bank credit facility of $179.0 million and had $41.0 million available under the bank credit facility. Forty million of the availability is subject to the approval of Hallmark Cards prior to the Company being able to draw such funds.

The Company’s principal sources of funds are currently 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 connection with the Company’s business strategy, the Company expects to continue making investments in programming and distribution during 2005. If necessary, the Company may reduce some of this anticipated spending in 2005. The Company’s principal uses of funds for the remainder of 2005 are expected to include the payment of operating expenses, licensing of programming, and interest under its bank credit facility.

The Company currently believes that cash on hand, remaining availability under its bank credit facility (drawings subject to approval of Hallmark Cards) and payments anticipated under the tax sharing agreement with Hallmark Cards, all of which are currently its principal sources of funds, will be sufficient to fund the current level of operations and meet its liquidity needs through at least the maturity date of its credit facility. As noted above, Hallmark Cards is required to approve borrowings under our $220.0 million bank credit facility in excess of $180.0 million. Crown Media Holdings has to date not requested Hallmark Cards to approve such drawing of funds; however, we anticipate that we will require such additional capacity and will require approval of Hallmark Cards during 2005. There can be no assurance that Hallmark Cards will approve such additional drawings and, if such drawings are not approved, the Company will need alternative sources of funding or will need to significantly curtail expenses.

The Company’s management anticipates that it will either extend or refinance the credit facility prior to its maturity date.  In addition, other financing alternatives could include the issuance of additional equity or debt securities.  There can be no assurance that the credit facility can or will be extended or refinanced or that additional funding will be available, if at all, on terms acceptable to the Company.  In addition, 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 increase in competition or other adverse operating conditions will impact the Company’s ability to achieve its projected operating results.

2. Summary of Significant Accounting Policies and Estimates

Interim Financial Statements

In the opinion of management, the accompanying condensed consolidated balance sheets and related interim consolidated statements of operations and cash flows, include all adjustments, consisting of normal recurring items necessary for their fair presentation in conformity with accounting principles generally accepted in the United States. Interim results are not necessarily indicative of results for a full year. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes to those statements for the year ended December 31, 2004, including the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

Basis of Presentation

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

In February 2005, the Company signed a definitive agreement to complete the sale of its international business and, accordingly, classified the operating results of the international business as discontinued operations in the

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accompanying statements of operations for all periods presented and related assets and liabilities as held for sale in the accompanying balance sheet as of March 31, 2005. The Company’s discontinued operations consisted of the international channel operations and the international rights to the film library assets.

Use of Estimates

The Company’s condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These accounting principles require the Company to make certain estimates, judgments and assumptions. The Company believes that the estimates, judgments and assumptions made when accounting for items and matters such as customer retention patterns, allowance for bad debts, useful lives of assets, ultimate revenue used in the film asset amortization calculations, asset valuations including cash flow projections, recoverability of assets, income taxes, reserves and other provisions and contingencies are reasonable, based on information available at the time they are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements, as well as the reported amounts of revenue and expenses during the periods presented. Actual results could differ from these estimates.

Film Assets and Film Library Impairment

The Company amortizes its film assets using the individual-film-forecast-computation method over a maximum period of 9.25 years from the date of acquisition. The individual-film-forecast-computation method amortizes such assets in the same ratio that current period actual revenue bears to estimated ultimate future revenues.

On a quarterly basis, the Company assesses whether events or circumstances have changed indicating that the fair value of a film is lower than its unamortized cost or carrying value. If the carrying value of any individual film asset exceeds its fair value, the film asset is written-down to its estimated fair value. A discounted cash flow model, based on management’s anticipated ultimate future revenue of the film, is used to estimate the fair value of the individual films. The Company considers the following factors, among others, in estimating ultimate future revenue for each film:  (a) the film’s performance in historical markets, (b) the public’s perception of the film’s story, cast, director, or producer, (c) historical results of similar films, (d) historical results of the cast, director, or producer on prior films, and (e) running time of the film.  In estimating a film’s fair value, the Company considers those cash outflows necessary to generate the film’s cash inflows such as exploitation, residual and participation costs and taxes.

The Company reviews its estimates of ultimate future revenues and participation costs as of each reporting date to reflect currently available information. Estimated ultimate future revenues are based on the history of each film and similar films, sales and marketing plans, and other factors, all of which require significant judgment and estimation by management. Differences between expenses determined using the new estimates and any amounts previously expensed during that fiscal year are charged or credited to the statement of operations in the period in which the estimates are revised.

For use of the film assets on the Hallmark Channel, the Company estimates the fair value of the internal usage based upon the portion of the film’s ultimate revenues attributable to the term of the license window. The Company first calculates the amount of cost attributable to the internal use using the individual-film-forecast-computation method and then expenses such amounts as the Company exhibits or exploits the film ratably over the term of the license window.

Cash and Cash Equivalents

Cash and cash equivalents include highly liquid investments with original maturities of three months or less that are readily convertible into cash and are not subject to significant risk from fluctuations in interest rates. As a result, the carrying amount of cash and cash equivalents approximates fair value.

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Allowance for Doubtful Accounts

The allowance for doubtful accounts is based upon the Company’s assessment of probable loss related to uncollectible accounts receivable.  The Company uses a number of factors in determining the allowance, including, among other things, collection trends and current anticipated economic conditions in each country in which the Company derives its revenue.  The Company’s bad debt expense was $1.0 million for the three months ended March 31, 2004. The Company’s bad debt recovery was $946,000 for the three months ended March 31, 2005.

Program License Fees

Program license fees are paid in connection with the acquisition of the rights to air programs acquired from others. Program rights are generally deferred and then amortized on a straight-line basis over their contractual license periods or anticipated usage. Crown Media Holdings periodically evaluates the realizability of these costs compared to the estimated future revenues associated with the programming expenses.

Estimates of net realizable value for domestic program license fees are determined using future estimated advertising revenues and anticipated patterns of programming usage on a day part basis as it pertains to programming licensed to the domestic channel. Estimates of net realizable value for international program license fees are determined using historical and future estimates of advertising and subscriber revenues attributable to each territory.  These estimates of expected annual future estimated revenues are compared to net book value of the program license fee assets to determine if the programming assets are realizable. Where the domestic and/or international analysis indicates the costs are in excess of the net realizable value, additional amortization is provided. No such additional amortization was required as of the date of the Company’s last analysis.

Subscriber Acquisition Fees

Subscriber acquisition fees are generally required to be paid to obtain carriage on domestic pay distributors systems. Under certain of these agreements with pay distributors, Crown Media United States is obligated to pay subscriber acquisition fees if defined subscriber levels are met or in order to obtain additional carriage of the Hallmark Channel by those pay distributors. Such costs are accrued when Crown Media United States receives notice from the distributors that they have met the contractual penetration percentage or subscriber count.

Subscriber acquisition fees are amortized over the contractual life of the distribution agreements (ranging from 4 to 9 years) as a reduction of subscriber fee revenue. If the amortization expense exceeds the revenue recognized on a per distributor basis, the excess amortization is included as a component of cost of services. Crown Media Holdings assesses the recoverability of these costs periodically. It also assesses the recoverability when events such as changes in distributor relationships occur or other indicators suggest impairment.

Property and Equipment

Property and equipment are stated at historical cost. Equipment under capital leases are initially recorded at the present value of the minimum lease payments.

Depreciation on equipment is calculated using the straight-line method over the estimated useful lives of the assets. Equipment held under capital leases and leasehold improvements are amortized straight-line over the shorter of the lease term or estimated useful life of the asset.

When property and equipment is sold or otherwise disposed of, the cost and related accumulated depreciation or 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.

Long-Lived Assets

The Company reviews long-lived assets, other than goodwill and other intangible assets with indefinite lives, for impairment whenever facts and circumstances indicate that the carrying amounts of the assets may not be recoverable. An impairment loss is recognized if the carrying amount of the asset is not recoverable and exceeds its fair value. Recoverability of assets to be held and used is measured by comparing the carrying amount of an asset to

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the estimated undiscounted future net cash flows expected to be generated by the asset. If the asset’s carrying value is not recoverable, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds its fair value. The Company determines fair values by using a combination of comparable market values and discounted cash flows, as appropriate.

Goodwill is reviewed for impairment annually or whenever an event occurs or circumstances change that indicates fair value might be below carrying value. Goodwill is carried at historical cost if the estimated fair value is greater than the carrying amounts. However, if estimated fair value is less than the carrying amount, goodwill is reduced to estimated fair value through an impairment charge to the Company’s consolidated statements of operations.

Revenue Recognition

Subscriber revenue from pay television distributors is 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. 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.

Advertising revenues are recognized as earned in the period in which the advertising is telecast. Revenue is recognized as commercial spots or long form programming are aired and as ratings guarantees to advertisers are achieved. Advertising revenues are recorded net of agency commissions. Agency commissions are calculated based on a stated percentage applied to gross billing revenue for the Company’s broadcasting operations. Customers remit the gross billing amount to the agency and the agency remits gross billings less their commission to the Company. Payments received in advance of being earned are recorded as deferred revenue.

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 received in cash for similar advertisements from buyers unrelated to the other party in the barter transaction. When the revenue does not meet the requirements of Emerging Issues Task Force (“EITF”) No. 99-17, Accounting for Advertising Barter Transactions, no revenue is recognized.

Revenue from film asset licensing agreements is recognized in accordance with Statement of Position (“SOP”) 00-02, Accounting by Distributors or Producers of Films. Revenues are recognized when all of the following have occurred:  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. Revenue from film asset licensing agreements containing multiple film titles is allocated among the various film titles based on their relative estimated fair values. Payments received from licensees prior to the availability of a film are recorded as deferred revenue. Fees payable with terms in excess of one year are discounted for revenue recognition purposes at the customer’s estimated incremental borrowing rate in accordance with Accounting Principles Board (“APB’) Opinion No. 21, Interest on Receivables and Payables.

Taxes on Income

Pursuant to the tax sharing agreement entered into with Hallmark Cards in March 2003, the Company’s results of operations for tax purposes became a part of the Hallmark Cards consolidated federal tax return as of and subsequent to March 2003.  However, the Company continues to account for income taxes on a separate return basis. Accordingly, the Company accounts for income taxes using an asset and liability method which 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 bases 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. Any payments received from Hallmark Cards under the tax sharing agreement are recorded as an increase in additional paid-in capital and any future utilization of deferred tax assets generated after March 2003 will be recorded as a reduction in paid-in capital, to the extent payments

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were previously received from Hallmark Cards for such benefits under the tax sharing agreement.

Stock-Based Compensation

The Company accounts for its stock-based employee compensation plan using the intrinsic value method under the recognition and measurement principles of 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 exercise price of the underlying stock options. In December 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of SFAS No. 123. SFAS No. 148 requires certain additional disclosures of the estimated fair value of stock-based compensation. Such estimated fair value is determined through the use of the Black-Scholes option pricing model. 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.

Had compensation expense for these plans been determined consistent with SFAS No. 123, Crown Media Holdings’ net loss and loss per share would have been increased to the following pro forma amounts for the three months ended March 31, 2004 and 2005:

Pro Forma Effects

(In thousands, except per share amounts)

Net Loss per Share

Basic net loss per share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed based on the weighted average number of common shares and potentially dilutive common shares outstanding. The calculation of diluted net loss per share excludes potential common shares if the effect would be antidilutive. Potential common shares consist of incremental common shares issuable upon the exercise of stock options and restricted stock units. Approximately 1.6 million and 1.4 million stock options for the three months ended March 31, 2004 and 2005, respectively, have been excluded from the calculations of earnings per share because their effect would have been antidilutive.

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 (loss). Foreign currency transaction gains and losses recorded upon the remeasurement of financial assets and liabilities denominated in currencies other than the functional currency of the subsidiary are included in determining net loss for the period.

Concentration of Credit Risk

Financial instruments, which potentially subject Crown Media Holdings to a concentration of credit risk, consist

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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.

Reclassifications

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

Recently Issued Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions. The amendments made by SFAS No. 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, APB Opinion No. 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. APB Opinion No. 29 provided an exception to its basic measurement principle (fair value) for exchanges of similar productive assets. The FASB believes that exception required that some nonmonetary exchanges, although commercially substantive, be recorded on a carryover basis. By focusing the exception on exchanges that lack commercial substance, the FASB believes SFAS No. 153 produces financial reporting that more faithfully represents the economics of the transactions. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date of issuance. The provisions of SFAS No. 153 shall be applied prospectively. The Company does not anticipate that the adoption of SFAS No. 153 will have a significant impact on the Company’s overall results of operations or financial position.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment. SFAS No. 123R replaced SFAS No. 123, Accounting for Stock-Based Compensation, and superseded Accounting Principles Board Opinion No. 25,  Accounting for Stock Issued to Employees.  SFAS No. 123R will require compensation cost related to share-based payment transactions to be recognized in the financial statements. As permitted by SFAS No. 123, Crown Media Holdings elected to follow the guidance of APB Opinion No. 25, which allowed companies to use the intrinsic value method of accounting to value their share-based payment transactions with employees.  Based on this method, Crown Media Holdings did not recognize compensation expense in its financial statements as the stock options granted had an exercise price equal to the fair market value of the underlying common stock on the date of the grant.  SFAS No. 123R allows measurement of the cost of share-based payment transactions to employees at the fair value of the award on the grant date and recognition of expense over the requisite service or vesting period. SFAS No. 123R allows implementation using a modified version of prospective application,  under which compensation expense for the unvested portion of previously granted awards and all new awards will be recognized on or after the date of adoption.  SFAS No. 123R also allows companies to adopt SFAS No. 123R by restating previously issued financial statements,  basing the amounts on the expense previously calculated and reported in their pro forma footnote disclosures required under SFAS No. 123. The provisions of SFAS No. 123R will be adopted by Crown Media Holdings using the modified prospective method beginning January 1, 2006.

In March 2005, the SEC staff issued guidance on FASB Statement No. 123 (revised 2004), Share-Based Payment, SFAS No. 123R. Staff Accounting Bulletin (“SAB”) No. 107 was issued to assist preparers by simplifying some of the implementation challenges of SFAS No. 123R while enhancing the information that investors receive.  SAB No. 107 creates a framework that is premised on two overarching themes: (a) considerable judgment will be required by preparers to successfully implement SFAS No. 123R, specifically when valuing employee stock options; and (b) reasonable individuals, acting in good faith, may conclude differently on the fair value of employee stock options. Key topics covered by SAB No. 107 include: (a) valuation models – SAB No. 107 reinforces the flexibility allowed by SFAS No. 123R to choose an option-pricing model that meets the standard’s fair value measurement

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objective; (b) expected volatility – the SAB provides guidance on when it would be appropriate to rely exclusively on either historical or implied volatility in estimating expected volatility; and (c) expected term – the new guidance includes examples and some simplified approaches to determining the expected term under certain circumstances.  The Company will apply the principles of SAB No. 107 in conjunction with its adoption of SFAS No. 123R.

3. Subscriber Acquisition Fees

Subscriber acquisition fees are comprised of the following:

Of the net balance at March 31, 2005, the Company expects $28.3 million will be recognized as a reduction of subscriber fee revenue and $80.5 million will be recognized as subscriber acquisition fee expense in future periods. The Company expects to amortize the net balance at March 31, 2005, as follows:

As of December 31, 2004, and March 31, 2005, the consolidated balance sheets also reflect subscriber acquisition fees payable of $35.9 million and $33.5 million, respectively. For the three months ended March 31, 2004 and 2005, Crown Media United States made cash payments of $2.5 million and $3.9 million, respectively.

4. Program License Fees

Program license fees are comprised of the following:

Programming costs for the three months ended March 31, 2004 and 2005, were $19.0 million and $28.0 million, respectively. Amortization of program license fees for continuing operations, which is included as a component of programming cost in the accompanying consolidated statements of operations, was $19.0 million and $28.0 million, respectively, for the three months ended March 31, 2004 and 2005.

At December 31, 2004, and March 31, 2005, $7.7 million and $2.7 million of program license fees were

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included in prepaid and other assets on the accompanying condensed consolidated balance sheets as the Company had made payments, but the airing windows had not commenced.

License fees payable are comprised of the following:

5. Property and Equipment

Property and equipment are comprised of the following:

Depreciation expense related to property and equipment was $924,000 and $900,000 for the three months ended March 31, 2004 and 2005, respectively.

Software and other intangible assets of $3.2 million and $2.6 million as of December 31, 2004, and March 31, 2005, respectively, have been included in prepaid and other assets in the accompanying condensed consolidated balance sheets.

6. Reorganization

In October 2002, the Company reorganized its operations in order to concentrate its efforts on the Hallmark Channel in the U.S.  The following table displays the activity and balances of the reorganization accrual account from December 31, 2003, to March 31, 2005, which is included in the current portion of accounts payable and accrued liabilities in the accompanying condensed consolidated balance sheets.

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7. Credit Facility

The Company has a credit agreement with a syndicate of banks, led by JP Morgan Chase Bank, under which the banks extended to the Company a secured credit facility in the original amount of up to $320.0 million.  The Company and the lending banks entered into the facility in 2001 and have subsequently amended the terms of this facility, with the most recent amendment on March 1, 2005.  The facility is guaranteed by the Company’s subsidiaries and is secured by all tangible and intangible property of Crown Media Holdings and its subsidiaries.  The bank credit facility encompassed a term loan of $100.0 million and a revolving line of credit of $220.0 million, inclusive of up to $20.0 million of letters of credit available to be issued at the Company’s request.  Upon the consummation of sale of the international business, the Company repaid and retired the $100.0 million term loan along with $95.0 million on the revolving line of credit under the credit facility. The credit facility now consists of a revolving line of credit of $220.0 million, which includes up to $20.0 million of letters of credit.  In addition, following such closing, any borrowings by the Company of amounts in excess of the $180.0 million under the revolving line of credit will require approval of Hallmark Cards.

Each loan under the bank credit facility bears interest at a Eurodollar rate or an alternate base rate as the Company may request at the time of borrowing 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 rates change.  The Company is required to pay a commitment fee of 0.2% per annum (0.5% prior to March 1, 2005) of the committed, but not outstanding, amounts under the revolving credit facility, payable in quarterly installments.

As of March 1, 2005, we entered into Amendment No. 8 to the agreement for our bank credit facility.  This amendment extended the maturity date to May 31, 2006, as well as made a number of other significant changes to the bank credit facility including elimination of certain financial covenants, changes to and waivers of financial covenants concerning 2004 violations and the future compliance, and a reduction in the interest rates and commitment fees under the credit facility.

Several changes to financial covenants in the Amendment No. 7 to the bank credit facility were not effective until the Foreign Asset Sale Effective Date.  The Foreign Asset Sale Effective Date did not occur in 2004, which was one of the reasons that the Company needed waivers of its compliance with certain financial covenants in its bank credit facility.  Amendment No. 8 waived the Company’s non-compliance with the following financial covenants:  (1) capital expenditures in 2004; (2) cash program acquisition guaranties in 2004; (3) trailing 12-month EBITDA for the quarter ended December 31, 2004; (4) cash payments to television distributors for subscribers in 2004; (5) net worth at December 31, 2004; (6) leverage ratio for the quarter ended December 31, 2004; and (7) interest coverage ratio for the 2004 year.  Amendment No. 8 also deleted the net worth covenant; amended the limit on the Company’s cash program guarantees in 2005; amended the quarterly EBITDA requirements for the remainder of the loan term; and amended the limit of cash payments to television distributors for subscribers, the minimum number of subscribers and the minimum gross subscriber revenue.  Further, pursuant to Amendment No. 8, the limitation on Restricted Payments was amended to allow us to make certain payments to Hallmark Cards or its affiliates.

At December 31, 2004, and March 31, 2005, Crown Media Holdings had outstanding borrowings of $310.0 million under the credit facility and there were no letters of credit outstanding. At March 31, 2005, $310.0 million of the outstanding balance bore interest at the Eurodollar rate (3.85% at March 31, 2005). Interest expense on borrowings under the credit facility for the three months ended March 31, 2004 and 2005, was $3.1 million, and $3.9 million, respectively.

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8. Related Party Long-Term Obligations

Hallmark Letter of Credit

Pursuant to Amendment No. 8 to the bank credit facility, Hallmark Cards has provided an irrevocable letter of credit issued to JP Morgan Chase Bank by Citibank, N.A. in the amount of $320.0 million, as credit support for our obligations under the Company’s credit facility.  The support letter of credit was reduced to $220.0 million upon the consummation of the sale of the Company’s international business and the reduction of the aggregate outstanding credit exposure of its lenders to $220.0 million.  Drawdowns under the letter of credit may be made for amounts due and payable under the credit facility. Amounts in excess of $180.0 million require the concurrence of Hallmark Cards.  Any proceeds received by JP Morgan Chase Bank from drawing under this support letter of credit will not be applied to repay the Company’s obligations, but will be used to purchase on the part of Hallmark Cards from the bank lenders subordinated participations in our obligations under its bank credit facility, junior in payment to the bank lenders under the bank credit facility.  The support letter of credit automatically expires on May 31, 2006. The Company pays to Hallmark Cards, as compensation for the support letter of credit, the amounts resulting from the 2% reduction in the interest rate and the 0.3% reduction in the commitment fee payable by the Company under the bank credit facility as provided in Amendment No. 8.

Senior Unsecured Note

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

The senior unsecured note payable to HC Crown does not require cash payments until August 2007. Instead, the principal amount of the senior unsecured note accretes at 10.25% per annum, compounding semi-annually, to $596.6 million at August 5, 2007.  From that date, interest at 10.25% per annum will be payable semi-annually on the accreted value of the senior unsecured note to HC Crown.  The note matures on August 5, 2011, and is pre-payable by Crown Media Holdings at any time after August 5, 2004, without penalty. At December 31, 2004 and March 31, 2005, $460.9 million and $472.6 million, respectively, of principal and accrued interest were included in the senior unsecured note payable in the accompanying consolidated balance sheet. The note purchase agreement for the senior unsecured note contains certain covenants which restrict on the part of the Company, among other matters, from the incurrence of any additional indebtedness, the repurchase or other acquisitions of the Company’s stock, investments in other parties and the incurrence of liens on the Company’s assets.  As a fee for the issuance of the notes, the Company paid $3.0 million to HC Crown, which was initially capitalized and is being amortized as additional interest expense over the term of the note payable.

Line of Credit Payable to HC Crown

On December 14, 2001, the Company executed a $75.0 million promissory note with HC Crown maturing on the earlier of six months from the termination of the credit facility or December 21, 2007.  This line of credit is subordinate to the bank credit facility. The rate of interest under this line of credit is equal to LIBOR plus three percent, payable quarterly. At both December 31, 2004, and March 31, 2005, borrowings under the note were $75.0 million. Accrued interest on the note of $6.1 million, is included in interest payable to HC Crown and $7.2 million is included in line of credit and interest payable to HC Crown as of December 31, 2004, and March 31, 2005, respectively on the accompanying condensed consolidated balance sheets.

Hallmark Obligations

In connection with Amendment No. 8, by a letter dated February 28, 2005, Hallmark Cards confirmed to the Company that neither Hallmark Cards nor any of its wholly-owned subsidiaries would demand payment from the Company on certain obligations outstanding as of December 31, 2004, until May 31, 2006, at the earliest. Furthermore, the Company does not intend to pay the aforementioned liabilities before May 31, 2006.  Therefore, the Company has classified these liabilities as non-current liabilities on the accompanying consolidated balance sheet.

9. Related Party Transactions

Tax Sharing Agreement

On March 11, 2003, Crown Media Holdings became a member of Hallmark Cards consolidated federal tax group and entered into a federal tax sharing agreement with Hallmark Cards (the “tax sharing agreement”). Hallmark

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Cards includes Crown Media Holdings in its consolidated federal income tax return.  Accordingly, Hallmark Cards has benefited from past tax losses and will benefit from future federal tax losses, which may be generated by Crown Media Holdings.  Based on the tax sharing agreement, Hallmark Cards has agreed to pay Crown Media Holdings all of the benefits realized or realizable by Hallmark Cards as a result of including Crown Media Holdings in its consolidated income tax return, 75% in cash on a quarterly basis and the balance when Crown Media Holdings becomes a federal taxpayer.  Under the tax sharing agreement, at Hallmark Cards’ option, the non-interest bearing balance of the 25% in federal tax benefits may also be applied as an offset against any amounts owed by Crown Media Holdings to any member of the Hallmark Cards consolidation group under any loan, line of credit or other payable, subject to limitations under any loan indentures or contracts restricting such offsets. As of December 31, 2004, Hallmark Cards has not exercised this option.

The Company received $14.3 million and $21.4 million under the tax sharing agreement during the three months ended March 31, 2004 and 2005, respectively. These receipts have been recorded as an addition to paid-in capital.

Costs Incurred on Crown Media Holdings’ Behalf

Since inception, Hallmark Entertainment has at times paid certain costs on behalf of Crown Media Holdings. Hallmark Entertainment incurred $530,000 and $408,000 of costs on Crown Media Holdings’ behalf for the three months ended March 31, 2004 and 2005, respectively. Non-interest bearing unreimbursed costs of $4.5 million and $4.9 million are included in payable to affiliates in the accompanying condensed consolidated balance sheets as of December 31, 2004, and March 31, 2005, respectively.

Services Agreement with Hallmark Cards

Crown Media Holdings entered into an Intercompany Services Agreement with Hallmark Cards, effective January 1, 2003, under which Hallmark Cards agreed for a term of three years to provide Crown Media Holdings with tax, risk management, health safety, environmental, insurance, legal, treasury and cash management services and real estate consulting services.  Under the agreement, the Company agreed to pay Hallmark Cards $515,000 per year for these services, plus out-of-pocket expenses and third party fees, payable in arrears on the last business day of each quarter. For each of the three months ended March 31, 2004 and 2005, Crown Media Holdings had accrued $129,000 under the agreement. At December 31, 2004, and March 31, 2005, non-interest bearing unpaid accrued service fees and unreimbursed expenses of $8.6 million and $8.8 million, respectively, were included in payable to affiliates in the accompanying condensed consolidated balance sheets.

Film Asset Services Agreement with Hallmark Entertainment

The Company entered into a film asset services agreement with Hallmark Entertainment, under which Hallmark Entertainment provides Crown Media Holdings with services related to the administration, distribution and other exploitation of the Company’s film assets. The services agreement expires on December 31, 2006, subject to cancellation by either party after the first or second year. In consideration for the services provided by Hallmark Entertainment, Crown Media Holdings is obligated to pay a service fee of $1.5 million per year, payable in quarterly installments of $375,000. At both December 31, 2004, and March 31, 2005, non-interest bearing unpaid accrued service fees of $375,000 were included in payable to affiliates in the accompanying condensed consolidated balance sheets.

Trademark Agreement with Hallmark Cards

Crown Media United States has trademark license agreement with Hallmark Licensing, Inc. for use of the “Hallmark” mark for the versions of the Hallmark Channel distributed in the United States and for the Hallmark Movie Channel.  Crown Media International and Crown Entertainment had trademark license agreements with Hallmark Cards for use of the “Hallmark” mark for the version of the Hallmark Channel distributed internationally.  The trademark license agreements for the Unites States Hallmark Channel and the Movie Channel expire on September 1, 2005. The Company is not required to pay any fees under the trademark license agreements.

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Program License Agreements with Hallmark Entertainment Distribution

Crown Media United States licenses programming for distribution in the United States from Hallmark Entertainment Distribution under a program license agreement, dated January 1, 2001. Under this program license agreement, Crown Media United States licenses programs owned or controlled by Hallmark Entertainment Distribution, as well as all programming produced by or on behalf of Hallmark Entertainment Distribution for Crown Media United States. The program agreement has a term of five years and is automatically renewable for additional three-year periods, subject to rate adjustments, so long as Hallmark Entertainment Distribution or its affiliates, owns an interest of 35% or more of Crown Media Holdings.  If, at any time, Hallmark Entertainment Distribution ceases to own a 35% interest in Crown Media Holdings, and if, at that time, the remaining term of the program agreement is less than two years, then the remaining term of the program agreement will be extended to the date two years after the date on which Hallmark Entertainment Distribution ceased to own a 35% interest in Crown Media Holdings.

Crown Media International had a program license agreement with Hallmark Entertainment Distribution dated January 1, 2001. The agreement would have expired on December 31, 2005, subject to a renewal through December 31, 2010. Under the terms of the agreement, Crown Media International had the exclusive right to exhibit Hallmark Entertainment Distribution produced programming in the territories in which Crown Media International operated during three 18-month windows. Crown Media International also had the exclusive right to exhibit programming in markets where it did not currently operate, if it elected to distribute the channel in those markets, subject to any agreement between Hallmark Entertainment Distribution and a third party existing at the time Crown Media International launches the channel in those markets. In addition, under the agreement, Hallmark Entertainment Distribution was generally obligated to sell to Crown Media International all of the programming it produces and Crown Media International was obligated to purchase up to 50 programs produced per year during the term of the agreement.

If Crown Media United States sub-licenses any licensed program to a third party, it must equally share with Hallmark Entertainment Distribution the excess, if any, of the sublicensing fee over the initial program license fee paid by the Company.  The Company did not sub-license any licensed programming to third parties during the three months ended March 31, 2004 and 2005.  Amounts due to Hallmark Entertainment Distribution as a result of these sub-licensing agreements have been included in license fees payable to affiliates in the accompanying balance sheets as noted below.

Programming costs related to the Hallmark program agreements were $4.6 million and $6.7 million, respectively, for the three months ended March 31, 2004 and 2005. As of December 31, 2004, and March 31, 2005, $152.0 million and $162.8 million, respectively, are included in license fees payable to affiliates in the accompanying condensed consolidated balance sheets. The Company obtained a letter from Hallmark Cards whereas Hallmark Cards or its subsidiaries will not demand payment of these license fees prior to May 31, 2006.

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

VISN owns a $25.0 million company obligated mandatorily redeemable preferred interest in Crown Media United States (the “preferred interest”) issued in connection with an investment by Crown Media International in Crown Media United States. On November 13, 1998, HEN Domestic Holdings, Inc., a wholly-owned subsidiary of Crown Media International, Vision Group, VISN and Henson Cable Networks, Inc. signed an amended and restated company agreement governing the operation of Crown Media United States, which agreement was further amended on February 22, 2001 and January 1, 2002 (the “company agreement”).

 Under the company agreement, the members agreed that if during any year ending after January 1, 2005 and prior to December 31, 2009, Crown Media United States has net profits in excess of $10.0 million, and the preferred interest has not been redeemed, Crown Media United States will redeem the preferred interest in an amount equal to the lesser of: (i) such excess net profits; (ii) $5.0 million; or (iii) the amount equal to the preferred liquidation preference on the date of redemption.  Crown Media United States may voluntarily redeem the preferred interest at any time, however, it is obligated to do so on the date of redemption (December 31, 2010). Due to the mandatory redemption provision of the preferred interest, on July 1, 2003, the preferred interest was remeasured at fair value

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and reclassified to non-current liabilities in accordance with the provisions of SFAS No. 150.

Under the company agreement, Crown Media United States may be required to make certain payments in regards to programming provisions to the National Interfaith Cable Coalition (“NICC”).  Specifically, Crown Media United States may be required to pay license fees to NICC or fund production costs consisting of: (i) a total of $5.3 million per year, with consumer price index escalations, for two recurring programming blocks produced by NICC; (ii) up to $10 million per year for an additional recurring “signature” series program block co-produced by NICC and Crown Media United States; (iii) up to $600,000 per “non-dramatic” holiday special produced by NICC; and (iv) up to $1.0 million per “dramatic” holiday special co-produced by NICC and Hallmark Entertainment. In addition, six months prior to the expiration of the agreement, Crown Media United States must negotiate in good faith with NICC regarding a continuation of this programming and funding commitment. If agreement is not reached and Crown Media United States does not continue the NICC programming and funding commitments at the same levels, NICC is entitled to compel Crown Media Holdings to repurchase all of NICC’s Crown Media Holdings shares at their then-current market value no later than 60 days following the expiration of the amendment. Crown Media United States, however, can nullify this put by electing to continue the NICC programming and funding commitments at the same levels.

Pursuant to additional amendments effective January 1, 2002, and January 1, 2004, Crown Media United States agreed to advance NICC $3,000,000 in each of 2002, 2003 and 2004 to help fund NICC’s cost of expanding its production operations to produce the aforementioned programming.  This advance will be recovered from the license fees payable for this programming when such programming is produced and accepted by Crown Media United States for distribution on the channel. These expenses are included as components of affiliate programming costs in the accompanying consolidated statements of operations.   See Note 14 regarding NICC’s threatened litigation against the Company.

During the three months ended March 31, 2004 and 2005, Crown Media United States paid NICC $3.5 million and $2.6 million, respectively, related to the company agreement, as amended.

11. Employee Incentives

In April 2003, the Company’s Board of Directors approved actions to provide additional incentives to 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 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, resulting in a total of 5,126,732 options exchanged for 2,050,693 RSUs. 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 determination of whether RSUs will be settled in cash or common stock is made by the Company’s Board of Directors. The RSUs vest over three years in one-third increments on the anniversary of the grant date each year.

Options for 279,254 shares of common stock owned by certain executives and vice presidents 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.

In May 2004, the Company’s Board of Directors approved an additional grant to employees of 1,065,000 RSUs. The Employment RSUs, which constitute 70% of the award granted in 2004, vest in equal one-third installments over the next three years on the anniversary of the grant date each year. The Company is accruing expense related to the Employment RSUs ratably over each installment’s vesting period. The Performance RSUs, constituting 30% of the award granted in 2004, vest on the 3^rd anniversary of the grant date, provided that the price of the Crown common stock is $14 or higher on that date. The Company will begin to accrue compensation expense for the Performance RSUs when it becomes probable that the price of the Company’s stock will be $14 or more on the 3^rd anniversary of the grant date.

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The Company is recording compensation expense based on the fair value of the common stock or cash equivalent required to settle the RSUs at each reporting period end during the vesting period of the RSUs. Such compensation expense is calculated using variable plan accounting.

The Company recorded $2.3 million and $2.4 million, of compensation expense associated with the RSUs during the three months ended March 31, 2004 and 2005, respectively, which has been recorded as a liability for restricted stock units in the accompanying consolidated balance sheet and is included in selling, general and administrative expense in the accompanying consolidated statement of operations. The Company settled certain RSUs during the three months ended March 31, 2005, for approximately $4.2 million in cash. Additionally, in conjunction with the close of the international transaction, the Company immediately vested and settled RSUs held by international employees in May 2005 for approximately $4.0 million in cash.

12. Segment Reporting

The Company’s continuing operations are currently organized into two principal divisions representing operating segments: domestic channel and film distribution. The Company evaluates performance and allocates resources based on the results of these segments. The key operating performance criteria used in this evaluation include revenue, segment income (loss) and total assets.  The results of operations of our international channel operating segment are not included in the segment reporting as they are classified separately as discontinued operations in the Company’s consolidated financial statements (see note 13).

The following tables present the Company’s key performance measures (in thousands):

March 31, 2004

March 31, 2005

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(1) Adjustment represents netting of certain subscriber acquisition fee expense against revenue not allocated to domestic segment and film asset license fees from international sources.

(2) Represents amounts not allocated to segments that are reviewed by our chief operating decision maker.

(3) Represents programming amortization excluded from individual segment income (loss) calculations.

(4) Represents assets held for sale.

No individual pay television distributor accounted for more than 15% of the Company’s consolidated subscribers for the three months ended March 31, 2004 and 2005.

13.  Assets Held for Sale and Discontinued Operations

On February 23, 2005, the Company signed an agreement for the sale of these assets and obtained other agreements enabling the Company to then conduct the sale on an “as is” basis.  The sale closed on April 26, 2006.  The accompanying balance sheet as of March 31, 2005, presents the international channel and film assets as “held for sale” pursuant to SFAS No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets.  Liabilities associated with these assets are similarly classified.  The accompanying condensed consolidated statements of operations and cash flows for each of the three month periods ended March 31, 2004 and 2005 present the associated results of operations and cash flows of the international assets as “discontinued operations.”

The carrying amounts of the major classes of assets and liabilities included in the disposal group are comprised of the following:

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The net losses from discontinued operations during each of the three month periods ended March 31, 2004 and 2005, consisted of the following:

Effective February 23, 2005, the Company ceased depreciating and amortizing certain of the international assets held for sale.  Had the Company not ceased such depreciation and amortization, the loss for discontinued operations for the three months ended March 31, 2005 would have included an additional $995,000 of depreciation and amortization expense and an additional $1.8 million of amortization of film assets.

Assets held for sale as of March 31, 2005, of $223.0 million were comprised of $77.8 million of assets previously included in our international segment and $145.2 million of assets previously included in our film distribution segment.

Interest expense includes an allocation of interest related to the Company’s bank credit facility that was required to be paid as a result of the sale.  The allocation was required by Emerging Issues Task Force (“EITF”) Issue No. 87-24, Allocation of Interest to Discontinued Operations.  Such interest expense amounted to $1.1 million and $1.4 million for the three month periods ended March 31, 2004 and 2005, respectively.  Upon receipt of cash from the sale, the Company was required to repay and retire the $100.0 million of the Company’s bank credit facility.

14. Commitments and Contingencies

In the normal course of business, the Company has entered into agreements that commit it to make cash payments in future periods with respect to non-cancelable leases and programming contracts.

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 have not breached the Amendment.  We cannot, however, predict at this time whether the letter will result in litigation, an amendment or other resolution. Accordingly, we have not provided for any amount of loss in these condensed financial statements for this matter.

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

The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” beginning on page 29 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

Description of Business and Overview

Crown Media Holdings, Inc. (“Crown Media Holdings,” “Crown Media” or the “Company”), through its subsidiaries, owns and operates pay television channels (collectively the “Hallmark Channel” or the “channel”) dedicated to high quality, entertainment programming for adults and families, in the United States and, prior to the sale of its international business, in various countries throughout the world.

Crown Media Holdings owns and operates the Hallmark Channel and the Hallmark Movie Channel in the United States and, prior to the sale of its international business, the Hallmark Channel in various countries throughout the world.  At the end of the first quarter, the Hallmark Channel was in 67.7 million homes in the United States and 60.1 million homes internationally.  The Hallmark Channel in the United States has been successful in increasing overall ratings.  During the first quarter of 2005, a new programming concept, Hallmark Channel Mystery Movies, was introduced.  This new programming concept premiered on Friday nights during the first quarter of 2005 and each of the movies averaged a household coverage rating of 1.3, which was a nearly 60% increase from the same period in the prior year.  In addition, the Hallmark Channel in the United States premiered a number of other original movies that also resulted in very strong ratings.  The success of our programming and ratings had a positive impact on the demand on our advertising in the first quarter of 2005.  As a result, our advertising sales increased significantly during the first quarter of 2005 as compared to the first quarter of 2004.  Enhanced programming and increased ratings are also important tools to use to drive increased distribution with cable operators.

On April 26, 2005, the sale of our international business was completed.  Proceeds from the sale have been used to repay and retire $100.0 million of our bank credit facility and reduce the outstanding balance on our $220.0 million revolving credit facility. The completion of the sale of the international business has allowed Crown Media Holdings to focus on the growth and success of the Hallmark Channel in the United States.

Crown Media Holdings also owns a film library.  The film library has approximately 640 titles.  Through its wholly owned subsidiary, Crown Media Distribution, Crown Media Holdings distributes titles from the library in a variety of television media including broadcast, cable, Video-on-Demand and High Definition Television. In addition, the Company utilizes the film library for programming content on the Hallmark Channels. The Company has increased its internal use of its film assets on the domestic channel in 2005 as compared to the prior year.

Also in the first quarter of 2005, Crown Media Holdings launched its second 24-hour linear channel, Hallmark Movie Channel.  The Hallmark Movie Channel will focus on movies and mini-series and will utilize content from our film library for programming.  The launch of the Hallmark Movie Channel is an opportunity for Crown Media Holdings to build a second programming asset, use this programming asset as a value added enhancement to increase distribution of the Hallmark Channel, and further leverage the content in our film library.

As Crown Media Holdings and the Hallmark Channel continue to develop, the core focus for the business remains unchanged.  First, distribution must continue to expand. While recent ratings performance ranks the Hallmark Channel in the top ten of cable networks, in terms of distribution, the Hallmark Channel is only in the top 40 cable networks. Increased distribution should improve not only our subscriber revenue, but should also improve our advertising revenue. The combination of our current ratings with increased distribution should also have a positive impact on advertising revenue. As noted above, increased distribution in and of itself will enhance advertising sales simply because of the increased viewer universe. However, combining growing distribution with increasing ratings is more powerful in terms of advertising revenue. As a result, the Hallmark Channel will continue

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to focus on enhancing the programming schedule through new series, additional original movies such as the recent Mystery Movies, and through unique scheduling concepts.

In addition, we plan to focus on library sales. The Crown Media film library is a large collection of award winning movies and mini-series. It is unique in that it is such a large collection of family oriented films. We plan to use the library on the Hallmark Channel, the Hallmark Movie Channel and for sales to third parties.

All of the above needs to be accomplished in a cost effective fashion. Cost management will continue to be a focus for the management of Crown Media Holdings.

The Hallmark Channel in the United States faces short-term and long-term challenges on the distribution front.  As noted above, the near-term focus remains on growing the subscriber base.  One of the nine largest multiple service operators has been our largest source of subscriber growth over the last 18 months due to contractual monetary incentives, and we believe that we will continue to grow our subscriber base with this multiple systems operator in the future.  The long-term distribution challenges will be renewing our distribution arrangements with the multiple system operators as they expire.  While the economics of the renewals is unknown and could have a significant impact on our business, we believe that the success of the Hallmark Channel in terms of ratings and the environment we have created with our programming schedule will enhance our renewal discussions. We also believe that our ability to offer to the multiple systems operators a second channel, the Hallmark Movie Channel, is a value added component of the renewal equation.  The largest factors contributing to the economics of the distribution agreements are license fees and subscriber acquisition fees.

The Hallmark Channel continues to improve its ratings.  Three factors have contributed to the ratings improvements of the Channel: acquired series and movies, original productions and marketing.  Acquired series ranging from Little House and Perry Mason to Walker, Texas Ranger and M*A*S*H have consistently delivered strong ratings across all day-parts.  Original productions are our most high profile programs and generate the channel’s highest ratings.  Original productions are significant in helping our distribution and advertising sales teams sell the channel. Substantially, all of our original programming is provided by Hallmark Entertainment, a subsidiary of Hallmark Cards. The recent success of the Mystery Movies and other recent originals drives this point home.

The marketing and promotion strategy is another essential part of the ratings equation.  Marketing and promotion are responsible for attracting viewers to our big events as well as building awareness of the channel in general.

To continue the ratings growth and enhance the demographics of our viewers, the Hallmark Channel must continue to invest in programming and marketing.  For the Hallmark Channel to continue to increase its attractiveness to distributors and advertisers, it has to increase the ratings, but also attract a younger more upscale audience, which is generally more attractive to advertisers.

Strong distribution and ratings growth delivering to larger audiences has made it possible for the advertising sales to grow rapidly over the last few years.  To advertisers, the Hallmark Channel offers a strong brand, positive environment and family friendly programming with a successful growth pattern.  These characteristics have enabled the channel to sell to advertisers in the packaged goods and pharmaceutical industries.  The next step for the Hallmark Channel will be to deliver the younger more upscale audience needed to attract advertisers from the attractive financial services and automotive industries.

International Business

The Company sold its international business to a group of investors comprised of Equity Partners, 3i and U.K. executive David Elstein (collectively, the “buyer”) in a transaction that closed on April 26, 2005. The sale included the international versions of the Hallmark Channel distributed outside the United States, the international rights to over 580 titles in the Crown Media film library, and the network broadcast facility based in Denver, Colorado.  The sale price was $242.0 million, subject to certain purchase price adjustments relating to receivables acquired and working capital changes. Upon closing of the transaction, the Company received cash proceeds of approximately $209.3 million; such proceeds were net of approximately $12.7 million paid to the buyer for future services to be provided by the buyer under a services contract and $20.0 million related to certain accounts receivable not acquired

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by the buyer.  Within 45 days from the close of the transaction, the purchase price may be adjusted for certain minimum working capital considerations, guarantees and commitments, which we estimate will reduce the net cash proceeds by approximately an additional $2.0 million in the aggregate. The Company agreed to pay the buyer approximately $24.1 million over a specified number of years to cover the fair value amount of certain obligations transferred with the international business. Proceeds from the transaction were used by Crown Media Holdings to reduce outstanding indebtedness under its bank credit facility and to pay transaction fees, restricted stock unit settlements, and employment contract terminations and severance for certain executives who were involved in the Company’s international business and not retained by the buyer.

Substantially all of the employees of the international business as well as the broadcast facility were retained by the buyer.  Subsequent to the sale, the Company has no continuing economic involvement with the operations of the international business.

The international business is classified in the financial statements at March 31, 2005 and for the three months ended March 31, 2004 and 2005, as assets held for sale and discontinued operations, respectively.

Revenue from Continuing Operations

Our revenue consists primarily of subscriber fees, advertising and film asset license fees.

Subscriber Fees

Subscriber fees are generally payable to us on a per subscriber basis by pay television distributors for the right to carry our channels. Generally, we pay certain television distributors up-front subscriber acquisition fees to carry our channel. Subscriber acquisition fees that we pay are capitalized and amortized over the contractual term of the applicable distribution agreement as a reduction in subscriber fee revenue. If the amortization expense exceeds the revenue recognized on a per distributor basis, the excess amortization is included as a component of cost of services. At the time we sign a distribution agreement, we evaluate the recoverability of the costs we incur against the incremental revenue directly and indirectly associated with each agreement.

Rates we receive per subscriber vary according to:

•                                          the level of sophistication and degree of competition in the market;

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

•                                          the packaging arrangements for the channel; and

•                                          other commercial terms and length of the contract term.

We are in continuous negotiations with our existing distributors to increase our subscriber base in order to enhance our advertising results. We are often subject to requests by distributors to pay subscriber acquisition fees for additional subscribers or to waive or accept lower subscriber fees if certain numbers of additional subscribers are provided. We also may help fund the distributors’ efforts to market our channels or we may permit distributors to offer limited promotional periods without payment of subscriber fees. As we continue our efforts to add subscribers, our domestic subscriber revenue will continue to be negatively affected by subscriber acquisition fee amortization, waiver of subscriber fees and bulk discounts resulting from the attainment of certain subscriber levels; however, we believe that as a result of these measures, our subscriber counts will increase which in turn will allow us to attract additional advertisers and command higher advertising rates.

Our channel is usually offered as one of a number of channels on either a basic tier or part of other program packages and is not generally offered on a stand-alone basis. Thus, while a cable or satellite customer may subscribe and unsubscribe to the tiers and program packages in which our channel is placed, these customers do not subscribe and unsubscribe to our channel alone.  We are not provided with information from the distributors on their overall

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subscriber churn and in what manner their churn rates affect our subscriber counts; instead, we are provided information on the total number of subscribers who receive the Hallmark Channel.

Our subscriber count depends on the number of distributors carrying the Hallmark Channel and the size of such distributors as well as the program tiers on which our channel is carried by these distributors. From time to time, we experience decreases in the number of subscribers as promotional periods end, or as a distributor arrangement is amended or terminated by us or the distributor. Changes to distribution arrangements in the first quarter of 2005 have not been significant. Management analyzes the estimated effect each new or amended distribution agreement will have on revenues and costs. Based upon these analyses, management endeavors to achieve a fair combination of subscriber commitments and subscriber acquisition fees with each of our domestic distributors.

Advertising

Advertising sales generally are made on the basis of a price per advertising spot or per unit of audience measurement (for example, a ratings point). Thus, our advertising revenues are heavily dependent on the viewership of our channel. Prices vary on a market-by-market basis. Rates differ among markets depending on audience demographics.

In the U.S., our advertising rates are generally calculated on the basis of an agreed upon price per unit of audience measurement in return for a guaranteed commitment by the advertiser. We commit to provide advertisers certain rating levels in connection with their advertising. Revenue is recorded net of estimated delivery shortfalls, which are usually settled by providing the advertiser additional advertising time. Advertising rates also vary by time of year due to seasonal changes in television viewership.

Film Asset License Fees

Crown Media Distribution generates revenue from the film assets by granting licenses to exhibit the films to third parties in the United States We are also using the films as programming for our channel and the Movie Channel. Customers for our film assets consist of other television channels, home video distributors and brokers who resell rights to our film assets. License fees for our film assets are generally negotiated based upon the size of the potential audience who will be viewing the programming.

Cost of Services

Our cost of services consists primarily of program license fees, amortization of our film assets; subscriber acquisition fee expense; the cost of signal distribution; administration, distribution and other exploitation of our film assets; and the cost of promotional segments that are aired between programs. We expect cost of services to continue to increase in the future as we expand our existing markets and third party programming to support our advertising strategy.

Critical Accounting Policies, Judgments and Estimates

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

For further information regarding our critical accounting policies, judgments and estimates, please see the Notes to Unaudited Consolidated Financial Statements contained in this Report and “Critical Accounting Policies, Judgments and Estimates” beginning on page 32 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, filed with the SEC.

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Effects of Transactions with Related and Certain Other Parties

In 2005 and in prior years, we entered into a number of significant transactions with Hallmark Cards and its subsidiaries. These transactions include, among other things, programming, trademark licenses, administrative services, a line of credit, a tax sharing agreement and the issuance of a $400.0 million senior unsecured note. For information regarding such transactions and transactions with other related parties, please see “Effects of Transactions with Related and Certain Other Parties” beginning on page 34 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, filed with the SEC.

Selected Historical Consolidated Financial Data of Crown Media Holdings

In the table below, we provide selected historical consolidated financial and other data of Crown Media Holdings and its subsidiaries. The following selected consolidated statement of operations data for three months ended March 31, 2004 and 2005, are derived from the unaudited financial statements of Crown Media Holdings and its subsidiaries. This data should be read together with the consolidated financial statements and related notes included elsewhere in this Form 10-Q.