In April 2009, the FASB issued FSP FAS 107-1 and Accounting Principles Board (APB) 28-1, Interim Disclosures about Fair Value of Financial Instruments. The FSP amends SFAS No. 107, Disclosures about Fair Value of Financial Instruments, to require an entity to provide disclosures about fair value of financial instruments in interim financial information. This FSP is to be applied prospectively and is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company has included the required disclosures in its financial information for the quarter ending June 30, 2009.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (SFAS 165).   SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  SFAS 165 is effective for the Company as of June 30, 2009.  The adoption of SFAS 165 did not have a material impact on the Company’s condensed consolidated financial statements.

In July 2009, the FASB issued SFAS No. 168, FASB Accounting Standards Codification (SFAS 168), as the single source of authoritative nongovernmental U.S. generally accepted accounting principles. The Codification is effective for interim and annual periods ending after September 15, 2009. All existing accounting standards are superseded as described in SFAS 168. All other accounting literature not included in the Codification is non-authoritative. Management is currently evaluating the impact of the adoption of SFAS 168 but does not expect the adoption of SFAS 168 to impact the Company’s condensed consolidated financial statements.

3. Program License Fees

Program license fees are comprised of the following:

		As of December 31,				As of June 30,
		2008				2009
		(In thousands)
Program license fees — non-affiliates		$	576,779			$	623,005
Program license fees — Hallmark Cards affiliates			10,967				12,068
Program license fees, at cost			587,746				635,073
Accumulated amortization			(267,603	)			(310,741	)
Program license fees, net		$	320,143			$	324,332

At December 31, 2008, and June 30, 2009, $7.6 million and $6.8 million, respectively, of program license fees were included in prepaid and other assets on the accompanying condensed consolidated balance sheets as the Company made payments for the program license fees prior to commencement of the respective license periods.

License fees payable are comprised of the following:

		As of December 31,				As of June 30,
		2008				2009
		(In thousands)
License fees payable — non-affiliates		$	231,218			$	225,836
License fees payable — Hallmark Cards affiliates			9,871				10,409
Total license fees payable			241,089				236,245
Less current maturities			(128,638	)			(118,780	)
Long-term license fees payable		$	112,451			$	117,465

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4. Credit Facility

On March 2, 2009, the Company and JPMorgan Chase Bank executed Amendment No. 15 to the credit facility, renewing the Company’s $45.0 million credit line and extending the maturity date to March 31, 2010, all effective April 1, 2009.  The facility is guaranteed by Hallmark Cards and the Company’s subsidiaries and is secured by all tangible and intangible property of Crown Media Holdings and its subsidiaries.  Interest rates under the credit facility increased from the Eurodollar rate to the Eurodollar rate plus 2.25% and from the Alternate Base rate to the Alternate Base rate plus 1.25%.

The Company had at June 30, 2009, $24.6 million of unused revolving credit capacity. The Company’s ability to borrow additional amounts under the credit facility is not limited or restricted.

Each borrowing 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.  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 the greatest of the prime rate of JP Morgan Chase Bank, the one month London interbank market for Eurodollars plus 1.00% or the Federal Funds effective rate plus 0.50%, and is adjusted whenever the applicable rate changes.  Prior to the effectiveness of Amendment No. 15, the Company was required to pay a commitment fee of 0.15% per annum of the committed, but not outstanding, amounts under the revolving credit facility, payable in quarterly installments. Pursuant to Amendment No. 15, the commitment fee was increased to 0.375% per annum.

At December 31, 2008, and June 30, 2009, the Company had outstanding borrowings under the credit facility of $28.6 million and $20.4 million, respectively, and there were no letters of credit outstanding. At December 31, 2008, the outstanding balance bore interest at the Eurodollar rate (a 2.02% weighted average rate). At June 30, 2009, the outstanding balance bore interest at the Eurodollar rate (a 2.57% weighted average rate). Interest expense on borrowings under the credit facility for each of the three months ended June 30, 2008 and 2009, was $541,000 and $182,000, respectively. Interest expense on borrowings under the credit facility for each of the six months ended June 30, 2008 and 2009, was $1.4 million and $289,000, respectively.

Covenants

The credit facility, as amended, contains a number of affirmative and negative covenants.  The Company was in compliance with these covenants at June 30, 2009.

5. Related Party Long-Term Obligations

Waiver and Standby Purchase

On March 10, 2008, the Company, Hallmark Cards and affiliates of Hallmark Cards who hold obligations of the Company entered into an Amended and Restated Waiver and Standby Purchase Agreement, which was most recently amended in May 2009, to extend the waiver period to May 1, 2010 (the “Waiver Agreement”).  In connection with the recapitalization proposal described in Note 6, a Hallmark Cards affiliate stated that it would not further extend the waiver period. The Waiver Agreement replaced a previous version of the Waiver and Standby Purchase Agreement dated March 21, 2006 as amended through October 2007.  The Waiver Agreement defers payments (excluding interest on the 2001, 2005 and 2006 notes mentioned below) due on any of the following obligations (the “Subject Obligations”) until May 1, 2010, and interest on the 10.25% Note until August 5, 2010, or an earlier date as described below as the waiver termination date, whereupon all of these amounts become immediately due and payable (the “Waiver Period”):

 

·

Note and interest payable to HC Crown, dated December 14, 2001, in the original principal amount of $75.0 million, payable to HC Crown. (Total amount outstanding at December 31, 2008, and June 30, 2009, including accrued interest was $109.8 million and $110.3 million, respectively. See Note and Interest Payable to HC Crown below.)

 

·

$70.0 million note and interest payable to Hallmark Cards affiliate, dated as of March 21, 2006, arising out of the sale to Crown Media Holdings of the Hallmark Entertainment film library. (Total amount outstanding at December 31, 2008, and June 30, 2009, including accrued interest was $62.7 million and $63.0 million, respectively. See Note and Interest Payable to Hallmark Cards Affiliate below.)

 

 

·	10.25% senior secured note, dated August 5, 2003, in the initial accreted value of $400.0 million, payable to HC Crown.  (Total amount outstanding at December 31, 2008, and June 30, 2009, including accrued interest was $686.6 million and $721.8 million, respectively. See Senior Secured Note below.)

 

·

Note and interest payable to Hallmark Cards affiliate, dated as of October 1, 2005, in the principal amount of $132.8 million. (Total amount outstanding at December 31, 2008, and June 30, 2009, including accrued interest was $172.1 million and $172.8 million, respectively. See Note and Interest Payable to Hallmark Cards Affiliate below.)

 

 

·

All obligations of the Company under the bank credit facility by virtue of Hallmark Cards’ deemed purchase of participations in all of the obligations under a guarantee which Hallmark Cards has given in support of the facility or the purchase by Hallmark Cards of all these obligations pursuant to the bank credit facility.

 

 

·	Any and all amounts due and owing to Hallmark Cards pursuant to the Tax Sharing Agreement (Total amount outstanding at June 30, 2009, was $6.1 million.).

 

Interest will continue to accrue on these obligations during the Waiver Period.  The Waiver Agreement also contains certain covenants, including but not limited to (1) our covenant not to take any action that would prohibit us from being included as a member of Hallmark Cards consolidated federal tax group, (2) compliance with obligations in the loan documents for the bank credit facility and (3) commercially reasonable efforts to refinance the obligations subject to the Waiver Period.  Pursuant to the Waiver Agreement, the Company must make prepayments on the outstanding debt from 100% of any “Excess Cash Flow” during the Waiver Period.  There was no Excess Cash Flow for the first or second quarters of 2009. For the six months ended June 30, 2009, the Company repaid $8.2 million of principal under the credit facility and $10.4 million of interest due to Hallmark Cards affiliates, which amounts would otherwise be Excess Cash Flow. Additionally, in July 2009, the Company paid interest of $5.3 million to Hallmark Cards affiliates.

 

The waiver termination date is May 1, 2010, or earlier upon occurrence of certain events including but not limited to the following:  (a) the Company fails to pay any principal or interest, regardless of amount, due on any indebtedness to unrelated parties with an aggregate principal amount in excess of $5.0 million or any other event or condition occurs that results in any such indebtedness becoming due prior to its scheduled maturity, provided that the waiver will not terminate if the Company reduces the principal amount of such indebtedness to $5.0 million or less within five business days of a written notice of termination from Hallmark Cards; or (b) the Company fails to pay interest on the bank credit facility described above to the extent that Hallmark Cards has purchased all or a portion of the indebtedness thereunder or to perform any covenants in the Waiver Agreement.

 

Under the Waiver Agreement, if the bank lender under the bank credit facility accelerates any of the indebtedness under the bank credit facility or seeks to collect any indebtedness under it, the Company may elect to exercise its right to require that Hallmark Cards or its designated subsidiary exercise an option to purchase all the outstanding indebtedness under the bank credit facility.  All expenses and fees in connection with this purchase would be added to the principal amount of the credit facility obligations.

 

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Hallmark Guarantee; Interest and Fee Reductions

Hallmark Cards has provided to the lending bank under the credit facility the Hallmark Cards facility guarantee.  The guarantee is unconditional for obligations of the Company under the bank credit facility.  If any payment is made on the guarantee, it will be treated as a purchase of the lending bank’s interest in the credit facility.

Prior to April 1, 2009, Hallmark Cards provided an irrevocable letter of credit to JP Morgan Chase Bank as credit support for our obligations under the Company’s bank credit facility for which we previously paid the letter of credit fees. This letter of credit was cancelled on April 1, 2009.

Also, when Hallmark Cards’ issuance of the letter of credit resulted in reductions in the interest rate and commitment fees under the credit facility, we agreed to pay and have paid an amount equal to the reductions to Hallmark Cards.  With Hallmark Cards’ guarantee issued in place of the letter of credit, commencing April 1, 2009, such fee is reduced to 0.875%, representing the 0.75% reduction in the interest rate and the 0.125% reduction in the commitment fee. These amounts reflect an increase in the credit facility rates.

Senior Secured Note

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

In accordance with the Waiver Agreement, cash payments are not required until August 5, 2010 (which is the first payment date after May 1, 2010). The principal amount of the senior secured note accretes at 10.25% per annum, compounding semi-annually, to February 5, 2010.  From that date, interest at 10.25% per annum is scheduled to be payable semi-annually in arrears on the accreted value of the senior note to HC Crown on August 5 and February 5 of each year until maturity.  The note matures on August 5, 2011, and is pre-payable without penalty. At December 31, 2008, and June 30, 2009, $686.6 million and $721.8 million, respectively, of principal and interest were included in the senior note payable in the accompanying consolidated balance sheets. The note purchase agreement for the senior note provides that if there is an event of default, the accreted value and any accrued and unpaid interest on the senior note would become due and payable when there is a default with respect to any other indebtedness in excess of $5.0 million. The note purchase agreement for the senior note contains certain restrictive covenants which, among other things, prevent the Company from incurring any additional indebtedness, purchasing or otherwise acquiring shares of the Company’s stock, investing in other parties and incurring liens on the Company’s assets.  As a fee for the issuance of the notes, 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.

Note and Interest Payable to HC Crown

On December 14, 2001, the Company executed a $75.0 million promissory note with HC Crown.  Pursuant to the Waiver Agreement, the note is payable in full on May 1, 2010 (although the maturity date of the note is December 31, 2009). Under the Waiver Agreement, accrued interest on this 2001 Note was added to principal through November 15, 2008.  Commencing November 16, 2008, interest is payable in cash, quarterly in arrears five days after the end of each calendar quarter. This note is subordinate to the bank credit facility. The rate of interest under this note is currently LIBOR plus 5% per annum (9.05% and 6.19% at December 31, 2008, and June 30, 2009, respectively). At December 31, 2008, and June 30, 2009, $108.6 million, is reported as note payable to Hallmark Cards affiliate and $1.3 million and $1.7 million, respectively, are reported as interest payable to Hallmark Cards affiliate on the accompanying condensed consolidated balance sheet. Interest of $1.3 million was paid on January 5, 2009, interest of $1.7 million was paid on April 6, 2009, and interest of $1.7 million was paid on July 6, 2009.

Note and Interest Payable to Hallmark Cards Affiliate

On October 1, 2005, the Company converted approximately $132.8 million of its license fees payable to Hallmark affiliates to a promissory note.  The rate of interest under this note is currently LIBOR plus 5% per annum (9.05% and 6.19% at December 31, 2008, and June 30, 2009, respectively). Pursuant to the Waiver Agreement, the promissory note is payable in full on May 1, 2010 (although the maturity date of the note is December 31, 2009).  Under the Waiver Agreement, accrued interest on this 2005 Note was added to principal through November 15, 2008.  Commencing November 16, 2008, interest is payable in cash, quarterly in arrears five days after the end of each calendar quarter. At December 31, 2008, and June 30, 2009, $170.1 million is reported as note payable to Hallmark Cards affiliate and $2.0 million and $2.7 million, respectively, are reported as interest payable to Hallmark Cards affiliate on the accompanying condensed consolidated balance sheet. Interest of $2.0 million was paid on January 5, 2009, interest of $2.7 million was paid on April 6, 2009 and interest of $2.7 million was paid on July 6, 2009.

Note and Interest Payable to Hallmark Cards Affiliate

On March 21, 2006, the Company converted approximately $70.4 million of its payable to a Hallmark Cards affiliate to a promissory note. The rate of interest under this note is currently LIBOR plus 5% per annum (9.05% and 6.19% at December 31, 2008, and June 30, 2009, respectively). Pursuant to the Waiver Agreement, the promissory note is payable in full on May 1, 2010 (although the maturity date of the note is December 31, 2009). Under the Waiver Agreement, accrued interest on this 2006 Note was added to principal through November 15, 2008.  Commencing November 16, 2008, interest is payable in cash, quarterly in arrears five days after the end of each calendar quarter. At December 31, 2008, and June 30, 2009, $62.0 million is reported as note payable to Hallmark Cards affiliates and $717,000 and $971,000, respectively, are reported as interest payable to Hallmark Cards affiliate on the accompanying condensed consolidated balance sheet. Interest of $717,000 was paid on January 5, 2009, interest of $996,000 was paid on April 6, 2009 and interest of $971,000 was paid on July 6, 2009.

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Interest Paid to HC Crown Related to the Credit Facility

Interest expense paid to HC Crown in connection with the credit facility was $322,000 for the three months ended June 30, 2008, and $850,000 for the three months ended June 30, 2009.  Interest expense paid to HC Crown in connection with the credit facility was $712,000 for the six months ended June 30, 2008, and $998,000 for the six months ended June 30, 2009.

Related Party Note Obligations

The aggregate maturities of related party notes for each of the five years subsequent to December 31, 2008, are as follows:

		Payments Due by Period
		Total				2009				2010				2011				2012				2013
		(In thousands)
Note and interest payable to HC Crown,   with principal deferred until  May 1, 2010		$	110,280			$	1,699			$	108,581			$	-			$	-			$	-
10.25 % Senior secured note to HC Crown,   including accrued interest, due August 5, 2011			721,765				-				-				721,765				-				-
Note and interest payable to Hallmark Cards affiliate   with principal deferred until May 1, 2010			172,771				2,662				170,109				-				-				-
Note and interest payable to Hallmark Cards affiliate   with principal deferred until May 1, 2010			62,978				971				62,007				-				-				-
		$	1,067,794			$	5,332			$	340,697			$	721,765			$	-			$	-

6. Related Party Transactions

Recapitalization Proposal

On May 28, 2009, the Company received a proposal (the “Proposal”) from HC Crown Corp. (“HCC”), a wholly owned subsidiary of Hallmark Cards, Incorporated, regarding a recapitalization of the Company's existing indebtedness and accounts payable to HC Crown Corp. and its affiliates (“HCC Debt”) in excess of $1.05 billion. Under the Proposal, $500.0 million principal amount of HCC Debt would be restructured into new secured loans (the “New Debt”) with a maturity date of September 30, 2011 and the remaining balance of the HCC Debt would be converted into an equal amount of convertible preferred stock (the “Preferred Stock”).

As stated in the Proposal, the New Debt would have two tranches: (1) Tranche 1 of $300.0 million would be cash-pay and would bear interest at the rate of 12% per annum and the Company would have the ability to pay-in-kind up to three quarterly payments and (2) Tranche 2 of $200.0 million would be pay-in-kind at the rate of 15% per annum. The New Debt would be secured by the Company's assets.

The terms of the Preferred Stock would include (1) an aggregate liquidation preference, equal to the amount of converted HCC Debt; (2) no preferential dividend but participation in any dividends on the Common Stock on an “as if converted” basis; (3) the ability to convert into common stock at a rate equal to the liquidation preference divided initially by $1.00 per share, which permits the Company’s existing shareholders (including Hallmark) to retain 15% ownership of the Company; (4) the Company's ability to redeem the Preferred Stock at a price equal to the liquidation preference; and (5) the ability to vote together with the Common Stock on an “as if converted” basis.

As part of the Proposal, the Company’s certificate of incorporation would be amended to authorize additional shares of Preferred Stock and Common Stock in amounts sufficient for the proposed conversion of HCC Debt into Preferred Stock and the conversion of such Preferred Stock into Common Stock.  The Proposal also contemplates a merger of Hallmark Entertainment Holdings and HEIC into the Company, with the shareholders in Hallmark Entertainment Holdings and HEIC receiving Common Stock of the Company in accordance with their indirect ownership of the Company immediately prior to such mergers.  Additionally, the existing Federal Income Tax Sharing Agreement would be amended to, among other things, permit the Company to deduct both cash-pay and pay-in-kind interest due to Hallmark Cards in calculating tax-sharing payments on a prospective basis.

The HCC Debt is subject to the Waiver Agreement described above that provides, among other things, that during the Waiver Period (which is scheduled to expire on May 1, 2010), HCC will not accelerate the maturity of the HCC Debt, initiate proceedings for the collection of the HCC Debt, foreclose on the collateral security for the HCC Debt, or commence or participate in certain bankruptcy proceedings with respect to the Company. In connection with the Proposal, HCC stated that it will not further extend the expiration of the Waiver Period.  The Company's Board of Directors has formed a Special Committee comprising of A. Drue Jennings (Chairman), Herb Granath and Peter Lund that is reviewing and considering the proposed recapitalization.  In July 2009, the Special Committee announced that it has retained an independent financial advisor to aid in the Special Committee’s review of the proposed recapitalization.

There can be no assurance as to whether the Proposal will be agreed to by the Company or when, if ever, a recapitalization of the Company will be consummated, and if consummated whether the terms will be the same or different than those set forth in the Proposal.  The Proposal has been filed with the Securities and Exchange Commission by the Company in a May 28, 2009 Form 8-K Report and by Hallmark Cards in an amendment to a Schedule 13D concerning the Company.

On July 16, 2009, counsel to HCC delivered a letter (the “July 16 Letter”) to counsel to the Special Committee.  In the July 16 Letter, counsel to HCC reiterated its understanding that the Special Committee needs time to determine an appropriate response to the Proposal.  Although HCC had requested to receive a decision from the Company regarding the Proposed prior to the filing of the Company’s second quarter Form 10-Q, HCC’s counsel confirmed in the July 16 Letter that the filing date was in no way intended as a deadline.  In addition, counsel to HCC confirmed that notwithstanding HCC’s understanding that the Company is unable to obtain refinancing of the debt owed to HCC, HCC assumes that the Special Committee will explore other refinancing alternatives.

For information on the lawsuit brought in July 2009 with respect to the Proposal, see Note 11, Subsequent Events.

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Tax Sharing Agreement

Overview

On March 11, 2003, Crown Media Holdings became a member of Hallmark Cards consolidated U.S. federal tax group and entered into a federal tax sharing agreement with Hallmark Cards (the “tax sharing agreement”). Hallmark Cards includes Crown Media Holdings in its consolidated U.S. federal income tax return.  Accordingly, Hallmark Cards has benefited from past tax losses and may 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 by Hallmark Cards as a result of including Crown Media Holdings in its consolidated income tax return.  These benefits are estimated and paid 75% in cash on a quarterly basis and the balance when Crown Media Holdings becomes a federal taxpayer.  A final true-up calculation is completed within 15 days after Hallmark Cards files its consolidated federal income tax return for the year.  Pursuant to the true-up calculation, Crown Media Holdings is obligated to reimburse Hallmark Cards the amount that any estimated payments have exceeded the actual benefit realized by Hallmark Cards and Hallmark Cards is obligated to pay Crown Media Holdings the amount that any actual benefit exceeds the estimated payments.  Under the tax sharing agreement, at Hallmark Cards’ option, the non-interest bearing balance of the 25% in federal tax benefits not funded immediately may be applied as an offset against any amounts owed by Crown Media Holdings to any member of the Hallmark Cards consolidated group under any loan, line of credit or other payable, subject to limitations under any loan indentures or contracts restricting such offsets.

The Company received $5.1 million, which was offset during the first quarter of 2008 against debt owed under the tax sharing agreement with Hallmark Cards, and $5.1 during the second quarter of 2008 under the tax sharing agreement ($10.2 million for the six months ended June 30, 2008). The Company recorded $2.8 million as a payable to Hallmark Cards affiliates during the first quarter of 2009 under the tax sharing agreement and $3.3 million as a payable to Hallmark Cards affiliates during the second quarter of 2009 ($6.1 million for the six months ended June 30, 2009). Any payments received from Hallmark Cards or credited against amounts owed by Crown Media Holdings to any member of the Hallmark Cards consolidated group under the tax sharing agreement have been recorded as paid-in capital in the consolidated statements of stockholders’ equity (deficit).

Services Agreement with Hallmark Cards

Hallmark Cards provides various support services to the Company under a 2003 agreement, the most recent renewal of which expires December 31, 2009.  Such services include tax, risk management, health safety, environmental, insurance, legal, treasury, human resources, cash management services and real estate consulting services.  In exchange, the Company is obligated to pay Hallmark Cards a fee, plus out-of-pocket expenses and third party fees, in arrears on the last business day of each quarter. Fees for Hallmark Cards’ services were $541,000 for 2008 and are scheduled to be $428,000 for 2009. With the concurrence of Hallmark Cards, the Company deferred payment of fees for services provided through September 2008. Commencing October 2008, the Company has paid the required monthly fees, amounting to $135,000 during the three months ended December 31, 2008, and   $107,000 during both the three months ended March 31, and June 30, 2009, and $214,000 during the six months ended June 30, 2009.

At December 31, 2008, and June 30, 2009, non-interest bearing unpaid accrued service fees and unreimbursed expenses of $14.8 million and $15.0 million, respectively, were included in payable to affiliates on the accompanying consolidated balance sheets. For the year ended December 31, 2008, and the six months ended June 30, 2009, related out-of-pocket expenses and third party fees were $1.1 million and $208,000, respectively.

Trademark License Agreement

Crown Media United States has a trademark license agreement with Hallmark Licensing, Inc. for use of the “Hallmark” mark for the Hallmark Channel and for the Hallmark Movie Channels.  During 2008, Hallmark Cards extended the trademark license agreements for the Hallmark Channel and the Hallmark Movie Channels to September 1, 2009. The Company is not required to pay any fees under the trademark license agreements.

The Company has accounted for the agreement pursuant to the contractual terms of the arrangement, which is royalty free.  Accordingly, no amounts have been reflected in the balance sheet or income statement of the Company.

7. 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 the Company in Crown Media United States. On November 13, 1998, the Company, Vision Group, VISN and Henson Cable Networks, Inc. signed an amended and restated company agreement governing the operation of Crown Media United States (the "company agreement"), which agreement was further amended on February 22, 2001, January 1, 2002, March 5, 2003, January 1, 2004, November 15, 2004 and December 1, 2005 (the “December 2005 NICC Settlement Agreement”).

Under the company agreement, the members agreed that if during any year ending after January 1, 2005 and on or prior to December 31, 2009, Crown Media United States has Federal taxable income (with possible adjustments) 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 Federal taxable income; (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 no later than December 31, 2010.

 

On January 2, 2008, the Company and NICC signed an agreement (the “Modification Agreement”) which, among other things, immediately extinguished a right to put to the Company common stock owned by NICC.  In addition, the Modification Agreement also settled the dispute with respect to whether an obligation to pay $15.0 million upon a change in control of Crown Media Holdings expired with, or survived, the December 31, 2007 expiration of the December 2005 NICC Settlement Agreement. We agreed to pay NICC $8.3 million in three equal installments payable in 2008, 2009 and 2010.  We also agreed to provide NICC a two-hour broadcast period granted each Sunday morning during the two year period ending December 31, 2009.  The discounted value of the broadcast period, estimated to be $1.4 million, is reflected as deferred revenue as of December 31, 2007. The deferred revenue is being amortized to revenue ratably over NICC’s two-year use of the broadcast commitment.

During the three months ended June 30, 2008 and 2009, Crown Media United States paid NICC $1.5 million and $40,000, respectively, under the terms of the Modification Agreement mentioned above and one programming agreement. During the six months ended June 30, 2008 and 2009, Crown Media United States paid NICC $6.4 million and $4.5 million, respectively, under the terms of the Modification Agreement mentioned above and one programming agreement.

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8. Share-Based Compensation

Approximately 200,000 stock options will expire in August 2009 related to the resignation of one of the Company’s executives in May 2009. Such options were fully vested at the time of resignation.

The Company recorded $328,000 and $1.7 million of compensation expense associated with the Employment and Performance restricted stock units (“RSUs”) during the three and six months ended June 30, 2008, respectively, which have been included in selling, general and administrative expense on the accompanying condensed consolidated statements of operations. The Company recorded $266,000 and $437,000 of compensation benefit associated with the Employment and Performance restricted stock units (“RSUs”) during the three and six months ended June 30, 2009, respectively, which have been included in selling, general and administrative expense on the accompanying condensed consolidated statements of operations. The Company recorded these RSUs at fair value during each period.

The Company issued cash settlements related to the RSUs of $3.8 million during the year ended December 31, 2008, and $724,000 during the six months ended June 30, 2009.

 

9.  Resignation Agreement and Long Term Incentive Plan

Resignation Agreements

The individual then serving as the Company’s chief executive officer resigned May 31, 2009.  Pursuant to the resignation agreement, in June 2009 the Company paid this individual $2.5 million, an amount representing the present value of the salary and bonus that otherwise would have been paid to him from June 1, 2009 through October 2, 2010, the scheduled expiration of his employment contract.  The Company is obligated to pay this individual a transaction bonus in the event a change in control of the Company occurs on or before August 29, 2009.  The Company is also obligated to provide him office space, an assistant and payment of COBRA insurance benefits for periods that expire at various times through May 31, 2010.

The Executive Vice President of Programming resigned from his position effective May 31, 2009. The executive will receive continued payment of the regular installments of his salary through December 31, 2009 ($523,000) and his salary through May 31, 2010 in one lump sum payable on January 15, 2010 ($347,000). He will also receive a payment of a pro rated annual bonus, determined by the Company, for the 2009 calendar year for the period up to the resignation date.  Finally, he received an amount equal to accrued but unused vacation/personal time ($42,000).

 

Long Term Incentive Compensation Agreements

The Company has granted Long Term Incentive Compensation Agreements (“LTI Agreements”) to vice presidents and above at the Company, which LTI Agreements were signed during the second quarter of 2009.  The target award under each LTI Agreements is a percentage of the employee’s base salary and range from $26,000 to $469,000 for executive officers of the Company.  Of each award, 50% is an Employment Award and 50% is a Performance Award.  The Employment Award will vest and be settled in cash on August 31, 2011, subject to earlier pro rata settlement as provided in the LTI Agreement.  The Performance Award will vest and be settled in cash 50% on December 31, 2010, and 50% on December 31, 2011, in accordance with the Company performance criteria concerning adjusted EBITDA and cash flow and subject to earlier pro rata settlement as provided in the LTI Agreement. Early settlement is provided in the case of involuntary termination of employment without cause on or after January 1, 2010, death or disability.  Potential payouts under the Performance Awards depend on achieving 90% or higher of a target threshold and range from 0% to 150% of the target award.  The Company’s Compensation Committee has the ability to increase or decrease the payout based on an assessment of demographics achieved, relative market conditions and management of expenses.

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10. Fair Value

The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments at December 31, 2008, and June 30, 2009.

		December 31, 2008								June 30, 2009
		Carrying				Significant Unobservable Inputs (Level 3) Fair				Carrying				Significant Unobservable Inputs (Level 3) Fair
		Amount				Value				Amount				Value
		(In thousands)
Senior secured note to HC Crown,
including accrued interest		$	686,578			$	599,683			$	721,765			$	709,978
Note and interest payable to HC Crown			109,837				86,544				110,280				106,151
Note and interest payable to Hallmark Cards    Affiliate			62,724				49,422				62,978				60,619
Note and interest payable to Hallmark Cards    Affiliate			172,077				135,584				172,771				166,302
Company obligated mandatorily redeemable
preferred interest			20,822				17,430				21,862				17,700

SFAS 157 defines fair value as the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value, the Company considers the principal or most advantageous market in which the Company would transact and the market-based risk measurements or assumptions that market participants would use in pricing the liability, such as inherent risk, transfer restrictions, and credit risk. Level 3 is defined as inputs that are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the liability.

The carrying amounts shown in the table are included on the accompanying consolidated balance sheets under the indicated captions. The valuation of the Company obligated mandatorily redeemable preferred interest is dependent upon the future pre-tax income of Crown Media United States since the Company is only obligated to make payments on the instrument within 60 days after the end of any fiscal year in which pre-tax income is generated by Crown Media United States with the remaining preferred liquidation preference payable in full on December 31, 2010.

The Company estimates the fair value of its debt to Hallmark Cards affiliates on a quarterly basis, commencing June 30, 2009, using the discounted future cash flow method.

Accounts payable and receivable are carried at reasonable estimates of their fair values because of the short-term nature of these instruments. Long-term license fees payable are also considered carried at reasonable estimates of their fair value. The interest rates on the bank credit facility is variable, has a relatively short maturity period and/or resets periodically; therefore, the fair value of this debt is not significantly affected by fluctuations in interest rates.  The credit spread in debt is fixed, but the market credit spread will fluctuate.

Estimates of the fair value of the Company’s financial instruments are presented in the tables above. As a result of recent market conditions, the Company has financial instruments for which limited or no observable market data is available. Fair value measurements for these instruments fall with Level 3 of the fair value hierarchy of SFAS 157. These fair value measurements are based primarily upon the Company’s own estimates and are often based on its current pricing policy, the current economic and competitive environment, the characteristics of the instrument, credit and interest rate risks, and other such factors. Therefore, the results cannot be determined with precision, cannot be substantiated by comparison to quoted prices in active markets, and may not be realized in an immediate settlement of the liability. Additionally, there are inherent uncertainties in any fair value measurement technique, and changes in the underlying assumptions used, including discount rates, liquidity risks, and estimates of future cash flows, could significantly affect the fair value measurement amounts.

The majority of the Company’s debt has been transacted with Hallmark Cards and its affiliates.

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11. Subsequent Event

Lawsuit

On July 13, 2009, a lawsuit was brought in the Delaware Court of Chancery against each member of the Board of Directors of Crown Media Holdings, Hallmark Cards and its affiliates, as well as the Company as a nominal defendant, by a minority stockholder of the Company regarding the recapitalization proposal (the “Proposal”) which the Company received from Hallmark Cards. The plaintiff is S. Muoio & Co. LLC which owns beneficially approximately 5.8% of the Company's Class A common stock, according to the complaint and filings with the Securities and Exchange Commission. The Proposal, which the Company publicly announced on May 28, 2009, provides for a recapitalization of its outstanding debt to Hallmark Cards affiliates in exchange for new debt and convertible preferred stock of the Company. The lawsuit claims to be a derivative action and a class action on behalf of the plaintiff and other minority stockholders of the Company. The lawsuit alleges, among other things, that, the defendants have breached fiduciary duties owed to the Company and minority stockholders in connection with the Proposal. The lawsuit includes allegations that if the Proposal is consummated, an unfair amount of equity would be issued to the majority stockholders, thereby reducing the minority stockholders' equity and voting interests in the Company, and that the majority stockholders would be able to eliminate the minority stockholders through a short-form merger. The complaint requests the court to enjoin the defendants from consummating the Proposal and to award plaintiff fees and expenses incurred in bringing the lawsuit.

On July 22, 2009, a Stipulation Providing for Notice of Transaction (the “Stipulation”) was filed with the Delaware Court of Chancery.  The Stipulation provided that the Company cannot consummate the transaction contemplated in the Proposal until not less than seven weeks after providing the plaintiff with a notice of the terms of the proposed transaction.  If the plaintiff moves for preliminary injunctive relief with respect to any such transaction, the parties will establish a schedule with the Court of Chancery to resolve such motion during the seven week period.  In addition, following the decision of the Court of Chancery, the Company will not consummate any transaction for a period of at least one week, during which time any party may seek an expedited appeal.  The Stipulation further provides that the plaintiff shall withdraw its motion for preliminary injunction filed on July 13, 2009 and that the action shall be stayed until the earlier of providing the notice of a transaction or an announcement by the Company that it is no longer considering a transaction.  

It is not currently possible to predict the outcome of the proceeding discussed in this Note. The plaintiff does not seek damages from the Company. Legal defense costs will be expensed as incurred.