UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

For the transition period from        to        .

Commission File Number: 000-30700

Crown Media Holdings, Inc.

(Exact Name of Registrant as Specified in Its Charter)

12700 Ventura Boulevard,

Suite 200,

Studio City, California  91604

(Address of Principal Executive Offices and Zip Code)

(818) 755-2400

(Registrant’s Telephone Number, Including Area Code)

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

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o   No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o   No x

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12 b-2 of the Exchange Act). Yes o   No x

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of June 30, 2005, the last business day of the registrant’s most recently completed second fiscal quarter, was $142,295,833.

As of February 28, 2006, the number of shares of Class A Common Stock, $.01 par value outstanding was 74,117,654, and the number of shares of Class B Common Stock, $.01 par value, outstanding was 30,670,422.

DOCUMENTS INCORPORATED BY REFERENCE

NONE.

TABLE OF CONTENTS

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

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

PART I

ITEM 1.                Description of Business

Company Overview

We own and operate a pay television channel, known as the Hallmark Channel (the “channel”), dedicated to high-quality, entertainment programming for adults and families. In addition, we own and operate the Hallmark Movie Channel, which airs programming predominately from our film library (the “Hallmark Channel” and the “Hallmark Movie Channel” are collectively referred to herein as the “Channels”.)  Also, we own a film library with nearly 600 titles of movies, mini series and series. Our Channels are distributed in the United States of America and its territories and possessions, including Puerto Rico.

The Channels offer compelling stories, masterfully written, directed and produced with talented actors. We believe that with the programming we own (the “Crown Media Library,” the “Library” or the “film assets”), together with the programming we license from RHI Entertainment Distribution, LLC (“RHI Entertainment Distribution”) and third parties, we have established these Channels as destinations for viewers seeking high-quality, entertainment for adults and families, and as attractive outlets for advertisers seeking to target these viewers. We have distribution agreements with leading pay television distributors. The following table shows for the Hallmark Channel: our programming sources, selected pay television distributors and the total number of our subscribers as of December 31, 2005.

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As of February 28, 2006, the Hallmark Channel had approximately 71.4 million subscribers. At the end of 2005, the Hallmark Movie Channel had approximately 500,000 subscribers. We view a “subscriber” as a household that receives, on a full or part-time basis, the Hallmark Channel or the Hallmark Movie Channel on a program tier of a distributor. We determine our subscribers from subscriber numbers reported by Nielsen Media Research. Subscribers include both viewers who pay a monthly fee for the tier programming and so-called “promotional” subscribers who are given free access to the tier by the distributor for a limited time.

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

Hallmark Entertainment Distribution was owned indirectly by Hallmark Cards; in January 2006 Hallmark Cards sold its ownership interests in Hallmark Entertainment LLC, and thus also Hallmark Entertainment Distribution, to its President and certain new investors. Hallmark Entertainment Distribution changed its name to RHI Entertainment Distribution, and Hallmark Entertainment LLC changed its name to RHI Entertainment, LLC (“RHI Entertainment”). As a result, the programming agreements with RHI Entertainment Distribution are with a non-affiliated third party. At the same time, notes and accounts payable by us to Hallmark Entertainment Distribution were transferred to Hallmark Entertainment Holdings, Inc., a subsidiary of Hallmark Cards.

We currently distribute the Hallmark Channel through approximately 5,200 cable systems and communities and satellite providers. By the end of 2005, we had agreements with Adelphia, Cablevision, Charter, Comcast, Cox, DirecTV, EchoStar, Insight, Mediacom, the National Cable Television Cooperative, Time Warner and many other pay television distributors, for the distribution of the Hallmark Channel. In addition, we have entered into agreements with several telephone companies that have started to furnish video programming to consumers, including SBC (now AT&T), the National Rural Telecommunications Cooperative, and Verizon. Five of our distributors accounted each for more than 10% of our consolidated subscriber revenue for the year ended December 31, 2005 and accounted together for a total of 87% of consolidated subscriber revenue at that date. Three of our distributors accounted each for more than 15% of our consolidated subscribers for the year ended December 31, 2005 and accounted together for 58% of our subscribers on that date.

Through Crown Media Distribution, we exploit the Film Library to the extent not used by our Channels. We license the use of Library films and programming to third parties in the United States including terrestrial broadcasters in return for license fees.

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

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Information concerning revenue, operating losses and identifiable assets attributable to our pay television programming services and our distribution of films may be found in Note 22 of Notes to Consolidated Financial Statements in this Report.

Strategic Alternatives for the Company

The Company announced on August 18, 2005, that its Board of Directors has authorized the Company to explore strategic alternatives for the Company, including a potential sale of the Company to a third party. In support of this initiative, a Special Committee of independent directors of the Board of Directors has been formed to oversee the process. Hallmark Cards, Incorporated has advised the Company’s Board of Directors that it fully supports the Board’s determination. Hallmark has also advised the Board that it would consider entering into a license agreement with respect to the Hallmark Channel name in connection with the sale of the Company if requested by a potential acquirer. As a result, the Company is currently engaged in a process that may result in strategic transactions concerning the operation or ownership of the Company. There can be no assurance that the Company will enter into or consummate any transaction, or as to the terms or timing thereof.

Development of Business

Crown Media Holdings, Inc., which was incorporated in the state of Delaware in December 1999, through its subsidiaries, owns and operates pay television Channels dedicated to high quality, entertainment programming for adults and families, in the United States. Significant investors in Crown Media Holdings include Hallmark Entertainment Investments Co., a subsidiary of Hallmark Cards, the National Interfaith Cable Coalition, Inc. (“NICC”), and, indirectly through their investments in Hallmark Entertainment Investments, Liberty Media Corporation (“Liberty Media”) and J.P. Morgan Partners (BHCA), L. P. (“J.P. Morgan”). The Hallmark Channel is operated and distributed by Crown Media United States. Crown Media International acquired an interest in Crown Media United States in 1998, and as a result of several transactions, Crown Media Holdings owned 100% of the common interests of Crown Media United States by March 2001. Prior to April 2005, when the Company sold its international operations, through the sale of Crown Media International, the Company operated its Channels in approximately 150 countries throughout the world.

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

Industry Overview

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

We are also a pay television channel provider. Pay television channel providers include all channel providers (except over-the-air broadcasters) and major U.S. cable and satellite networks. Pay television channel providers often produce programming and acquire or license programming from program

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suppliers and generally package the programming according to an overriding theme and brand strategy. Pay television providers and distributors generally restrict viewership through security encryption devices that limit viewership to paying subscribers. Pay television channel providers compete with each other for distribution and to attract viewers and advertisers. Pay television providers generally target audiences with a certain demographic composition, so that they can then sell advertising to advertisers seeking to reach the providers’ demographic audiences.

Pay television distributors own and operate the platforms used to deliver channels to subscribers. These distributors use several different technologies to reach their subscribers as described below. Distributors attempt to create a mix of channels that will be attractive to their subscriber population in an attempt to gain new subscribers and to reduce subscriber turnover. Distributors have different levels of service for subscribers, with each service level containing some different channels. Recently, pay television distributors have created a “tier” of family programming; we are on two such tiers as of the date of this Report. Distributors have begun to offer additional broadband services such as Internet access, telephony and video-on-demand over their systems.

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

Distribution Platforms

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

Sources of Revenue

Subscriber Fees

Pay television customers subscribe to basic services by paying monthly fees for basic channels to pay television distributors. The customers can also subscribe to additional packages of premium or pay-per-view services upon payment of additional fees. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Generally, we charge our pay television distributors a monthly subscriber fee for the right to broadcast our Channels. Generally, these distribution agreements last from three to ten years, and sometimes include annual increases of subscriber fees. A distribution agreement may also involve a payment by us for the establishment of the relationship or, together with or in lieu of any payment, waived subscriber fees for our Channels to distributors for a period of time and discounts or no fees if certain subscriber levels are achieved. Please see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, for information regarding subscriber fees. For the years ended December 31, 2003, 2004, and

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2005 revenue derived from subscriber fees for the Channels were approximately $4.3 million, $9.9 million and $18.7 million, respectively.

Advertising Revenue

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

The ability of a television channel to generate advertising revenue largely depends on estimated or actual viewing levels, primarily based on ratings, and on advertising rates. In the United States, independent ratings systems on which advertising sales can be based are well established and widely accepted within the industry. In addition, pay television channel providers and distributors may also provide estimated or actual subscriber information. Currently, our Channel sells the approximately 50% of its advertising in the “up-front” season, generally in June and July, for the last quarter of the same year and the first three quarters of the following year. We hold back a small percentage of our inventory for audience deficiency units, “ADUs,” and sell the remainder in the spot or scatter market. ADUs are units of inventory that are made available to advertisers as compensation for advertising purchased in programs which did not deliver the ratings which the advertisers had been guaranteed.

Historically, advertisers have spent more on advertising through traditional broadcast television than through pay television. We believe that as pay television continues to gain viewership relative to broadcast television, it should attract a larger percentage of the total available dollars spent on television advertising. Also, as pay television draws audience share from broadcast television, audience demographics (i.e. viewers categorized by characteristics such as age, sex and income) become fragmented. As a result, advertisers are able to target the specific groups of viewers who are most likely to purchase their products, by buying advertising on channels which attract the desired viewer demographic.

We have advertising sales offices in New York, Los Angeles, Chicago, Atlanta and Detroit. In addition, we have made significant investments in programming, research, marketing and promotions, all specifically designed to support the sale of advertising time on our Channels. For the years ended December 31, 2003, 2004, and 2005 revenues from the sale of advertising time on our Channels were approximately $77.6 million, $106.3 million and $146.1 million, respectively.

Ratings

Among the 60 ad-supported cable channels in the United States market in 2005, the Hallmark Channel ranked 9th in total day with an average 0.707 household rating for the year and 11th for prime time with an average 1.033 household rating for the year, according to Nielsen Media Research. In 2004, among the 54 ad-supported cable channels in the United States market, the Hallmark Channel ranked 10th in total day with an average 0.6 household rating and 14th for prime time with an average 0.871 household rating, according to Nielsen Media Research. Total day means the time period measured from the time each day the broadcast of commercially-sponsored programming commences to the time such commercially-sponsored programming ends. We believe that the key demographics for the Hallmark Channel are the viewers in the groups Adults 25-54 and Women 25-54.

Licensing Revenue

We license our film assets to broadcasters and video distributors (pay television channel providers) who pay a license fee for the right to exhibit or distribute the programming over a certain period of time.

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Our licensing of film assets is an important contributor to our revenues and, because the amortization of our film assets is a non-cash expense, also to our cash flow.

Programming

Our Channels offer a range of high quality, entertainment programming for adults and families including movies, miniseries, epics, historical dramas, romances, literary classics, and contemporary stories. Sources for programming on our Channels include the Crown Media Library, programming licensed from RHI Entertainment Distribution, and programming licensed from other third parties. Prior to the purchase of the Crown Media Library in 2001, we licensed substantially all of the titles in that Library from Hallmark Entertainment Distribution, which is now RHI Entertainment Distribution.

Examples of programming from our Library and the RHI Entertainment Distribution library include, Larry McMurtry’s Lonesome Dove, The Outsider, Talking to Heaven, Frederick Forsyth’s Icon, Supernova and Larry McMurtry’s Dead Man’s Walk as well as programming previously shown as Hallmark Hall of Fame such as John Grisham’s Painted House, Fallen Angel, Sarah, Plain and Tall and What the Deaf Man Heard. We benefit from these original RHI Entertainment Distribution productions, which are sometimes premiered and often aired on our Channel. Examples of other third party programming shown on our Channel include the popular drama series M*A*S*H, Little House on the Prairie, Diagnosis Murder, Matlock, Walker Texas Ranger and The Waltons. Other examples of our third party programming include acquired movies and miniseries such as The Parent Trap, City Slickers and A Fistful of Dollars. Our license agreements with third parties typically provide for a license fee paid out over the term of the license for the right to exhibit a program in the United States within a specified period of time.

Distribution

The Hallmark Channel ended 2005 with 70.7 million subscribers, an increase of 9% from 64.6 million at the 2004 year-end. We currently distribute the Hallmark Channel to approximately 76% of all United States pay television subscribers. The following table shows the approximate number of pay television households and the Hallmark Channel subscribers for each of the eight largest pay television distributors, and all other pay television distributors as a group, in the United States as of December 31, 2005.

(1)          Source: Nielsen Code and The Nielsen Public U.E. December 2005.

Our subscribers in the United States have grown from approximately 16.0 million full time subscribers at January 1, 2001 to approximately 71.0 million full time subscribers at December 31, 2005.

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Although the Hallmark Channel’s distribution agreement with Adelphia expired on December 31, 2005, Adelphia has continued to carry the channel pursuant to the terms of the expired agreement. Adelphia is the subject of a purchase agreement with Comcast and Time Warner. Once this purchase is completed, we expect that the Adelphia systems will then be covered by the terms of the existing Hallmark Channel agreements with Comcast and Time Warner. Our other major distribution agreements expire from December 2006 through December, 2010. Of these distribution agreements, agreements accounting for approximately 77.8% of our subscriber base at December 31, 2005 will terminate and be the subject of renewal negotiations prior to or on December 31, 2007. In October, 2005, we entered into a renewal of our distribution agreement with one of the major distributors for a period of 3.3 years.

Sales and Marketing

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

For over fifty years Hallmark has been a leader in high-quality original television production. The Hallmark Channel and the Hallmark Movie Channel are the only home on cable television for the movies previously shown as Hallmark Hall of Fame, a selection of movies from an award-winning entertainment series.

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

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

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

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

Hallmark Movie Channel

After operating on a limited basis throughout 2004, we fully launched our second 24-hour linear channel, the Hallmark Movie Channel, during the first quarter of 2005. The Hallmark Movie Channel focuses on movies and mini-series and utilizes content from our film library for programming. The launch of the Hallmark Movie Channel provides an opportunity for the Company to build a second programming asset, use this programming asset as a value added enhancement to increase distribution of the Hallmark Channel, and realize further value from the content in our film library.

Channel Operations

The programming department has been responsible for ensuring the consistent quality of the programming we offer. The programming, scheduling and acquisitions departments work in conjunction with the traffic department and creative services to create the distinctive appearance of our Channel. Some of these functions are outsourced on an as-needed basis.

The creation of our Channel begins with the acquisition of programming. We have approximately 600 titles in the Crown Media Library. In addition, we license programming from RHI Entertainment Distribution and other program suppliers. Our staff or third parties review and summarize all potential programming to ensure compliance with our quality and content standards.

The creation of on-air promotional segments “interstitials”, which are broadcast between the feature movies, miniseries and series, are typically outsourced to external vendors. These interstitials are intended

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to invite viewership, guide viewers to specific programming, and promote “brand awareness” for the Hallmark Channel and the Hallmark Movie Channel.

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

The traffic department inserts promotional segments and advertising into the play list and creates the daily log, which contains a detailed schedule of the stream of programming, commercials and promotional materials that will ultimately be viewed by the subscribers of the Hallmark Channel.

Channel Delivery

We deliver the daily log and digital tapes of the Channels’ programming, commercials and promotional messages to a third party “Network Operations Center” in Denver, where the programming, advertising and promotional elements are combined and compressed into a single signal, and transported to a Denver uplink facility. The uplink facility then transmits the signal to a satellite transponder that covers the United States and the transponder transmits the signal back to cable head-end facilities and direct-to-home satellite services operated by pay television distributors who receive and decode our signal and transmit our Channels to their subscribers.

The following chart summarizes for the primary distribution platforms through which we deliver our Channels, our primary pay television distributors, and the uplink and satellites we currently use to deliver our Channels.

The contracts with the parties providing uplink, satellite and other services for the delivery of our Channel in the United States expire from 2012 through 2019. Such contracts may be terminated by the vendors prior to the expiration of the contracts under conditions that are customary to contracts of this type. Amounts payable under these contracts, as well as international contracts, are reflected in “Operating and Capital Leases” in the schedule of contractual commitments as of December 31, 2005, as shown in Item 7 below.

Film Distribution

Crown Media Distribution owns the Crown Media Library, consisting currently of United States rights to approximately 600 titles, and generates revenue from the film assets in the library by granting licenses to use the films to third parties. We are also using the films as programming for our television Channels and various interactive uses including pay per view and video on demand.

Crown Media Distribution oversees sales and distribution of the Crown Media Library to third-party licensees. Third-party licensees purchase rights on an exclusive or non-exclusive basis to exhibit titles from the Library in various television media including home video. Crown Media Distribution has a service

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agreement with RHI Entertainment, providing for services relating to the administration, distribution and other exploitation of the Crown Media Library, and directs the RHI Entertainment sales force in all sales matters pertaining to the Crown Media Library.

Competition

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

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

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

Competitive Strengths

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

Pay Television Channel Branded with the Well-Known Hallmark Name

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

Distribution Contracts that Call for Increasing Subscriber Counts and Fees

At December 31, 2005, we had distribution agreements with Adelphia, Cablevision, Charter, Comcast, Cox, DirecTV, EchoStar, and Time Warner in the United States, as well as a number of other distributors. The terms of our major distribution agreements generally provide for subscriber fee increases over time, although some provide for lower or no subscriber fees if certain levels of subscribers are achieved. We expect to be able to renew these deals prior to their expiration. See “Risk Factors Relating to Our Business” below.

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

Our Library gives us control over a significant amount of popular and award-winning programming that we can either air on our Channel or license in the United States to third parties. These titles provide us with a portion of our core programming, and by owning these titles, we have the flexibility to use them

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as needed to create the most effective program schedules. Owning these titles also eliminates the license fees we otherwise would have to pay for these titles and provides a revenue stream for us from licensing the titles to third parties.

We have a three-year program agreement with RHI Entertainment Distribution ending December 31, 2008, that provides us with access to new movies and mini-series produced especially for the Hallmark Channel, as well as to titles in the RHI Entertainment Distribution library which have been produced for other major networks over the past five years. This agreement is described in more detail in Part III, Item 13. Certain Relationships and Related Transactions—Agreements Concerning Film Assets below.

Experienced Management

Members of our senior management team have experience launching, promoting and operating channels. They have held senior positions at such companies as The Discovery Channel, ABC, CBS Sports, Turner Network Television and USA Networks.

Competitive Risks

One Primary Channel Distributed Domestically

We operate one primary Channel in the United States. Many competitors have more than one channel and are also diversified entertainment companies, giving them an advantage in dealing with distributors and advertisers. These companies are also able to leverage costs across multiple channels. Until the Hallmark Movie Channel is more widely distributed, it will not provide significant leverage in negotiations with distributors and advertisers.

Entertainment Programming

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

Ratings Which Affect Advertising

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

Research

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

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

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

Our Channel’s performance is tracked through an internal tracking study established in July 2001, which is a monthly telephone survey conducted among a national probability sample of approximately

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1,000 adults. The research department also subscribes to a number of other services, which are useful in obtaining information about viewers of our Channel.

Employees

We had 186 employees at December 31, 2005, and 187 employees in April 2005. Neither we nor any of our subsidiaries are parties to collective bargaining agreements. We believe that our relations with our employees are good. Substantially all of our domestic Channels’ employees work at our offices in Studio City, California and New York, New York.

Financial Information about Geographic Areas

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

Risk Factors and Forward-Looking Statements

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

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

Risks Relating to Our Business

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

Both our channels have a history of net losses and we expect to continue to report net losses for the foreseeable future. As of December 31, 2005, we had an accumulated deficit of approximately $1.5 billion, total stockholders’ deficit of approximately $123.2 million, goodwill of approximately $314.0 million, and film assets of $380.3 million.

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

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

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

We have a substantial amount of indebtedness. As of December 31, 2005, our total debt was $972.4 million and we had $15.9 million of cash and cash equivalents and $10.0 million available under our bank credit facility subject to the approval of Hallmark Cards to cover the negative cash flow resulting from our current operations. In addition, in March 2006, we signed a waiver and standby purchase agreement, which converted $70.0 million of payables to a Hallmark Cards affiliate into a note payable. This amount currently is not included in our calculation of total debt. Subject to restrictions under our debt agreements, we may also seek equity or debt financing from time to time to cover our operating losses, to finance acquisitions or capital expenditures or for other purposes.

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

·       our vulnerability to adverse general economic conditions is heightened;

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

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

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

·       we are sensitive to fluctuations in interest rates; and

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

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

Information concerning our liquidity may be found in Note 1 of our Notes to Consolidated Financial Statements in this Report.

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

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

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Our liquidity is dependent on external funds.

Because we currently operate at a loss, we may have a negative cash flow and any unanticipated significant expense or any development that hampers our growth in revenue or decreases any of our revenue, would result in the need for additional external funds in order to continue operations. Further, as discussed in this report under “Liquidity and Capital Resources” below, we need to extend, refinance or replace our bank line of credit on or prior to May 31, 2006, or to extend or replace borrowings from Hallmark Cards by May 31, 2007, that would result from the banks drawing upon the irrevocable letter of credit supporting the bank credit facility or from Hallmark Cards’ purchasing the loans under that facility (see note 12 to our Consolidated Financial Statements), and extend or refinance outstanding notes payables to Hallmark Cards and its subsidiaries on or prior to May 31, 2007.

Upon maturity of the credit facility on May 31, 2006, the lending group led by JP Morgan Chase has the right to elect to forego the receipt of cash to pay the principal amount of the credit facility in full, which is provided for under the terms of an irrevocable letter of credit provided by Hallmark Cards described in note 12, but instead can elect to initiate a process to foreclose on the Company’s assets. Such foreclosure proceedings, which we view as a remote possibility, would affect our ability to continue our operations. Prior to any such possible foreclosure proceedings, however, the Company would consider various alternatives as indicated above. In the alternative, the Company would cause Hallmark Cards, pursuant to the terms of the waiver and standby purchase agreement, to exercise its option to purchase the banks interest in the credit facility and the credit facility would then be subject to Hallmark Cards agreement not to demand payment prior to May 31, 2007.

We need to renew distribution agreements covering more than a majority of our subscribers prior to December 31, 2007.

Our distribution agreements with eight of the major distributors in the United States, accounting for approximately 83% of our subscriber base as of December 31, 2005, will terminate on or prior to December 31, 2007 pursuant to the terms of the agreements. If we are unable to renew these distribution agreements, we could lose substantial numbers of subscribers. Although we believe we will be able to negotiate new agreements on favorable terms, it is difficult to predict what the level of subscriber fees will be or whether the distributors will request marketing or “launch” support payments as a condition for renewal. Any significant loss of subscribers, reduction in subscriber fees or obligation to pay launch support or marketing payments could materially affect our subscriber and advertising revenues and affect materially our cash flow and ability to achieve profitability.

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

We currently acquire library programming, new productions and first-run presentations under a program license agreement with RHI Entertainment Distribution, which agreement was revised on October 11, 2005. The revised agreement expires December 31, 2008. Under the revised agreement, RHI Entertainment Distribution is required to produce and deliver to us, and we are required to order and license and pay for, a minimum of 12 original television movies and three original mini-series in each of 2006 and 2007 (subject to our right to cancel these productions in 2007). There are also other programming obligations. If RHI Entertainment Distribution is not able to produce all the movies and mini-series which we require in 2006 and 2007 or we are not able to negotiate a new production agreement with RHI Entertainment Distribution for 2008 and subsequent years, we could be forced to acquire the needed programming from alternative sources or to produce it ourselves at a greater cost and our ability to effectively program our Channels could be negatively affected.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

We license the name “Hallmark” from Hallmark Licensing, Inc., a subsidiary of Hallmark Cards, for use in the names of our channels. This license will expire on September 1, 2006. If Hallmark Cards determines not to renew the trademark license agreements for any reason, including failure to comply with Hallmark Cards’ programming standards, we would be forced to significantly revise our business plan and operations, and could experience a significant erosion of our subscriber base and advertising revenue, particularly in the United States.

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

We currently rely on third parties to supply key network infrastructure services, including uplink, playback, transmission and satellite services to our market, which are available only from limited sources.

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We have occasionally experienced delays and other problems in receiving communications equipment, services and facilities and may, in the future, be unable to obtain such services, equipment or facilities on the scale and within the time frames required by us on terms we find acceptable, or at all. If we are unable to obtain, or if we experience a delay in the delivery of, such services, we may be forced to incur significant unanticipated expenses to secure alternative third party suppliers or adjust our operations, which could hinder our growth and reduce our revenue and potential profitability.

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

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

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

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

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

Our stock price may be volatile and could decline substantially.

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

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

·       material announcements by us or our competitors;

·       governmental regulatory action;

·       technological innovations by competitors or competing technologies;

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

·       changes in general market conditions or economic trends.

Additionally, of the approximately 74.1 million shares of the Company’s outstanding Class A common stock, only 15.3 million shares (approximately 21%) are not held by affiliates of the Company. This stock ownership structure may also be a cause of volatility in the market price of the Company’s Class A common stock.

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Risks Relating to Our Industry

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

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

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

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

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

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

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

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

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

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

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

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

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

Moreover, the increased capacity of digital distribution platforms, including the introduction of digital terrestrial television, may reduce the competition for the right to carry channels and allow development of extra services at low incremental cost. These lower incremental costs could lower barriers to entry for competing channels, and place pressure on our operating margins and market position.

Changes in laws or regulations could adversely affect our distribution and thus our revenues.

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

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

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

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

Available Information

We will make available free of charge through our website, www.hallmarkchannel.com, the Annual Report, our quarterly reports on Form 10-Q, our current reports on Form 8-K, and amendments to such reports, as soon as reasonably practicable after we electronically file or furnish such material with the Securities and Exchange Commission.

Additionally, we will make available, free of charge upon request, a copy of our Code of Business Conduct and Ethics, which is applicable to all of our employees, including our senior financial officers. Requests for a copy of this code should be addressed to the General Counsel at 12700 Ventura Boulevard, Studio City, California  91604.

ITEM 1A.        Risk Factors

See “Risks Related to Our Business” and “Risks Related to Our Industry” in Item 1 above, which sections are incorporated herein by reference.

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ITEM 1B.       Unresolved Staff Comments

Not applicable.

ITEM 2.                Properties

The following table provides certain summary information with respect to the principal real properties leased by the Company. We do not own any real property. The leases for these United States offices and facilities expire between 2006 and 2010. The Company believes the facilities, office space and other real properties leased are adequate for its current operations.

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

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

ITEM 3.                Legal Proceedings

We are subject to incidental litigation risks in the ordinary course of our business. We are not currently the subject of any material, pending legal proceeding.

On December 1, 2005, the Company settled a dispute with the National Interfaith Cable Coalition over alleged breaches of a 2001 programming agreement and entered into a new agreement. See Item 13 “Certain Relationships and Related Transactions” for information on this new agreement.

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

Not applicable.

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PART II

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

Market Information

Our Class A common stock is listed on the Nasdaq National Market System under the ticker symbol “CRWN.” Set forth below are the high and low sales prices for our Class A common stock for each quarterly period in 2004 and 2005, as reported on the Nasdaq National Market System.

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

Holders

As of February 8, 2006, there were 65 record holders of our Class A common stock and one record holder of our Class B common stock.

Dividends

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

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides as of December 31, 2005, information for our only equity compensation plan, which is the Amended and Restated 2000 Long Term Incentive Plan.

Equity Compensation Plan Information

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Stock Purchases

We did not make any repurchases of our outstanding shares during the fourth quarter of 2005. None of our executive officers purchased shares in open market transactions during the fourth quarter of 2005.

ITEM 6.                Selected Financial Data

Selected Historical Consolidated Financial Data of Crown Media Holdings

In the table below, we provide you with selected historical consolidated financial and other data of Crown Media Holdings and its subsidiaries. The following selected consolidated statement of operations data for the years ended December 31, 2001, 2002, 2003, 2004 and 2005, and the consolidated balance sheet data as of December 31, 2001, 2002, 2003, 2004 and 2005, are derived from the audited financial statements of Crown Media Holdings and its subsidiaries. This data should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

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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 accompanying statements of operations for all periods presented. This sale closed in April 2005. The Company’s discontinued operations consisted of the international channel operations and the international rights to the film library assets.

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(1)          In March 2006, the Company signed a waiver and standby purchase agreement, which converts $70.0 million of payables to a Hallmark Cards affiliate into a note payable. This amount is not included in the long-term debt calculation.

ITEM 7.                Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Current Business

Crown Media Holdings, Inc. (“Crown Media Holdings,” “Crown Media” or the “Company”), through its subsidiaries, owns and operates pay television channels dedicated to high quality, entertainment programming for adults and families, in the United States. In addition, the Company owns a film library with approximately 600 titles. The library product is used on the Hallmark Channel, the Hallmark Movie Channel and sold to third parties.

With 70.7 million subscribers in the United States at the end of 2005, Crown Media Holdings is the 39th most widely distributed advertising-supported cable channel in the United States. In 2005, the Hallmark Channel also increased its overall ratings as to viewers. We finished the year the 9th highest rated advertising-supported cable channel for total day ratings and the 11th highest rated advertising-supported cable channel in prime time as measured by Nielsen Research. The growth in ratings during 2005 began with our Holiday campaign at the end of 2004. This campaign focused on Holiday-themed movies and linked together promotions with the Hallmark Gold Crown Stores. The result of this campaign was an increase in new viewers to the Hallmark Channel. To build upon the success of the Holiday campaign, 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. During the second quarter, additional Mystery Movies were aired. In addition, the Hallmark Channel premiered a number of other original movies that also resulted in strong ratings.  Programming successes continued in the third quarter which was the highest rated quarter in the Channel’s history. Similar to 2004, and in an effort to build upon our year to date ratings performance, the Channel launched a Holiday campaign in the fourth quarter of 2005. This campaign was also successful. The fourth quarter became the highest rated fourth quarter in the Channel’s history. Two of our movies in December recorded 3.0 or higher household ratings, as measured by Nielson, and all of our Holiday movies delivered strong audience demographic performance.

We formally launched our second 24-hour linear channel, the Hallmark Movie Channel, during the first quarter of 2005. The Hallmark Movie Channel focuses on movies and mini-series and utilizes content

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from our film library for programming. At year end 2005, we had approximately 500,000 subscribers to the Hallmark Movie Channel.

As mentioned above, the Company owns a film library comprised of approximately 600 titles. Through our subsidiary, Crown Media Distribution, we license rights in the United States to titles in the library to a variety of customers. In addition, the Company utilizes the film library for programming content on the Hallmark Channel and Hallmark Movie Channel. We have increased the internal use of the film assets as a result of the launch of the Hallmark Movie Channel and a decision to air more movies on the Hallmark Channel.

As the Hallmark Channel and the Hallmark Movie Channel continue to develop, the core focus for the business remains unchanged. First, distribution must continue to expand. While the ratings performance of the Hallmark Channel ranks in the top ten of cable networks according to Nielsen, in terms of distribution, the Hallmark Channel is only in the top 40 cable networks. Increased distribution can have a positive impact on our subscriber revenue (depending on any subscriber acquisition fees incurred) and should increase our advertising revenue as advertisers pay higher rates to cable networks that are more broadly distributed. However, combining growing distribution with increasing ratings is more powerful in terms of advertising revenue. As a result, the Hallmark Channel will continue to focus on enhancing its programming schedule through the acquisition of new series, additional original movies such as the recent Mystery Movies, and through unique scheduling concepts.

We plan to develop the Hallmark Movie Channel as an additional revenue source. It can play a role in terms of contract renewals with the various distributors. It will generate revenue in 2006 and as distribution continues to expand, the financial contribution of the Hallmark Movie Channel may continue to grow.

In addition, we plan to focus on library sales. Our film library is a large collection of award winning movies and mini-series, which is unique in that it is such a large collection of family oriented films.

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

Current Challenges

The Hallmark Channel faces challenges on the distribution front. The distribution agreements are important because they affect our number of subscribers, which in turn has a major impact on our subscriber fees, the number of persons viewing our programming, and thus rates charged for advertising. We have an ongoing focus on growing our subscriber base. The current and long-term distribution challenges will be renewing our distribution arrangements with the multiple system operators as they expire. See “Risk Factors Relating to Our Business” and “Channels-Distribution” in Item 1 Business above. While the economics of the renewals and potential cash incentive payments are 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 multiple systems operators a second channel, the Hallmark Movie Channel, as well as programming for their other distribution platforms such as VOD, are value added components of the renewal equation. In October 2005, we renewed our distribution agreement with one of the major distributors in the United States.

Domestic telephone companies are entering into the business of distributing television channels to households through their wire-lines. We have reached agreement with several telephone companies which permit the carriage of the Hallmark Channel and Movie Channel and are negotiating with others. We expect that subscribers to these telephone services will in large part be customers previously served by existing cable television companies and satellite television companies. To date, subscribers and revenues through telephone companies has been insignificant.

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Three factors have contributed to the ratings improvements of the Channel: acquired series and movies, original productions and marketing. Acquired series ranging from 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 RHI Entertainment Distribution.

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 its ratings and draw a younger more upscale audience, which is generally more attractive to advertisers.

Delivering strong ratings growth to larger audiences has made it possible for our 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 gain advertisers from the more lucrative financial services and automotive industries.

Strategic Alternatives for the Company

See “Strategic Alternatives for the Company” in Item 1 above .

International Business

In April 2005, the Company completed the sale of  its international business to a group of investors comprised of Equity Partners, 3i and U.K. executive David Elstein (collectively, “Sparrowhawk,” the “buyer” or the “buyer of  international business”). 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 Operations Center based in Denver, Colorado. The Company received cash proceeds of $209.3 million, net of the prepayment described below, and recognized an accounting loss of $6.5 million from the sale. Approximately $4.7 million of transaction costs were incurred by the Company in connection with the sale.

In accordance with the conditions of the sale and subsequent settlement, the Company has accrued $26.8 million at December 31, 2005, which represents the estimated present value of the cash expected to be paid by the Company to or on behalf of the buyer at various times through December 31, 2015. Included in this amount was $16.7 million at the sale date, of estimated payments, which were determined using the contractual payments due on certain lease arrangements that were assumed by the buyer. The Company is obligated to reimburse the buyer for these lease payments at or about the same time the buyer is obligated to pay the lessor. Also, the Company estimated a liability of approximately $4.5 million to pay the estimated residual and participation costs that the buyer would otherwise be obligated to pay to third parties through April 2015 in connection with film library sales. The amount of this liability could fluctuate based upon the actual internal usage or sales of these films by the buyer. Any revisions to these estimated liabilities will be reflected as gain (loss) from the sale of discontinued operations in future periods.

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In the fourth quarter of 2005, the Company recorded charges of $4.6 million to recognize additional costs for the settlement of certain disputed items and claims of the buyer. These charges included $3.4 million related to the interpretation of working capital representations used in determining the original sales price and $0.9 million related to disputed operating costs incurred at the time of the closing date of the sale. These post closing adjustments are covered by the accrual described in the preceding paragraph.

The Company will continue to use the Network Operations Center sold to Sparrowhawk for the distribution of the domestic channel pursuant to a $25.3 million, seven year technical services agreement with the buyer. The Company made a prepayment under the technical services agreement to the buyer in the amount of $12.7 million upon closing of the sale transaction and the balance is payable monthly in equal installments through the expiration of the agreement. The unused portion of the prepayment is classified as Prepaid and Other Assets in the accompanying condensed consolidated balance sheet and will be amortized to operating expense over the life of the contract. A deferred credit of $7.6 million was recorded to reflect the amount by which the $25.3 million contract exceeded the estimated fair value of the related services. The deferred credit will be amortized over the life of the contract, resulting in a reduction of operating expenses in future periods.

Subsequent to the sale, the Company has no continuing economic involvement with the operations of the international business.

Impairment of Assets

Please see Note 3 of Notes to the Consolidated Financial Statements in this Report for information on impairment charges for 2005.

Revenue

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 distributors for the right to carry our channels. We have paid certain distributors up-front subscriber acquisition fees to carry our channels. 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 on a cumulative basis exceeds the revenue recognized on a per distributor basis, the excess amortization is included as a component of cost of services.

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 carriage 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 subscriber revenue will continue to be negatively affected

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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 levels 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 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. Any decreases in subscribers due to these changes to distribution arrangements in the third 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 number of people viewing our channel. Rates vary based on audience demographics, time period and ratings.

Our advertising rates are generally 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 and the resulting levels of viewers watching their advertising material. Thus, our advertising revenue is a function of the ratings garnered by the channel and the number of subscribers receiving the channel. 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

The Company 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 the Hallmark Channel and the Hallmark Movie Channel. Customers for our film assets consist of other television channels, syndicators, home video distributors and brokers who resell rights to our film assets. License fees for our film assets are generally negotiated based upon the perceived quality of the films, the size of the potential audience who will be viewing the programming, the means of distribution or exhibition and the length of the airing window. The market for our film library is typically seasonal, with over half of the annual sales occurring in the fourth quarter. This seasonality is due to the timing of our customers’ program scheduling activities.

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

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expect cost of services to continue to increase in the future as we expand our existing distribution universe 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 Consolidated Financial Statements contained in this Report.

The following discussion concerns certain accounting estimates and assumptions that are considered to be material due to the levels of subjectivity and judgment necessary to account for uncertain matters and the susceptibility of such matters to changes.

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 operating environment expected for the next several years, (b) the size of the library as a whole, (c) historical license fee revenue per film, (d) each title’s age, quality, and marketability, (e) existing sales plans including the amount of product desired to be sold each year, (f) future performance estimates, (g) assumptions and estimates underlying past and future estimates, and (h) risk factors that could effect future operations of the Library. 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 discount rate used in the Company’s discounted cash flow model is based upon management’s estimate of the rate a lender would require related to the risks and uncertainties surrounding the timing and probability of the cash flow estimates.

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 amortization expense determined using the new estimates and any amounts previously expensed during that current 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 and the Hallmark Movie 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 described above and then expenses such amounts ratably over the term of the license window.

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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.

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 deferred license fees in relation to the estimated future revenues.

Estimates of net realizable value for 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 Channel. 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 expected to be recovered. Where the analysis indicates the costs are in excess of the estimated net realizable value, impairment is recognized.

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 cumulative subscriber fee revenue recognized, or to be 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 by comparing the net carrying amount to the estimates of future subscriber fee and advertising revenues. It also assesses the recoverability when events such as changes in distributor relationships occur or other indicators suggest impairment.

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 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 on November 30 or whenever an event occurs or there is a change in circumstances 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

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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 in accordance with Emerging Issues Task Force No. 01-9 (“EITF No. 01-9”), Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products). 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. In 2005, $2.3 million and $920,000, which previously were reported as subscriber acquisition fee amortization expense, have been reclassified as reductions of subscriber fees revenue for the years ended December 31, 2003 and 2004, respectively.

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.

Revenue from film asset licensing agreements is recognized in accordance with Statement of Position (“SOP”) 00-02, Accounting by Producers or Distributors 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 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.

Restatement of Nine Months Consolidated Statement of Cash Flows

See Note 2 of Consolidated Financial Statements for information on a restatement of our unaudited consolidated statement of cash flows for the nine months ended September 30, 2005.

Effects of Transactions with Related and Certain Other Parties

Hallmark Transactions

In 2006 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, the issuance of a $400.0 million senior unsecured note, a note payable and a waiver agreement.

Bank Credit Facility

As part of an amendment to our bank credit facility in March 2005, Hallmark Cards has provided a letter of credit to the lenders for an amount equal to the maximum amount which may be borrowed under the bank credit facility. Hallmark has also provided to us a waiver and standby purchase agreement stating

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that Hallmark Cards and its subsidiaries will not demand payments of various obligations owed by us to subsidiaries of Hallmark Cards, including draws under the above mentioned letter of credit until May 31, 2007, and providing us the right to cause Hallmark Cards to purchase all of the bank lenders’ interest in loans to us pursuant to Amendment No. 9 to the bank credit facility. The Company entered into Amendment No. 9 with the bank credit facility in March 2006. See “Bank Credit Facility” below.

Tax Sharing Agreement

In March 2003, the Company became a member of Hallmark Cards consolidated federal tax group and entered into a Tax Sharing Agreement with Hallmark Cards, which was amended at the time the Company issued the senior unsecured note to HC Crown. We account for income taxes as if Crown Media Holdings were a separate taxpayer. Accordingly, Hallmark Cards’ ability to use our tax losses does not impact our assessment of the need for a valuation allowance on deferred tax assets, including future tax losses. Any payments received from Hallmark Cards under the Tax Sharing Agreement are recorded as an increase in paid-in capital. For information regarding the Tax Sharing Agreement, please see Notes 13 and 16 to the Notes to Consolidated Financial Statements contained in this Report.

Senior Unsecured Note

On August 5, 2003, Crown Media Holdings repurchased all of the outstanding trust preferred securities of Crown Media Trust and related contingent appreciation certificates issued by the Company. The securities were repurchased for approximately $329.1 million. Funds for this repurchase were obtained from the proceeds from the issuance of a senior unsecured note issued to HC Crown in the amount of $400.0 million. For information regarding our senior unsecured note, please see Note 12 to the Notes to Consolidated Financial Statements contained in this Report.

NICC License Agreement

For information regarding the amendment to our license agreement with NICC, please see Item 13 “Certain Relationships and Related Transactions” contained in this Report.

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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 the years ended December 31, 2003, 2004 and 2005, are derived from the audited 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 Annual Report on Form 10-K.

(1)             Total day is the time period measured from the time each day the broadcast of commercially sponsored programming commences to the time such commercially sponsored programming ends.

(2)             Primetime is defined as 8:00—11:00 P.M. in the United States.

(3)             These Nielsen ratings are for the time period January 1 through December 31.

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Results of Operations

Year Ended December 31, 2004 Compared to Year Ended December 31, 2005

Revenue.

Our revenue increased 43% for the year ended December 31, 2005. Our 90% increase in subscriber fee revenue for the year ended December 31, 2005, was the result of the expiration of waived subscriber fees for certain of our domestic distributors and an increase in subscribers. Subscriber acquisition fee amortization recorded as a reduction of revenue was $12.1 million for the year ended December 31, 2005, and $12.2 million for the comparable period in 2004, as a result of fees required under distribution agreements negotiated in prior years and a renewal of a major distribution agreement negotiated in 2005. Subscriber counts have increased as a result of previously amended distribution agreements in the United States, which provide for financial incentives for distribution growth, as well as the ratings success of the Hallmark Channel. The ability to increase our subscriber base is important both in terms of growing our subscriber and advertising revenues.

The 37% increase in advertising revenue reflects the following during 2005: the 9% growth in subscribers; higher household ratings; and higher advertising rates resulting from the increase in distribution and viewership. Additionally, the number of advertisers on our channel rose from 403 at December 31, 2004, to 414 at December 31, 2005.

Revenue from the sale of our film assets totaled $21.7 million for the year ended December 31, 2005, compared with $22.0 million for the comparable period in 2004. Sublicense fees and other revenue for the year ended December 31, 2005, was $10.8 million primarily due to the sub-licensing of Little House on the Prairie to a third party.

Cost of services.   Cost of services as a percent of revenue increased to 130% for the year ended December 31, 2005, as compared to 129% in the prior year’s period. This increase was related to the 43% increase in revenue explained above.

Total programming costs for the year ended December 31, 2005, increased 34% due to our focus on higher quality series programming such as M*A*S*H, Judging Amy, and J.A.G. and the related amortization. In addition, the Hallmark Channel introduced the Mystery Movies in the first quarter of 2005, which also involve higher costs and related amortization.

Non-cash impairment charges in a total amount of $22.0 million and $25.5 million related to our film assets for the years ended December 31, 2004 and 2005, respectively. The impairment charges for the film assets were recognized in the third and fourth quarters of 2005 and the third and fourth quarters of 2004 based upon then current projections for the sales and internal use of the film assets.

Amortization of film assets increased 79% for the year ended December 31, 2005, compared to the same periods in 2004 primarily as a result of the impairment of our film assets and related recalculation of amortization and the use of the film assets by our Movie Channel. We anticipate an increase in the amortization of our film assets during 2006 because of the use of the film assets by our Movie Channel. The recalculation of amortization results from revisions of the estimates of ultimate revenue on certain film products.

Generally, our distribution agreements have required the Company to pay subscriber acquisition fees to distributors for additional subscribers. Our subscribers increased from 64.6 million at December 31, 2004, to 70.7 million at December 31, 2005, and the Company incurred additional subscriber acquisition fees for this increase in subscribers. The Company amortizes these costs over the remaining life of the distribution agreement, which has resulted in a 38% increase in our subscriber acquisition fee amortization expense for the year ended December 31, 2005, as compared to the prior year.

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Operating costs for the year ended December 31, 2005, increased $10.6 million primarily due to a $8.8 million increase in bad debt expense, a $565,000 increase in equipment expense, $536,000 increase in playback, transponder and uplink expense, and a $1.1 million increase in amortization expense related to our capital lease placed into service during fourth quarter 2004.

Selling, general and administrative expense.   Our selling, general and administrative expense increased for the year ended December 31, 2005, due to an increase in consulting expense and audit fees associated with our regulatory requirements under the Sarbanes-Oxley Act and offset by a decrease in compensation expense associated with our restricted stock units.

Marketing expense.   For the year ended December 31, 2005, our marketing expense increased 47% primarily due to the 2005 Mystery Movie marketing campaign for the Hallmark Channel. In order to build upon the success of our 2004 Holiday promotion and to assist with the sale of our advertising inventory in the upfront market, the Company commenced the Mystery Movie franchise in the first quarter of 2005. The prior year’s marketing activity was significantly less as there were not as many special programming events in the first half of 2004.

Interest expense.   Interest expense increased 23% for the year ended December 31, 2005, due to interest on our $400.0 million senior unsecured note payable, which increased by $4.6 million for the year ended December 31, 2005, as compared to the prior year, and interest on our $75.0 million promissory note, which increased by $1.8 million for the year ended December 31, 2005, as compared to the prior year. Interest on our senior unsecured note payable increased as accrued interest was added to the principal. Interest increased related to our promissory note due to a higher interest rate. Interest expense also increased $1.5 million related to our interest expense on our capital lease for a transponder. Additionally, a portion of interest expense, which was formerly payable to our bank syndicate and is now payable to HC Crown as a result of Amendment No. 8 of our credit facility. was $3.2 million. In October 2005, we converted $132.8 million of license fees payable into a note payable to Hallmark Entertainment Distribution and the related interest expense was $2.4 million for the year ended December 31, 2005.

Loss from Continuing Operations.   Loss from continuing operations for the year ended December 31, 2004 and 2005, was $174.8 million and $215.5 million, respectively. Our loss from continuing operations increased primarily due to (1) a $7.7 million increase in marketing expense to continue to drive ratings; (2) increase in loss generated from library sales and the internal use of the library product on the Channel; (3) increase in selling, general and administrative expense described above; and (4) an increase in interest expense of $13.7 million as explained above due to relatively higher borrowings during 2005 as compared to the prior year period. These increases are partially offset by subscriber and advertising revenue increases, which were greater than the increases in programming costs.

Loss from Discontinued Operations.   Loss from discontinued operations for the years ended December 31, 2004 and 2005, was $142.0 million and $10.7 million, respectively. Loss from discontinued operations was less for the year ended December 31, 2005, as compared to the comparable period for 2004, because the Company sold the international business on April 26, 2005.

Year Ended December 31, 2003 Compared to Year Ended December 31, 2004

Revenue.

Our revenue increased 39% for the year ended December 31, 2004. Our 128% increase in subscriber fee revenue for the year ended December 31, 2004, was the result of the expiration of waived subscriber fees for certain of our domestic distributors and an increase in subscribers. Subscriber acquisition fee amortization recorded as a reduction of revenue was $12.2 million for the year ended December 31, 2004, and $9.4 million for the comparable period in 2003, as a result of fees required under distribution agreements negotiated in previous years.

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The 37% increase in advertising revenue reflects the following during 2004: the 15% growth in domestic; higher household ratings; and higher advertising rates resulting from the increase in distribution and viewership. Additionally, the number of advertisers on our domestic channel rose from 326 at December 31, 2003, to 403 at December 31, 2004.

Revenue from the sale of our film assets totaled $22.0 million for the year ended December 31, 2004, compared with $17.5 million for the comparable period in 2003.

Cost of services.   Cost of services as a percent of revenue decreased to 8% for the year ended December 31, 2004, as compared to 13% in the prior year’s period. These decreases were related to the 39% increase in revenue explained above.

Non-cash impairment charges in a total amount of $22.0 million related to our film assets as explained above.

Amortization of film assets increased 123% for the year ended December 31, 2004, compared to the same periods in 2003 primarily as a result of the impairment of our film assets and related recalculation of amortization. Total programming costs for the year ended December 31, 2004, increased 32% due to the increased costs associated with the amortization of certain programming such as M*A*S*H and J.A.G. for our domestic channel.

Operating costs for the year ended December 31, 2004, decreased $2.3 million primarily due to a $929,000 decrease in bad debt expense and a $909,000 decrease in sales commission expense.

Selling, general and administrative expense.   Our selling, general and administrative expense increased for the year ended December 31, 2004, primarily because of $7.7 million of retention program expense related to the proposed sale of the international business. Additionally, we recorded $11.5 million of restricted stock unit expense for the year ended December 31, 2004, as compared to $5.9 million in the prior year period.

Loss from Continuing Operations.   Loss from continuing operations for the year ended December 31, 2003 and 2004, was $186.6 million and $174.8 million, respectively. Our loss from continuing operations decreased primarily due to subscriber and advertising revenue increasing greater than programming costs. These decreases are partially offset by an increase in selling, general and administrative expense described above, and an increase in interest expense of $20.4 million as compared to the prior year period. Guaranteed preferred beneficial interest accretion in 2003 related to future obligations on our debentures issued on December 17, 2001, in connection with the trust preferred securities of Crown Media Trust. The 2003 expense only included guaranteed preferred beneficial interest accretion for a partial year due to the repurchase of our preferred securities on August 5, 2003. Interest expense  increased due to interest on our $400.0 million senior unsecured note payable commencing August 5, 2003, which amounted to $43.8 million for the year ended December 31, 2004 compared to $17.1 million in the prior year period. The terms of our senior unsecured note payable do not require any cash payment for interest or principal until August 2007.

Loss from Discontinued Operations.   Loss from discontinued operations for the years ended December 31, 2003 and 2004, was $35.6 and $142.0 million, respectively. Loss from discontinued operations was higher for the year ended December 31, 2004, as compared to the comparable period for 2003, because of the impairment of film assets and technical equipment related to the sale of the international business.

Liquidity and Capital Resources

Cash used in operating activities from continuing operations was $15.2 million and $121.9 million for the years ended December 31, 2004 and 2005, respectively. Cash was used primarily to fund operating

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expenditures related to losses from continuing operations of $174.8 million and $215.6 million for the years ended December 31, 2004 and 2005, respectively. The increase in cash flow used in operations was primarily due to an increase of payments to Hallmark Entertainment Distribution for programming of $88.4 million ($26.6 million of which is included in the increase of prepaid and other assets) and an increase of $12.8 million in subscriber acquisition fee payments.

Cash used in investing activities was $878,000 for the year ended December 31, 2004. Cash provided by investing activities was $213.1 million for the year ended December 31, 2005. This increase is primarily due to proceeds from the sale of our international business of $222.0 million.

Cash provided by financing activities was $66.6 million for the year ended December 31, 2004. Cash used in financing activities was $72.3 million for the year ended December 31, 2005. During the year ended December 31, 2005, we repaid $195.0 million under our bank credit facility. Additionally, we borrowed $95.0 million under our bank credit facility to repay certain programming obligations to Hallmark Cards affiliates, pay severance and RSU settlements for certain employees of the international business and to meet our operating demands during the year ended December 31, 2005. We received $56.6 million and $56.1 million (including the $30.0 million offset to intercompany debt during the third quarter of 2005) under the Tax Sharing Agreement during 2004 and 2005, respectively.

Cash used in discontinued operations was $44.1 million and $14.8 million for the years ended December 31, 2004 and 2005, respectively. Cash used in discontinued operations decreased as the international sale was completed in April 2005.

Cash used in operating activities was $126.4 million and $15.2 million for the years ended December 31, 2003 and 2004, respectively. Cash was used primarily to fund operating expenditures related to losses from continuing operations of $186.6 million and $174.8 million for the years ended December 31, 2003 and 2004, respectively. The decrease in cash flow used in operations was primarily due to higher domestic advertising revenue.

Cash used in investing activities was $2.5 million and $878,000 for the years ended December 31, 2003 and 2004, respectively. Cash used in investing activities decreased primarily due to expenditures for our new domestic channel website being placed into service during 2003.

Cash provided by financing activities was $165.3 million and $66.6 million for the years ended December 31, 2003 and 2004, respectively. During the years ended December 31, 2003 and 2004, we received proceeds of $49.4 million and $56.6 million, respectively, from our Tax Sharing Agreement with Hallmark Cards. We borrowed $70.0 million under our line of credit with HC Crown to meet our operating demands during the year ended December 31, 2003. Primarily from the proceeds of the $400.0 million senior unsecured note, on August 5, 2003, we redeemed the trust preferred securities and paid the private placement holders $326.7 million of principal, call premium and minimum return and we repaid $76.3 million on our bank credit facility.

Cash used in discontinued operations was $33.7 million and $44.2 million for the years ended December 31, 2003 and 2004, respectively. Cash used in discontinued operations primarily increased due to higher payments for program license fees to third parties and decreased cash receipts due to the announcement of the sale of the international business.

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The following table aggregates all of our contractual commitments as of December 31, 2005.