NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For
the Three and Nine Months Ended September 30, 2008 and 2009
1.
Business and Organization
Organization
Crown
Media Holdings, Inc. (“Crown Media Holdings,” “Crown Media” or the “Company”),
through its wholly-owned subsidiary, Crown Media United States, LLC (“Crown
Media United States”), owns and operates pay television channels (collectively
the “Channels” or the “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.
("Hallmark Entertainment Investments"), a subsidiary of Hallmark Cards,
Incorporated ("Hallmark Cards"), the National Interfaith Cable Coalition, Inc.
("NICC"), the DIRECTV Group, Inc. and, indirectly through their investments in
Hallmark Entertainment Investments, Liberty Media Corporation and J.P. Morgan
Partners (BHCA), L. P.
The
Company’s continuing operations are currently organized into one operating
segment, the domestic channels.
As of
September 30, 2009, the Company had $8.4 million in cash and cash equivalents on
hand and $42.5 million of current borrowing capacity under the bank credit
facility. Day-to-day cash disbursement requirements have typically
been satisfied with cash on hand and operating cash receipts supplemented with
the borrowing capacity available under the bank credit facility and forbearance
by Hallmark Cards and its affiliates. The Company’s management
anticipates that the principal uses of cash up to May 1, 2010, will include the
payment of operating expenses, accounts payable and accrued expenses,
programming costs, interest and repayment of principal under the bank credit
facility and interest of approximately $8.0 million to $12.0 million due under
certain notes to the Hallmark Cards affiliates from October 1, 2009, through May
1, 2010. The amounts outstanding under the bank credit agreement and
those notes are due May 1, 2010 as discussed below.
Operating
activities for the year ended December 31, 2008 and the nine months ended
September 30, 2009, yielded positive cash flow from operations. As discussed
below, there can be no assurance that the Company’s operating activities will
generate positive cash flow in future periods.
Another
significant aspect of the Company’s liquidity is the deferral of payments on
obligations owed to Hallmark Cards and its subsidiaries. Under the Amended and
Restated Waiver Agreement as amended with Hallmark Cards and its affiliates (the
“Waiver Agreement”), the deferred payments under such obligations are extended
to May 1, 2010. These obligations comprised $340.7 million at
September 30, 2009. An additional $740.1 million (10.25% Senior
Secured Note) of principal and interest outstanding at September 30, 2009,
payable to a Hallmark Cards’ affiliate in August 2011, is also subject to the
Waiver Agreement until May 1, 2010. Interest amounts related to the
10.25% note will be added to principal through February 5, 2010. The Hallmark
affiliate has indicated that it will not extend the Waiver Agreement beyond May
1, 2010.
Effective
April 1, 2009, the bank credit facility’s maturity date was extended to March
31, 2010, and the bank’s lending commitment was set at $45.0
million. The Company’s ability to pay amounts outstanding on the
maturity date is highly dependent upon its ability to generate sufficient,
timely cash flow from operations between September 30, 2009 and March 31,
2010. Based on the Company’s forecasts for 2009 and 2010, which
assume no principal payments on notes payable to Hallmark Cards and its
affiliates, the Company would have sufficient cash to repay all or most of the
bank credit facility on the maturity date, if necessary. However,
there is uncertainty regarding the Company’s future advertising revenues, so it
is possible that the cash flow may be less than the expectations of the
Company’s management.
Upon
maturity of the credit facility on March 31, 2010, to the extent the facility
has not been paid in full, renewed or replaced, the Company could require under
the Waiver Agreement that Hallmark Cards purchase the interest of the lending
bank in the facility. In that case, Hallmark Cards would have all the
obligations and rights of the lending bank under the bank credit facility and
could demand payment of outstanding amounts at any time after May 1, 2010, under
the terms of the Waiver Agreement.
The
Company believes that cash on hand, cash generated by operations, and borrowing
availability under its bank credit facility through March 31, 2010, when
combined with (1) the deferral of any required payments on related-party debt,
any 2009 tax sharing payments and related interest on the 10.25% Senior Secured
Note described under the Waiver Agreement, and (2) if necessary, Hallmark Cards’
purchase of any outstanding indebtedness under the bank credit facility on March
31, 2010, as described below, will be sufficient to fund the Company’s
operations and enable the Company to meet its liquidity needs through May 1,
2010.
The
sufficiency of the existing sources of liquidity to fund the Company’s
operations is dependent upon maintaining subscriber and advertising revenue at
or near the amount of such revenue for the nine months ended September 30, 2009.
A significant decline in the popularity of the Channels, a further economic
decline in the advertising market, an increase in program acquisition costs, an
increase in competition or other adverse changes in operating conditions could
negatively impact the Company’s liquidity and its ability to fund the current
level of operations. For the first three quarters, lower viewership
ratings in 2009 as compared to 2008 for the Company's programming on the
Hallmark Channel resulted in an increase in audience deficiency units owed to
advertisers, thereby reducing revenues and cash flows. Since the
second quarter of 2008, the Company has also experienced a softening of
advertising rates in the direct response and general rate scatter market because
of the national recession. Subsequent to the first quarter of 2008,
the rates for the Company's advertising spots in the scatter market and direct
response advertising were lower than 2007 levels. These market
conditions have continued in 2009, with rates lower in the third quarter of 2009
and the first nine months of 2009 when compared to the same periods in 2008. The
Company expects continued lower rates through 2009 and into 2010. In response to
these market conditions, the Company has implemented certain cost containment
measures for 2009, and has a limited number of additional, contingent cost
cutting measures that can be implemented in the remainder of 2009 depending on
market conditions.
The
Company is currently unable to meet its obligations which come due on and after
May 1, 2010. A default on the obligations due on May 1, 2010 would
also result in a default under the Company’s 10.25% Senior Secured Note. The
Company anticipates that prior to May 1, 2010, it will be necessary to extend,
refinance or restructure (i) the bank credit facility and (ii) the promissory
notes payable to affiliates of Hallmark Cards. As part of a combination of
actions and in order to obtain additional funding, the Company may consider
various alternatives, including restructuring of the debt if possible,
refinancing the bank credit facility, raising additional capital through the
issuance of equity or debt securities, or other strategic alternatives. If the
current adverse credit market conditions continue, a restructuring or
refinancing could be difficult to achieve and if achieved could include changes
to existing interest rates and other provisions within the current debt
arrangements. These changes may have a negative impact on future operating
results and cash flows.
As
discussed in Note 6, the Hallmark Cards' affiliate has proposed a
recapitalization of the Company's obligations. There can be no
assurance that the Company will accept and consummate this proposal, with or
without modification. Further, there can be no assurance that the Company will
ever consummate a refinancing or recapitalization.
2.
Summary of Significant Accounting Policies and Estimates
Interim
Financial Statements
In the
opinion of management, the accompanying condensed consolidated balance sheets
and related interim condensed consolidated statements of operations and cash
flows include all adjustments, consisting of normal recurring items necessary
for their fair presentation in conformity with accounting principles generally
accepted in the United States. Interim results are not necessarily indicative of
results for a full year. These condensed consolidated financial statements
should be read in conjunction with the audited consolidated financial statements
and the notes to those statements for the year ended December 31, 2008, included
in the Company’s Annual Report on Form 10-K for the year ended December 31,
2008.
Basis
of Presentation
The
condensed consolidated financial statements include the accounts of Crown Media
Holdings and its wholly-owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
The
preparation of financial statements in accordance with generally accepted
accounting principles requires the consideration of events or transactions that
occur after the balance sheet date but before the financial statements are
issued. Depending on the nature of the subsequent event, financial statement
recognition or disclosure of the subsequent event is
required. Subsequent events have been evaluated through the time of
filing of the Company’s Form 10-Q Report on November 5, 2009, which represents
the date the unaudited condensed consolidated financial statements were
issued.
Use
of Estimates
The
preparation of the accompanying condensed consolidated financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions about future events. These
estimates and the underlying assumptions affect the amounts of assets and
liabilities reported, disclosures about contingent assets and liabilities, and
reported amounts of revenue and expenses. Such estimates include the valuation
of accounts receivable, goodwill, program license fee assets, subscriber
acquisition fee assets, and other long-lived assets, legal contingencies,
indemnifications, and assumptions used in the calculation of income taxes, among
others. These estimates and assumptions are based on management’s best estimates
and judgment. Management evaluates its estimates and assumptions on an ongoing
basis using experience and other factors, including the current economic
environment, which management believes to be reasonable under the circumstances.
Management adjusts such estimates and assumptions when facts and circumstances
dictate. Illiquid credit markets, volatile markets for equity, foreign currency,
and energy, and declines in consumer spending have combined to increase the
uncertainty inherent in such estimates and assumptions. Estimates of the effects
of future events are inherently uncertain; therefore, actual results could
differ significantly from these estimates. Whenever revisions to estimates are
warranted by subsequent events or changes in conditions, the effect of such
revisions will be reflected in the financial statements of future
periods.
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. The Company’s bad debt expense was $235,000 and
$1.1 million for the three and nine months ended September 30, 2009,
respectively. The Company’s bad debt expense was $38,000 and $43,000 for the
three and nine months ended September 30, 2008, respectively.
Fair
Value of Financial Instruments
Financial
Accounting Standards Board (“FASB”) Accounting Standards Codification (the
“ASC”) Topic 820,
Fair Value
Measurements and Disclosures
, provides guidance which defines fair value,
establishes a framework for measuring fair value and specifies disclosures about
fair value measurements. On January 1, 2008 we adopted that portion
of the standard that relates to those nonfinancial assets and liabilities
which are recognized or disclosed at fair value on a recurring basis (that
is, at least annually). On January 1, 2009, subject to the FASB’s delayed
implementation, we adopted the remaining provisions of the standard. After
adoption, we now determine fair value as an exit price, representing the price
that would be received to sell an asset or paid to transfer a liability in
an orderly transaction between market participants.
The
Company does not have balance sheet items carried at fair value on a recurring
basis such as derivative financial instruments which are valued primarily based
on quoted prices in active or brokered markets for identical as well as similar
assets and liabilities. Significant balance sheet items which are subject to
non-recurring fair value measurements consist of goodwill and property and
equipment. The adoption of the standard in 2008 had no effect on the measurement
of the Company’s financial assets and liabilities. The standard has not had an
impact on the determination of fair value related to non-financial assets and
non-financial liabilities in the first nine months of
2009.
Net
Loss per Share
Basic net
loss per share is computed by dividing the net loss for the period by the
weighted average number of common shares outstanding during the period. Diluted
net loss per share is computed based on the weighted average number of common
shares and potentially dilutive common shares outstanding. The calculation of
diluted net loss per share excludes potential common shares if the effect would
be antidilutive. Potential common shares consist of incremental common shares
issuable upon the exercise of stock options. Approximately 341,000 stock options
for each of the three and nine months ended September 30, 2008, have been
excluded from the calculations of earnings per share because their effect would
have been antidilutive. Approximately 88,000 stock options for each of the three
and nine months ended September 30, 2009, have been excluded from the
calculations of earnings per share because their effect would have been
antidilutive.
Concentration
of Credit Risk
Financial
instruments, which potentially subject Crown Media Holdings to a concentration
of credit risk, consist primarily of cash, cash equivalents and accounts
receivable. Generally, Crown Media Holdings does not require collateral to
secure receivables. Crown Media Holdings has no significant off-balance sheet
financial instruments with risk of losses.
Four and
five of our distributors each accounted for more than 10% of our consolidated
subscriber revenue for the three months ended September 30, 2008 and 2009, and
together accounted for a total of 68% and 76% of consolidated subscriber revenue
during the three months ended September 30, 2008 and 2009,
respectively. Three of our distributors each accounted for
approximately 15% or more of our consolidated subscribers for both the three
months ended September 30, 2008 and 2009, respectively, and accounted for 61% of
our subscribers during both the three months ended September 30, 2008 and 2009,
respectively.
Four and
five of our distributors each accounted for more than 10% of our consolidated
subscriber revenue for both the nine months ended September 30, 2008 and 2009,
and together accounted for a total of 68% and 76% of consolidated subscriber
revenue during the nine months ended September 30, 2008 and 2009,
respectively. Three of our distributors each accounted for
approximately 15% or more of our consolidated subscribers for both the nine
months ended September 30, 2008 and 2009, respectively, and accounted for 61%
our subscribers during both the nine months ended September 30, 2008 and 2009,
respectively.
Recently
Issued Accounting Pronouncements
The
FASB’s Accounting Standards Codification is effective for all interim and annual
financial statements issued after September 15, 2009. The ASC is now
the single official source of authoritative, nongovernmental generally accepted
accounting principles (GAAP) in the United States. The historical
GAAP hierarchy was eliminated and the ASC became the only level of authoritative
GAAP, other than guidance issued by the Securities and Exchange
Commission. Our accounting policies were not affected by the
conversion to the ASC. However, we have conformed references to
specific accounting standards in these notes to unaudited condensed consolidated
financial statements to the appropriate section of the ASC.
In August
2009, the FASB issued Accounting Standards Update No. 2009-05
Fair Value Measurements and
Disclosures (
ASC Topic 820
) - Measuring Liabilities at Fair
Value
(ASC Update 2009-05). This update provides amendments to reduce
potential ambiguity in financial reporting when measuring the fair value of
liabilities. Among other provisions, this update provides clarification that in
circumstances in which a quoted price in an active market for the identical
liability is not available, a reporting entity is required to measure fair value
using one or more of the valuation techniques described in ASC Update 2009-05.
The Company will adopt ASC Update 2009-05 prospectively from October 1,
2009. We have not determined the impact, if any, that this update may
have on our financial statements.
In
October 2009, the FASB issued Accounting Standards Update, 2009-13, Revenue
Recognition (ASC Topic 605):
Multiple Deliverable Revenue
Arrangements – A Consensus of the FASB Emerging Issues Task Force.
This
update provides application guidance on whether multiple deliverables exist, how
the deliverables should be separated and how the consideration should be
allocated to one or more units of accounting. This update establishes a selling
price hierarchy for determining the selling price of a deliverable. The selling
price used for each deliverable will be based on vendor-specific objective
evidence, if available, third-party evidence if vendor-specific objective
evidence is not available, or estimated selling price if neither vendor-specific
or third-party evidence is available. The Company will be required to apply this
guidance prospectively for revenue arrangements entered into or materially
modified after January 1, 2011; however, earlier application is permitted. The
Company has not determined the impact that this update may have on its financial
statements.
3.
Program License Fees
Program
license fees are comprised of the following:
|
|
|
As of December 31,
|
|
|
As of September 30,
|
|
|
|
|
2008
|
|
|
2009
|
|
|
|
|
(In
thousands)
|
|
|
Program
license fees —
non-affiliates
|
|
$
|
576,779
|
|
|
$
|
623,076
|
|
|
Program
license fees — Hallmark Cards affiliates
|
|
|
10,967
|
|
|
|
12,467
|
|
|
Program
license fees, at
cost
|
|
|
587,746
|
|
|
|
635,543
|
|
|
Accumulated
amortization
|
|
|
(267,603
|
)
|
|
|
(330,766
|
)
|
|
Program
license fees,
net
|
|
$
|
320,143
|
|
|
$
|
304,777
|
|
At
December 31, 2008, and September 30, 2009, $7.6 million and $3.5 million,
respectively, of program license fees were included in prepaid and other assets
on the accompanying condensed consolidated balance sheets as the Company made
payments for the program license fees prior to commencement of the respective
license periods.
License
fees payable are comprised of the following:
|
|
|
As of December 31,
|
|
|
As of September 30,
|
|
|
|
|
2008
|
|
|
2009
|
|
|
|
|
(In
thousands)
|
|
|
License
fees payable —
non-affiliates
|
|
$
|
231,218
|
|
|
$
|
208,201
|
|
|
License
fees payable — Hallmark Cards affiliates
|
|
|
9,871
|
|
|
|
10,513
|
|
|
Total
license fees
payable
|
|
|
241,089
|
|
|
|
218,714
|
|
|
Less
current
maturities
|
|
|
(128,638
|
)
|
|
|
(113,108
|
)
|
|
Long-term
license fees
payable
|
|
$
|
112,451
|
|
|
$
|
105,606
|
|
4.
Credit Facility
On March
2, 2009, the Company and JPMorgan Chase Bank executed Amendment No. 15 to the
credit facility, renewing the Company’s $45.0 million credit line and extending
the maturity date to March 31, 2010, all effective April 1, 2009. The
facility is guaranteed by Hallmark Cards and the Company’s subsidiaries and is
secured by all tangible and intangible property of Crown Media Holdings and its
subsidiaries. Interest rates under the credit facility increased from
the Eurodollar rate to the Eurodollar rate plus 2.25% and from the Alternate
Base rate to the Alternate Base rate plus 1.25%.
The
Company had at September 30, 2009, $42.5 million of unused revolving credit
capacity. The Company’s ability to borrow additional amounts under the credit
facility is not limited or restricted.
Each
borrowing under the bank credit facility bears interest at a Eurodollar rate or
an Alternate Base Rate as the Company may request at the time of
borrowing. The Eurodollar rate is based on the London interbank
market for Eurodollars, and remains in effect for the time period of the loan
ranging from one, two, three, six or twelve months. The alternate
rate is the greatest of the prime rate of JP Morgan Chase Bank, the one month
London interbank market for Eurodollars plus 1.00% or the Federal Funds
effective rate plus 0.50%, and is adjusted whenever the applicable rate
changes. Prior to the effectiveness of Amendment No. 15, the Company
was required to pay a commitment fee of 0.15% per annum
of the
committed, but not outstanding, amounts under the revolving credit facility,
payable in quarterly installments. Pursuant to Amendment No. 15, the commitment
fee was increased to 0.375% per annum.
At
December 31, 2008, and September 30, 2009, the Company had outstanding
borrowings under the credit facility of $28.6 million and $2.5 million,
respectively, and there were no letters of credit outstanding. At December 31,
2008, the outstanding balance bore interest at the Eurodollar rate (a 2.02%
weighted average rate). At September 30, 2009, the outstanding balance bore
interest at the Eurodollar rate (a 2.51% weighted average rate). Interest
expense on borrowings under the credit facility for each of the three months
ended September 30, 2008 and 2009, was $389,000 and $53,000, respectively.
Interest expense on borrowings under the credit facility for each of the nine
months ended September 30, 2008 and 2009, was $1.8 million and $342,000,
respectively.
Covenants
The
credit facility, as amended, contains a number of affirmative and negative
covenants. The Company was in compliance with these covenants at
September 30, 2009.
5.
Related Party Long-Term Obligations
Waiver
and Standby Purchase
On March
10, 2008, the Company, Hallmark Cards and affiliates of Hallmark Cards who hold
obligations of the Company entered into an Amended and Restated Waiver and
Standby Purchase Agreement, which was most recently amended in May 2009, to
extend the waiver period to May 1, 2010 (the “Waiver Agreement”). In
connection with the recapitalization proposal described in Note 6, a Hallmark
Cards affiliate stated that it would not further extend the waiver period. The
Waiver Agreement replaced a previous version of the Waiver and Standby Purchase
Agreement dated March 21, 2006 as amended through October 2007. The
Waiver Agreement defers payments (excluding interest on the 2001, 2005 and 2006
notes mentioned below) due on any of the following obligations (the “Subject
Obligations”) until May 1, 2010, and interest on the 10.25% Note until August 5,
2010, or an earlier date as described below as the waiver termination date,
whereupon all of these amounts become immediately due and payable (the “Waiver
Period”):
|
·
|
Note
and interest payable to HC Crown, dated December 14, 2001, in the original
principal amount of $75.0 million, payable to HC Crown. (Total amount
outstanding at December 31, 2008, and September 30, 2009, including
accrued interest was $109.8 million and $108.6 million, respectively. See
Note and Interest
Payable to HC Crown
below.)
|
|
·
|
$70.0
million note and interest payable to Hallmark Cards affiliate, dated as of
March 21, 2006, arising out of the sale to Crown Media Holdings of the
Hallmark Entertainment film library. (Total amount outstanding at December
31, 2008, and September 30, 2009, including accrued interest was
$62.7 million and $62.0 million, respectively. See
Note and Interest Payable to
Hallmark Cards Affiliate
below.)
|
|
·
|
10.25%
senior secured note, dated August 5, 2003, in the initial accreted value
of $400.0 million, payable to HC Crown. (Total amount
outstanding at December 31, 2008, and September 30, 2009, including
accrued interest was $686.6 million and $740.1 million, respectively. See
Senior Secured Note
below.)
|
|
·
|
Note
and interest payable to Hallmark Cards affiliate, dated as of October 1,
2005, in the principal amount of $132.8 million. (Total amount outstanding
at December 31, 2008, and September 30, 2009, including accrued interest
was $172.1 million and $170.1 million, respectively. See
Note and Interest Payable to
Hallmark Cards Affiliate
below.)
|
|
·
|
All
obligations of the Company under the bank credit facility by virtue of
Hallmark Cards’ deemed purchase of participations in all of the
obligations under a guarantee which Hallmark Cards has given in support of
the facility or the purchase by Hallmark Cards of all these obligations
pursuant to the bank credit
facility.
|
|
·
|
Any
and all amounts due and owing to Hallmark Cards pursuant to the Tax
Sharing Agreement (Total amount outstanding at September 30, 2009, was
$4.9 million.).
|
Interest
will continue to accrue on these obligations during the Waiver
Period. The Waiver Agreement also contains certain covenants,
including but not limited to (1) our covenant not to take any action that
would prohibit us from being included as a member of Hallmark Cards consolidated
federal tax group, (2) compliance with obligations in the loan documents
for the bank credit facility and (3) commercially reasonable efforts to
refinance the obligations subject to the Waiver Period. Pursuant to
the Waiver Agreement, the Company must make prepayments on the outstanding debt
from 100% of any “Excess Cash Flow” during the Waiver Period. There
was no Excess Cash Flow for the first, second or third quarters of 2009. For the
nine months ended September 30, 2009, the Company repaid $26.1 million of
principal under the credit facility and $20.6 million of interest due to
Hallmark Cards affiliates, which amounts would otherwise be Excess Cash
Flow.
The
waiver termination date is May 1, 2010, or earlier upon occurrence of certain
events including but not limited to the following: (a) the Company
fails to pay any principal or interest, regardless of amount, due on any
indebtedness to unrelated parties with an aggregate principal amount in excess
of $5.0 million or any other event or condition occurs that results in any such
indebtedness becoming due prior to its scheduled maturity, provided that the
waiver will not terminate if the Company reduces the principal amount of such
indebtedness to $5.0 million or less within five business days of a written
notice of termination from Hallmark Cards; or (b) the Company fails to pay
interest on the bank credit facility described above to the extent that Hallmark
Cards has purchased all or a portion of the indebtedness thereunder or to
perform any covenants in the Waiver Agreement.
Under the
Waiver Agreement, if the bank lender under the bank credit facility accelerates
any of the indebtedness under the bank credit facility or seeks to collect any
indebtedness under it, the Company may elect to exercise its right to require
that Hallmark Cards or its designated subsidiary exercise an option to purchase
all the outstanding indebtedness under the bank credit facility. All
expenses and fees in connection with this purchase would be added to the
principal amount of the credit facility obligations.
Hallmark
Guarantee; Interest and Fee Reductions
Hallmark
Cards has provided to the lending bank under the credit facility the Hallmark
Cards facility guarantee. The guarantee is unconditional for
obligations of the Company under the bank credit facility. If any
payment is made on the guarantee, it will be treated as a purchase of the
lending bank’s interest in the credit facility.
Prior to
April 1, 2009, Hallmark Cards provided an irrevocable letter of credit to JP
Morgan Chase Bank as credit support for our obligations under the Company’s bank
credit facility for which we previously paid the letter of credit fees. This
letter of credit was cancelled on April 1, 2009.
The above
mentioned credit support provided by Hallmark Cards resulted in reductions in
the interest rate and commitment fees under the credit facility; however, we
agreed to pay and have paid an amount equal to the reductions in the
interest rate and commitment fees to Hallmark Cards. Prior to April
1, 2009, we paid 2.25% and 0.375% to Hallmark Cards, representing the reductions
in the interest rate and commitment fees, respectively. On April 1, 2009, as
noted in Note 4, the interest rate and commitment fees under the renewed credit
facility increased and we began paying Hallmark Cards a smaller reduction amount
of the interest rate and commitment fees equal to 0.75% and 0.125%.
Senior
Secured Note
In August
2003, the Company issued a senior note to HC Crown for $400.0 million. A portion
of the proceeds was used to repurchase the Company’s outstanding trust preferred
securities, and the balance of the proceeds, after expenses, was used to reduce
amounts outstanding under its bank credit facility.
In
accordance with the Waiver Agreement, cash payments are not required until
August 5, 2010 (which is the first payment date after May 1, 2010). The
principal amount of the senior secured note accretes at 10.25% per annum,
compounding semi-annually, to February 5, 2010. From that date,
interest at 10.25% per annum is scheduled to be payable semi-annually in arrears
on the accreted value of the senior note to HC Crown on August 5 and February 5
of each year until maturity. The note matures on August 5, 2011,
and is pre-payable without penalty. At December 31, 2008, and September 30,
2009, $686.6 million and $740.1 million, respectively, of principal and interest
were included in the senior note payable in the accompanying consolidated
balance sheets. The note purchase agreement for the senior note provides that if
there is an event of default with respect to any other indebtedness in excess of
$5.0 million, the accreted value and any accrued and unpaid interest on the
senior note would become due and payable. The note purchase agreement for the
senior note contains certain restrictive covenants which, among other things,
prevent the Company from incurring any additional indebtedness, purchasing or
otherwise acquiring shares of the Company’s stock, investing in other parties
and incurring liens on the Company’s assets. As a fee for the
issuance of the notes, the Company paid $3.0 million to HC Crown, which was
initially capitalized and is being amortized as additional interest expense over
the term of the note payable.
Note
and Interest Payable to HC Crown
On
December 14, 2001, the Company executed a $75.0 million promissory note with HC
Crown. Pursuant to the Waiver Agreement, the note is payable in full
on May 1, 2010 (although the maturity date of the note is December 31, 2009).
Under the Waiver Agreement, accrued interest on this 2001 Note was added to
principal through November 15, 2008. Commencing November 16, 2008,
interest is payable in cash, quarterly in arrears five days after the end of
each calendar quarter. This note is subordinate to the bank credit facility. The
rate of interest under this note is currently LIBOR plus 5% per annum (9.05% and
5.60% at December 31, 2008, and September 30, 2009, respectively). At December
31, 2008, and September 30, 2009, $108.6 million, is reported as note payable to
Hallmark Cards affiliate and $1.3 million and $0, respectively, are reported as
interest payable to Hallmark Cards affiliate on the accompanying condensed
consolidated balance sheet. Interest of $1.3 million was paid on January 5,
2009, interest of $1.7 million was paid on April 6, 2009, interest of $1.7
million was paid on July 6, 2009, and interest of $1.6 million was paid on
September 30, 2009.
Note
and Interest Payable to Hallmark Cards Affiliate
On
October 1, 2005, the Company converted approximately $132.8 million of its
license fees payable to Hallmark affiliates to a promissory note. The
rate of interest under this note is currently LIBOR plus 5% per annum (9.05% and
5.60% at December 31, 2008, and September 30, 2009, respectively). Pursuant to
the Waiver Agreement, the promissory note is payable in full on May 1, 2010
(although the maturity date of the note is December 31, 2009). Under
the Waiver Agreement, accrued interest on this 2005 Note was added to principal
through November 15, 2008. Commencing November 16, 2008, interest is
payable in cash, quarterly in arrears five days after the end of each calendar
quarter. At December 31, 2008, and September 30, 2009, $170.1 million is
reported as note payable to Hallmark Cards affiliate and $2.0 million and $0,
respectively, are reported as interest payable to Hallmark Cards affiliate on
the accompanying condensed consolidated balance sheet. Interest of $2.0 million
was paid on January 5, 2009, interest of $2.7 million was paid on April 6, 2009,
interest of $2.7 million was paid on July 6, 2009, and interest of $2.4 million
was paid on September 30, 2009.
Note
and Interest Payable to Hallmark Cards Affiliate
On March
21, 2006, the Company converted approximately $70.4 million of its payable to a
Hallmark Cards affiliate to a promissory note. The rate of interest under this
note is currently LIBOR plus 5% per annum (9.05% and 5.60% at December 31, 2008,
and September 30, 2009, respectively). Pursuant to the Waiver Agreement, the
promissory note is payable in full on May 1, 2010 (although the maturity date of
the note is December 31, 2009). Under the Waiver Agreement, accrued interest on
this 2006 Note was added to principal through November 15,
2008. Commencing November 16, 2008, interest is payable in cash,
quarterly in arrears five days after the end of each calendar quarter. At
December 31, 2008, and September 30, 2009, $62.0 million is reported as note
payable to Hallmark Cards affiliates and $717,000 and $0, respectively, are
reported as interest payable to Hallmark Cards affiliate on the accompanying
condensed consolidated balance sheet. Interest of $717,000 was paid on January
5, 2009, interest of $996,000 was paid on April 6, 2009, interest of $971,000
was paid on July 6, 2009, and interest of $887,000 was paid on September 30,
2009.
Interest
Paid to HC Crown Related to the Credit Facility
Interest
expense paid to HC Crown in connection with the credit facility was $241,000 for
the three months ended September 30, 2008, and $15,000 for the three months
ended September 30, 2009. Interest expense paid to HC Crown in
connection with the credit facility was $953,000 for the nine months ended
September 30, 2008, and $1.0 million for the nine months ended September 30,
2009.
Related
Party Note Obligations
The
aggregate maturities of related party notes for each of the five years
subsequent to September 30, 2009, are as follows:
|
|
|
Payments
Due by Period
|
|
|
|
Total
|
|
|
|
2010
|
|
|
|
2011
|
|
|
2012
|
|
|
2013
|
|
|
2014
|
|
|
|
|
(In
thousands)
|
|
Note
and interest payable to HC Crown,
with
principal deferred until May 1, 2010
|
|
$
|
108,611
|
|
|
$
|
108,611
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
10.25
% Senior secured note to HC Crown,
including
accrued interest, due August 5, 2011
|
|
|
740,083
|
|
|
|
-
|
|
|
|
740,083
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Note
and interest payable to Hallmark Cards affiliate
with
principal deferred until May 1, 2010
|
|
|
170,109
|
|
|
|
170,109
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Note
and interest payable to Hallmark Cards affiliate
with
principal deferred until May 1, 2010
|
|
|
62,007
|
|
|
|
62,007
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
$
|
1,080,810
|
|
|
$
|
340,727
|
|
|
$
|
740,083
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
6.
Related Party Transactions
Recapitalization
Proposal
On
May 28, 2009, the Company received a proposal (the “Proposal”) from HC
Crown Corp. (“HCC”), a wholly owned subsidiary of Hallmark Cards, Incorporated,
regarding a recapitalization of the Company's existing indebtedness and accounts
payable to HC Crown Corp. and its affiliates (“HCC Debt”) in excess of
$1.05 billion. Under the Proposal, $500.0 million principal amount of
HCC Debt would be restructured into new secured loans (the “New Debt”) with a
maturity date of September 30, 2011 and the remaining balance of the HCC
Debt would be converted into an equal amount of convertible preferred stock (the
“Preferred Stock”).
As stated
in the Proposal, the New Debt would have two tranches: (1) Tranche 1
of $300.0 million would bear cash-pay interest at the rate of 12% per annum with
the Company having the right to pay-in-kind up to three quarterly payments and
(2) Tranche 2 of $200.0 million would bear pay-in-kind at the
rate of 15% per annum. The New Debt would be secured by the Company's
assets.
The terms
of the Preferred Stock would include (1) an aggregate liquidation
preference, equal to the amount of converted HCC Debt; (2) no preferential
dividend but participation in any dividends on the Common Stock on an “as if
converted” basis; (3) the right to convert into common stock at a rate
equal to the liquidation preference divided initially by $1.00 per share, which
permits the Company’s existing shareholders (including Hallmark) to retain 15%
ownership of the Company; (4) the Company's right to redeem the Preferred
Stock at a price equal to the liquidation preference; and (5) the right to
vote together with the Common Stock on an “as if converted” basis.
As part
of the Proposal, the Company’s certificate of incorporation would be amended to
authorize additional shares of Preferred Stock and Common Stock in amounts
sufficient for the proposed conversion of HCC Debt into Preferred Stock and the
conversion of such Preferred Stock into Common Stock. The Proposal
also contemplates a merger of Hallmark Entertainment Holdings and HEIC into the
Company, with the shareholders in Hallmark Entertainment Holdings and HEIC
receiving Common Stock of the Company in accordance with their indirect
ownership of the Company immediately prior to such
mergers. Additionally, the existing Federal Income Tax Sharing
Agreement would be amended to, among other things, permit the Company to deduct
both cash-pay and pay-in-kind interest due to Hallmark Cards in calculating
tax-sharing payments on a prospective basis.
The HCC
Debt is subject to the Waiver Agreement described above that provides, among
other things, that during the Waiver Period (which is scheduled to expire on
May 1, 2010), HCC will not accelerate the maturity of the HCC Debt,
initiate proceedings for the collection of the HCC Debt, foreclose on the
collateral security for the HCC Debt, or commence or participate in certain
bankruptcy proceedings with respect to the Company. In connection with the
Proposal, HCC stated that it will not further extend the expiration of the
Waiver Period. The Company's Board of Directors has formed a Special
Committee of three independent directors to review and consider the
Proposal. In July 2009, the Special Committee announced that it has
retained an independent financial advisor to aid in the Special Committee’s
review of the Proposal.
There can
be no assurance that the Company will accept and consummate this Proposal, with
or without modification. The Proposal was filed with the Securities and Exchange
Commission by the Company in a May 28, 2009 Form 8-K Report and by
Hallmark Cards in an amendment to a Schedule 13D concerning the
Company.
On July
16, 2009, counsel to HCC delivered a letter (the “July 16 Letter”) to counsel to
the Special Committee. In the July 16 Letter, counsel to HCC
reiterated its understanding that the Special Committee needs time to determine
an appropriate response to the Proposal. Although HCC had requested
to receive a decision from the Company regarding the Proposed prior to the
filing of the Company’s second quarter Form 10-Q, HCC’s counsel confirmed in the
July 16 Letter that the filing date was in no way intended as a
deadline. In addition, counsel to HCC confirmed that notwithstanding
HCC’s understanding that the Company is unable to obtain refinancing of the
debt owed to HCC, HCC assumes that the Special Committee will explore other
refinancing alternatives.
For
information on the lawsuit brought in July 2009 with respect to the Proposal,
see Note 11, Commitments and Contingencies.
Tax Sharing
Agreement
Overview
On
March 11, 2003, Crown Media Holdings became a member of Hallmark Cards
consolidated U.S. federal tax group and entered into a federal tax sharing
agreement with Hallmark Cards (the “tax sharing agreement”). Hallmark Cards
includes Crown Media Holdings in its consolidated U.S. federal income tax
return. Accordingly, Hallmark Cards has benefited from past tax
losses and may benefit from future federal tax losses, which may be generated by
Crown Media Holdings. Based on the tax sharing agreement, Hallmark
Cards has agreed to pay Crown Media Holdings all of the benefits realized by
Hallmark Cards as a result of including Crown Media Holdings in its consolidated
income tax return. These benefits are estimated and paid 75% in cash
on a quarterly basis and the balance when Crown Media Holdings becomes a federal
taxpayer. A final true-up calculation is completed within 15 days
after Hallmark Cards files its consolidated federal income tax return for the
year. Pursuant to the true-up calculation, Crown Media Holdings is
obligated to reimburse Hallmark Cards the amount that any estimated payments
have exceeded the actual benefit realized by Hallmark Cards and Hallmark Cards
is obligated to pay Crown Media Holdings the amount that any actual benefit
exceeds the estimated payments. Under the tax sharing agreement, at
Hallmark Cards’ option, the non-interest bearing balance of the 25% in federal
tax benefits not funded immediately may be applied as an offset against any
amounts owed by Crown Media Holdings to any member of the Hallmark Cards
consolidated group under any loan, line of credit or other payable, subject to
limitations under any loan indentures or contracts restricting such
offsets.
The
Company received $5.3 million, which was offset during the third quarter of 2008
against debt owed under the tax sharing agreement with Hallmark Cards ($15.5
million for the nine months ended September 30, 2008). The Company recorded a
$1.2 million reduction to the payable to Hallmark Cards affiliates during the
third quarter of 2009 under the tax sharing agreement ($4.9 million payable for
the nine months ended September 30, 2009). All payments received from Hallmark
Cards or otherwise credited against amounts owed by Crown Media Holdings to any
member of the Hallmark Cards consolidated group, all pursuant to the tax sharing
agreement, have been recorded as paid-in capital.
Services
Agreement with Hallmark Cards
Hallmark
Cards provides various support services to the Company under a 2003 agreement,
the most recent renewal of which expires December 31, 2009. The
Company plans to request a renewal of this agreement on similar terms to the
current agreement. Such services include tax, risk management, health safety,
environmental, insurance, legal, treasury, human resources, cash management
services and real estate consulting services. In exchange, the
Company is obligated to pay Hallmark Cards a fee, plus out-of-pocket expenses
and third party fees, in arrears on the last business day of each quarter. Fees
for Hallmark Cards’ services were $541,000 for 2008 and are scheduled to be
$455,000 for 2009. With the concurrence of Hallmark Cards, the Company deferred
payment of fees for services provided through September 2008. Commencing October
2008, the Company has paid the required monthly fees, amounting to $135,000
during the three months ended December 31, 2008, $127,000 during the three
months ended September 30, 2009, and $341,000 during the nine months ended
September 30, 2009.
At
December 31, 2008, and September 30, 2009, non-interest bearing unpaid accrued
service fees and unreimbursed expenses of $14.8 million and $15.1 million,
respectively, were included in payable to affiliates on the accompanying
consolidated balance sheets. For the year ended December 31, 2008, and the nine
months ended September 30, 2009, related out-of-pocket expenses and third party
fees were $1.1 million and $278,000, respectively.
Trademark
License Agreement
Crown
Media United States has a trademark license agreement with Hallmark Licensing,
Inc. for use of the “Hallmark” mark for the Hallmark Channel and for the
Hallmark Movie Channels. In September 2009, Hallmark Cards extended
the trademark license agreements for the Hallmark Channel and the Hallmark Movie
Channels to September 1, 2010. The Company is not required to pay any fees under
the trademark license agreements.
The
Company has accounted for the agreement pursuant to the contractual terms of the
arrangement, which is royalty free. Accordingly, no amounts have been
reflected in the balance sheet or income statement of the Company.
7.
Company Obligated Mandatorily Redeemable Preferred Interest and NICC License
Agreements
VISN owns
a $25.0 million company obligated mandatorily redeemable preferred interest in
Crown Media United States (the “preferred interest”) issued in connection with
an investment by the Company in Crown Media United States. On November 13, 1998,
the Company, Vision Group, VISN and Henson Cable Networks, Inc. signed an
amended and restated company agreement governing the operation of Crown Media
United States (the "company agreement"), which agreement was further amended on
February 22, 2001, January 1, 2002, March 5, 2003, January 1, 2004, November 15,
2004 and December 1, 2005 (the “December 2005 NICC Settlement
Agreement”).
Under the
company agreement, the members agreed that if during any year ending after
January 1, 2005 and on or prior to December 31, 2009, Crown Media
United States has Federal taxable income (with possible adjustments) in excess
of $10.0 million, and the preferred interest has not been redeemed, Crown Media
United States will redeem the preferred interest in an amount equal to the
lesser of: (i) such excess Federal taxable income; (ii) $5.0 million; or (iii)
the amount equal to the preferred liquidation preference on the date of
redemption. Crown Media United States may voluntarily redeem the
preferred interest at any time; however, it is obligated to do so no later than
December 31, 2010. Because of the mandatory redemption provisions, this equity
instrument is reflected as a liability in the accompanying consolidated balance
sheets. Notwithstanding provisions of the Tax Sharing Agreement, the Company
believes that it will not have Federal taxable income in 2009. Accordingly, the
accreted amount of this obligation is classified among other than current
liabilities as of December 31, 2008, and September 20, 2009.
On
January 2, 2008, the Company and NICC signed an agreement (the “Modification
Agreement”) which, among other things, immediately extinguished a right to put
to the Company common stock owned by NICC. In addition, the
Modification Agreement also settled the dispute with respect to whether an
obligation to pay $15.0 million upon a change in control of Crown Media Holdings
expired with, or survived, the December 31, 2007 expiration of the December
2005 NICC Settlement Agreement. We agreed to pay NICC $8.3 million in three
equal installments payable in 2008, 2009 and 2010. We also agreed to
provide NICC a two-hour broadcast period granted each Sunday morning during the
two year period ending December 31, 2009. The discounted value
of the broadcast period, estimated to be $1.4 million, is reflected as deferred
revenue as of December 31, 2007. The deferred revenue is being amortized to
revenue ratably over NICC’s two-year use of the broadcast
commitment.
During
the three months ended September 30, 2008 and 2009, Crown Media United States
paid NICC $0 and $40,000, respectively, under the terms of the Modification
Agreement and one programming agreement. During the nine months ended September
30, 2008 and 2009, Crown Media United States paid NICC $6.4 million and $4.6
million, respectively, under the terms of the Modification Agreement and one
programming agreement.
8.
Share-Based Compensation
Approximately
200,000 stock options expired, without being exercised, in August 2009 following
the resignation of one of the Company’s executives in May 2009. Such options
were fully vested at the time of resignation.
The
Company recorded $649,000 and $2.4 million of compensation expense associated
with the Employment and Performance restricted stock units (“RSUs”) during the
three and nine months ended September 30, 2008, respectively, which have been
included in selling, general and administrative expense on the accompanying
condensed consolidated statements of operations. The Company recorded $134,000
of compensation expense and $303,000 of compensation benefit associated with the
Employment and Performance RSUs during the three and nine months ended September
30, 2009, respectively, which have been included in selling, general and
administrative expense on the accompanying condensed consolidated statements of
operations. The Company recorded these RSUs at fair value during each
period.
The
Company issued cash settlements related to the RSUs of $3.8 million during the
year ended December 31, 2008, and $1.5 million during the nine months ended
September 30, 2009.
At
December 31, 2008, the CEO’s share appreciation rights (“SARs”) were valued at
$440,000 using the $2.85 closing price of a share of our common stock on
December 31, 2008. At September 30, 2009, these SARs were valued at $0 as the
related CEO resigned on May 4, 2009. The Company recorded $42,000 and $0 in
compensation benefit related to SARs for the three months ended September 30,
2008 and 2009, respectively, on our condensed consolidated statement of
operations as a component of selling, general and administrative
expense. The Company recorded $730,000 and $247,000 in compensation
benefit related to SARs for the nine months ended September 30, 2008 and 2009,
respectively, on our condensed consolidated statement of operations as a
component of selling, general and administrative expense. The SARs
were recorded in accounts payable and accrued liabilities on the accompanying
condensed consolidated balance sheet at December 31, 2008.
9. Resignation
Agreements, Long Term Incentive Plan and Employee Terminations
Resignation
Agreements
The
individual then serving as the Company’s chief executive officer resigned May
31, 2009. Pursuant to the resignation agreement, in June 2009 the
Company paid this individual $2.5 million, an amount representing the present
value of the salary and bonus that otherwise would have been paid to him from
June 1, 2009 through October 2, 2010, the scheduled expiration of his employment
contract. The Company was obligated to pay this individual a
transaction bonus if a change in control of the Company occurred on or before
August 29, 2009. The Company is obligated to provide him office
space, an assistant and payment of COBRA insurance benefits for periods that
expire at various times through May 31, 2010.
The
Executive Vice President of Programming resigned from his position effective
May 31, 2009. The executive will receive continued payment of the regular
installments of his salary through December 31, 2009 ($523,000) and his salary
through May 31, 2010 in one lump sum payable on January 15, 2010 ($347,000). He
will also receive a payment of a pro rated annual bonus, determined by the
Company, for the 2009 calendar year for the period up to the resignation
date. Finally, he received an amount equal to accrued but unused
vacation/personal time ($42,000).
Long
Term Incentive Compensation Agreements
In the
second quarter of 2009, the Company granted Long Term Incentive Compensation
Agreements (“LTI Agreements”) to vice presidents and above. The
target award under each LTI Agreements is a percentage of the employee’s base
salary and range from $26,000 to $469,000 for executive officers of the
Company. Of each award, 50% is an Employment Award and 50% is a
Performance Award. The Employment Award will vest and be settled in
cash on August 31, 2011, subject to earlier pro rata settlement as provided in
the LTI Agreement. The Performance Award will vest and be settled in
cash 50% on December 31, 2010, and 50% on December 31, 2011, in accordance with
the Company performance criteria concerning adjusted EBITDA and cash flow and
subject to earlier pro rata settlement as provided in the LTI Agreement. Early
settlement is provided in the case of involuntary termination of employment
without cause on or after January 1, 2010, death or
disability. Potential payouts under the Performance Awards depend on
achieving 90% or higher of a target threshold and range from 0% to 150% of the
target award. The Company’s Compensation Committee has the ability to
increase or decrease the payout based on an assessment of demographics achieved,
relative market conditions and management of expenses.
Employee
Terminations
In August
2009, the Company terminated the employment of certain
individuals. The Company recorded severance expense of approximately
$1.2 million during the third quarter of 2009 as part of selling, general and
administrative expenses.
10.
Fair Value
The
following table presents the carrying amounts and estimated fair values of the
Company’s financial instruments at December 31, 2008, and September 30,
2009.
|
|
|
December
31, 2008
|
|
|
September
30, 2009
|
|
|
|
|
Carrying
|
|
|
Significant
Unobservable
Inputs
(Level
3)
Fair
|
|
|
Carrying
|
|
|
Significant
Unobservable
Inputs
(Level
3)
Fair
|
|
|
|
|
Amount
|
|
|
Value
|
|
|
Amount
|
|
|
Value
|
|
|
|
|
(In
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior
secured note to HC Crown,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
including
accrued interest
|
|
$
|
686,578
|
|
|
$
|
599,683
|
|
|
$
|
740,083
|
|
|
$
|
724,613
|
|
|
Note
and interest payable to HC Crown
|
|
|
109,837
|
|
|
|
86,544
|
|
|
|
108,611
|
|
|
|
104,101
|
|
|
Note
and interest payable to Hallmark Cards
Affiliate
|
|
|
62,724
|
|
|
|
49,422
|
|
|
|
62,007
|
|
|
|
59,448
|
|
|
Note
and interest payable to Hallmark Cards
Affiliate
|
|
|
172,077
|
|
|
|
135,584
|
|
|
|
170,109
|
|
|
|
163,089
|
|
|
Company
obligated mandatorily redeemable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
preferred
interest
|
|
|
20,822
|
|
|
|
17,430
|
|
|
|
22,382
|
|
|
|
19,200
|
|
ASC Topic
820 defines fair value of a liability as the price that would be paid to
transfer a liability in an orderly transaction between market participants at
the measurement date. When determining fair value, the Company considers the
principal or most advantageous market in which the Company would transact and
the market-based risk measurements or assumptions that market participants would
use in pricing the liability, such as inherent risk, transfer restrictions, and
credit risk. Level 3 is defined as inputs that are generally unobservable and
typically reflect management’s estimates of assumptions that market participants
would use in pricing the liability.
The
carrying amounts shown in the table are included on the accompanying
consolidated balance sheets under the indicated captions. The valuation of the
Company obligated mandatorily redeemable preferred interest is dependent upon
the future pre-tax income of Crown Media United States since the Company is only
obligated to make payments on the instrument within 60 days after the end of any
fiscal year in which pre-tax income is generated by Crown Media United States
with the remaining preferred liquidation preference payable in full on December
31, 2010.
The
Company estimates the fair value of its debt to Hallmark Cards affiliates on a
quarterly basis, commencing June 30, 2009, using the discounted future cash flow
method.
Accounts
payable and receivable are carried at reasonable estimates of their fair values
because of the short-term nature of these instruments. Long-term license fees
payable are also considered carried at reasonable estimates of their fair value.
Interest rates on borrowings under the bank credit facility are for relatively
short periods and variable. Therefore, the fair value of this debt is not
significantly affected by fluctuations in interest rates. The credit
spread in debt is fixed, but the market credit spread will
fluctuate.
Estimates
of the fair value of the Company’s financial instruments are presented in the
tables above. As a result of recent market conditions, the Company has financial
instruments for which limited or no observable market data is available. Fair
value measurements for these instruments are included in Level 3 of the fair
value hierarchy of ASC Topic 820. These fair value measurements are based
primarily upon the Company’s own estimates and are often based on its current
pricing policy, the current economic and competitive environment, the
characteristics of the instrument, credit and interest rate risks, and other
such factors. Therefore, the results cannot be determined with precision, cannot
be substantiated by comparison to quoted prices in active markets, and may not
be realized in an immediate settlement of the liability. Additionally, there are
inherent uncertainties in any fair value measurement technique, and changes in
the underlying assumptions used, including discount rates, liquidity risks, and
estimates of future cash flows, could significantly affect the fair value
measurement amounts.
The
majority of the Company’s debt has been transacted with Hallmark Cards and its
affiliates.
11.
Commitments and Contingencies
Lawsuit
On July
13, 2009, a lawsuit was brought in the Delaware Court of Chancery against each
member of the Board of Directors of Crown Media Holdings, Hallmark Cards and its
affiliates, as well as the Company as a nominal defendant, by a minority
stockholder of the Company regarding the recapitalization proposal (the
“Proposal”) which the Company received from HCC. The plaintiff is S. Muoio &
Co. LLC which owns beneficially approximately 5.8% of the Company's Class A
common stock, according to the complaint and filings with the Securities and
Exchange Commission. The Proposal, which the Company publicly announced on May
28, 2009, provides for a recapitalization of its outstanding debt to Hallmark
Cards affiliates in exchange for new debt and convertible preferred stock of the
Company. The lawsuit claims to be a derivative action and a class action on
behalf of the plaintiff and other minority stockholders of the Company. The
lawsuit alleges, among other things, that, the defendants have breached
fiduciary duties owed to the Company and minority stockholders in connection
with the Proposal. The lawsuit includes allegations that if the Proposal is
consummated, an unfair amount of equity would be issued to the majority
stockholders, thereby reducing the minority stockholders' equity and voting
interests in the Company, and that the majority stockholders would be able to
eliminate the minority stockholders through a short-form merger. The complaint
requests the court to enjoin the defendants from consummating the Proposal and
to award plaintiff fees and expenses incurred in bringing the
lawsuit.
On July
22, 2009, a Stipulation Providing for Notice of Transaction (the “Stipulation”)
was filed with the Delaware Court of Chancery. The Stipulation provides
that the Company will not consummate any transaction arising out of or relating
to the Proposal until not less than seven weeks after providing the plaintiff
with a notice of the terms of the proposed transaction. If the plaintiff
moves for preliminary injunctive relief with respect to any such transaction,
the parties will establish a schedule with the Court of Chancery to resolve such
motion during the seven week period. In addition, following the decision
of the Court of Chancery, the Company will not consummate any transaction for a
period of at least one week, during which time any party may seek an expedited
appeal. The Stipulation further provides that the plaintiff shall withdraw
its motion for preliminary injunction filed on July 13, 2009 and that the action
shall be stayed until the earlier of providing the notice of a transaction or an
announcement by the Company that it is no longer considering a transaction.
The
Company is unable to predict the outcome of the legal proceeding discussed in
this Note. The plaintiff does not seek monetary damages from the Company or
other named defendants. However, if the plaintiff’s request for relief is
granted, the Company will be unable to consummate the recapitalization described
in the Proposal. Legal fees to defend the proceeding described in this Note are
being expensed as incurred.
12.
Subsequent Event
At
November 5, 2009, the Company believes that it will be necessary in the first
quarter of 2010 to record a charge to cost of services of approximately $4.0
million to $5.0 million. This relates to the Company’s planned launch of a high
definition version of the Hallmark Channel in February 2010.