Annual Report
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form
10-K
(Mark
One)
[X]
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For
the fiscal year ended December 31, 2009
or
[
]
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For
the transition period
from to .
Commission
File Number: 000-30700
Crown
Media Holdings, Inc.
(Exact
Name of Registrant as Specified in Its Charter)
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Delaware
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84-1524410
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(State
or Other Jurisdiction
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(I.R.S.
Employer
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of
Incorporation or Organization)
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Identification
No.)
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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:
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Title of Each Class
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Name
of Each Exchange
on Which Registered
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Class
A Common Stock, $0.01 par value
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The
NASDAQ Stock Market LLC
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Securities
registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
[ ] 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 [ ] 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 [ ]
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files).[ ] Yes [ ] No
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. [ ]
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company. See definitions of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer
[ ] Accelerated
filer [
] Non-accelerated
filer
[X] Smaller
reporting company [ ]
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
ý
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, 2009, the last business day of the registrant’s most
recently completed second fiscal quarter, was $34,774,121.
As of
February 28, 2010, 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
Portions
of the Registrant’s Proxy Statement for the 2010 Annual Meeting of Stockholders,
to be filed, are incorporated by reference in Part III of this Form
10-K.
TABLE
OF CONTENTS
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Page
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Part
I
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Item
1
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Business
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Item
1A
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Risk
Factors
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Item
1 B
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Unresolved
Staff Comments
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Item
2
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Properties
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Item
3
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Legal
Proceedings
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Item
4
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Submission
of Matters to a Vote of Security Holders
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Part
II
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Item
5
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Market
for Our Common Equity, Related Stockholder
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Matters
and Issuer Purchases of Equity Securities
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Item
6
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Selected
Financial Data
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Item
7
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Management's
Discussion and Analysis of Financial Condition
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and
Results of Operations
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Item
7A
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Quantitative
and Qualitative Disclosures About Market Risk
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Item
8
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Financial
Statements and Supplementary Data
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Item
9
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Changes
in and Disagreements with Accountants on Accounting
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and
Financial Disclosure
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Item
9A
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Controls
and Procedures
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Item
9B
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Other
Information
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Part
III
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Item
10
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Directors,
Executive Officers and Corporate Governance
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Item
11
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Executive
Compensation
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Item
12
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Security
Ownership of Certain Beneficial Owners and
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Management
and Related Stockholder Matters
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Item
13
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Certain
Relationships and Related Transactions
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and
Director Independence
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Item
14
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Principal
Accountant Fees and Services
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Part
IV
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Item
15
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Exhibits,
Financial Statement Schedules
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Signatures
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In
this Annual Report on Form 10-K the terms "Crown Media Holdings" or the
“Company,” refer to Crown Media Holdings, Inc. and, unless the
context requires otherwise, subsidiaries of Crown Media Holdings that operate or
have operated our businesses, including Crown Media United States, LLC ("Crown
Media United States"). The term "common stock" refers to our Class A common
stock and Class B common stock, unless the context requires
otherwise.
The
name Hallmark and other product or service names are trademarks or registered
trademarks of their owners.
PART
I
ITEM
1. Business
Company
Overview
We own
and operate pay television channels (the “Channels”), known as the Hallmark
Channel, the Hallmark Movie Channel and the Hallmark Movie Channel HD, each of
which is dedicated to high-quality entertainment programming for adults and
families. The Hallmark Channel is a 24-hour television destination
for family-friendly programming and a leader in the production of original
movies. The Hallmark Movie Channel is a 24-hour cable network
dedicated to offering viewers a collection of movies appropriate for the entire
family, and the Hallmark Movie Channel HD, which was launched in April 2008, is
simulcast alongside the Hallmark Movie Channel. The Hallmark Movie Channel
offers a mix of Hallmark Channel original movies, classical theatrical films,
and Hallmark Hall of Fame presentations. 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 and recognized actors. We believe that 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 our Channels’ programming sources,
selected pay television distributors and the total number of subscribers as of
December 31, 2009.
We view a
“subscriber” as a household that receives, on a full or part-time basis, a
channel on a program tier of a distributor. We determine our Hallmark
Channel 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. This programming
includes original movies produced by a variety of experienced television
production companies and “off network” television series. Our production
agreements cover one specific movie or a package of several
movies. Typically under these agreements, our Channels have the right
to exhibit the movies for an initial window of 3 to 5 years and have the right
to extend the term for an additional 3 years, which we exercise based on the
performance of the movies in their initial window. With respect to television
series which we acquire from third parties, we typically have the right to
exhibit the series for a window of 3 to 5 years.
We
currently distribute (a) the Hallmark Channel through approximately 5,450 cable,
satellite and other pay television distribution systems and (b) the
Hallmark Movie Channel through approximately 800 such systems. As of the end of
2009, we had agreements with AT&T Inc. (U-verse), Cablevision, Charter,
Comcast, Cox, DirecTV, Dish Network, Mediacom, the National Cable Television
Cooperative, Time Warner, Verizon Communication (FiOS), and many other pay
television distributors, for the distribution of the Hallmark Channel. We also
have agreements with AT&T Inc. (U-verse), Cablevision, Charter, Comcast,
Cox, Dish Network, DirecTV, National Cable Televisions Cooperative (“NCTC”),
Time Warner, Verizon Communications (FiOS) and other select distributors, which
give these distributors the right to distribute the Hallmark Movie Channel and
the Hallmark Movie Channel HD. In addition, we have entered into
agreements with several telephone companies that have started to furnish video
programming to consumers, including the National Rural Telecommunications
Cooperative and AT&T.
Five of
our distributors each accounted for more than 10%, and together accounted for a
total of 76%, of our consolidated subscriber revenue for the year ended December
31, 2009. Three of our distributors each accounted for approximately
15% or more of our consolidated subscribers for the year ended December 31,
2009, and together accounted for 61% of our consolidated subscribers on that
date.
We
license the trademark “Hallmark” for use on our Channels pursuant to certain
trademark license agreements with a subsidiary of Hallmark Cards, Incorporated.
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.
During
2009, domestic channel operations comprised the Company’s sole operating
segment.
Recent
Developments
Recapitalization
of the Company
As
previously disclosed, the Company’s Board of Directors formed a Special
Committee of three independent directors to review and consider a May 28, 2009
proposal from H C Crown Corp. (“HCC”) regarding a recapitalization of the
amounts owed by the Company to HCC and its affiliates. HCC is a
wholly-owned subsidiary of Hallmark Cards, Incorporated (“Hallmark
Cards”). On February 9, 2010, the Special Committee of the Board and
HCC approved and executed a Recapitalization Term Sheet, representing
non-binding terms of recapitalization transactions for the
Company. On February 26, 2010, the Company entered into the Master
Recapitalization Agreement with Hallmark Cards, HCC and related entities that
provides for the recapitalization transactions and the agreements described
below (the “Recapitalization”). The summary of the terms of the
Recapitalization transactions is qualified entirely by reference to the
agreements to which each summary description relates, each of which we have
filed with the Securities and Exchange Commission (the “SEC”).
The
Recapitalization transactions include, among other things, $315.0 million
principal amount of the HCC Debt (as defined below) being restructured into new
debt instruments, $185.0 million principal amount of the HCC Debt being
converted into convertible preferred stock of the Company, Class B Common Stock
being converted into Class A Common Stock with Class A Common Stock becoming the
only authorized and outstanding common stock of the Company (the “Class A Common
Stock”), and the balance of the HCC Debt being converted into shares of Class A
Common Stock. Upon execution of the Master Recapitalization
Agreement, the automatic termination of the waiver under the existing Amended
and Restated Waiver and Standby Purchase Agreement (the “Waiver Agreement”) with
Hallmark Cards and HCC was extended until August 31, 2010; the Waiver Agreement
defers payment dates on HCC Debt (excluding accounts payable).
Other
aspects of the Recapitalization concern a Credit Agreement for the new debt, an
amendment to the Tax Sharing Agreement with Hallmark Cards, a registration
rights agreement, mergers of two intermediate holding companies with the
Company, efforts to extend or replace the Company’s revolving line of credit,
Hallmark Cards’ willingness to guarantee $30.0 million of a revolving line of
credit, a standstill agreement of Hallmark entities pursuant to which such
entities agree not to acquire, through December 31, 2013, additional shares of
Class A Common Stock of the Company, subject to certain exceptions, and agree to
certain restrictions on their ability to sell or transfer shares of Class A
Common Stock of the Company until December 31, 2013 and, subject to lesser
restrictions, until December 31, 2020.
Each of
the Company (subject to approval by the Special Committee) and HCC has the right
to terminate the Master Recapitalization Agreement at any time after the later
of (x) June 30, 2010 and (y) 45 days following receipt of notice that the
information statement filed by the Company will not be reviewed by the SEC or
that the SEC staff has no further comments thereon, if the Recapitalization has
not been consummated prior to that date. Even if there were such a
termination, the Waiver Agreement will continue to provide that the automatic
termination date of the waiver will extend to August 31, 2010. The
closing of the Recapitalization is subject to a number of conditions, including,
among other things, (a) representations and warranties of the Company being
accurate, (b) obtaining a one-year revolving credit agreement mentioned below,
(c) there being no judgment or order which prohibits the consummation of the
Recapitalization and (d) Hallmark Cards not having delivered a written
notice to the Company certifying that Hallmark Cards in its sole discretion (but
only after consultation with outside legal counsel) shall have determined that
the status of any pending or threatened litigation or regulatory proceeding
involving the Company or its subsidiaries in connection with the
Recapitalization is unsatisfactory to Hallmark Cards. See Note 16 of
the Consolidated Financial Statements for information regarding a pending
lawsuit on the Recapitalization in which the plaintiff objects to the
Recapitalization.
From the
date of the Master Recapitalization Agreement to the Closing Date, the Company
will be subject to various affirmative covenants (including covenants to operate
in the ordinary course of business and to keep available the services of its
officers and employees and preserve the present relationships with persons doing
business with it) as well as various negative covenants (including, among
others, with respect to sales, leases or transfers outside the ordinary course
of business and acquisitions of material assets other than in accordance with
past practices).
If the
Recapitalization is consummated, the Hallmark parties will own, excluding the
shares of Class A Common Stock that would be received upon conversion of the
preferred stock, at least 90.1% of the sum of the outstanding common stock of
the Company and shares subject to outstanding options (the outstanding options
are for 87,238 shares on the date hereof). Certain aspects of the
Recapitalization require stockholder approval. Hallmark Entertainment
Holdings, Inc. (“HEH”) and certain Hallmark Cards affiliates as direct or
indirect owners of a more than a majority of the Company’s voting stock have
stated in the Master Recapitalization Agreement their written consents as
stockholders to these matters in lieu of holding a meeting of the Company’s
stockholders. No vote of other stockholders will be requested or
required. The closing of the Recapitalization cannot occur until 20
calendar days after an information statement required by regulations of the SEC
is sent to the stockholders of the Company, or if such information statement is
furnished by sending a Notice of Internet Availability, until 40 calendar days
after such notice is sent to the stockholders of the Company. The
Master Recapitalization Agreement requires that the Company use best efforts to
prepare and file the information statement with the SEC as promptly as is
reasonably practicable (but not later than March 20, 2010).
General
In the
Recapitalization:
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$315.0
million principal amount of the HCC Debt will be restructured into new
debt instruments on the terms summarized below (the “New Debt”), $185.0
million principal amount of the HCC Debt will be converted into an equal
amount of convertible preferred stock of the Company on the terms
summarized below (the “Convertible Preferred Stock”), and the balance of
the HCC Debt as of the closing of the Recapitalization (the “Closing
Date”) will be converted into shares of Class A Common Stock at the
Conversion Price (as described below). As a result of the
Recapitalization, immediately following the closing of the
Recapitalization transactions, all of the HCC Debt, except to the extent
converted and continued as New Debt, will be extinguished and
discharged.
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“HCC
Debt” means (i) the aggregate principal amount of all indebtedness owed to
Hallmark Cards, HCC and their controlled affiliates, including accrued and
unpaid interest thereon through the Closing Date, but excluding accrued
but unpaid interest with respect to the 2001 Note, the 2005 Note and the
2006 Note; (b) all accounts payable and open intercompany accounts of the
Company and its subsidiaries owed to HCC and Hallmark Cards and their
controlled affiliates (other than the Company and its subsidiaries); and
(c) any amounts due to Hallmark Cards or its affiliates under the Tax
Sharing Agreement (as defined below) through December 31, 2009; provided
that for the avoidance of doubt the following shall not constitute HCC
Debt: (i) Reimbursement Obligations (as defined in the Master
Recapitalization Agreement), (ii) Ordinary Course of Business Obligations
(as defined in the Master Recapitalization Agreement), and (iii) any
amounts due to Hallmark Cards or its affiliates under the Tax Sharing
Agreement accruing on or after January 1, 2010. “2001 Note”
means the Promissory Note, dated as of December 14, 2001, of the Company
in the original principal amount of $75.0 million payable to HCC; “2005
Note” means the Promissory Note, dated as of October 1, 2005, of a
wholly-owned subsidiary of the Company in the original principal amount of
$132,785,424 payable to HCC; and “2006 Note” means the Promissory Note,
dated as of March 21, 2006, of the Company in the original principal
amount of $70,414,087.87 payable to
HCC.
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“Conversion
Price” means the amount equal to (x) the quantity of (i) the total HCC
Debt as of the Date of Determination, less (ii) $500 million, divided by
(y) the Conversion Price Shares. “Conversion Price Shares”
means a notional number of shares of Class A Common Stock which, when
combined with the number of shares of Class A Common Stock directly or
indirectly owned by Hallmark Cards as of the Date of Determination (for
purposes of such calculation (x) including with respect to shares of Class
A Common Stock owned directly by Hallmark Entertainment Investments Co.
(“HEIC”) only HEH’s pro rata portion of the Class A Common Stock owned by
HEIC, and (y) excluding the shares of Class A Common Stock that will be
receivable by HCC upon conversion of the Convertible Preferred Stock),
will equal 90.1% of the sum of (i) all outstanding shares of Class A
Common Stock on the Date of Determination prior to the Closing Date, (ii)
the Conversion Price Shares and (iii) all shares potentially issuable upon
exercise of all outstanding options as of the Date of
Determination.
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“Date of
Determination” means the Closing Date, provided that if the Closing Date occurs
on or after March 31, 2010, the “Date of Determination” will be deemed to be
March 31, 2010.
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The
terms of the New Debt as set forth in the Credit Agreement will include
without limitation the following:
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Maturity: December
31, 2013.
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Tranches:
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§
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Term
A Loan of $200 million will be cash-pay in terms of interest and will bear
interest at the rate of 9.5% per annum through December 31, 2011,
increasing to 12% on and after January 1, 2012 through December 31,
2013.
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Term
B Loan of $115 million will be payable-in-kind, by adding interest to the
principal (“PIK”), through December 31, 2010 and will become cash-pay for
the quarterly period beginning on January 1, 2011 and for all quarterly
periods thereafter. The interest rate will be 11.5% through December 31,
2011, increasing to 14% on and after January 1, 2012 and continuing
through December 31, 2013.
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PIK
Toggle: The Company will have the option to PIK up to three quarterly cash
payments in the aggregate for the Term A Loan and the Term B
Loan. For the avoidance of doubt, contractual PIK payments
under the Term B Loan will not reduce the number of optional PIK payments
available to the Company, and if the Company opts to PIK both the Term A
Loan and the Term B Loan cash payments in a single quarter then that will
count as two of the Company’s three quarterly PIK
options.
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Prepayment:
The New Debt will be pre-payable at any time at par plus accrued
interest.
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Mandatory
Prepayments: 100% of net cash proceeds from asset sales or other
dispositions, except to the extent such net cash proceeds are reinvested
in productive assets of a kind then used or usable in the business of the
Company or its subsidiaries within 180 days of the sale or other
disposition; 100% of net cash proceeds from equity issuances; 100% of net
cash proceeds from debt issuances (exclusive of the Revolver as described
below); 75% of Excess Cash Flow (as defined in the New Debt agreements);
and upon the sale of assets in advance of a condemnation proceeding, or
following the occurrence of a casualty or condemnation for which the
Company or its subsidiaries have received proceeds, after such proceeds
have been used to replace the subject assets. Prepayments must
be applied in the following order (i) first to PIK interest on the Term A
Loan (ii) then to principal on the Term A Loan (iii) then to PIK interest
on the Term B Loan, and (iv) finally to principal on the Term B
Loan.
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Change
in Control: The principal and interest on the New Debt will
become immediately due and payable upon a change in control (as defined in
the Credit Agreement) arising from (i) a Premium Transaction (as described
below) or (ii) a transaction approved by a special committee of the
Company's Board of Directors.
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Collateral: An
existing lien on substantially all of the Company’s assets will be
modified so it secures obligations under the Credit
Agreement. It is contemplated that this security interest will
be subordinate to the lender under the bank revolving credit
facility.
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NICC
Reserve Account: The Company is required to redeem the preferred
interest held by a wholly-owned subsidiary of National Interfaith Cable
Coalition (“NICC”) in Crown Media United States for $25.0 million by
December 31, 2010. Prior to closing of the Credit Agreement, the
Company will establish with a financial institution a NICC Reserve Account
in the Company's name and deposit in that account amounts which the
Company chooses as a sinking fund for the mandatory redemption of that
preferred interest. The funds in the NICC Reserve Account are to be
used to make any scheduled payments on the NICC preferred interest and at
no time is the amount to exceed $25.0
million.
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Covenants: Negative
covenants include limitations on debt incurrence; dividends; liens;
capital expenditures; investments; restricted payments; sale/leaseback
transactions; creation of subsidiaries; changes in business conducted;
execution or amendment of material agreements in such a way as could be
reasonably be expected to be materially disadvantageous to the Hallmark
lenders; transactions with affiliates; and dispositions of
property.
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Financial
covenants include: The Company will not permit its Cash
Interest Coverage Ratio as the end of any fiscal quarter to be less than
2.0:1.0.
“Cash
Interest Coverage Ratio” is defined as the ratio of (a) EBITDA to (b) the sum of
the Term A Loan and the Term B Loan cash interest expense (excluding PIK
interest), in each case for a Measurement Period of four consecutive
fiscal quarters ending on the date of determination, adjusted pro rata for the
three full quarters following the Closing Date.
“EBITDA”
means for any period (x) Consolidated Net Income plus (y) to the extent
Consolidated Net Income was reduced by such items: (i) provision for income
taxes during such period; (ii) interest expense deducted in computing
Consolidated Net Income; (iii) total depreciation expense and total amortization
expense (other than amortization of capitalized film costs); (iv) any
extraordinary, unusual or non-recurring expenses or losses, whether or not
included as a separate item in the statement of such Consolidated Net Income for
such period (including, but not limited to losses on sales of assets outside of
the ordinary course of business, impairment of assets, restructuring charges,
transactions costs of the Recapitalization payable by the Company and write-offs
of deferred costs for such period); (v) any other non-cash charges (other than
write-offs or write-downs during such period of inventory, accounts receivable
or any other current assets or liabilities in the ordinary course of business);
minus (z)(i) any extraordinary, unusual or non-recurring income or gains
(including, whether or not otherwise included as a separate item in the
statement of such Consolidated Net Income for such period, gains on sale of
assets outside of the ordinary course of business) for such period and (ii) any
other non-cash income items increasing Consolidated Net Income for such period,
all as determined for such period in conformity with GAAP.
The
credit agreement for the Term A Loan and Term B Loan includes cross defaults if
there is a default by the Company on any indebtedness for borrowed money and
similar obligations in excess of $1,000,000 or if there is a failure to pay the
redemption amount of $25.0 million on the preferred interest held by the NICC
subsidiary in Crown Media United States or if there is demand on the Hallmark
guarantee on the Revolver.
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The
terms of the Convertible Preferred Stock will include without limitation
the following:
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Liquidation
preference: In the event of any liquidation or winding up of
the Company, the holders of the Convertible Preferred Stock will be
entitled to receive, in preference to the holders of the common stock of
the Company, an amount equal to the greater of (x) $1,000 per share plus
accrued but unpaid dividends thereon, or (y) that amount that would be
received by such holders on an “as converted” basis (the “Liquidation
Preference”). A consolidation, merger, reorganization or other
form of acquisition of the Company or a sale of all or substantially all
of its assets will be deemed to be a liquidation or winding up for
purposes of the liquidation
preference.
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Dividends:
No dividends will accrue or be payable from the date of issue of the
Convertible Preferred Stock through December 31, 2010; cumulative PIK
dividends will accrue from and after January 1, 2011 through December 31,
2011 at a rate per annum of 14%; cumulative PIK dividends will accrue from
and after January 1, 2012 through December 31, 2014 at a rate per annum of
16%; and cumulative cash-pay dividends will accrue for all periods
thereafter at a rate per annum of 16%, in each case payable solely out of
lawfully available surplus. The Convertible Preferred Stock
will participate with the common stock of the Company as to dividends on
an “as converted” basis. The Company may elect to pay
accumulated PIK dividends in cash at any time, subject to lawfully
available surplus.
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Optional
Conversion: At the option of the holder, each share of
Convertible Preferred Stock becomes and remains convertible at the earlier
of December 31, 2013, or upon a payment or refinancing by the Company
of all or substantially all of the New Debt, into such number of shares of
common stock of the Company as is determined by dividing the Liquidation
Preference of $1,000 plus accrued and unpaid dividends with respect to
such shares of Convertible Preferred Stock by the conversion
price, with anti-dilution protection, including, among other things, an
adjustment for certain issuances of common stock of the Company without
consideration or for a consideration per share less than the then
Conversion Price.
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Redemption: The
Company must redeem (to the extent funds are lawfully available) the
Convertible Preferred Stock when and as the Company receives, upon a
refinancing of the New Debt, net proceeds from such refinancing in excess
of the aggregate outstanding principal and interest amounts of New Debt
(“Excess Refinancing Proceeds”). The Company may voluntarily
redeem the Convertible Preferred Stock at the Liquidation Preference at
any time upon 10-days written
notice.
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Voting: The
Convertible Preferred Stock will vote together with the common stock of
the Company on an “as-converted” basis. In addition, the
consent of holders of more than 50% of the Convertible Preferred Stock,
voting as a separate class, will be required for the Company to do any of
the following, among other things: (i) Authorize or sell any
equity securities
pari
passu
or senior in right of liquidation to the Preferred Stock;
(ii) except for certain indebtedness permitted by the Credit Agreement,
authorize or issue any debt security unless the debt security has received
the prior approval of the Board of Directors, or amend the terms of any
agreement regarding material indebtedness of the Company unless the
amendment has been approved by the Board of Directors; (iii) repurchase or
redeem equity securities (other than from an employee following
termination pursuant to an arrangement or agreement), or declare or pay
any dividend on the common stock of the Company; (iv) sell, merge,
recapitalize, reorganize, liquidate or dissolve the Company; (v) make any
acquisitions greater than $5,000,000; (vi) amend organizational documents
or enter into an agreement that adversely affects or alters the rights,
preferences or privileges of the Convertible Preferred Stock; and (vii)
issue any additional shares of common stock of the Company (other than
pursuant to options outstanding on the Closing Date) or options or rights
to acquire common stock of the
Company.
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Tax
Sharing Agreement
The
existing Federal Income Tax Sharing Agreement between Hallmark Cards and the
Company will be amended effective as of January 1, 2010 (as amended, the “Tax
Sharing Agreement”). The amendment will provide, among other things,
that:
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Hallmark
Cards will not pay any Crown Tax Benefits (defined in the Tax Sharing
Agreement) in cash and instead will carry forward any such amounts to
offset future Crown Tax Liability (defined in the Tax Sharing
Agreement);
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the
Company will be allowed to deduct both cash-pay and PIK interest due to
Hallmark Cards in calculating tax-sharing
payments;
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the
conversion of the HCC Debt pursuant to the Recapitalization will not be
deemed the payment of interest expense to Hallmark
Cards;
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tax
attributable to the cancellation of indebtedness income will be excluded
from the calculation of tax sharing payments;
and
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any
amounts related to taxes owed to Hallmark Cards prior to December 31,
2009, will be included in the HCC Debt, which will be converted into Class
A Common Stock.
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The first
payment by the Company pursuant to the Tax Sharing Agreement will occur after
the first full quarter following the Closing Date and will be made in respect of
the period commencing from January 1, 2010 through the last day of the first
full quarter following the Closing Date.
Registration
Rights Agreement
The
Company and HCC will enter into a Registration Rights Agreement providing for
three demand registration rights, three demand resale registration rights and
unlimited piggyback registration rights. The registration rights
concern, among other things, Class A Common Stock issued in the
Recapitalization, Class A Common Stock issuable upon the conversion of the
Convertible Preferred Stock, and Class A Common Stock acquired pursuant to
subscription rights of HCC described below.
Mergers
and Amendments to Certificate of Incorporation
Two
intermediate holding companies (HEIC and HEH) will be merged with and into the
Company, and the stockholders of those companies will receive their pro rata
direct ownership of Class A Common Stock in connection therewith (the
“Mergers”). The Company’s stockholders will receive no consideration
in connection with these mergers.
The
Company will effect an amendment to the Company’s certificate of incorporation
which will automatically convert the shares of Class B Common Stock into shares
of Class A Common Stock and eliminate the super-voting nature of the Class B
Common Stock, resulting in the only authorized common stock being the Class A
Common Stock. The amendment will increase the Company’s authorized
capital stock to 500,000,000 shares of Class A Common Stock and decrease the
authorized Preferred Stock to 1,000,000 shares of preferred stock which may be
issued in series designated by the Board of Directors, of which 400,000 will be
designated as Series A Preferred Stock.
The
provisions dealing with corporate opportunities will be revised to further
delineate the duties of a director or officer of the Company who is also a
director or officer of Hallmark Cards or its affiliates with respect to business
opportunities and corporate transaction opportunities.
Currently
the Company is governed by Section 203 of the Delaware General Corporation Law,
dealing with restrictions on business combinations, although, by the terms of
Section 203, the restrictions on business combinations do not currently apply to
Hallmark Cards or its affiliates. Pursuant to the amendments to the
Certificate of Incorporation, the Company will elect not to be governed by
Section 203 unless and until such time as (i) Section 203, but for the opt-out
provision, would apply to the Company or (ii) there is a transaction in which
Hallmark's beneficial interest in the Company is reduced to less than 50% of the
outstanding shares of Class A Common Stock.
Further,
the Company’s Board of Directors and Hallmark Cards affiliates representing more
than a majority of the voting power of the Company’s capital stock have approved
of an amendment to the Company’s Certificate of Incorporation that provides for
a reverse stock split at any time prior to December 31, 2013 upon the request of
a special committee of the Company’s Board of Directors. The exact
ratio of the reverse stock split will be determined by the Board of Directors,
upon the recommendation of the special committee.
Revolver
As a
condition to closing, the Company must have obtained a revolving credit facility
from a third-party lender with a term of not less than 360 days from the Closing
Date and with availability of at least $30.0 million (the
“Revolver”). The Revolver will have other terms and conditions
reasonably acceptable to the Company, and Hallmark Cards must have guaranteed,
or caused one or more of its affiliates to have guaranteed, the
Revolver.
Waiver
Agreement
The
Waiver Agreement, which was entered into on March 10, 2008 and most recently
amended in May 2009, has been amended to provide that the waiver thereunder will
terminate automatically on August 31, 2010. Additionally, Hallmark
will use its best efforts to ensure that the Company will have continued access
to up to $30.0 million under the Company’s existing revolving credit facility
while the Waiver Agreement is in effect.
Standstill
Agreement
Hallmark
Cards and HCC (“Hallmark” in this context) will enter into a stockholders
agreement (the “Stockholders Agreement”) with standstill provisions pursuant to
which they will agree that Hallmark will not acquire any additional shares of
common stock of the Company through December 31, 2013, except:
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additional
shares of Class A Common Stock resulting from the conversion of the
Convertible Preferred Stock;
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acquisitions
pursuant to the subscription rights described in the next
paragraph;
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with
the prior approval of a special committee of the Company’s Board of
Directors comprised solely of independent, disinterested directors;
and
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from
January 1, 2012 through December 31, 2013, either (i) pursuant to a tender
offer for all of the Company’s shares of Class A Common Stock, which
tender offer is subject to a majority-of-a-minority tender condition, or
(ii) pursuant to a “Premium Transaction” as described below under “Co-Sale
Rights.”
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Until
termination of the Stockholders Agreement, in the event that the Company
proposes to issue additional shares of capital stock, options or rights to
acquire equity securities or debt securities convertible into equity securities,
the Company will offer to HCC and its affiliates such additional shares as will
be necessary to ensure that Hallmark continues to own on a fully-diluted basis
at least the same percentage of the shares of all classes of the Company capital
stock as HCC and its affiliates owned immediately prior to such
issuance.
Co-Sale
Rights
The
Stockholders Agreement also provides that:
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Until
December 31, 2013, HCC may not sell or transfer its Class A Common Stock
to a third party, except:
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from
the Closing Date through December 31, 2013, with the prior approval of a
special committee of the Company’s Board of Directors comprised solely of
independent, disinterested
directors;
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on
or after January 1, 2012, (i) in a Premium Transaction or (ii) pursuant to
a public offering or block trade in which to the knowledge of HCC, no
purchaser (together with its affiliates and associates) acquires
beneficial ownership of a block of shares of the Company in excess of 5%
(in the case of a public offering) or 2% (in the case of any block trade)
of the outstanding Class A Common Stock;
and
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to
an affiliate of Hallmark Cards or pursuant to a bona fide pledge of the
shares to a lender that is not an affiliate of Hallmark Cards
(collectively, a “Permitted
Transfer”).
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A
“Premium Transaction” is a transaction involving the sale or transfer by
Hallmark of its shares of Class A Common Stock to a third party (by merger or
otherwise) in which all stockholders unaffiliated with Hallmark will be entitled
to participate and will be entitled to receive both (x) consideration equivalent
in value to the highest consideration per share of Class A Common Stock received
by HCC in connection with such transaction, and (y) a premium of $0.50 per share
of Class A Common Stock (subject to adjustment for any stock splits,
combinations, reclassifications, adjustments, sale of Class A Common Stock by
the Company, or sale of Class A Common Stock by HCC pursuant to a public
offering or block trade as permitted above, or any similar
transaction). For the avoidance of doubt, the aggregate premium shall
not exceed $17,400,880, which is the product of the number of outstanding shares
owned by minority stockholders as of the date of the Master Recapitalization
Agreement multiplied by $0.50. Also, for the avoidance of doubt, HCC
may effectuate a Premium Transaction pursuant to a short-form merger (or other
merger) between the Company and HCC or any purchaser of its shares, so long as
the holders of Class A Common Stock not affiliated with HCC receive the
consideration provided for in this paragraph in connection with such
merger.
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From
and after January 1, 2014 until the earlier of (x) December 31, 2020 and
(y) such time as Hallmark and its controlled affiliates no longer
beneficially own a majority of the outstanding Class A Common Stock, HCC
may not sell or transfer, in one or a series of related transactions, a
majority of the outstanding shares of Class A Common Stock to a third
party, unless (i) in a Permitted Transfer, (ii) with the prior approval of
a special committee of the Board of Directors or (iii) all stockholders
unaffiliated with Hallmark will be entitled to either (a) participate in
such transaction on the same terms as HCC or (b) receive cash
consideration equivalent in value to the highest consideration per share
of Class A Common Stock received by HCC in connection with such
transaction.
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In
addition, the Stockholders Agreement sets forth the terms on which Hallmark
Cards or one of its affiliates is required to provide a guarantee of the
Revolver. The Hallmark obligations regarding the standstill
provisions, co-sale rights and the guarantee of the Revolver will terminate upon
a payment default on the New Debt, subject to a 60-day grace/cure
period. The Stockholders Agreement also terminates on the earlier of
such time as Hallmark and its affiliates cease to own a majority of the Class A
Common Stock or December 31, 2020.
Listing
Requirements
Pursuant
to the Stockholders Agreement, the Company will use its commercially reasonable
best efforts to maintain the listing of the Class A Common Stock on the NASDAQ
Global Market through December 31, 2013. Until that date, HCC will
(i) vote in favor of any proposed amendment to the Company’s certificate of
incorporation to effect a reverse stock split with respect to the Class A Common
Stock to maintain the listing on the NASDAQ Global Market if recommended by a
majority of directors who are not affiliates of Hallmark and (ii) reasonably
cooperate with the Company in meeting with representatives of the NASDAQ Global
Market in support of such listing. Through December 31, 2013, HCC
will not cause the Company to voluntarily delist the shares of Class A Common
Stock from NASDAQ Global Market or deregister the shares of Class A Common Stock
under the Securities Exchange Act of 1934, as amended (except in connection with
a Premium Transaction or tender offer by Hallmark which is a permitted
acquisition of stock as described above).
Martha
Stewart Agreement
In
January 2010, Crown Media United States, LLC entered into a multi-year agreement
with Martha Stewart Living Omnimedia, Inc. (“Martha Stewart Living”) to
exclusively televise original episodes of the popular daytime home and lifestyle
series
The Martha Stewart
Show
on Hallmark Channel beginning September 2010. As part of the
agreement, Martha Stewart Living will also develop a range of new and original
series and prime time specials that will complement Hallmark Channel’s
schedule. Beginning in the fall of 2010, Mondays through Fridays,
The Martha Stewart
Show
, will be presented 10 a.m. to 11 a.m. (ET/PT), kicking off a
two-and-half-hour block of original Martha Stewart
programming. Following
The Martha Stewart Show
, from
11 a.m. to 12:30 p.m. (ET/PT) each weekday, the Hallmark Channel will present
exclusive original programming currently in development at Martha Stewart Living
that will feature a portfolio of creative content for which the Martha Stewart
brand is known and which will showcase experts and personalities from within
Martha Stewart Living. Additionally, Martha Stewart Living will
develop numerous holiday and interview specials for prime time on the
network.
Company
History
Crown
Media Holdings, Inc. was incorporated in the State of Delaware in December 1999.
Its wholly-owned subsidiary, Crown Media United States, LLC, owns, operates and
distributes the Channels. Significant investors in Crown Media Holdings include
Hallmark Entertainment Investments Co. (“Hallmark Entertainment Investments”), a
subsidiary of 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 ("Liberty Media")
and J.P. Morgan Partners (BHCA), L. P. ("J.P. Morgan").
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 Part III - Item 13 below and Part III
- Item 12 below regarding beneficial ownership of our securities.
Employees
We had
178 employees at December 31, 2008, and 159 employees at December 31, 2009.
Neither we nor any of our subsidiaries are parties to collective bargaining
agreements. We believe that our relations with our employees are good. Most of
our Channels’ employees work at our offices in Studio City, California and New
York, New York.
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.
We are 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 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. Pay television distributors often create “tiers” of
programming services, and our services occasionally are offered on family or
movie programming tiers. Various distributors offer additional broadband
services such as Internet access, telephony and video-on-demand over their
systems.
As a
result of the competition for use of the digital cable capacity for channels and
broadband services, pay television channel providers are often required
initially to pay subscriber acquisition fees to pay television distributors for
carriage on their systems or the addition of subscribers. 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, telephone companies
(“Telcos”) feature a combination of traditional cable and Protocol Television
(“IPTV”) technologies. For example, Verizon adopted a hybrid model combining
traditional cable and IPTV technologies while AT&T launched full-fledged
IPTV networks. While traditional cable systems devote a slice of
bandwidth for each channel and then cablecast them all out at once, IPTV uses a
"switched video" architecture in which only the channel being watched at that
moment is sent over the network, freeing up capacity for other features and more
interactivity. 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. For promotional
purposes we exhibit excerpts of certain programming, and in one case, an entire
program, on our website. The one case is the offering of our original
series “Adoption” on the internet, for both its first and second seasons.
Additionally, we offered streaming of certain original Holiday movies online
during December 2009. We also currently offer certain episodes of
Jack Hanna’s Animal Adventure online in full length.
Sources
of Revenue
Subscriber
Fees
Subscriber
fees are generally payable to us on a per subscriber basis by pay television
distributors for the right to carry our Channels. Rates we receive per
subscriber vary with changes in the following factors, among
others:
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the
degree of competition in the
market;
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the
relative position in the market of the distributor and the popularity of
the channel;
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the
packaging arrangements for the channel;
and
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length
of the contract term and other commercial
terms.
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We are in
continuous negotiations with our existing distributors to increase our
subscriber base in order to enhance our advertising revenue. We have been
subject in the past to requests by major distributors to pay subscriber
acquisition fees for additional subscribers or to waive or accept lower
subscriber fees if certain numbers of additional subscribers are provided. We
also may help fund the distributors' efforts to market our Channels or we may
permit distributors to offer limited promotional periods without payment of
subscriber fees.
Our
Channels are usually offered as one of a number of channels on either a basic
tier or part of other program packages and are 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 one of our Channels is
placed, these customers do not subscribe and unsubscribe to our Channels
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 Channels.
Our
subscriber count depends on the number of distributors carrying one of our
Channels 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. The
level of subscribers could also be affected by a distributor repositioning our
Channels from one tier to another tier. Management analyzes the estimated effect
each new or amended distribution agreement will have on revenue and costs. Based
upon these analyses, if subscriber acquisition fees are needed, management
endeavors to achieve a fair combination of subscriber commitments and subscriber
acquisition fees.
We have
generally paid certain television distributors up-front subscriber acquisition
fees to obtain initial carriage on domestic pay distributor systems. Subscriber
acquisition fees that we pay are capitalized and amortized over the contractual
term of the applicable distribution agreement as a reduction in subscriber fee
revenue. If the amortization expense exceeds the revenue recognized on a per
distributor basis, the excess amortization is included as a component of cost of
services. At the time we sign a distribution agreement and periodically
thereafter, we evaluate the recoverability of the costs we incur against the
incremental revenue directly and indirectly associated with each
agreement.
Generally,
our distribution agreements last from three to ten years, and usually include
annual increases of subscriber fees. In the past, for the most part, these
distribution agreements also involved payments 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. Please
see Item 7, Management’s Discussion and Analysis of Financial Condition and
Results of Operations, for information regarding subscriber fees.
Advertising
Revenue
Television
advertising is sold in a variety of formats. Most advertising supported cable
networks 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 with a commitment 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. An
additional form of television advertising is direct response advertising, which
is designed to elicit a specific and quantifiable response from the
viewer. Unlike spot advertising, fees payable for this form of
advertising are measured by viewer response to advertising, such as product
purchases, rather than the viewer ratings which measures success in
programming. A majority of the Hallmark Channel advertising revenue
is comprised of spot advertising. The Hallmark Movie Channel’s revenue has been
comprised to date primarily of direct response revenue. Please see “Current
Challenges – Ratings” in Item 7, “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” for information on the Hallmark
Movie Channel’s commencing to sell spot advertising based on Nielsen
ratings.
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. Our rates for spot
advertisements are generally calculated on the basis of an agreed upon price per
unit of audience measurement in return for a guaranteed commitment by the
advertiser. We commit to provide advertisers certain rating levels in connection
with their advertising. Advertising rates also vary by time of year due to
seasonal changes in television viewership. Revenue is recorded net of estimated
delivery shortfalls (often referred to as “audience deficiency
units”). Audience deficiency units (“ADUs”) are units of inventory
(rights to utilize future advertising timeframes) that are made available to
advertisers as fulfillment for past advertisements in programs that
under-delivered on the guaranteed viewership ratings. ADUs are
usually settled by providing the advertiser additional advertising time.
Historically, there has been no cash paid to an advertiser to settle ADUs , but
in 2009, the Company provided an immaterial amount of cash for settlements. The
remainder of the revenue is recognized as the “make-good” advertising time is
delivered in satisfaction of ADUs. Revenue from direct response advertising
depends largely
upon actions of
viewers.
Our
Channel typically sells 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 ADUs and sell the remainder in the spot or
scatter market and to advertisers that purchase up-front inventory on a calendar
year basis. For information on the up-front 2009/2010 season, see
“Advertising Revenue” in Item 7, “Management’s Discussion and Analysis of
Financial Condition and Results of Operations.”
Among the
76 ad-supported cable channels in the United States market in 2009, the Hallmark
Channel ranked 14
th
in
total day viewership with an average 0.589 household rating for the year and
10
th
for
prime time with an average 0.991 household rating for the year, according to
Nielsen Media Research. In 2008, among the 73 ad-supported cable
channels in the United States market, the Hallmark Channel ranked 11
th
in
total day viewership with an average 0.695 household rating and 8
th
for
prime time with an average 1.168 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 have
advertising sales offices in New York, Los Angeles, Chicago, and Atlanta. 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. In December 2008, we entered into an agreement
with Google Inc. under which advertisers may place ads on the Channels through
the Google platform, which started in early 2009 for the Hallmark Movie Channel
and the Hallmark Channel.
See Item
7, “Management’s Discussion and Analysis of Financial Condition and Results of
Operation” for further information on advertising and ratings.
Programming
Our
Channels offer a range of high-quality entertainment programming for adults and
families including popular television series, movies, miniseries, theatricals,
romances, literary classics, and contemporary stories. Sources for programming
on our Channels include programming licensed from Buena Vista Television, CBS
Television Distribution, Hallmark Hall of Fame, Paramount Pictures, RHI
Entertainment Distribution, Twentieth Television, Warner Bros. and other third
party producers.
Examples
of programming from other producers include, the Hallmark Channel original
movies
Come Dance at My
Wedding
,
The Good
Witch, Mrs. Washington Goes to Smith,
and
Old Fashioned Thanksgiving.
Examples of programming from the RHI Entertainment Distribution library
include, Steve Martini’s
The
Judge, The Outsider, Talking to Heaven
, and
The Five People You’ll Meet in
Heaven
. We benefit from original productions, whether they have aired on
other networks or are premiered on our Channel. Examples of other third party
programming shown on our Channel include the popular series
M*A*S*H, Little House on the
Prairie, 7
th
Heaven, Touched by an Angel, The
Golden Girls
and
Cheers
. Examples
of Twentieth Television family-friendly movies include
Big
,
Cheaper by the Dozen
,
Home Alone
and
Working
Girl
. Other examples of our third party programming include
acquired movies and miniseries such as
Ever After, The Ultimate Gift, My
Favorite Martian
and
Hocus Pocus
. 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.
Our
channels air, and benefit from, programming previously shown as Hallmark Hall of
Fame such as John Grisham’s
Painted House, The Magic of Ordinary
Days, Back When We Were Grownups, Sarah, Plain and Tall
and
What the Deaf Man
Heard
.
We have
occasionally sublicensed exhibition rights to third parties to select programs
in order to reduce our programming costs.
Distribution
The
Hallmark Channel ended 2009 with 88.3 million subscribers, an increase of 3%
from 85.5 million at the 2008 year-end. We currently distribute the Hallmark
Channel to approximately 85% 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 eleven largest pay
television distributors, and all other pay television distributors as a group,
in the United States as of December 31, 2009.
Our
subscribers in the United States have grown from approximately 16.0 million full
time subscribers at January 1, 2001.
Our major
distribution agreements have terms with options which extend through December
2023. Of these distribution agreements, an agreement accounting for
approximately 5% of our subscriber base at December 31, 2009, will expire and be
the subject of renewal negotiations on or prior to December 31, 2010. A
distribution agreement with NCTC representing approximately 9% of our Hallmark
Channel subscriber base as of December 31, 2009, expired in December
2009. Our Channels continue to be distributed by NCTC under the terms
of the expired agreement through an extension to that agreement while
negotiations continue on a renewal.
At
December 31, 2009, the Hallmark Movie Channel was distributed to over 29.1
million subscribers, an increase of nearly 14.5 million subscribers from 14.6
million at December 31, 2008. As of October 15, 2009, the Hallmark Movie Channel
was distributed in the nation’s top 30 demographic measurement areas
(DMA’s).
Sales
and Marketing
Our
primary target demographics are women aged 25 to 54 and adults aged 25 to
54. Our programming is targeted to adults, but is generally
appropriate for viewing by the entire family, which is important to viewers,
advertisers and affiliates.
For over
fifty years Hallmark has been a leader in high-quality original television
production. The Hallmark Channel and the Hallmark Movie Channel have the
exclusive cable license to broadcast 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 our programming combine
to:
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provide
our viewers with tangible evidence of our commitment to the best in
entertainment for the entire
family;
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enhance
our ability to attract advertising commitments and higher rates
(“Cost-Per-Thousands” or “CPM’s”) from the largest advertisers;
and
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provide
a competitive advantage in negotiating long-term distribution agreements
with pay television distributors.
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Crown
Media Holdings currently uses the websites www.hallmarkchannel.com and
www.hallmarkmoviechannel.com to promote the Channels and their programs and to
provide information to potential viewers. These websites support
major programming events such as original movie premieres and program
acquisitions as well as contain information regarding the Channels’ program
schedule and information on the Channels’ programs and their stars. Further, the
sites provide platforms for viewer participation in the Channels’ sweepstakes
promotions and community areas. The sites have advertiser imaging
including banner messages and video content.
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 marketing and creative services
departments to create the distinctive appearance of our
Channels. Some of these functions are outsourced on an as-needed
basis.
The
creation of our Channels begins with the acquisition of programming. 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 created by the
Company’s employees, but are occasionally outsourced to external vendors. These
interstitials are intended to invite viewership, guide viewers to specific
programming, and promote "brand awareness" for the Channels. Occasionally, these
interstitials are sponsored by advertisers, resulting in additional advertising
revenue.
The
scheduling department creates the play list, which contains a list of daily
programming. The scheduling department works with advertising sales, research
and distributor sales and marketing personnel to continuously monitor the
effectiveness of programming content and sequence. 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
distributed to the subscribers of the Channels.
Channel
Delivery
We
deliver the daily log and digital tapes of the Hallmark Channel and Hallmark
Movie Channel programming, commercials and promotional messages to a third party
network operations center in Los Angeles, California, where the programming,
advertising and promotional elements are combined and compressed. The
Channels are compiled in high definition (“HD”) and then the same versions of
the Channels are created in standard definition (“SD”). The Los Angeles facility
transmits the combined signals to a satellite transponder that covers the United
States. The transponder transmits the signal back to cable head-end facilities,
Telcos 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.
|
Primary
|
Primary
|
Channel
|
Uplink
|
|
|
Distribution
|
Pay
TV
|
Origination
|
Providers/
|
|
|
Platforms
|
Distributors
|
Providers/Locations
|
Locations
|
Satellites
|
|
Cable
|
AT&T
(U-verse)
|
Andrita
Studios
|
Andrita
Studios
|
Hallmark
Channel:
|
|
Cablevision
|
Los
Angeles, CA
|
Los
Angeles, CA
|
SES
Americom
|
|
|
Charter
|
||||
|
Comcast
|
Hallmark
Movie Channel: AMC 11
|
|||
|
Cox
|
||||
|
NCTC
|
||||
|
Mediacom
|
||||
|
Time
Warner
|
||||
|
Verizon
Communications (FiOS)
|
||||
|
Satellite
|
DirecTV
|
Andrita
Studios
|
Andrita
Studios
|
Hallmark
Channel:
|
|
Direct-to-
|
Dish
Network
|
Los
Angeles, CA
|
Los
Angeles, CA
|
SES
Americom
|
|
home
|
||||
|
Hallmark
Movie Channel: AMC 11
|
The
contracts with the parties providing origination, uplink, satellite and other
services for the delivery of our Channels in the United States expire from 2013
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, 2009, as shown in
Item 7 below. Agreements with two other parties for the delivery of the Channels
were terminated in early 2010. See “Results of Operations – Year Ended December
31, 2008 Compared to Year Ended December 31, 2009 – Cost of Services” under Item
7, “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” regarding these terminations.
Competition
The pay
television industry is highly competitive. Our Channels compete 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, TV Land, 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. 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, basic
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
believe that our primary competitive strengths include the
following:
|
·
|
Programming
. We
have established a track record of providing high quality family
programming.
|
|
·
|
Pay Television Channels
Branded with the Well-Known Hallmark Name.
Our Channels are 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 affects
ratings and advertising revenue.
|
|
·
|
Experienced
Management
. Members of our senior management team have
experience promoting and operating channels. They have held senior
positions at such companies as ABC, CBS Sports, Fox Family, Discovery
Channel, AMC and USA Networks.
|
Competitive
Risks
We
believe that our primary competitive risks include the following:
|
·
|
One Primary Channel
Distributed Domestically.
We operate only two
channels. Many of our competitors have more than two channels
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. Our competitors may
have more flexibility in
programming.
|
|
·
|
Ratings Which Affect
Advertising
. Our ratings are a significant and generally
positive factor. Nevertheless, our competitors include channels with more
subscribers and higher ratings, which affect rates that we can charge for
advertising.
|
Research
The
research department at the Company provides strategic and tactical guidance to
decision-makers within the Company, as well as supplying information about the
Channels to our potential advertisers and affiliates. This department provides
data on the size and demographics of our audience and information about our
audiences, competitors, markets and industry.
Currently,
our Channels’ 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 Channels’ market share.
The
research department has sophisticated research tools 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
Channels’ performance is tracked through an internal tracking study established
in July 2001, which is a monthly telephone survey conducted among a national
probability sample of approximately 1,000 adults. The research department also
subscribes to a number of other services, which are useful in obtaining
information about viewers of our Channel.
Available
Information
We
will make available free of charge through our website, www.hallmarkchannel.com,
this Annual Report on Form 10-K, 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 Crown Media Holdings, Inc., 12700 Ventura
Boulevard, Studio City, California 91604.
ITEM
1A. Risk Factors
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.
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, 2009, we had an
accumulated deficit of approximately $2.2 billion, total stockholders’ deficit
of approximately $698.0 million, and goodwill of approximately $314.0
million.
We cannot
assure you that we will achieve an operating profit or sustain a positive cash
flow. If we are not able to do so, the trading price of our Class A common stock
may fall significantly. To diminish our losses, to continue to be profitable
before interest expense and to continue to generate a positive cash flow, we
will need to increase our advertising and subscriber revenue. This will require,
among other things, maintaining the distribution of our Channels, attracting
more and younger viewers to our channels, attracting more advertisers, and
maintaining or increasing our subscriber and 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 maintain subscriber levels
and enhance our programming, which may result in increased costs for
programming. Over the last five years, these actions have contributed to net
losses for Crown Media Holdings. To achieve positive net income, we would also
need to decrease our interest expense by reducing our outstanding
indebtedness.
We
believe that our ability to continue operations depends upon completion of the
Recapitalization.
We are
unable to meet our debt obligations due August 31, 2010, which are owed to
affiliates of Hallmark Cards and are owed under the bank credit
facility. The Recapitalization is intended to exchange the existing
debt obligations to the Hallmark affiliates for new debt, preferred stock and
common stock. Hallmark Cards and its affiliates own beneficially a
sufficient number of shares of Class A and Class B stock to approve the
Recapitalization transactions. Nevertheless, consummation of the
Recapitalization transactions is not assured. Various conditions must
be satisfied for a closing of the Recapitalization, including that Hallmark
Cards has not delivered a written notice to the Company certifying that Hallmark
Cards, in its sole discretion, shall have determined that the status of any
pending or threatened litigation or a regulatory proceeding involving the
Company or its subsidiaries in connection with the Recapitalization is
unsatisfactory to Hallmark Cards. A lawsuit challenging the original
proposal for the Recapitalization was filed in 2009, and the plaintiff in that
lawsuit has indicated a continuing objection to the
Recapitalization. We do not know what steps will be taken in this
existing lawsuit or whether any new lawsuits will be brought in regard to the
Recapitalization. In any event, there can be no assurance that the
Recapitalization will be completed.
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. At this time, prior to the Recapitalization,
to the extent interest is deferred and added to principal, the indebtedness
increases. As of December 31, 2009, our total debt was $1.1 billion, and we had
$10.5 million of cash and cash equivalents and $44.0 million available under our
bank credit facility to support our operations.
As a
result of our present level of debt and the terms of our debt
instruments:
|
|
•
our vulnerability to adverse general economic conditions is
heightened;
|
|
|
•
we are 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;
|
|
•
our ability to obtain additional financing in the future for working
capital, capital expenditures, acquisitions, general corporate purposes or
other purposes may be impaired; and
|
|
|
•
offers to purchase the Company or its assets at prices that may be
attractive to stockholders may be
limited.
|
Our
ability to meet our debt and other obligations and to reduce our total debt
likely depends at this time on completing the Recapitalization; in the future
our ability to meet our debt and other obligations will depend on our 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.
Even if
the Recapitalization is completed, we will have substantial indebtedness
(although significantly reduced) as well as dividends that are paid or accrued
on the preferred stock that will be outstanding, and the factors listed above
(some to a lesser extent) will continue to apply.
Information
concerning our liquidity may be found in Note 1 of our Notes to Consolidated
Financial Statements in this Report.
We
have significant interest expense, which may impact our future
operations.
High
levels of interest expense could have negative effects on our future operations.
Interest expense, which includes amortization of debt issuance costs and
interest expense on borrowings under our senior and demand notes and bank credit
facility, was significant over the past year. Although interest expense was
lower in the past twelve months than in the previous twelve months, we continue
to have significant outstanding indebtedness and related interest expense. The
Recapitalization would significantly reduce our outstanding indebtedness and
interest expense; nevertheless, even with the Recapitalization, there will be
substantial indebtedness and related interest expense. A substantial portion of
our cash flow from operations will 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 be assured 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.
Our
liquidity is dependent on external funds.
Although
in the past twelve months we generated positive cash flow from operations,
unanticipated significant expense or any developments that hamper our growth in
revenue or decreases any of our revenue, may result in the need for additional
external funds in order to continue operations. Except for the Recapitalization,
we have no arrangements for any such additional external financings, whether
debt or equity, and are not certain whether any new external financing would be
available on acceptable terms. Any new debt financing would require
the cooperation and agreement of existing lenders.
The
Company is currently unable to meet its debt obligations to Hallmark Cards and
its affiliates and under the bank credit facility which come due on and after
August 31, 2010. A default on the obligations due on August 31, 2010,
would also result in a default under the Company’s 10.25% Senior Secured Note.
The Company anticipates that prior to August 31, 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. To
accomplish those changes, the Company plans to complete the
Recapitalization.
The
Recapitalization contemplates that we will endeavor to have a revolving line of
credit with JPMorgan Chase or another third party in the amount of $30.0 million
with a maturity date of not less than 360 days from closing the
Recapitalization.
There is no
assurance that Hallmark Cards and its affiliates will extend dates for the
deferral of payments on indebtedness owed by us or participate in any extension,
refinancing or restructuring of the indebtedness
.
We have
substantial outstanding obligations owed to Hallmark Cards and its
affiliates. These obligations include promissory notes and amounts
owed under a service agreement. Hallmark Cards, its affiliates and we
are parties to the Waiver Agreement, as amended, under which principal payments
and certain interest payments on the promissory notes are deferred until August
31, 2010, subject to earlier termination as provided in that
Agreement. See Item 7. Management’s Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital Resources
- Bank Credit Facility and Hallmark Notes and Item 13 - Certain Relationships
and Related Transactions and Director Independence. These obligations
and the Waiver Agreement have been negotiated by us with Hallmark Cards and its
affiliates. Hallmark Cards and its affiliates have indicated that
they do not intend to extend the Waiver Agreement beyond August 31,
2010. Any decision by Hallmark Cards and its affiliates on these
matters other than pursuant to the Recapitalization is at their
discretion.
“Most
Favored Nations” provisions may require modification of existing distribution
agreements which could adversely affect subscriber revenue.
A number
of our existing distribution agreements contain "most favored nations" or “MFN”
clauses. These clauses typically provide that, in the event we enter into an
agreement with another distributor on more favorable terms, these terms must be
offered to the distributor holding the MFN right, subject to certain exceptions
and conditions. These clauses cover matters such as subscriber fees, launch
support, local advertising time and other financial and operating provisions. In
the past, after entering into new distribution agreements, we have been asked by
some of the distributors holding MFN rights to modify their distribution
agreements to incorporate financial terms similar to those in the new
agreements. Any claims of this type in the future could result in lower
overall subscriber revenue or increased cash outlays; however, if our
subscription base is increased as a result of such modifications, 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.
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. Our competitors may have greater numbers of original
productions, 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 cause a decline in both
advertising and subscriber fees revenue. The decline in revenue could
hinder or prevent us from achieving profitability or maintaining a positive cash
flow and could adversely affect the market price of our Class A common
stock.
In the
second, third and fourth quarters of 2009, except for the holiday period
commencing with Thanksgiving and ending on January 3, 2010, we experienced
declines in viewer ratings across demographic categories, compared to the same
periods of 2008, resulting in decreases in advertising revenues and cash
flows. This decline has continued in the early part of
2010. A number of changes to our program schedule were implemented in
the second and third quarters of 2009, including the replacement of programs
that had appeared in the schedule for a number of years, as well as a shift in
scheduling strategy to more specifically target our prime demographic group of
women 25-54. These changes have caused a temporary disruption to
established viewing patterns for our audience resulting in declines in household
ratings but over time are intended to increase our delivery of viewers in the
women 25-54 demographic category. We are considering further changes
in our programming that may be helpful. We must successfully
implement the program rescheduling with an increase in ratings, which is
uncertain, or otherwise address the decrease in ratings in order to maintain or
increase our advertising revenues, to maintain subscriber fees and to maintain
or improve our cash flow from operations.
In
addition, our delivery of key demographics continues to be impacted by industry
developments. One potentially significant factor is the continued
growth of time-shifting digital video recording devices (DVRs). DVRs heighten
the impact of competition as viewers are able to increase their access to what
they consider to be new, compelling content. The number of cable
networks investing in original programming increased 74% in 2009, and acquired
(non-original) programming now represents only 33% of the prime time cable
programming. Although Hallmark Channel continues to invest in
original programming, our increase in investment for original content did not
match the growth of the market or many of our competitors.
If
we are unable to increase our advertising revenue, we may be unable to achieve
improved results.
Although
it is expected over time that our advertising revenue will increase, if we fail
to significantly increase our advertising revenue, we may be unable to achieve
or sustain improved results or to expand our business. A failure to
increase advertising revenue may be a result of any or all of the following: (i)
a continued decline in viewer ratings mentioned above; (ii) the current economic
environment presents uncertainty regarding the condition of the advertising
marketplace and the financial health of many industry segments and individual
companies, including those which advertise on our channels; (iii) we may be
unable to reduce our average viewer age to be within our target audience of
viewers between the ages of 25 and 54; (iv) we may be unable to identify,
attract and retain experienced sales and marketing personnel with relevant
experience; (v) 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; (vi) the
advancement of technologies such as Digital Video Recording may cause
advertisers to shift their expenditures to media in which their commercial
messages are not circumvented by the technology; and/or (vii) we will not be
able to increase our advertising sales rate-card or may be required to run
additional advertising spots to fulfill guaranteed delivery numbers 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 and our number of
subscribers.
Current
economic conditions have resulted in softness of advertising rates and may
materially adversely impact our business.
In the
second half of 2008 and during the first three quarters of 2009, we experienced
some softening of our general advertising rate prices and a more dramatic
decrease in the rates of our direct response advertising because of economic
conditions. The volume of advertising has not been impacted. See
“Results of Operations” in Item 7, Management’s Discussion and Analysis of
Financial Condition and Results of Operations - Year Ended December 31, 2008
Compared to Year Ended December 31, 2009, in this Report for additional
information on this subject.
In
addition, the turmoil in the investment market, the tightening of credit and
relatively high, increasing levels of unemployment in the United States have
lead to an increased level of commercial and consumer delinquencies, lack of
consumer confidence, increased market volatility and possibly a reduction in
business activity generally. A continuation of these conditions could
have the following negative effects, among others: (1) a reduction in
spending by advertisers and consumers in general, which in turn could reduce our
number of subscribers and/or advertising rates, resulting in reduced revenue;
and (2) a further increase in bad debts or the reserve for bad
debts. These factors could make more difficult the goal of a
continuing positive cash flow, any renewal of the Bank credit facility and any
financial restructuring.
Hallmark
Entertainment Investments controls us and this control could create conflicts of
interest or inhibit potential changes of control.
Hallmark
Entertainment Investments owns all of our outstanding shares of Class B common
stock and, together with other affiliates of Hallmark Cards, owns approximately
71.8% of the outstanding shares of our Class A common stock, representing in the
aggregate approximately 94.5% 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. Additionally, a significant portion of our overall
indebtedness is held by Hallmark Cards or its wholly owned affiliates. This
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. In
addition, the control that Hallmark Cards and/or these specific wholly-owned
affiliates may exert over us, either directly or indirectly, could give rise to
conflicts of interest in certain situations.
After the
Recapitalization, Hallmark Cards will own 90.1% of the outstanding Common Stock
and will be subject to standstill and other provisions in a stockholder
agreement as described earlier in this Report.
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, 2010. 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.
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. 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 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 recorded a significant amount of goodwill. 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 (deficit) could be materially adversely
affected.
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 the following:
• any
failure to recapitalize or restructure our outstanding
indebtedness;
• failure
of our operating results to meet the expectations of investors in any
quarter;
•
economic conditions that adversely affect our advertising rates or our number of
subscribers;
•
material announcements by us or our competitors;
•
governmental regulatory action;
|
|
•
technological innovations by competitors or competing
technologies;
|
|
|
•
perceptions by the investing community or our customers with respect to
the prospects of our company or our
industry;
|
• changes
in general market conditions or economic trends; and
• failure
by us to renew major distribution agreements.
Additionally,
of the approximately 74.1 million shares of the Company’s outstanding Class A
common stock, only 11.6 million shares (approximately 16%), plus shares held by
The DIRECTV Group, Inc. and National Interfaith Cable Coalition, are held by
non-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.
Prior to
entering into a new agreement on January 2, 2008, certain programming and other
commitments in then existing agreements with the National Interfaith Cable
Coalition (“NICC”) would have terminated upon the sale of 50% or more of the
shares of Class A common stock owned by NICC. On January 2, 2008, we
and NICC entered into a new agreement superseding prior agreements and
terminating most programming relationships with NICC. Additionally,
NICC owns approximately 4.4 million shares of the Company’s Class A common
stock. As a result of the agreement mentioned above, NICC has sold
some of its Class A common stock and may continue to do so, which could have an
adverse impact on the share price of our Class A common stock.
Risks
Relating to Our Industry
The
recent change in the television rating system in the United States could reduce
our Channel revenue and our ability to achieve profitability.
Our
domestic advertising revenue is partially dependent on television ratings
provided by Nielsen Media Research. In 2007, Nielsen modified its ratings system
by increasing its household sample size. In the fourth quarter of 2007, Nielsen
began measuring and providing performance data based on viewing of commercial
content as well as programming content. As the impact of the changes
continue to take effect, 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 nature of the changes in the
measurement systems. From the beginning of the fourth quarter of 2007
through the fourth quarter of 2008, we experienced a decrease in viewers of
approximately 5% under the new ratings measurement system compared to the system
previously in use
.
We
continue to factor the new rating information into our advertising rates as
Nielsen is continually in the process of modifying its ratings system to
accommodate emerging technologies.
Competition
could reduce our Channels 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 industry 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 having lower
viewership, such as our Channels, to accept decreasing amounts for subscriber
fees, to pay higher subscriber acquisition fees or to allow carriage of the
Channels 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 operating
results and cash flow.
New
distribution technologies may fundamentally change the way we distribute our
Channels and could significantly decrease our revenue or require us to incur
significant capital expenditures.
Our
future success will depend, in part, on our ability to anticipate and adapt to
technological changes and to offer, on a timely basis, services that meet
customer demands and evolving industry standards. The pay television industry
has been, and is likely to continue to be, subject to:
|
|
•
rapid and significant technological change, including continuing
developments in technology which do not presently have widely accepted
standards; and
|
|
|
•
frequent introductions of new services and alternative technologies,
including new technologies for providing video
services.
|
For
example, the advent of digital technology is likely to accelerate the
convergence of broadcast, telecommunications, Internet and other media and could
result in material changes in the economics, regulations, intellectual property
usage and technical platforms on which our business relies, including lower
retail rates for video services. These changes could fundamentally affect the
scale, source, and volatility of our revenue streams, cost structures, and
operating results, 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.
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 offices and facilities expire between 2010 and
2016. The Company believes the facilities, office space and other real
properties leased are adequate for its current operations.
|
Location
|
Use
|
Approximate
Area in
Square Feet
|
|||
|
12700
Ventura Blvd.
|
Executive
and administrative office and post
|
37,164 | |||
|
Studio
City, California
|
production
and editing facilities
|
||||
|
1325
Avenue of the Americas
|
Advertising
sales and administrative office
|
16,937 | |||
|
New
York, New York
|
and
advertising traffic
|
||||
|
6430
S. Fiddlers Green Circle
|
Administrative
office
|
4,500 | |||
|
Greenwood
Village, Colorado
|
|||||
|
205
N. Michigan Ave.
|
Advertising
sales office
|
3,048 | |||
|
Chicago,
Illinois
|
|||||
|
1170
Peachtree Street
|
Advertising
sales office
|
180 | |||
|
Atlanta,
Georgia
|
|||||
We own
most of the equipment and furnishings used in our businesses, except for
satellite transponders, which are leased. See Note 6 of Notes to Consolidated
Financial Statements for information on our leasing of property and
equipment.
ITEM
3. Legal Proceedings
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 HC Crown Corp. The plaintiff is S.
Muoio & Co. LLC which owns beneficially approximately 5.8% of the Company's
Class A common stock, according to the complaint and filings with the Securities
and Exchange Commission. The Proposal, which the Company publicly announced on
May 28, 2009, provides for a recapitalization of its outstanding debt to
Hallmark Cards affiliates in exchange for new debt and convertible preferred
stock of the Company. The lawsuit claims to be a derivative action and a class
action on behalf of the plaintiff and other minority stockholders of the
Company. The lawsuit alleges, among other things, that, the defendants have
breached fiduciary duties owed to the Company and minority stockholders in
connection with the Proposal. The lawsuit includes allegations that if the
Proposal is consummated, an unfair amount of equity would be issued to the
majority stockholders, thereby reducing the minority stockholders' equity and
voting interests in the Company, and that the majority stockholders would be
able to eliminate the minority stockholders through a short-form merger. The
complaint requests the court to enjoin the defendants from consummating the
Proposal and to award plaintiff fees and expenses incurred in bringing the
lawsuit.
On July
22, 2009, a Stipulation Providing for Notice of Transaction (the “Stipulation”)
was filed with the Delaware Court of Chancery. The Stipulation provided
that the Company cannot consummate the transaction contemplated in the Proposal
until not less than seven weeks after providing the plaintiff with a notice of
the terms of the proposed transaction, including copies of the final transaction
agreements. 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. Notice of the terms of the proposed
Recapitalization, including copies of the agreements, was provided to the
plaintiff on March 1, 2010.
By a
letter of February 28, 2010, the plaintiff in this lawsuit informed the Special
Committee of the Board of Directors, which considered and negotiated the
Recapitalization, that the plaintiff objected to the proposed Recapitalization
on the terms set forth in the term sheet dated February 9, 2010. The
plaintiff asserted, among other things, that the transactions contemplated by
the term sheet would unfairly dilute the economic and voting interests of the
Company’s minority stockholders, that the transactions should be subject to a
vote of the majority of the minority stockholders and that the proposed
transactions remain inadequate. The plaintiff indicated that if the
Company executed definitive documents for the Recapitalization, the plaintiff
would pursue the litigation. The February 26, 2010, agreements
executed by the Company for the Recapitalization followed the provisions in the
earlier term sheet.
It is not
currently possible to predict the outcome of the proceeding discussed in this
report. The plaintiff does not seek monetary damages from the Company. Legal
fees incurred to defend the proceeding described in this report will be expensed
as incurred. See “Risk Factors” above for any potential impact of this lawsuit
on completion of the Recapitalization.
ITEM
4. Submission of Matters to a Vote of Security Holders
Not
applicable.
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 Global Market under the ticker symbol
"CRWN." There is no established public trading market for our Class B common
stock, of which 100% is owned by Hallmark Entertainment Investments. Set forth
below are the high and low sales prices for our Class A common stock for each
quarterly period in 2008 and 2009, as reported on the NASDAQ Global
Market.
|
|
Price Range
|
|||||||
|
Common Stock
|
High
|
Low
|
||||||
|
2008
|
||||||||
|
First
Quarter
|
$ | 6.480 | $ | 4.520 | ||||
|
Second
Quarter
|
$ | 5.440 | $ | 4.200 | ||||
|
Third
Quarter
|
$ | 5.350 | $ | 3.640 | ||||
|
Fourth
Quarter
|
$ | 5.230 | $ | 1.630 | ||||
|
2009
|
||||||||
|
First
Quarter
|
$ | 2.890 | $ | 1.170 | ||||
|
Second
Quarter
|
$ | 3.280 | $ | 1.450 | ||||
|
Third
Quarter
|
$ | 2.100 | $ | 1.450 | ||||
|
Fourth
Quarter
|
$ | 1.940 | $ | 1.190 | ||||
Holders
As of
February 12, 2010, there were 55 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 2010 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
Information
related to our Amended and Restated 2000 Long Term Incentive Plan, our only
equity compensation plan, is presented as of December 31, 2009 in the
following table.
Equity
Compensation Plan Information
|
Plan
Category
|
Number
of Securities
to
be Issued
Upon
Exercise of
Outstanding
Options,
Warrants and Rights
|
Weighted-Average
Exercise
Price of
Outstanding
Options,
Warrants and Rights
|
Number
of Securities
Remaining
Available
for
Future Issuance
Under
Equity
Compensation
Plans
(Excluding
the Number of
Securities
to be Issued Upon
Exercise
of Outstanding
Options)
|
|||||||||
|
(In
thousands)
|
(In thousands)
|
|||||||||||
|
Equity
compensation plans approved by
security
holders
|
87 | $ | 13.89 | 9,913 | ||||||||
Stock
Purchases
We did
not make any repurchases of our outstanding shares during the fourth quarter of
2009. None of our executive officers purchased shares of our Class A
Common Stock in open market transactions during the fourth quarter of
2009.
Performance
Graph
T
he following graph compares
total stockholder return on our Class A Common Stock since December 31, 2004
through December 31, 2009, to the NASDAQ Composite Index and a Peer Group Index
consisting of Time Warner Inc., Outdoor Channel Holdings, Inc. and Walt Disney
Co. The graph assumes that $100 was invested in our stock on December
31, 2004 and that the same amount was invested in the NASDAQ Composite Index and
the Peer Group Index. Historical results are not necessarily
indicative of future performance. The following graph is deemed furnished and
not filed with the SEC.
The
closing sale price for our stock on December 31, 2004, was $8.60. Our
closing stock price on December 31, 2009, the last trading day of our 2009
fiscal year, was $1.45.
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, 2005,
2006, 2007, 2008 and 2009, and the consolidated balance sheet data as of
December 31, 2005, 2006, 2007, 2008 and 2009, 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 for the years ended December 31, 2007, 2008 and
2009, included in this Annual Report on Form 10-K.
In April
2005, the Company completed the sale of its international business and
classified the operating results of the international business as discontinued
operations in the accompanying statements of operations for all periods
presented. The Company’s discontinued operations consisted of the international
channel operations and the international rights to the film library
assets.
In
December 2006, the Company completed the sale of its film assets.
|
Years Ended December 31,
|
||||||||||||||||||||
|
|
2005
|
2006
|
2007
|
2008
|
2009
|
|||||||||||||||
|
(In
thousands, except per share amounts)
|
||||||||||||||||||||
|
Revenue:
|
||||||||||||||||||||
|
Subscriber
fees
|
$ | 18,746 | $ | 24,869 | $ | 27,812 | $ | 57,153 | $ | 63,597 | ||||||||||
|
Advertising
|
143,780 | 172,950 | 205,666 | 222,967 | 213,770 | |||||||||||||||
|
Advertising
by Hallmark
Cards
|
2,335 | 1,240 | 508 | 429 | 775 | |||||||||||||||
|
Film
asset license
fees
|
21,693 | 1,815 | — | — | — | |||||||||||||||
|
Sublicense
fees and other
revenue
|
10,830 | 305 | 378 | 1,245 | 1,422 | |||||||||||||||
|
Total
revenue,
net
|
197,384 | 201,179 | 234,364 | 281,794 | 279,564 | |||||||||||||||
|
Cost
of Services:
|
||||||||||||||||||||
|
Programming
costs
|
||||||||||||||||||||
|
Hallmark
Cards
affiliates
|
74 | 74 | 82 | 798 | 1,235 | |||||||||||||||
|
Non-affiliates
|
120,503 | 152,119 | 164,287 | 139,900 | 126,293 | |||||||||||||||
|
Amortization
of film
assets
|
51,619 | 14,739 | (5,220 | ) | (745 | ) | — | |||||||||||||
|
Impairment
of film
assets
|
25,542 | 225,832 | — | 176 | — | |||||||||||||||
|
Subscriber
acquisition fee amortization expense
|
35,928 | 31,044 | 30,996 | — | — | |||||||||||||||
|
Amortization
of capital
lease
|
1,158 | 1,157 | 1,158 | 1,158 | 1,158 | |||||||||||||||
|
Contract
termination fees
expense
|
— | — | — | — | 4,718 | |||||||||||||||
|
Other
costs of
services
|
20,448 | 11,273 | 11,222 | 12,492 | 14,175 | |||||||||||||||
|
Total
cost of
services
|
255,272 | 436,238 | 202,525 | 153,779 | 147,579 | |||||||||||||||
|
Selling,
general and administrative expense
|
55,138 | 43,968 | 61,452 | 46,706 | 47,069 | |||||||||||||||
|
Marketing
expense
|
24,160 | 16,021 | 19,733 | 19,603 | 6,551 | |||||||||||||||
|
Depreciation
and amortization expense
|
4,471 | 2,865 | 1,656 | 1,932 | 1,947 | |||||||||||||||
|
Gain
from sale of film
assets
|
— | (8,238 | ) | — | (101 | ) | (682 | ) | ||||||||||||
|
(Loss)
income from operations before interest
|
(141,657 | ) | (289,675 | ) | (51,002 | ) | 59,875 | 77,100 | ||||||||||||
|
Interest
expense, net of interest income
|
(73,880 | ) | (98,728 | ) | (108,144 | ) | (100,157 | ) | (100,539 | ) | ||||||||||
|
Loss
before discontinued operations and cumulative
|
||||||||||||||||||||
|
effect
of change in accounting principle
|
(215,537 | ) | (388,403 | ) | (159,146 | ) | (40,282 | ) | (23,439 | ) | ||||||||||
|
Loss
from discontinued operations, net of tax
|
(10,683 | ) | — | — | — | — | ||||||||||||||
|
(Loss)
gain from sale of discontinued operations, net of tax
|
(6,538 | ) | 1,530 | 114 | 3,064 | 847 | ||||||||||||||
|
Loss
before cumulative effect of change
|
||||||||||||||||||||
|
in
accounting
principle
|
(232,758 | ) | (386,873 | ) | (159,032 | ) | (37,218 | ) | (22,592 | ) | ||||||||||
|
Cumulative
effect of change in accounting principle
|
— | (2,099 | ) | — | — | — | ||||||||||||||
|
Net
loss
|
$ | (232,758 | ) | $ | (388,972 | ) | $ | (159,032 | ) | $ | (37,218 | ) | $ | (22,592 | ) | |||||
|
Other
comprehensive loss:
|
||||||||||||||||||||
|
Foreign
currency translation adjustment
|
(3,434 | ) | — | — | — | — | ||||||||||||||
|
Comprehensive
loss
|
$ | (236,192 | ) | $ | (388,972 | ) | $ | (159,032 | ) | $ | (37,218 | ) | $ | (22,592 | ) | |||||
|
Weighted
average number of Class A and Class B shares
outstanding,
basic and
diluted
|
104,619 | 104,788 | 104,038 | 104,776 | 104,788 | |||||||||||||||
|
Loss
per share before discontinued operations and cumulative
effect
of change in accounting principle, basic and
diluted
|
$ | (2.06 | ) | $ | (3.71 | ) | $ | (1.53 | ) | $ | (0.39 | ) | $ | (0.23 | ) | |||||
|
(Loss)
gain per share from discontinued operations,
basic
and
diluted
|
(0.16 | ) | 0.02 | 0.00 | 0.03 | 0.01 | ||||||||||||||
|
Cumulative
effect of change in accounting principle,
basic
and
diluted
|
— | (0.02 | ) | — | — | — | ||||||||||||||
|
Net
loss per share, basic and
diluted
|
$ | (2.22 | ) | $ | (3.71 | ) | $ | (1.53 | ) | $ | (0.36 | ) | $ | (0.22 | ) | |||||
|
As of December 31,
|
||||||||||||||||||||
|
|
2005
|
2006
|
2007
|
2008
|
2009
|
|||||||||||||||
|
(In
thousands)
|
||||||||||||||||||||
|
Balance
Sheet Data:
|
||||||||||||||||||||
|
Cash
and cash equivalents
|
$ | 15,926 | $ | 13,965 | $ | 1,974 | $ | 2,714 | $ | 10,456 | ||||||||||
|
Goodwill
|
314,033 | 314,033 | 314,033 | 314,033 | 314,033 | |||||||||||||||
|
Total
assets
|
1,273,826 | 767,783 | 676,241 | 739,345 | 698,061 | |||||||||||||||
|
Total
long-term debt, excluding current
maturities
|
971,589 | 975,007 | 1,044,772 | 1,090,616 | 771,814 | |||||||||||||||
|
Stockholders'
deficit
|
(123,189 | ) | (478,944 | ) | (683,760 | ) | (666,933 | ) | (698,030 | ) | ||||||||||
|
Other
Data:
|
||||||||||||||||||||
|
Capital
expenditures
|
$ | 504 | $ | 713 | $ | 1,668 | $ | 1,868 | $ | 507 | ||||||||||
|
Total
subscribers at year end
|
70,666 | 74,641 | 83,915 | 85,540 | 88,320 | |||||||||||||||
ITEM
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations
The
Company’s consolidated financial statements and accompanying notes to
consolidated financial statements included in Item 8 of this Annual Report on
Form 10-K should be read in conjunction with the discussion and analysis that
follows.
Current
Challenges
The
Company faces numerous operating challenges. Among them are increasing
viewership ratings, maintaining and increasing advertising revenue, maintaining
and expanding the distribution of the Channels, broadening viewership
demographics to meet our target audience, and controlling costs and expenses. In
addition, the Company believes that it is necessary to complete the
Recapitalization;
see
“Recapitalization” in Item 1, Business and the “Liquidity” discussion below in
this Item 7.
Ratings
Ratings
success plays a significant role in our ability to achieve our distribution and
advertising goals. Our ratings declined from 11
th
in
total day viewership and 8
th
for
prime time in 2008 to 14
th
in
total day viewership and 10
th
for
prime time in 2009. We believe our ratings are affected by our
ability to (i) acquire and produce series and movies that appeal to our target
demographic and (ii) develop a programming schedule that attracts a high number
of viewers. Original productions are our most high profile programs and generate
the Hallmark Channel’s highest ratings. In the past, the Company has typically
incurred additional marketing and promotional expenses surrounding original
productions and certain acquired movies to drive higher ratings. Certain
acquired series delivered historically strong ratings, but recently they have
been part of the decline experienced in viewer ratings. In order to reverse the
recent decline in ratings, we plan to continue or increase the number of our
original productions and develop a programming schedule that attracts a greater
number of viewers in our target demographic, all while controlling the expenses
relating to these actions. Our recent acquisition of the broadcast
rights of Martha Stewart Living and our planned 26 original productions for
broadcast in 2010 are key parts of these plans.
The
Hallmark Movie Channel has not been the subject of ratings measurement by
Nielsen Media Research. However, as currently planned, the Hallmark Movie
Channel will have Nielsen ratings commencing in the second quarter of 2010, and
we will sell advertising inventory for the Hallmark Movie Channel commencing in
that quarter based on a price per unit of audience measurement.
Advertising
Revenue
Continued
weakness in the economy has resulted generally in lower demand and lower rates
for our inventory of ad spots available for the scatter market and lower revenue
from direct response advertising when comparing the 2009 year to the 2008 year.
Notwithstanding the relatively higher CPMs negotiated in the 2008/2009 broadcast
year upfront sales period versus the 2007/2008 broadcast year upfront sales
period, our advertising revenue for the year ended December 31, 2009, decreased
relative to the year ended December 31, 2008, primarily because of lower viewer
ratings and also because of lower rates in the scatter market. With the
shortfall in achieving viewership commitments, our liability for ADUs has
increased significantly since December 31, 2008.
In the
2009/2010 upfront process, we entered agreements with major advertising firms
representing approximately 41% of our advertising inventory for the last quarter
of 2009 and the first three quarters of 2010. This inventory was sold
at CPMs (i.e., advertising rates per thousand viewers) approximately 1.6% lower
than the inventory sold in the 2008/2009 upfront. In the 2008/2009
upfront sales process, we entered agreements for approximately 51% of our
advertising inventory for the last quarter of 2008 and the first three quarters
of 2009. We held more advertising inventory from the 2009/2010
upfront than the 2008/2009 upfront, for use in the general scatter market,
because of lower CPMs offered by some advertisers in the 2009/2010 upfront. The
Company intends to sell the balance of the general rate inventory for the
2009/2010 broadcast season to advertisers that purchase upfront inventory on a
calendar year basis, rather than an advertising year basis, and in the scatter
marketplace.
Following
the upfront period, sales of our general rate, direct response and
paid-programming inventory are made closer to the timing of the actual
advertisement. We have historically seen significant increases in
rates on these remaining advertising sales over the rates obtained from our
upfront sales. As compared to the upfront sales for the same periods,
scatters rates in 2009 were higher by the following percentages: 45% for the
first quarter of 2009; 40% for the second quarter of 2009; 46% for the third
quarter of 2009; and 60% for the fourth quarter of 2009. However,
during the fourth quarter of 2008 and each of the quarters in 2009 rates for the
scatter market and direct response advertising decreased when compared to the
same periods in the prior year, except there was a slight increase in the fourth
quarter of 2009 scatter rates as compared to the fourth quarter of 2008 scatter
rates.
Advertisers
with upfront contracts have an option to terminate their contracts, as well as
an option to expand the amount of inventory purchased under the contracts. In
prior years, cancellations of upfront contracts were unusual. During the twelve
months period ended September 2009 comprising the 2008/2009 broadcast season,
advertisers canceled approximately 13% of the inventory covered by such
contracts. The Company sold the balance of the 2008/2009 general rate
inventory, including that resulting from the cancellations, in the scatter
market.
Distribution
Agreements
Distribution
agreements are important because they affect our number of subscribers, which in
turn have a major impact on our subscriber fees, the number of persons viewing
our programming, and the rates charged for advertising. The long-term
distribution challenge is renewing our distribution arrangements with the
multiple system operators as they expire on favorable terms. Our major
distribution agreements have terms which expire at various times from December
31, 2009, through December 2023, inclusive of renewal options. An Agreement with
National Cable Televisions Cooperative representing approximately 12% of our
total Hallmark Channel subscriber base expired in December 2009. The Company is
currently in negotiations with the National Cable Televisions Cooperative to
enter into a new agreement. Agreements representing an additional 5% of our
subscribers to our Hallmark Channel
will expire prior to
December 31, 2010.
Domestic
telephone companies have entered the business of distributing television
channels to households through their wire-lines. We have distribution agreements
with several telephone companies for the carriage of the Hallmark Channel, the
Hallmark Movie Channel and Hallmark Movie Channel HD, and continue to seek
agreements with other telephone companies.
The
universe of cable TV subscribers in the United States is approximately 100
million homes. The top 30 cable TV networks in the United States,
measured by the number of subscribers, have 90 million or more
subscribers. Our goal is for the Hallmark Channel to reach 90 million
subscribers and the Hallmark Movie Channel to reach 40 million subscribers in
the next one to two years.
Demographics
As pay
television channels draw audience share, 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
believe that the key demographics for the Hallmark Channel are the viewers in
the groups Adults aged 25 to 54 and Women aged 25 to 54. However, the
average median age of a viewer of the Hallmark Channel was 59.5 in 2009 and 59.8
in 2008. In order to achieve our revenue goals, we need to draw in
our target audience. The broadcast on the Hallmark Channel of Martha
Stewart Show and other Martha Stewart Living productions, commencing in
September 2010, are a key part of our efforts to attract our target
audience.
For
additional information on demographics and viewer ratings, please see “Sources
of Revenue – Advertising Revenue” in Item 1, Business, and “Results of
Operations – Year Ended December 31, 2008 Compared to Year Ended December 31,
2009 – Revenue” in Item 7, Management’s Discussion and Analysis of Financial
Condition and Operating Results.
Cost
Control
We expect
to continue experiencing increases in our bad debt expense during 2010, which
increases also occurred in 2009, because of the economic downturn. Such
increased expense is expected to result from certain customers, primarily
advertisers, which will experience cash flow problems in this adverse economic
environment.
We
launched a high definition version of the Hallmark Channel in February
2010. The costs for this launch were approximately $5.0 million,
approximately $4.4 million of which represents a non-cash charge related to the
terminations of two existing channel delivery agreements, which was recorded in
2009. This amount is subject to change based upon several factors. The Company
may also incur additional costs including the cost of converting certain
television series to high definition. The launch of a high definition
version will further the Company’s efforts to maintain
competitiveness.
Revenue
from Continuing Operations
Our
revenue consists primarily of subscriber fees and advertising
fees. For the years ended December 31, 2007, 2008 and 2009 revenue
derived from subscriber fees for the Channels was approximately $27.8 million,
$57.2 million and $63.6 million, respectively. For the years
ended December 31, 2007, 2008 and 2009 revenue from the sale of advertising time
on our Channels were approximately $206.2 million, $223.4 million and $214.5
million, respectively. Information relating to subscriber fees and advertising
fees is presented above in “
Item 1 Business – Sources of
Revenue
”
Cost
of Services
Our cost
of services consists primarily of the amortization of program license fees; the
cost of signal distribution; and the cost of promotional segments that are aired
between programs. See the discussion of programming costs in “Results of
Operations” below. See also discussion of operating costs in “Results of
Operations” below for an anticipated increase in the operating costs for the
first quarter of 2010 due to the costs of launching a high definition version of
the Hallmark Channel.
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 revenue 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.
Program
License Fees
Program
license fees are paid in connection with the acquisition of the rights to air
programs acquired from others. The cost of program rights are deferred and then
amortized on a straight-line basis over the shorter of their contractual license
periods or anticipated usage. On a yearly basis, the Company evaluates the
realizability of these deferred license fees in relation to the estimated future
revenue. Estimates of net realizable value for program license fees are
determined using future estimated advertising revenue and anticipated patterns
of programming usage on a day part basis (blocks of time during the day) as it
pertains to programming licensed to a Channel. These estimates of expected
annual future estimated revenue 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, additional programming costs are immediately recognized in
the amount of the excess.
Goodwill
At
December 31, 2009, the Company had a stockholders’ deficit of $698.0 million and
a goodwill asset of $314.0 million. All of our goodwill relates to our domestic
channel operations segment within Crown Media United States, which is also our
only reporting unit. The Company’s market capitalization exceeds the negative
carrying value of the reporting unit.
We
performed our annual assessment of the recoverability of our goodwill and other
nonamortizable intangible assets as of November 30 using a market approach to
determine fair value. In our market approach, we identified publicly traded
companies whose business and financial risks are comparable to ours. We then
compared the market values of those companies to our calculated value. We also
identified recent sales of companies in lines of business similar to ours and
compared the sales prices in those transactions to the calculated value of
ours.
We also
used the discounted cash flow analysis approach to validate the fair value
determined by our market approach. The values determined in our discounted cash
flow analysis corroborated the value calculated in our market approach. We
estimated the fair value of our reporting unit for the Step 1 Test using a
discounted cash flow analysis. The cash flow projections (the "2009 Cash Flow
Projections") used in our analysis were prepared by management and represent
management's estimate of the future cash flows to be generated by operations
during 2010 through 2014 (Years 1-5). For the 5 years ended
December 31, 2009, revenue grew at an annual growth rate of approximately
3%. Our gross margin increased over the same time period from a negative 103% to
a positive 28%. Given the downturn in the economy in 2009, management determined
that it was prudent to adjust the growth rates used in the 2009 Cash Flow
Projections. Therefore, the 2009 Cash Flow Projections include growth rates
which are lower than historical growth rates and lower than the growth rates
used in our 2008 cash flow projections. The growth rates used in the 2009 Cash
Flow Projections are considered by management to be appropriate and reflect the
current state of the economy. The 2009 Cash Flow Projections include many
assumptions, including assumptions regarding the timing of an economic recovery
and the impact of any such recovery on operations. In this regard, the 2009 Cash
Flow Projections are based on the economy stabilizing and growing modestly in
2010 and that the economy is somewhat more normalized in the years beyond
2010.
The
projected cash flows were discounted using a blended discount rate of 14%, which
represents an estimate of the weighted average cost of capital. The weighted
average cost of capital incorporates risk premiums that reflect the current
economic environment. Such discount rate is higher than the rate used in prior
years due to changes in the marketplace for credit and risk premiums. Terminal
growth rates (the approximation of ongoing growth rates) after Year 5
consider the above noted factors for the initial five years forecasted cash
flows and forecasted CPI increases.
We also
reconcile the estimated fair value of our reporting unit to our market
capitalization. As long as we continue to have a stockholders’
deficit and only one reporting unit, we believe it is unlikely we would have a
goodwill impairment. However, ignoring that our positive market
capitalization exceeds our shareholders’ deficit, we have discussed below the
sensitivity of our discounted cash flow analysis.
The
estimated fair value determined in our Step 1 Test was in excess of the
reporting unit’s carrying value, and accordingly no Step 2 Test was performed
and no impairment charge was recorded. We note that if our fair value estimate
was 58% lower, we would still not have triggered a Step 1 failure and no
impairment charge would be taken.
The
foregoing impairment test requires a high degree of judgment with respect to
estimates of future cash flows and discount rates as well as other assumptions.
Therefore, any value ultimately derived may differ from our estimate of fair
value. Further, if the environment continues to experience recessionary
pressures for an extended period of time, our cash flow projections will need to
be revised downward and we could have impairment charges in the future. In this
regard, we estimate that if we were to use a compound annual growth rate for
revenue that is approximately 50% to 60% lower than the rate currently used in
the 2009 Cash Flow Projections and that we achieved the margins assumed in the
2009 Cash Flow Projections, we could in the future fail the Step 1 Test and
would be required to perform the Step 2 Test to measure any impairment of
goodwill
.
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.
Revenue
Recognition
Subscriber
revenue from pay television distributors is recognized as revenue when an
agreement is executed, programming is provided, the price is fixed and
determinable, and collectibility is reasonably assured. Subscriber fees from pay
television distributors are recorded net of amortization of subscriber
acquisition costs. If the amortization expense exceeds the revenue recognized on
a per distributor basis, the excess amortization is included as a component of
cost of services.
Advertising
revenue, net of agency commissions, is recognized in the period in which related
commercial spots or long form programming are aired and as ratings guarantees to
advertisers are achieved. 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 or audience
deficiency units.
Audience
Deficiency Unit Liability
Audience
deficiency units (“ADUs”) are units of inventory that are made available to
advertisers as fulfillment for the inventory the advertiser purchased that ran
in programs that under-delivered on the guaranteed ratings.
An
audience deficiency liability results when impressions delivered on guaranteed
ratings are less than the impressions guaranteed to advertisers. Such liability
arises as a matter of industry practice rather than as a matter of written
contract. The liability is reduced when the Company airs the
advertisement during another program to “make-good” on the under-delivery of
impressions. The Company typically does not remit cash to advertisers
in satisfaction of such deficiencies.
Effects
of Transactions with Related and Certain Other Parties
Hallmark
Transactions
In 2009
and in prior years, we entered into a number of significant transactions with
Hallmark Cards and its subsidiaries. These transactions include, among other
things, trademark licenses, and administrative services agreement, a Tax Sharing
Agreement, the issuance of a $400.0 million senior note, notes payable and
the Amended Waiver and Standby Agreement. A summary of the terms and
financial impact of these transactions is described below in Item 13 “
Certain Relationships and Related
Transactions
” which is incorporated by reference into this Item
7. Certain of these agreements would be modified if the
Recapitalization were implemented.
NICC
Agreement
For
information regarding the amendment to our agreements with NICC including the
required redemption of a preferred interest in Crown Media United States, please
see Item 13 “
Certain
Relationships and Related Transactions – VISN Preferred Interest
”
contained in this Report.
Selected
Historical Consolidated Financial Data of Crown Media Holdings
In the
table below, we provide selected historical consolidated financial and other
unaudited data of Crown Media Holdings and its subsidiaries. The following
selected consolidated statement of operations data for the years ended December
31, 2007, 2008 and 2009, 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.
Results
of Operations
Year
Ended December 31, 2008 Compared to Year Ended December 31, 2009
Revenue.
Our
revenue from continuing operations, comprised primarily of subscriber and
advertising fees, decreased $2.2 million or 1% in 2009 over 2008. Our subscriber
fee revenue increased $6.4 million or 11%. The amount of subscriber
acquisition fees that was recorded as a reduction of subscriber fee revenue was
approximately $2.7 million and $2.6 million for 2008 and 2009, respectively.
Subscriber revenue increased in 2009 primarily due to an increase in the number
of Hallmark Channel pay subscribers and small contractual rate
increases.
The $8.9
million or 4% decrease in advertising revenue is primarily due to declines in
viewer ratings across demographic categories for 2009 compared 2008. Audience
deficiency unit revenue decreased $10.5 million from revenue of $4.1 million for
2008, to contra-revenue of $6.4 million for the same period in 2009 as a result
of such ratings declines, leading to a corresponding decrease in revenue
recognized by the Company.
We
believe that recent changes to our program schedule, along with increased
competition (including the availability of high definition distribution by
competitors), contributed to a decline in ratings. From 2005 until early 2009,
our programming schedule did not change significantly. Beginning in 2008, a
number of programs that had previously received strong ratings began to
experience ratings declines, and we placed television series in certain
timeslots instead of movies or original productions. Also, a number
of programs in the schedule provided strong household ratings performance but
less effective delivery of our key demographic, women age 25-54. In
2009, we began to introduce new content into the schedule with the objective of
increasing the delivery of women 25-54. The schedule changes likely
resulted in some viewer confusion and did result in lower ratings. We
continue to experience success in select dayparts, and we will continue to focus
on program acquisitions, original program production and schedule changes that
are intended to improve both the viewer ratings and the demographic delivery of
the Hallmark Channel.
The fact
that Hallmark Channel was not broadcast in high definition may have had a
negative impact on ratings in 2009. Of the top 44 advertising
supported cable networks with a 0.4 household rating or higher in prime time,
only six of those networks (including Hallmark Channel) were not offered in high
definition. Of those six networks, three experienced double-digit
ratings decreases in 2009 compared to 2008 and three experienced single digit
increases. In 2009, 33% of viewers with access to high definition
programming services tuned to those high definition services
first. The growth in popularity of high definition programming is
expected to continue in 2010 and beyond, and these high definition trends are
part of our decision to launch Hallmark Channel in high definition in February
2010.
The 2009
year also represented a year of increased competition within cable
television. The number of cable networks investing in original
programming increased 74% in 2009, and acquired (non-original) programming now
represents only 33% of prime time cable programming. Although
Hallmark Channel continues to invest in original programming, our increase in
investment for original content did not match the growth of the market or many
of our competitors. The impact of the programming competition is
heightened by the continued growth of time-shifting digital video recording
devices, or DVR’s. With the proliferation of these devices, viewers
are able to increase their access to the new, compelling content.
For the
year ended December 31, 2009, Nielsen ranked the Hallmark Channel 14
th
in
total day viewership with a 0.589 household rating and 10
th
in
primetime with a 0.991 household rating among the 76 cable channels in the
United States market.
Cost of services.
Cost of
services as a percent of revenue decreased to 53% in 2009 as compared to 55% in
2008. This decrease results primarily from the effects of the 9% decrease in
programming costs, discussed below, offset in part by the 4% decrease in
advertising revenue discussed above.
Programming
costs decreased $13.2 million or 9% from 2008. In the second and third quarters
of 2008, we entered into agreements to amend significant programming agreements
which added programs and deferred certain payments for programming content to
periods beyond 2008. Some of the agreements resulted in the extension of related
program licenses to cover slightly longer periods of availability, the deferral
of expected delivery of certain programming and the deferral of certain payments
primarily from 2008 until 2009. Upon the amendment of the agreements, we
prospectively changed the amortization of program license fees for any changes
in the period of expected usage and/or changes in license fees. The
effects of these amendments on 2008 amortization were not significant.
Additionally, we
returned our exclusivity rights to one title, which resulted in a lower asset
and liability balance. During the first quarter of 2009, we also
entered into amendments to some of our original programming agreements which
extended the current license period to those titles, and thus, resulted in lower
amortization in 2009 compared to 2008. Additionally, during 2009, we
did not enter into any significant new third party license agreements, so
expiring program rights and the related amortization were not replaced in full
with assets and amortization from newer license agreements.
Operating
costs for 2009 increased $2.3 million over 2008 due in part to the $1.2 million
increase in bad debt expense and the $912,000 of severance expense recorded in
May 2009 related to one executive’s resignation. The Company’s bad debt expense
was $1.3 million for 2009, as compared to $75,000 for 2008. The
increase in bad debt expense is due to certain advertising customers
experiencing cash flow problems under current economic
conditions. The Company will continue to monitor cash collections as
part of estimating this expense.
Additionally,
the Company recorded negative film amortization of $745,000 in 2008 that
resulted principally from the Company’s periodic reassessment and eventual
payment of its liabilities for residuals and participations associated with the
Company’s third-party licensing and self-use of the Company’s film library prior
to the sale of the Company’s international film rights in April 2005 and the
Company’s domestic film rights in December 2006.
During
the fourth quarter of 2009, we negotiated the termination of two channel
delivery agreements related to the launch of the Hallmark Channel into high
definition. The estimated costs of termination were approximately $4.7
million. We may incur additional costs during 2010 to obtain high
definition versions of certain of our programming.
Selling, general and administrative
expense.
Our selling, general and administrative expense increased
slightly year over year. The Company recorded $2.5 million of
severance expense associated with the resignation of its President on May 31,
2009. The Company also recorded $1.2 million of severance expense associated
with the termination of 15 employees in August 2009. These increases in expense
were offset by decreases in the travel, communication, and RSU related expenses.
Travel and communication events related expenses decreased approximately $1.3
million period over period. Additionally, the Company recorded $1.1 million of
compensation expense associated with RSUs during 2008, as compared to $269,000
of compensation benefit associated with RSUs for 2009. See Note 14 to the
consolidated financial statements in this Report.
Marketing
expense
. Our marketing expense decreased 67% in 2009 versus
2008. During 2008, we invested in five significant marketing
promotions. The five marketing promotions were centered around the
original movies: “The Good Witch” in January 2008, “Bridal Fever” in
February 2008, “A Gunfighter’s Pledge” in July 2008, and both “Old Fashioned
Thanksgiving” and “Moonlight and Mistletoe” in November 2008. The Company had
one significant marketing promotion in January 2009 centered around the original
movie, “Taking a Chance on Love.” As part of our contingency cost reduction
efforts, promotional and marketing efforts were reduced overall during 2009
compared to 2008.
Marketing
expenses may increase in 2010 to promote the Hallmark Channel’s programming
schedule, including the Martha Stewart Living productions.
Gain from sale of film
assets
. In December 2009 the Company concluded that payments for
residuals and participations, which are liabilities from the Company’s December
2006 sale of its film assets, would occur generally later than originally
estimated in December 2006. Accordingly, the Company reduced the
carrying amount of the liability by $682,000 and recognized a corresponding gain
from sale of film assets in the accompanying statement of
operations.
Interest
expense.
Interest expense in 2009 increased $382,000 compared
to 2008. The principal balance under our credit facility was
$28.6 million at December 31, 2008, and $1.0 million at December 31, 2009. The
interest rate on our bank credit facility increased from 1.22% at December 31,
2008, to 2.49% at December 31, 2009. Interest rates on our 2001, 2005 and 2006
notes decreased from 9.05% at December 31, 2008, to 5.29% at December 31, 2009.
The benefit of these rate decreases was offset by a higher principal balance on
the Senior Secured Note, resulting in interest expense for 2009 being nearly the
same as for 2008.
Gain on sale of discontinued
operations
. The terms of our April 2005 sale of the
international business require that we reimburse the buyer for its cost of
residuals and participations incurred in connection with the its exploitation of
the related international film rights through April 25, 2015. At the
time of the sale, we recorded an estimate of our liability for this obligation
and considered the amount in our determination of our loss from the sale of
discontinued operations as reported in 2005. During the fourth
quarter of 2008, the buyer requested us to reimburse it for such obligations
incurred in connection with its exploitation of these films through December 31,
2007. Using the historical information provided by the buyer, we
reduced the estimate of our remaining liability as of December 31, 2008, by
$5.1 million. This change in estimate was reflected as a $3.1 million
gain on sale of discontinued operations and a $2.0 million decrease in interest
expense.
Termination
of one agreement relating to channel delivery also resulted in a change in the
estimated life of the deferred credit for playback services. After
termination of services, there is no longer a recurring monthly expense for
compression and uplink services. Accordingly, the adjustment to
eliminate the unneeded portion of the deferred credit of approximately $847,000
was recognized during the fourth quarter of 2009. Through December 31,
2009, the aggregate loss on sale of the international business is $1.0
million.
Year
Ended December 31, 2007 Compared to Year Ended December 31, 2008
Revenue.
Our
revenue from continuing operations, comprised primarily of subscriber fees and
advertising, increased $47.4 million or 20% in 2008 over 2007. Our subscriber
fee revenue increased $29.3 million or 105% as a result of (1) an increase in
the number of paying subscribers, (2) significantly improved subscriber fee
rates following renewal of all of our major distribution agreements in 2007 and
2008, and (3) a significant reduction in the amount of subscriber acquisition
fees netted against gross subscriber revenue. The renewed
distribution agreements also sharply reduced the subscriber acquisition fees we
must pay our distributors for carriage of our channels. The amount of subscriber
acquisition fees that was recorded as a reduction of subscriber fee revenue
decline from $6.5 million in 2007 to $2.7 million in 2008, reflecting the
system-by-system effect of increased subscriber fee rates and reduced subscriber
acquisition fees.
The $17.2
million or 8% increase in advertising revenue reflects an increase in
advertising rates along with improved delivery of committed viewership ratings
and increase in the number of available general rate ad spots, offset in part by
a decrease in the effectiveness of direct response advertising. The
Hallmark Movie Channel contributed $3.2 million of the increase.
During
the second, third and fourth quarters of 2008 we experienced a softening of
advertising rates in the scatter and direct response markets as a result of
deteriorating national economic conditions. This softening continued
throughout 2009. The relative decrease in advertising revenue in the third
quarter of 2008 compared to the second quarter of 2008 was greater than the
seasonal decrease we would typically have expected. Advertising
revenue for the fourth quarter of 2008 was $60.4 million compared to $63.0
million in the fourth quarter of 2007. We were not significantly
affected by cancellations under advertising contracts. In response to
the lower advertising rates, starting in the third quarter of 2008, we reduced
the amount of time allotted to on-air self-promotion and increased the time
available for paid advertising. The volume of advertising did not
decrease.
For 2008,
Nielsen ranked the Hallmark Channel 11
th
in
total day viewership with a 0.695 household rating and 8
th
in
primetime with a 1.168 household rating among the 73 ad-supported cable channels
in the United States market. Although we had an increase in distribution to the
Nielsen Universe of approximately 2% in the fourth quarter of 2008 versus the
fourth quarter of 2007, our household ratings were down 7% for the fourth
quarter of 2008 compared to the fourth quarter of 2007. We believe
that the reasons for this circumstance include significant sample adjustments to
viewers in determining ratings, a shift of viewers to cable news channels during
the unprecedented media coverage of the national elections and the economic
crisis. Our year-to-date household ratings were also down slightly due to
the 2008 Summer Olympics.
Cost of
services.
Cost of services as a percent of revenue decreased
to 55% in 2008 as compared to 86% in 2007. This decrease resulted from the
combined effects of the 20% increase in revenue, discussed above, and the 100%
decrease in subscriber amortization fee amortization expense discussed
below.
Programming
costs decreased $23.7 million or 14% from 2007 largely as a result of the
December 31, 2007, expiration of our programming agreement with NICC and our
efforts to manage costs. This was offset in part by our licensing of Hallmark
Hall of Fame movies under a new 2008 agreement with Hallmark Cards that provides
10-year exhibition windows for all licensed films. During the third
quarter of 2008, we entered into amendments to significant programming
agreements which added programming and deferred certain payments of for program
content to periods beyond 2008.
Subscriber acquisition fee amortization
expense resulted from subscriber acquisition costs incurred previously by us and
amortized over the remaining life of the relevant distribution agreement.
Subscriber acquisition fee amortization expense decreased 100% as all of the
expense was netted against revenue in 2008. The Company’s three largest
affiliation agreements became fully amortized during the fourth quarter of 2007
as they expired and renewal agreements were executed.
Negative
film amortization of $5.2 million and $745,000 in 2007 and 2008, respectively,
resulted principally from the Company’s periodic reassessment and eventual
payment of its liabilities for residuals and participations associated with the
Company’s third-party licensing and self-use of it film library prior to the
sale of its international film rights in April 2005 and its domestic film rights
in December 2006. In 2007, such favorable adjustments amounted to
$521,000 in the second quarter and $4.7 million in the third
quarter. In 2008, such adjustment amounted to $1.1 million in the
third quarter.
Operating
costs in 2008 increased $1.3 million over 2007 primarily due to a $540,000
increase in expenses associated with the distribution of the Hallmark Movie
Channel HD in high definition format and the $716,000 increase in salaries and
benefits expense related to cost of living adjustments.
Selling, general and administrative
expense.
Our selling, general and administrative expense decreased $14.6
million or 23%. Contributing to this favorable change were decreases
of $3.5 million in RSU expense and $2.5 million in SAR expense. Also
contributing was a $7.8 million decrease in legal expense, following our January
2008 settlement with NICC which was reflected in the 2007 year.
Marketing
expense
. Our marketing expense decreased 1%. During 2007, we
invested in five significant marketing promotions. The five marketing
promotions were centered around the original movies: “Love is a Four Letter
Word” in February 2007, “A Stranger’s Heart” in May 2007, “Avenging Angel” in
July 2007, “All I Want for Christmas” in December 2007 and “The Note” in
December 2007. The Company also had five significant marketing promotions in
2008 centered around the original movies: “The Good Witch” in January 2008,
“Bridal Fever” in February 2008, “A Gunfighter’s Pledge” in July 2008, and both
“Old Fashioned Thanksgiving” and “Moonlight and Mistletoe” in November 2008.
Total amounts spent for the five significant marketing promotions were lower in
2008 as compared to 2007. In addition to the radio, television, print and online
advertising included in the significant marketing promotions, we executed a
multi-market event to drive press coverage, viewer awareness and tune-in to the
movie. The Company also engaged in other smaller, promotional activities
throughout 2007 and 2008, with lower expenditures for these activities in 2008
as compared to 2007.
Interest
expense.
Interest expense in 2008 decreased $8.0 million
compared to 2007. The principal balance of our credit facility
decreased from $87.6 million at December 31, 2006, to $69.6 million at December
31, 2007, to $28.6 million at December 31, 2008. The interest rate on our bank
credit facility decreased from 5.6% at December 31, 2007, to 1.22% at December
31, 2008. The benefit of this rate decrease was offset in part by higher
principal balances on four of the five notes payable to Hallmark
affiliates. Additionally, on April 14, 2008, the Tax Note was
credited $1.5 million for the Company’s share of an IRS interest refund that
Hallmark Cards received. This refund of interest reduced the balance of the Tax
Note. During the year ended December 31, 2007, the Company recorded $7.9 million
of interest expense related to the Tax Note. See information on the
Tax Note in “Bank Credit Facility and Hallmark Notes – Note and Interest Payable
to Hallmark Cards” below. Interest expense in 2008 also included a
$2.0 million reduction to give effect to our change in the estimate of our
indemnification liability to the buyer of our international business as
described in the next paragraph
Gain on sale of discontinued
operations
. The terms of our April 2005 sale of the
international business require that we reimburse the buyer for its cost of
residuals and participations incurred in connection with the its exploitation of
the related international film rights through April 25, 2015. At the
time of the sale, we recorded an estimate of our liability for this obligation
and considered the amount in our determination of our loss from the sale of
discontinued operations as reported in 2005. During the fourth
quarter of 2008, the buyer requested us to reimburse it for such obligations
incurred in connection with its exploitation of these films through December 31,
2007. Using the historical information provided by the buyer, we
reduced the estimate of our remaining liability as of December 31, 2008, by
$5.1 million. This change in estimate was reflected as a $3.1 million
gain on sale of discontinued operations and a $2.0 million decrease in interest
expense. Through December 31, 2008, the aggregate loss on sale
of the international business was $1.8 million.
Liquidity
and Capital Resources
Year
Ended December 31, 2008 Compared to Year Ended December 31, 2009
In 2008,
our operating activities provided $48.1 million of cash compared to $37.6
million of in 2009.
The Company’s net loss
for the year ended December 31, 2009, decreased $14.6 million to $22.6 million
from $37.2 million for the year ended December 31, 2008. Our depreciation and
amortization expense for 2009 decreased $12.2 million to $133.0 million from
$145.2 million in 2008. The Company had lower additions to program
license fees in 2009 as compared to 2008 due to amendments to agreements with
certain third party programming suppliers during 2008 to add programming
content. Pursuant to the Waiver Agreement, the Company paid $19.6 million for
interest on the 2001, 2005 and 2006 Notes that accrued November 16, 2008,
through September 30, 2009. The Company made programming payments of $138.4
million and $146.5 million in 2008 and 2009, respectively.
Cash used
in investing activities was $5.4 million and $1.4 million in 2008 and 2009,
respectively. During 2008 and 2009, we purchased property and equipment of $1.9
million and $507,000, respectively. During 2008 and 2009, the Company paid $3.6
million and $936,000, respectively, to the buyer of the international business
for amounts due under the terms of the sale agreement, primarily for
reimbursement of transponder lease payments. The Company established a liability
and recorded a related loss for these payments as part of the 2005 sale of our
international business.
Cash used
in financing activities was $41.9 million and $28.4 million in 2008 and 2009,
respectively. We borrowed $30.5 million and $18.1 million under our credit
facility to supplement the cash requirements of our operating and investing
activities in 2008 and 2009, respectively. We repaid principal of $71.5 million
and $45.6 million under our bank credit facility in 2008 and 2009,
respectively.
Year
Ended December 31, 2007 Compared to Year Ended December 31, 2008
In 2007,
our operating activities provided $14.6 million of cash compared to $48.1
million of in 2008.
The most significant
contribution to this favorable change of $33.5 million was the increase in
operating cash receipts from $240.4 million to $282.6 million during the years
ended December 31, 2007 and 2008, respectively. Additionally, the Company’s net
loss for the year ended December 31, 2008, decreased $121.8 million to $37.2
million from $159.0 million for the year ended December 31, 2007. Our
depreciation and amortization expense for 2008 decreased $47.1 million to $145.2
million from $198.2 million in 2007. The Company had higher additions
to program license fees in 2008 as compared to 2007 due to amendments to
agreements with certain third party programming suppliers during 2008 to add
programming content. On January 5, 2009, pursuant to the Waiver Agreement, the
Company paid $3.9 million for interest on the 2001, 2005 and 2006 Notes that
accrued from November 16, 2008, through December 31, 2008.
Cash used
in investing activities was $7.8 million and $5.4 million in 2007 and 2008,
respectively. During 2007 and 2008, we purchased property and equipment of $1.7
million and $1.9 million, respectively. During 2007 and 2008, the Company paid
$4.1 million and $3.6 million, respectively, to the buyer of the international
business for amounts due under the terms of the sale agreement, primarily for
reimbursement of transponder lease payments. In 2007, we purchased a film asset
for $2.1 million.
Cash used
in financing activities was $18.8 million and $41.9 million in 2007 and 2008,
respectively. We borrowed $18.1 million and $30.5 million under our credit
facility to supplement the cash requirements of our operating and investing
activities in 2007 and 2008, respectively. We repaid principal of $36.3 million
and $71.5 million under our bank credit facility in 2007 and 2008,
respectively.
Contractual
Obligations
The
following table summarizes the future cash disbursements to which we are
contractually committed as of December 31, 2009:
|
Scheduled
Payments by Period in Millions
|
||||||||||||||||||||
|
Contractual
Obligations
|
Total
|
Less
than 1 Year
|
1-3
Years
|
4-5
Years
|
After
5 Years
|
|||||||||||||||
|
Credit
facility and interest payable (1)
|
$ | 1.0 | $ | 1.0 | $ | - | $ | - | $ | - | ||||||||||
|
Company
obligated mandatorily redeemable
preferred interest, including
accretion (2)
|
25.0 | 25.0 | - | - | - | |||||||||||||||
|
Senior
secured note to HC Crown,
including accrued interest
(1)
|
883.8 | 39.3 | 844.5 | - | - | |||||||||||||||
|
Notes
and interest payable to Hallmark Cards affiliates(1)
|
351.3 | 351.3 | - | - | - | |||||||||||||||
|
Capital
lease obligations (1)
|
21.5 | 2.2 | 4.3 | 4.3 | 10.7 | |||||||||||||||
|
Operating
leases
|
30.3 | 5.9 | 10.9 | 9.9 | 3.6 | |||||||||||||||
|
Other
obligations
|
||||||||||||||||||||
|
Program
license fees payable for non-affiliate current and future windows
(3)(4)
|
276.4 | 102.1 | 125.3 | 49.0 | - | |||||||||||||||
|
Program
license fees payable for Hallmark Cards affiliate current and future
windows (3)(4)
|
8.0 | 1.4 | 3.2 | 3.4 | - | |||||||||||||||
|
Funding
of original productions (3)(4)
|
33.0 | 20.2 | 12.8 | - | - | |||||||||||||||
|
Subscriber
acquisition fees
|
0.5 | 0.5 | - | - | - | |||||||||||||||
|
Obligations
to NICC due to January 2, 2008 Agreement (5)
|
2.8 | 2.8 | - | - | - | |||||||||||||||
|
Deferred
compensation and interest
|
2.5 | 0.9 | 0.6 | 0.3 | 0.7 | |||||||||||||||
|
Payable
to buyer of international business
|
1.2 | 1.2 | - | - | - | |||||||||||||||
|
Other
payables to buyer of international business
|
0.6 | 0.3 | 0.1 | 0.1 | 0.1 | |||||||||||||||
|
Other
payables to buyer of film assets
|
21.0 | 4.3 | 4.8 | 6.0 | 5.9 | |||||||||||||||
|
Total
Contractual Cash Obligations
|
$ | 1,658.9 | $ | 558.4 | $ | 1,006.5 | $ | 73.0 | $ | 21.0 | ||||||||||
|
(1)
Includes future interest. Subsequent to the balance sheet date, the
termination dates were extended to August 31, 2010. These amounts do
not contain interest for the period May 1 through August 31,
2010.
|
||||||||||||||||||||
|
(2)
The company obligated mandatorily redeemable preferred interest is to be
redeemed on or before December 31, 2010.
|
||||||||||||||||||||
|
(3)
The amounts and timing for certain of these commitments are contingent
upon the future delivery date and type of programming
produced,
|
||||||||||||||||||||
|
and,
as such, the estimated amount and timing may change.
|
||||||||||||||||||||
|
(4)
Contains airing windows that open subsequent to year end and, therefore,
the liability is not included on the balance sheet as of December 31,
2009.
|
||||||||||||||||||||
|
(5)
Pursuant to the January 2, 2008, agreement, the Company paid NICC $1.3
million in January 2010. Also, the Company
|
||||||||||||||||||||
|
made
a 6% payment based on the outstanding balance of the VISN preferred
interest in Crown Media United States in January 2010.
|
||||||||||||||||||||
Cash
Flows
As of
December 31, 2009, the Company had $10.5 million in cash and cash equivalents on
hand and $44.0 million of borrowing capacity under the bank credit
facility. On March 2, 2010, the Company and the bank set the maximum
amount that could be borrowed under the bank credit facility at $30.0 million
and extended the maturity date to August 31, 2010. After this
amendment, the Company had $30.0 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 August
31, 2010, will include the payment of operating expenses, accounts payable and
accrued expenses, programming costs, costs incurred in connection with the
Recapitalization, interest and repayment of principal under the bank credit
facility and interest of approximately $15.0 million to $18.0 million due under
certain notes to Hallmark Cards affiliates from January 1 through August 31,
2010. The amounts outstanding under the bank credit agreement and
those notes to Hallmark affiliates are due August 31, 2010 as discussed
below.
The
Company generated positive cash flows from operating activities for each of the
years ended December 31, 2007, 2008 and 2009. As indicated 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 August 31, 2010. These obligations comprised $345.3 million at
December 31, 2009. An additional $758.8 million (10.25% Senior
Secured Note) of principal and interest outstanding at December 31, 2009,
payable to a Hallmark Cards’ affiliate in August 2011, is also subject to the
Waiver Agreement until August 31, 2010. Interest amounts related to
the 10.25% note will be added to principal through August 5,
2010. The deferral of payments under the Waiver Agreement terminates
on August 31, 2010. Hallmark Cards and its affiliates have no
obligation, and have stated no intent, to extend this termination date.
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
Company’s ability to pay amounts outstanding under the bank credit facility on
the maturity date is highly dependent upon its ability to generate sufficient,
timely cash flow from operations between January 1 and August 31,
2010. Based on the Company’s forecasts for 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 cash flows may be less than the expectations of the Company’s
management.
Upon
maturity of the credit facility on August 31, 2010, to the extent the facility
has not been paid in full, renewed or replaced, the Company could exercise its
option under the Waiver Agreement and require Hallmark Cards to 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 August 31, 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 August 31, 2010, when
combined with (1) the deferral of otherwise required payments under the 10.25%
Senior Secured Note related-party debt and the tax sharing agreement, and (2) if
necessary, Hallmark Cards’ purchase of any outstanding indebtedness under the
bank credit facility on August 31, 2010 will be sufficient to fund the Company’s
operations and enable the Company to meet its liquidity needs until the earlier
of August 31, 2010 or the closing of the Recapitalization described
above.
The
Company has entered into the Master Recapitalization Agreement for the
Recapitalization transactions, including the exchange of existing debt owed to H
C Crown Corp. for new debt, preferred stock and common stock. It is a
condition of the Recapitalization that the Company have obtained a revolving
credit facility from a third-party lender
, guaranteed by Hallmark
Cards or one of its affiliates,
with a term of not less than 360 days of
the closing date of the Recapitalization, with the availability of at least
$30.0 million and on other terms and conditions reasonably acceptable to the
Company. If the Recapitalization is closed as contemplated at this
time, the Company believes that cash on hand, cash generated by operations and
borrowing availability under the contemplated revolving credit facility will be
sufficient to fund the Company’s operations and enable the Company to meet its
liquidity needs until at least March 31, 2011.
The form
of credit agreement with HCC and other Hallmark Card affiliates in the
Recapitalization requires that, prior to closing of the credit agreement, the
Company establish with a financial institution a reserve account (called the
"NICC Reserve Account") in the Company's name for amounts that the Company may
choose as a sinking fund with respect to the $25.0 million payable by December
31, 2010, for the redemption of the preferred interest in Crown Media United
States. The preferred interest is held by VISN Management Corp. which is a
wholly-owned subsidiary of National Interfaith Cable Coalition. At no time
may the amounts in the NICC Reserve Account exceed $25.0 million. In order
to redeem the preferred interest, the Company may need to borrow up to $25.0
million under the bank credit facility.
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 year ended December 31, 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.
The
closing of the Recapitalization is subject to a number of conditions, including,
among other things, (a) representations and warranties of the Company being
accurate, (b) obtaining the revolving credit agreement mentioned above, (c) no
judgment or order which prohibits the consummation of the Recapitalization and
(d) Hallmark Cards’ not having delivered a written notice to the Company
certifying that Hallmark Cards in its sole discretion shall have determined that
the status of any pending or threatened litigation or regulatory proceeding
involving the Company or its subsidiaries in connection with the
Recapitalization is unsatisfactory to Hallmark Cards. If for any
reason the Recapitalization is not consummated, the Company would be unable to
meet its obligations which become due on August 31, 2010
, which provides
substantial doubt about the entity’s ability to continue
. In
addition, it is unlikely that the Company could obtain, without a guarantee or
other support of Hallmark Cards, other equity or debt financing prior to
August 31, 2010 in order to replace or refinance obligations becoming due
on that date. This is the view of the special committee which
considered and negotiated the Recapitalization. Accordingly, the
Company believes the ability of the Company to continue its operations depends
upon completion of the Recapitalization.
The
special committee of the Board believes that the Recapitalization is fair to the
stockholders (other than Hallmark Cards and its affiliates) and in the best
interest of the Company.
Bank
Credit Facility and Hallmark Notes
In 2001,
we entered into a credit agreement (which agreement has been amended
subsequently, with the most recent amendment dated March 2, 2010) with a
syndicate of banks, led by JP Morgan Chase Bank, N.A. as Administrative Agent
and Issuing Bank. The facility is guaranteed by our subsidiaries, is
secured by all tangible and intangible property of Crown Media Holdings and its
subsidiaries, and is guaranteed by Hallmark Cards. As a result of
amendments through March 2010, the bank credit facility is a revolving line of
credit with JP Morgan Chase Bank, N.A., in the amount of $30.0 million due on
August 31, 2010. The credit agreement for the bank credit facility, including
all of its amendments, are exhibits to this Report or are incorporated herein by
reference.
In
connection with Amendment No. 14, JP Morgan Chase Bank became the sole lender
under the bank credit facility by acquiring the interests of all other lending
banks. Concurrent with the execution of the March 2008 amendment, the existing
Hallmark Cards’ support letter of credit was reissued by JPMorgan in the face
amount of $90.0 million and with an expiration date of June 10,
2009. Effective April 1, 2009, this letter of credit was cancelled
with the permission of JPMorgan Chase Bank, and Hallmark Cards is providing a
guarantee agreement.
Each loan
under the bank credit facility bears interest at a Eurodollar rate or an
alternate base rate as we 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 based upon the prime rate
of JP Morgan Chase Bank, a certificate of deposit rate or the Federal Funds
effective rate, which is adjusted whenever the rates change. We were
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 of 0.15% per
annum was increased to 0.375% per annum, which results in no increase to us
because the difference was previously paid by us to Hallmark Cards.
The
credit agreement, as amended, contains a number of affirmative and negative
covenants. Negative covenants include, among other things:
Limitations on indebtedness; liens; investments; “Restricted Payments;” changes
in our business activities; and not amending the promissory note with HC Crown,
a related letter of credit issued for our benefit or certain of our other
material agreements. Restricted Payments include any distribution on
our equity, any redemption or other acquisition of our equity including
redemption of the company obligated mandatorily redeemable preferred interest,
any payment on debt of Crown Media Holdings which is subordinated to the bank
loans, any reduction of the HC Crown line of credit for Crown Media Holdings,
any payment on certain obligations assumed by Crown Media Holdings under the
purchase agreement for the film assets and any other payment to Hallmark Cards
or any of its affiliates. The credit agreement, however, permits
Crown Media Holdings to make payments to Hallmark Cards or an affiliate in
payment of a valid outstanding obligation (but not any principal payments in
excess of $10.0 million in the aggregate with respect to such obligations,
subject to any applicable subordination agreement) or any commercially
reasonable fees in consideration for Hallmark Cards having extended its
guarantee for the bank credit facility under Amendment No. 15.
Events of
default under the amended credit agreement include, among other
things, (1) the failure to pay principal or interest, with the
default continuing unremedied for five days after receipt of a remittance
advice, (2) a failure to observe covenants, (3) a change in control, (4) the
Hallmark Cards’ guarantee of the credit facility shall have expired or otherwise
terminated or Hallmark Cards shall have disavowed its obligations under the
guarantee or default shall otherwise have occurred in accordance with the terms
of the guarantee, (5) a termination by Hallmark Cards or any of its affiliates
of the right of Crown Media Holdings or its subsidiaries to use the names
“Hallmark” or “Crown” in their television services or any Channels owned or
operated by them. For purposes of the credit facility, a change in
control means that (a) Hallmark Cards ceases to own directly or indirectly
at least 80% of the equity interest of Hallmark Entertainment Investment,
(b) Hallmark Entertainment Holdings ceases to have sufficient voting power
to elect a majority of Crown Media Holdings’ board of directors or beneficial
ownership of over a majority of the outstanding equity interest of Crown Media
Holdings having voting power, (c) the majority of the Board is not
comprised of individuals who were either in office or who were nominated by a
two-third’s vote of individuals in office or so nominated as at December 17,
2001, or (d) the consummation by the Company of a Rule 13e-3 transaction
(or a “going-private” transaction) as defined in the Securities Exchange
Act.
Affirmative
covenants include, without limitation, the following: (1) (a) within 90 days
after the end of each fiscal year, submit to the banks audited consolidated
financial statements of the Company required to be submitted to the S.E.C., and
(b) within 45 days after the end of each of the first three fiscal quarters,
submit to the banks unaudited consolidated financial statements of the Company
required to be submitted to the S.E.C.; (2) cause the Company’s corporate
existence to be effective; (3) keep tangible properties material to the
Company’s business in good condition; (4) provide notice of the following
material events: (a) any event of default, (b) material adverse change in the
condition or operations of any credit party, (c) any action which could affect
the performance of the credit parties’ obligations under the Credit Agreement,
(d) any other event which could result in a material adverse effect, (e) opening
or change of any executive office, (f) change in the name of the credit parties,
(g) any event which affects the collectibility of receivables or decrease the
value of the collateral, (h) proposed material amendment to any material
agreement that are part of the collateral and (i) any notice which a credit
party received with respect to a claimed default; (5) (a) insure its assets
adequately, (b) insure against other hazards and risks, (c) maintain
distributor’s “errors and omissions” insurance, (d) maintain broadcaster’s
“errors and omissions” insurance, (e) cause all insurance to provide to the
Lender a written notice of any termination or material change of coverage and
(f) upon request, provide to the Lender a statement of insurance coverage; (6)
maintain true and complete books and records of financial operations and provide
the Agent access to such books and records; (7) observe and perform all material
agreements with respect to the distribution/exploitation of the Products (as
defined in the Credit Agreement); (8) pay all taxes and other governmental
charges and indebtedness in the ordinary course of business of the credit
parties; (9) defend the collateral against all liens, other than permitted
encumbrances; (10) upon receipt of any (a) payment from any obligor which should
be remitted to the Agent or (b) the proceeds of any sale of Product, remit such
payment or proceeds to the Agent; (11) comply with all applicable environmental
laws, notify the Agent of any material violation of any applicable environmental
laws and indemnify the Agent and the Issuing Bank against any environmental
law-related claims; and, (12) (a) upon request, execute and deliver all
necessary documents to perfect the liens on the collateral and to carry out the
purpose of the Credit Agreement and its ancillary documents and (b) clarify, if
necessary, the chain of title for any item of the Products.
Negative
covenants include limitations on (1) indebtedness, (2) liens, (3) guaranties,
(4) investments, (5) making “Restricted Payments,” (Restricted Payments include
any distribution on equity, any redemption or other acquisition of our equity
including redemption of the company obligated mandatorily redeemable preferred
interest, any payment on debt of the Company which is subordinated to the bank
loans, any reduction of the HC Crown line of credit for the Company, any payment
on certain obligations assumed by the Company under the purchase agreement for
the film assets and any other payment to Hallmark Cards or any of its
affiliates. The credit agreement, however, permits the Company to
make payments to Hallmark Cards or an affiliate in payment of a valid
outstanding obligation (but not any principal payments in excess of $10.0
million in the aggregate with respect to such obligations, subject to any
applicable subordination agreement) or any commercially reasonable fees in
consideration for Hallmark Cards having extended its guarantee for the bank
credit facility, (6) sale of assets, (7) sale of receivables, (8) entering into
any sale and leaseback transactions, (9) entering into transactions with
affiliates, (10) amending the promissory note with HC Crown, a related letter of
credit issued for our benefit or certain of our other material agreements, (11)
creating negative pledge, (12) mergers or acquisitions, (13) production of any
item of Product in any fiscal year having an aggregate budgeted negative cost in
excess of $5.0 million, (14) changing our business activities, (15) entering
into certain transactions that are prohibited under ERISA, (16) entering into
any interest rate protection agreement or currency agreement, (17) acquiring or
creating any new subsidiary, (18) using or storing hazardous materials on our
premises, and (19) creating any first tier subsidiary other than CM
Intermediary or have any asset related to the Channel at a level above CM
Intermediary.
Waiver
and Standby Purchase Agreement
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 February 2010, as
part of the Master Recapitalization Agreement, to extend the waiver period to
August 31, 2010 (the “Waiver Agreement”). The Waiver Agreement defers
payments (excluding interest on the 2001, 2005 and 2006 notes listed below) due
on any of the following obligations (the “Subject Obligations”) until August 31,
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”). Each of
these listed agreements is described below in Item 13 “
Certain Relationships and Related
Transactions
”.
|
·
|
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 2009, including accrued interest was
$109.8 million and $110.0 million,
respectively.)
|
|
·
|
$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 2009, including accrued interest was $62.7 million and $62.8
million, respectively.)
|
|
·
|
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 2009, including accrued interest was
$686.6 million and $758.8 million,
respectively.)
|
|
·
|
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 2009, including accrued interest was $172.1
million and $172.4 million,
respectively.)
|
|
·
|
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 December 31, 2009, was $8.5
million.).
|
Interest
will continue to accrue on these obligations during the Waiver Period and is
payable as indicated above. The Waiver Agreement also contains
certain covenants, including but not limited to (1) our covenant not to
take any action (including the issuance of new stock or options) 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 Excess Cash Flow of $7.7 million for the year ended December 31, 2009, of
which $4.6 million of interest on the 2001, 2005 and 2006 Notes was remitted to
a Hallmark Cards’ affiliate on January 5, 2010. See Note 8 to the Consolidated
Financial Statements for the Use of the Excess Cash Flow to make payments to a
Hallmark Cards affiliate and to Hallmark Cards. Pursuant to the Master
Recapitalization Agreement, we have not made the payments representing the
remaining amounts of Excess Cash Flow for 2009. Payment continues to
be deferred under the extension of the Waiver Agreement. Excess Cash
Flow for 2008 of $45.9 million was used to make payments on the bank credit
facility of $40.9 million, on the Tax Note of $228,000 and on interest payments
of $4.7 million.
The
waiver termination date is August 31, 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 (other than the bank credit facility) 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 as provided in
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.
The
Waiver Agreement does not limit any existing rights of Hallmark Cards or its
affiliates to offset amounts owed to us under the Hallmark Tax Sharing Agreement
or as otherwise agreed by us against these obligations. Additionally, during the
Waiver Period, Hallmark Cards was permitted to offset future tax benefits it
realizes pursuant to the Tax Sharing Agreement, first against accrued and unpaid
interest and then to the unpaid principal balance of the Tax Note until the
earlier of such time as the balance reaches zero or the maturity date of the Tax
Note. The Tax Note was paid in full (both principal and interest) on
December 31, 2008, without penalty.
With tax
sharing payments included in the deferred obligations, estimated tax sharing
payments, if any, which the Company would otherwise be required to pay to
Hallmark Cards after consideration of the deferred deductibility of interest on
the 10.25% Senior Secured Note are deferred until August 31, 2010. Pursuant to
the terms of the Tax Sharing Agreement, prior to changes as part of the
Recapitalization, the Company will not realize a current tax benefit from such
interest until it is paid to Hallmark Cards.
In
addition, we provided a release to Hallmark Cards and related parties for any
matters prior to the date of the restated Waiver Agreement.
In
consideration for Hallmark Cards to execute Amendment No. 4 to the waiver and
standby agreement, on July 27, 2007, the Company executed a Copyright Security
Agreement and Security and Pledge Agreement for the benefit of Hallmark Cards
and its affiliates. Under the agreements, the Company and its
subsidiaries grant security interests to Hallmark Cards and its affiliates in
any copyright license and program license agreements and all other personal
property.
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 8, 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. In
accordance with the Waiver Agreement, cash payments are not required until
February 5, 2011 (which is the first payment date after August 31, 2010). The
principal amount of the senior secured note accretes at 10.25% per annum,
compounding semi-annually, to August 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 February 5, 2011, and
upon maturity on August 5, 2011, and is pre-payable without penalty. At
December 31, 2008 and 2009, $686.6 million and $758.8 million, respectively, of
principal and interest were included in the senior note payable in the
accompanying consolidated balance sheets. The note purchase agreement for the
senior note provides that if there is an event of default 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 August 31, 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
5.29% at December 31, 2008 and 2009, respectively). At December 31, 2008 and
2009, $108.6 million, is reported as note payable to Hallmark Cards affiliate
and $1.3 million and $1.5 million, respectively, are reported as interest
payable to Hallmark Cards affiliate on the accompanying consolidated balance
sheet. Interest of $6.3 million was paid in 2009, and interest of $1.5 million
was paid on January 5, 2010.
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
5.29% at December 31, 2008 and 2009, respectively). Pursuant to the Waiver
Agreement, the promissory note is payable in full on August 31, 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 2009, $170.1 million is reported as note payable to
Hallmark Cards affiliate and $2.0 million and $2.3 million, respectively, are
reported as interest payable to Hallmark Cards affiliate on the accompanying
consolidated balance sheet. Interest of $9.8 million was paid on in 2009, and
interest of $2.3 million was paid on January 5, 2010.
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 5.29% at December 31, 2008
and 2009, respectively). Pursuant to the Waiver Agreement, the promissory note
is payable in full on August 31, 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 2009, $62.0
million is reported as note payable to Hallmark Cards affiliates and $717,000
and $838,000, respectively, are reported as interest payable to Hallmark Cards
affiliate on the accompanying consolidated balance sheet. Interest of $3.6
million was paid in 2009, and interest of $838,000 was paid on January 5,
2010.
Note
and Interest Payable to Hallmark Cards
During
2007, the Internal Revenue Service completed its examination of Hallmark Cards'
consolidated tax returns for fiscal years 2003 and 2004 and determined that,
with respect to a portion of the losses attributable to the Company for fiscal
years 2003 and 2004, Hallmark Cards should not have carried back such losses to
its consolidated federal tax returns filed for fiscal years 2001 and
2002. These losses are available as carry-forwards in the
consolidated federal tax return beginning in 2005 and later
years. Furthermore, the examination changed the amount of
foreign tax credits that had previously been conveyed to the Company under the
Tax Sharing Agreement. Because the Company’s share of the tax benefits realized
from such losses and credits, $25.2 million, were either contributed to the
Company in cash or applied as an offset against amounts owed by the Company to
other members of the consolidated group, the Company was obligated to return
this amount to Hallmark Cards plus interest related thereto in the amount of
$7.9 million. As a result, the Company recorded a $33.1 million
payable to Hallmark Cards with a corresponding $25.2 million reduction of
additional paid-in capital and a $7.9 million charge to interest expense, all of
which were recognized during 2007.
On July
27, 2007, the Company replaced a payable to Hallmark Cards under the Tax Sharing
Agreement with a $33.1 million promissory note payable to Hallmark Cards due in
July 2009 with interest at LIBOR plus 3% per annum (the "Tax
Note"). The Tax Note could be prepaid in whole or in part with no
penalty. The Company was not required to make any cash payments prior
to maturity. Until the Tax Note and related interest were paid in full, Hallmark
Cards offset any future tax benefits it realized pursuant to the Tax Sharing
Agreement, first against accrued and unpaid interest and then against the unpaid
principal balance. In 2007, Hallmark Cards offset $12.2 million against $1.1
million of accrued and unpaid interest and $11.1 million of unpaid principal.
Additionally, in September 2007, the Company recorded an additional $85,000
charge to interest expense related to the receipt of an invoice for the actual
amount owed in regard to the return of tax benefits under the Tax Sharing
Agreement. In 2008, Hallmark Cards offset $21.3 million against $1.0 million of
accrued and unpaid interest and $20.3 million of unpaid principal.
On April
14, 2008, the Internal Revenue Service refunded to Hallmark Cards a portion of
the interest previously paid in connection with the disallowance of certain net
operating losses. In July 2008, Hallmark Cards notified the Company
that they had reduced the Company’s indebtedness as of April 14, 2008, under the
Tax Note by $1.5 million in consideration of the Company’s applicable portion of
such refund. Accordingly, the Company reduced interest expense during
2008.
In
December 2008, the Company paid $121,000 in principal and $107,000 in interest
to fully satisfy its obligation under this note. The Tax Note and all payments
thereunder were subordinated to the bank credit facility extended to the Company
by JP Morgan Chase Bank.
Interest
Expense Paid to HC Crown
Interest
expense paid to HC Crown was $1.8 million for the year ended December 31, 2007,
$1.1 million for the year ended December 31, 2008, and $1.0 million for the year
ended December 31, 2009. Prior to Amendments No. 8 and No. 10 to the Company’s
credit facility, such amounts would have been paid to the bank
syndicate.
Tax
Sharing Agreement
On March
11, 2003, Crown Media Holdings became a member of Hallmark Cards consolidated
federal tax group and entered into the Tax Sharing Agreement with Hallmark
Cards. Hallmark Cards includes Crown Media Holdings in its
consolidated federal income tax return. Accordingly, Hallmark Cards
has benefited from past tax losses and may benefit from future tax losses, which
may be generated by Crown Media Holdings. Based on the Tax Sharing
Agreement, Hallmark Cards pays Crown Media Holdings all of the benefits realized
by Hallmark Cards as a result of consolidation, 75% in cash on a quarterly basis
and the balance when Crown Media Holdings becomes a taxpayer. Under
the Tax Sharing Agreement, at Hallmark Cards’ option, this 25% balance may also
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 any limitations under any loan indentures or
contracts restricting such offsets.
The
Company received $21.3 million under the Tax Sharing Agreement during 2008,
which were offset against the Tax Note. The Company incurred liability under the
Tax Sharing Agreement to Hallmark Cards in the amount of $8.5 million during
2009. This amount remains owed to Hallmark Cards as of December 31,
2009, and is covered by the Waiver Agreement.
The Tax
Sharing Agreement will be amended in the Recapitalization.
See
“Recapitalization” in
Item 1, Business and Note 1 to the Consolidated Financial
Statements.
ITEM
7A. Quantitative and Qualitative Disclosures about Market Risk
We only
invest in instruments that meet high credit and quality standards, as specified
in our investment policy guidelines. These instruments, like all fixed income
instruments, are subject to interest rate risk. The fixed income portfolio will
decline in value if there is an increase in interest rates. If market interest
rates were to increase immediately and uniformly by 10% from levels as of
December 31, 2009, the decline of the fair value of the fixed income portfolio
would not be material.
As of
December 31, 2009, our cash, cash equivalents and short-term investments had a
fair value of $10.5 million, which was invested in cash and short-term
commercial paper. The primary purpose of these investing activities has been to
preserve principal until the cash is required to fund operations or can be used
to reduce borrowings under our credit facility based on the maturity schedule of
loans under that agreement. Consequently, the size of this portfolio is nominal
and fluctuates as cash is provided by and used in our business.
The value
of certain investments in this portfolio can be impacted by the risk of adverse
changes in securities and economic markets and interest rate fluctuations. For
the year ended December 31, 2009, the impact of interest rate fluctuations,
changed business prospects and all other factors did not have a material impact
on the fair value of this portfolio, or on our income derived from this
portfolio.
We have
not used derivative financial instruments for speculative purposes. As of
December 31, 2009, we are not hedged or otherwise protected against risks
associated with any of our investing or financing activities.
We
are exposed to market risk.
We are
exposed to market risk, including changes to interest rates. To reduce the
volatility relating to these exposures, we may enter into various derivative
investment transactions in the near term pursuant to our investment and risk
management policies and procedures in areas such as hedging and counterparty
exposure practices. We have not and will not use derivatives for speculative
purposes.
If we use
risk management control policies, there will be inherent risks that may only be
partially offset by our hedging programs should there be any unfavorable
movements in interest rates or equity investment prices.
The
estimated exposure discussed below is intended to measure the maximum amount we
could lose from adverse market movements in interest rates and equity investment
prices, given a specified confidence level, over a given period of time. Loss is
defined in the value at risk estimation as fair market value loss.
Our
interest income and expense is subject to fluctuations in interest
rates.
Our
material interest bearing assets consisted of cash equivalents and short-term
investments. The balance of our interest bearing assets was $10.5 million, or 1%
of total assets, as of December 31, 2009. Our material liabilities subject to
interest rate risk consisted of our bank credit facility, our line of credit and
interest payable to HC Crown, our line of credit and interest payable to
Hallmark Cards affiliate, and our note and interest payable to Hallmark Cards
affiliate. The balance of those liabilities was $346.3 million, or 25% of total
liabilities, as of December 31, 2009. Net interest expense for the year ended
December 31, 2009, was $100.5 million, 36%, of our total revenue. Our net
interest expense under these liabilities is sensitive to changes in the general
level of interest rates, primarily U.S., LIBOR and Eurodollar interest rates. In
this regard, changes in U.S. and LIBOR interest rates affect the fair value of
interest bearing liabilities.
If market
interest rates were to increase or decrease by 1% from levels as of December 31,
2009, our interest expense would increase or decrease by $3.6
million.
ITEM
8. Financial Statements and Supplementary Data
Our
Consolidated Financial Statements begin at page F-1 of this Annual Report on
Form 10-K.
ITEM
9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
None.
ITEM
9A. Controls and Procedures
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Disclosure
Controls and Procedures
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As of the
end of the period covered by this report, the Company, under the supervision and
with the participation of the Company’s management, including its Chief
Executive Officer and Chief Financial Officer, carried out an evaluation of the
effectiveness of the design and operation of the Company’s disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) as of December 31, 2009. In performing its
assessment of the Company’s internal control over financial reporting,
management used the criteria set forth in
Internal Control – Integrated
Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based upon this evaluation, the Company’s Chief Executive
Officer and Chief Financial Officer concluded that the Company’s disclosure
controls and procedures were effective as of that date for purposes of
recording, processing, summarizing and timely reporting material information
required to be disclosed in reports that the Company files under the Securities
Exchange Act of 1934.
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Management’s
Report on Internal Control over Financial
Reporting
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Management
is responsible for establishing and maintaining adequate internal control over
financial reporting. A company's internal control over financial reporting is a
process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. Because of
its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Management, including the Chief Executive Officer and Chief Financial Officer,
has conducted an evaluation of the effectiveness of the Company’s internal
control over financial reporting as of December 31, 2009, based on the
criteria for effective internal control described in
Internal Control — Integrated
Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on its assessment, management concluded that the
Company’s internal control over financial reporting was effective as of
December 31, 2009.
KPMG LLP,
an independent registered public accounting firm, audited the effectiveness of
the Company’s internal control over financial reporting as of December 31, 2009,
as stated in their report included in the Financial Statement section of this
Report.
Changes
in Internal Control over Financial Reporting
There
were no changes in the Company’s internal control over financial reporting that
occurred during the quarter ended December 31, 2009, that materially affected,
or are reasonably likely to materially affect, the Company’s internal control
over financial reporting.
Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, will be or have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of any system of
controls also is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions; over time,
control may become inadequate because of changes in conditions, or the degree of
compliance with the policies or procedures may deteriorate. Because of the
inherent limitation in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected.
ITEM
9B. Other Information
Not
applicable.
PART
III
The
information required by this Part III is incorporated by reference to
information in the definitive proxy statement for our 2010 annual meeting of
stockholders under the headings “Election of Directors,” “Board Information,”
“Compensation of Directors and Executive Officers,” “Section 16(a) Beneficial
Ownership Reporting Compliance,” “Security Ownership of Certain Beneficial
Owners and Management,” and “Principal Accountant Fees and Services.” We intend
to file the definitive proxy statement with the Securities and Exchange
Commission on or prior to April 30, 2010.
ITEM
10. Directors, Executive Officers and Corporate Governance
The
information required by this Item 10 is set forth in the Proxy Statement to be
delivered to stockholders in connection with our 2010 Annual Meeting of
Stockholders (“the Proxy Statement”) under the headings “Election of Directors,”
“Board Information,” and “Compensation of Directors and Executive Officers,” and
is incorporated by reference herein.
The
information required by this Item 11 is set forth in the Proxy Statement under
the headings “Board Information,” and “Compensation of Directors and Executive
Officers,” and is incorporated by reference herein.
ITEM
12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
The
information required by this Item 12 is set forth in the Proxy Statement under
the heading “Security Ownership of Certain Beneficial Owners and Management,”
and is incorporated by reference herein.
ITEM
13. Certain Relationships and Related Transactions and Director
Independence
The
information required by this Item 13 is set forth in the Proxy Statement under
the headings “Certain Relationships and Related Transactions” and is
incorporated by reference herein. The descriptions of related party
transactions below are stated in this Report because the transactions are
referenced in other Items of this Report.
The
following summary descriptions of agreements to which we are a party are
qualified in their entirety by reference to the agreement to which each summary
description relates, each of which we have filed with the SEC.
Policies
and procedures for the review, approval or ratification of transactions with
related persons
Generally,
there are two types of related party transactions which the Company enters into:
(1) transactions with Hallmark Cards to promote and market Hallmark Channel and
Hallmark Movie Channel and (2) Affiliate Transactions (as such term is defined
under the Second Amended and Restated Stockholders Agreement, dated August 30,
2001 described below (the "Stockholders Agreement")), which are subject to the
Stockholders Agreement. Affiliate Transactions are any transactions
with parties to the Stockholders Agreement with certain exceptions.
The Audit
Committee, under its charter, has been delegated by the Board the authority to
review and approve related party transactions. To seek approval of
marketing-related transactions with Hallmark Cards, management begins by
providing the Audit Committee a summary of the transactions, together with
researched data which supports management's decision in selecting Hallmark Cards
as a commercially reasonable and cost effective partner for such marketing
activities. At its meetings, the Audit Committee discusses the
appropriateness of the transaction for the Company and renders a
decision. For efficiency purposes, the Audit Committee has asked
management to seek approval only if a transaction involves a financial
commitment on the part of the Company that is greater than $5,000 per
transaction. Notwithstanding the foregoing, management seeks approval
of transactions surrounding major holiday campaigns (for example, Valentine's
Day, Mother's Day and Christmas) regardless of the monetary value
involved. These practices result from requirements in the
Stockholders Agreement as well as corporate governance principles, are reflected
in minutes and are not otherwise the subject of written policies or procedures.
To seek
approval of any related-party transactions, management begins by providing a
summary of the transaction and any documents that are necessary for the
independent directors to review and approve the transactions. Such
directors then conduct a meeting (or multiple meetings, if necessary) to discuss
the appropriateness of the transactions for the Company and render their
decision. If a transaction has a value of more than $35.0 million,
the Board generally forms a special committee of directors who are independent
of the transaction at hand and delegate authority to such committee to review
and approve the transaction. The special committee have authority to
retain financial advisors and legal counsel who advise the committee on matters
relating to the transaction. These practices result from requirements
in the Stockholders Agreement as well as corporate governance principles, are
reflected in minutes and are not otherwise the subject of written policies or
procedures.
"Hallmark
Hall of Fame" Programming License Agreement
In 2008,
Crown Media United States entered into an agreement with Hallmark Cards to
license 58 “Hallmark Hall of Fame” movies, consisting of 16 contemporary
Hallmark Hall of Fame titles (i.e., produced from 2003 to 2008) and 42 older
titles, for exhibition on the Hallmark Channel and Hallmark Movie
Channel. These titles are licensed for ten year windows, with windows
commencing at various times between 2007 and 2010, depending on
availability. This agreement makes the Hallmark Channel and Hallmark
Movie Channel the exclusive home for these movies. The total license
fee for these movies is $17.2 million and is payable in equal monthly
installments over 10 year exhibition windows.
VISN
Preferred Interest
VISN, a
subsidiary of the National Interfaith Cable Coalition, Inc. (“NICC”), owns
a $25.0 million preferred interest in Crown Media United
States. Under the Crown Media United States Amended and Restated
Company Agreement, originally dated November 13, 1998, the members agreed that
if during any year ending after January 1, 2005 and 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:
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such
excess;
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·
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$5.0
million; or
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·
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the
amount equal to the preferred liquidation preference on the date of
redemption.
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Crown
Media United States did not have such taxable income in 2009. Crown Media United
States may voluntarily redeem the preferred interest at any time, however, it is
obligated to do so on the date of redemption (December 31, 2010). The preferred
interest has a liquidation preference of $25.0 million. See information below on
a January 2, 2008, agreement under which VISN may request the preferred interest
be replaced with promissory notes of Crown Media Holdings.
Crown
Media United States Programming Agreement with NICC
On
January 2, 2008, Crown Media Holdings entered into an agreement with the NICC
regarding termination of any right of NICC under the agreement covering the
operation of Crown Media United States (the “Company Agreement”) to compel Crown
Media Holdings to buy all of the outstanding shares of Class A common stock
owned by NICC and NICC’s subsidiary VISN Management Corp. (“VMC”) at the then
current market value. The January 2008 agreement also covers other
aspects of Crown Media Holdings’ relationship with NICC.
The
January 2008 agreement provided for the following:
·
The put
agreement was terminated, and the purported exercise of the put was
waived.
·
Throughout
2008 and 2009, Crown will provide to NICC the use of a two-hour time period each
Sunday morning for programming by NICC and NICC shall retain any advertising
revenue from such time period. Neither NICC nor Crown is obligated to
make any payment regarding this time period or the programming.
·
NICC
voluntarily relinquished its right to designate one director on Crown Media
Holdings’ Board of Directors, effective with the resignation of its designee on
December 19, 2007.
·
In
settlement of a claim of NICC for $15,000,000 in the event of a change of
control, Crown will pay NICC the total amount of $3,750,000 in three
installments of $1,250,000 each on January 20, 2008, January 20, 2009 and
January 20, 2010. If there would have been a change of control prior
to January 20, 2010, Crown would have paid the remaining unpaid installments at
that time. The Company has paid the January 20, 2008, 2009 and 2010,
installments.
·
For so
long as the preferred interest remains outstanding, Crown will remit to NICC
payments equivalent to 6.0% per annum of outstanding balance of the preferred
interest. The 2008 and 2009 payments have been made.
·
At the
request of VMC, Crown will replace the preferred interest in Crown Media United
States held by NICC/VMC with a promissory note of Crown and, at VMC’s option, a
second note payable to an independent not-for-profit corporation designated by
VMC. Such notes with an aggregate face amount equal to the
outstanding preferred interest at the conversion date would bear interest at
6.0% and a maturity date of December 31, 2010. If the preferred
interest is not exchanged for notes, Crown will redeem the preferred interest as
set forth in the Company Agreement of Crown Media United States.
·
To the
extent required by the Stockholders Agreement of HEIC, Crown will consent, and
obtain the consent of HEIC, for VMC to assign its ownership of HEIC shares to a
non-profit corporation designated by VMC or to NICC. The shares will
continue to be subject to the HEIC Stockholders Agreement.
·
Except as
provided or referenced in the January 2008 Agreement, the term and conditions of
the following prior agreements between or among the parties to the January 2008
agreements were superseded: The Company Agreement and the December
2005 agreement. The Stockholders Agreement is modified to the extent
provided in the January 2008 Agreement. In addition, the parties
provided mutual releases.
During
the years ended December 31, 2008 and 2009, Crown Media United States paid the
National Interfaith Cable Coalition $6.4 million and $4.6 million, respectively,
related to the Company Agreement, the December 2005 Agreement and the January
2008 Agreement.
DIRECTV
Affiliation Agreement
On August
20, 2001, Crown Media United States entered into an Affiliation Agreement with
DIRECTV, Inc., a wholly owned subsidiary of DIRECTV Enterprises,
Inc. Pursuant to the Affiliation Agreement, DIRECTV distributes the
Hallmark Channel on the TOTAL CHOICE ® tier of its DBS distribution system in
the United States and pays us license fees for such distribution. At
the same time we entered into a Stock Purchase Agreement with DIRECTV
Enterprises whereby we issued 5,360,202 shares of our Class A common stock,
which shares were subsequently transferred to its parent company, The DIRECTV
Group, Inc. In March 2008, we renewed this distribution agreement for a
multi-year term and additionally provided DIRECTV with the right to distribute
the Standard Definition and High Definition versions of the Hallmark Movie
Channel. As of December 31, 2009, DIRECTV accounted for 17.7 million of our
subscribers.
Hallmark
Advertising
Hallmark
Cards purchased $429,000 and $775,000 of advertising on the Hallmark Channel in
the United States at negotiated market rates, respectively, during the years
ended December 31, 2008 and 2009.
During
November and December of 2009 and February of 2010, Hoops & Yoyo, popular
animation characters created and owned by Hallmark Cards, hosted certain of our
original movies airing on Hallmark Channel. The characters appeared
intermittently during the airing of the movies to provide commentaries and
narratives pertinent to the movies. Hallmark Cards provided the
content and no license fee was paid by the Company to Hallmark Cards for such
content.
Bank
Credit Facility and Hallmark Notes
See Note
8 of our Notes to Consolidated Financial Statements in this Report and “Bank
Credit Facility and Hallmark Notes” in Item 7 Management’s Discussion and
Analysis of Financial Condition and Results of Operations of this Report for
information on the several notes payable to Hallmark Cards and its affiliates.
See “Recapitalization” in Item 1, Business and Note 1 to the Consolidated
Financial Statements.
Stockholders
Agreement and Registration Rights
General
We are a
party to a stockholders agreement, amended and restated as of August 30, 2001,
as amended (including the modification in the January 2, 2008, agreement with
NICC) with VISN, The DIRECTV Group, Inc. (“DIRECTV”), and Hallmark Entertainment
Investments. The stockholders agreement provides that our Board will consist of
not less than 15 directors, with 12 nominated by Hallmark Entertainment
Investments, and two independent directors, who must not be officers, directors
or employees of any of the parties or their affiliates, and who will be
nominated by the Board. The rights of the parties to nominate a
director will terminate on the later of (1) such party owning less than 5% of
our common stock then outstanding or (2) such party ceasing to own at least 75%
of the number of shares of our common stock held by them immediately after our
initial public offering in May 2000. DIRECTV is entitled to appoint an observer
to the board of directors of Crown Media Holdings until DIRECTV and its
affiliates cease to own beneficially in the aggregate at least 75% of the shares
of our common stock acquired in the August 2001 transaction by the predecessor
holder of the shares and now held by DIRECTV.
The
stockholders agreement also provides that we will not enter into any material
transaction, except for specified transactions, with any of the other parties or
their affiliates involving an aggregate value of (1) $35.0 million or less,
unless such transaction is approved by a majority of our independent directors
and (2) more than $35.0 million, unless such transaction is approved by a
majority of the members of our Board not nominated by the interested
party.
In
addition, the stockholders agreement provides that, in the event that Hallmark
Entertainment Investments proposes to transfer 20% or more of our outstanding
common stock to an unaffiliated third party, each other party to the
stockholders agreement will have the right to participate on the same terms in
that transaction with respect to a proportionate number of such other party’s
shares, except for DIRECTV.
Hallmark
Entertainment Investments Co. Stockholders Agreement
On March
11, 2003, Hallmark Entertainment Holdings contributed 100% of the Crown Media
Holdings shares owned by it to Hallmark Entertainment Investments. Two of Crown
Media Holdings investors, Liberty Crown, Inc. (“Liberty”), a subsidiary of
Liberty Media, and J.P. Morgan, also contributed 100% of their Crown Media
Holdings shares to Hallmark Entertainment Investments and VISN contributed 10%
of its Crown Media Holdings shares to Hallmark Entertainment Investments, all in
return for Hallmark Entertainment Investments shares. Prior to the Hallmark
Entertainment Investments transaction, J.P. Morgan and Liberty were parties to
the Crown Media Holdings stockholders agreement described above. As a result of
the Hallmark Entertainment Investments transaction, J.P. Morgan and Liberty no
longer have any rights pursuant to such stockholders agreement. However,
Hallmark Entertainment Investments has advised Crown Media Holdings that J.P.
Morgan and Liberty will retain similar rights with respect to Crown Media
Holdings pursuant to the Hallmark Entertainment Investments stockholders
agreement dated March 11, 2003, among Hallmark Entertainment Investments,
Hallmark Entertainment Holdings, Liberty, VISN, and J.P. Morgan, including the
following:
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Liberty
has the right to designate one person as one of the directors to the Crown
Media Holdings Board that Hallmark Entertainment Investments is entitled
to nominate under the Crown Media Holdings stockholders agreement
described above. J.P. Morgan had the right to designate one person as one
of the directors to the Crown Media Holdings Board but has surrendered
such right.
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Hallmark
Entertainment Investments will not permit Crown Media Holdings or its
subsidiaries to enter into any material transaction, except for specified
transactions, with any affiliates involving an aggregate value of (a)
$35.0 million or less, unless such transaction is approved by a majority
of Crown Media Holdings’ independent directors and (b) more than $35.0
million, unless such transaction is approved by a majority of the members
of Crown Media Holdings’ Board not nominated by any affiliate of Hallmark
Entertainment Holdings (provided that directors designated by Liberty and
J.P. Morgan will not be treated as being nominated by any affiliate of
Hallmark Entertainment Holdings);
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registration
rights as provided for minority stockholders in the Crown Media Holdings
stockholders agreement;
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Hallmark
Entertainment Investments may not take certain actions as specified in the
Hallmark Entertainment Investments stockholder agreement without the
consent of J.P. Morgan and Liberty;
and
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if
Hallmark Entertainment Holdings proposes to transfer 20% or more of
Hallmark Entertainment Investments common stock to an unaffiliated third
party, each of J.P. Morgan, Liberty and VISN will have the right to
participate on the same terms in the transaction on a proportional
basis.
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Registration
Rights
Under the
stockholders agreement, Hallmark Entertainment Investments has the right to
require us on four occasions, and the other parties, as a group, have the right
to require us on two occasions, to register for sale their shares of our common
stock, so long as the number of shares they require us to register in each case
is at least 7% of our common stock then outstanding. The other
parties also have an unlimited number of “piggyback” registration
rights. This means that any time we register our common stock for
sale, they will have the right to include their common stock in that offering
and sale.
We are
obligated to pay all expenses that result from the registration of the other
parties’ common stock under the stockholders agreement, other than registration
and filing fees, attorneys’ fees, underwriter fees or expenses and underwriting
discounts and commissions. We have also indemnified the other parties
against any liabilities that may result from their sale of common stock,
including Securities Act liabilities.
Rights
Relating To Crown Media United States Amended and Restated Company
Agreement
Under the
stockholders agreement, so long as the Company or any of its affiliates are
entitled to have a representative on the Crown Media United States governance
committee, and VISN and its affiliates either were entitled to nominate to, or
designate a member of, our Board, or beneficially owned any preferred interests
in Crown Media United States, neither the Company nor any of its affiliates were
able without the consent of the member of our Board nominated by VISN or a
representative of NICC, to vote in favor of:
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any
specified change in, or action described in, the Crown Media United States
amended and restated company agreement that relates to VISN’s preferred
interest in Crown Media United States or that relates to VISN’s rights to
programming on the Hallmark Channel in the U.S. or its programming
budget;
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any
repayment or redemption of specified equity interests in Crown Media
United States;
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any
transfer of all of Crown Media United States’ assets or any business
combination involving Crown Media United States where Crown Media United
States is not the surviving entity, unless the transferee assumes
specified obligations under the Crown Media United States amended and
restated company agreement until the later of the fifth anniversary of
these offerings or the second anniversary of the transfer or business
combination;
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the
dissolution of Crown Media United States, except in connection with a
complete liquidation;
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any
transfer of all of Crown Media United States’ assets to, or any business
combination involving Crown Media United States’ with, us or any of our
affiliates, or any other material transaction with us or any of our
affiliates, unless we comply with specified restrictions relating to any
financial benefit we receive from the transaction that is more than what
we would have received had the transaction been on an arm’s-length basis
or on commercially reasonable
terms;
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any
transfer of all of Crown Media United States’ assets or any business
combination involving Crown Media United States where Crown Media United
States is not the surviving entity, prior to the second anniversary of the
initial public offering; or
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any
amendment to the Crown Media United States’ amended and restated company
agreement that would result in none of us or our affiliates having the
right to consent to take any of the actions listed in the above bullet
points.
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The
restrictions set forth above were extinguished upon execution of a settlement
agreement dated January 2, 2008 between Crown Media Holdings and NICC, pursuant
to which NICC voluntarily relinquished its right to designate a director on our
Board, effective with the resignation of NICC's designee on December 19,
2007 (for a description of this settlement agreement, see above "Item
13. Certain Relationships and Related Transactions and Director Independence -
Crown Media United States Program Agreement with NICC").
Intercompany
Services Agreement
The
Company has an intercompany services agreement with Hallmark Cards, which was
entered into in 2003 for a term of three years and then extended for additional
years through December 31, 2010. Under the agreement, Hallmark Cards provides us
with the following services:
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tax
services;
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risk
management, health, safety and environmental services and
insurance;
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legal
services;
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treasury
and cash management services;
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real
estate consulting services;
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human
resources services; and
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other
services mutually agreed by the
parties.
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We have
agreed to pay Hallmark Cards $541,000 in 2008 and $455,000 in 2009 per year for
these services, plus out-of-pocket expenses and third party fees, payable in
arrears on the last business day of each quarter. The balance of the payable for
services, expenses and fees under this and the previous services agreement as of
both December 31, 2008 and 2009, was approximately $5.5 million. We believe that
the services being provided under the agreement have a value at least equal to
the annual fee. For the last three months of 2008, the Company paid the monthly
amount due under the intercompany service agreement in the amount of
approximately $135,000. The Company made timely payments in
2009.
Hallmark
Trademark License Agreements
Crown
Media United States operates under the benefit of a limited trademark license
agreement with Hallmark Licensing, Inc., dated March 27, 2001, which has been
extended through September 1, 2009. The amended and restated Crown
Media United States trademark agreement permits Crown Media United States to
name its network service as the “Hallmark Channel.” The agreement
contains usage standards, which limit certain types of programming and
programming content aired on Crown Media United States’ network. Crown Media
United States also has a similar trademark license agreement with Hallmark
Licensing, Inc., which is effective January 1, 2004, and as extended expires
September 1, 2010, to permit the use of the Hallmark trademark in the name of
the “Hallmark Movie Channel”.
Under the
agreement, if Hallmark Cards notifies us in writing that it has determined that
we have failed to comply with the usage standards set forth in the agreement or
have otherwise breached our obligations under the agreement, we are required to
stop any non-complying activity within 10 days of that notice or we may be in
default of the agreement. We also may be in default if Hallmark Cards
delivers such a written notice to us with respect to its standards three or more
times in any 12-month period. In addition, there may be a default
under the agreement if we fail to cure any breach of the program agreement with
RHI Entertainment Distribution, if we fail to make any payments due under loan
agreements within five days of the due date, or if we receive an opinion from
our auditors that shows that we no longer are a going concern. The Company
obtained a waiver for the trademark license agreement dated March 3, 2010, from
Hallmark Cards related to its going concern opinion over its 2009 financial
statements.
The
license agreements can be terminated immediately and without notice if we
transfer in any way our rights under the license agreements, if we have an event
of default under the agreement or in events of bankruptcy, insolvency or similar
proceedings.
Tax
Sharing Agreement
For more
information regarding amounts owed by the Company to Hallmark Cards under the
Tax Sharing Agreement and a Tax Note, see Item 7, Management’s Discussion and
Analysis of Financial Condition and Results of Operation – Bank Credit Facility
and Hallmark Notes and – Tax Sharing Agreement. See “Recapitalization” in Item
1, Business and Note 1 to the Consolidated Financial Statements.
Certain
Business Relationships and Conflicts of Interest
Hal