**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**For the quarterly period ended December 31, 2006**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**For the transition period from         to         **

**Commission File Number 333-110025**

**Monitronics International, Inc.**

(Exact name ofregistrant as specified in its charter)

| **Texas**                                                       |   | **74-2719343**                           |
|-----------------------------------------------------------------|--------|------------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification Number) |
|                                                            |   |                                     |
| **2350  Valley View Lane, Suite 100**                           |
| **Dallas,  Texas 75234**                                        |
| (Address of  principal executive offices)                       |
| (Zip Code)                                                      |
|                                                            |   |                                     |
| **(972)243-7443**                                               |
| (Registrant’s  telephone number, including area code)      |

 

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Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes x  No o

Indicateby check mark whether the registrant is a large accelerated filer, acceleratedfiler, or a non-accelerated filer.  Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.  Large acceleratedfiler  ̈  Accelerated filer o  Non-acceleratedfiler x

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).  Yes o  No x

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date:

| ** ** | **Title of Each Class**                         |   | **Outstanding  at January 31, 2007** | ** ** |
|------------|-------------------------------------------------|--------|--------------------------------------|------------|
|       | Class A Common  Stock, par value $.01 per share |   | 31,102,317                           |       |
|       | Class B Common  Stock, par value $.01 per share |   | None                                 |       |

 

 

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| **Part I Financial Information** | **Page**   |
|----------------------------------|------------|
| Item 1.                          |       | Financial Statements | 3 |
|                             |       | Consolidated Balance Sheets as of December 31, 2006  and June 30, 2006 | 3 |
|                             |       | Consolidated Statements of Operations for three and  the six months ended December 31, 2006 and 2005 | 4 |
|                             |       | Consolidated Statements of Cash Flows for the six  months ended December 31, 2006 and 2005 | 5 |
|                             |       | Notes to Consolidated Financial Statements | 6 |
| Item 2.                          |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations | 11 |
| Item 3.                          |       | Quantitative and Qualitative Disclosures About Market  Risk | 17 |
| Item  4.                         |       | Controls  and Procedures | 18 |
|                             |       |   |   |
| **Part  II Other Information**   | 18         |
| Item 1.                          |       | Legal Proceedings | 18 |
| Item 1A.                         |       | Risk Factors | 18 |
| Item 2.                          |       | Unregistered Sales of Equity Securities and Use of  Proceeds | 18 |
| Item 3.                          |       | Defaults Upon Senior Securities | 18 |
| Item 4.                          |       | Submission of Matters to a Vote of Security Holders | 18 |
| Item  5.                         |       | Other Information | 18 |
| Item 6.                          |       | Exhibits | 18 |
| ** **                       | ** ** |
| **Signatures**                   | 20         |

2

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**PARTI.   FINANCIAL INFORMATION**

##### **Item1.  Financial Statements**

**MONITRONICSINTERNATIONAL, INC.**

## **CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share data)**
| ** **                                                                                                                  | ** **   | **December 31,** | ** **   | **June 30,** | ** **   |
|-----------------------------------------------------------------------------------------------------------------------------|--------------|-----------------------|--------------|-------------------|--------------|
| ** **                                                                                                                  | ** **   | **2006**              | ** **   | **2006**          | ** **   |
| ** **                                                                                                                  | ** **   | **(Unaudited)**       | ** **   | ** **        | ** **   |
| **Assets**                                                                                                                  | *** *** | *** ***          | *** *** | *** ***      | *** *** |
| Current assets:                                                                                                             |         |                  |         |              |         |
| Cash and cash equivalents                                                                                                   |         | $                     | 1,016        |              | $            | 862 |   |
| Accounts receivable, less allowance for doubtful  accounts of $1,512 as of December 31, 2006 and $1,763 as of June 30, 2006 |         | 7,643                 |         | 6,888             |         |
| Prepaid expenses and other current assets                                                                                   |         | 2,496                 |         | 1,154             |         |
| Total current  assets                                                                                                       |         | 11,155                |         | 8,904             |         |
|                                                                                                                        |         |                  |         |              |         |
| Property and  equipment, net                                                                                                |         | 10,537                |         | 10,102            |         |
| Subscriber accounts,  net of accumulated amortization of $466,960 as of December 31, 2006 and  $434,095 as of June 30, 2006 |         | 470,015               |         | 470,112           |         |
| Deferred  financing costs, net                                                                                              |         | 8,257                 |         | 9,643             |         |
| Goodwill                                                                                                                    |         | 14,795                |         | 14,795            |         |
| Total assets                                                                                                                |         | $                     | 514,759      |              | $            | 513,556 |   |
|                                                                                                                        |         |                  |         |              |         |
| **Liabilities and Shareholders’ Net Capital**                                                                          | ** **   | ** **            | ** **   | ** **        | ** **   |
| Current  liabilities:                                                                                                       |         |                  |         |              |         |
| Accounts payable                                                                                                            |         | $                     | 1,713        |              | $            | 2,794 |   |
| Accrued expenses                                                                                                            |         | 3,398                 |         | 3,261             |         |
| Purchase holdbacks                                                                                                          |         | 8,734                 |         | 8,676             |         |
| Deferred revenue                                                                                                            |         | 5,325                 |         | 5,405             |         |
| Interest payable                                                                                                            |         | 7,142                 |         | 6,508             |         |
| Taxes payable                                                                                                               |         | 698                   |         | 124               |         |
| Current portion of long-term debt                                                                                           |         | 11,987                |         | 7,185             |         |
| Total current  liabilities                                                                                                  |         | 38,997                |         | 33,953            |         |
|                                                                                                                        |         |                  |         |              |         |
| Non-current  liabilities:                                                                                                   |         |                  |         |              |         |
| Long-term debt, less current portion                                                                                        |         | 424,036               |         | 421,076           |         |
| Redeemable preferred stock, net                                                                                             |         | 50,388                |         | 48,098            |         |
| Total non-current  liabilities                                                                                              |         | 474,424               |         | 469,174           |         |
|                                                                                                                        |         |                  |         |              |         |
| Commitments and  contingencies                                                                                              |         |                  |         |              |         |
| Shareholders’  net capital:                                                                                            |         |                  |         |              |         |
| Class A common stock, $.01 par value:                                                                                       |         |                  |         |              |         |
| Authorized shares — 80,000,000                                                                                         |         |                  |         |              |         |
| Issued and outstanding shares — 31,102,317 shares as  of December 31, 2006 and 31,102,317 shares as of June 30, 2006   |         | 311                   |         | 311               |         |
| Class B common stock, $.01 par value:                                                                                       |         |                  |         |              |         |
| Authorized shares — 700,000                                                                                            |         |                  |         |              |         |
| Issued and outstanding shares — none                                                                                   |         | —                |         | —            |         |
| Additional paid-in capital                                                                                                  |         | 124,819               |         | 124,819           |         |
| Treasury stock, at cost, 968,722 shares as of  December 31, 2006 and 915,099 shares as of June 30, 2006                     |         | (9,673                | )            | (9,358            | )            |
| Accumulated deficit                                                                                                         |         | (114,119              | )            | (105,343          | )            |
| Total  shareholders’ net capital                                                                                       |         | 1,338                 |         | 10,429            |         |
| Total liabilities and  shareholders’ net capital                                                                       |         | $                     | 514,759      |              | $            | 513,556 |   |

 

*Seeaccompanying notes.*

3

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**MONITRONICS INTERNATIONAL, INC.**

###### **CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

** **
| ** **                        | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                        | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | **(In thousands)**                             | ** ** |
|                              |       |                                                |       |                                              |       |   |   |   |   |
| Revenue                           |       | $                                                   | 48,158     |                                              | $          | 46,605 |   | $ | 95,688 |   | $ | 91,557 |   |
| Cost of services                  |       | 6,770                                               |       | 5,704                                             |       | 12,760 |   | 11,212 |   |
| Gross profit                      |       | 41,388                                              |       | 40,901                                            |       | 82,928 |   | 80,345 |   |
|                              |       |                                                |       |                                              |       |   |   |   |   |
| Operating  expenses:              |       |                                                |       |                                              |       |   |   |   |   |
| Sales, general and administrative |       | 8,870                                               |       | 9,153                                             |       | 17,660 |   | 17,894 |   |
| Depreciation                      |       | 574                                                 |       | 546                                               |       | 1,190 |   | 1,163 |   |
| Amortization                      |       | 23,058                                              |       | 22,136                                            |       | 45,770 |   | 43,619 |   |
|                              |       | 32,502                                              |       | 31,835                                            |       | 64,620 |   | 62,676 |   |
| Operating income                  |       | 8,886                                               |       | 9,066                                             |       | 18,308 |   | 17,669 |   |
|                              |       |                                                |       |                                              |       |   |   |   |   |
| Other expense:                    |       |                                                |       |                                              |       |   |   |   |   |
| Interest expense                  |       | 13,307                                              |       | 12,245                                            |       | 26,426 |   | 23,164 |   |
|                              |       | 13,307                                              |       | 12,245                                            |       | 26,426 |   | 23,164 |   |
| Loss before  income taxes         |       | (4,421                                              | )          | (3,179                                            | )          | (8,118 | ) | (5,495 | ) |
| Provision for  income taxes       |       | 331                                                 |       | 5                                                 |       | 658 |   | 18 |   |
| Net loss                          |       | $                                                   | (4,752     | )                                                 | $          | (3,184 | ) | $ | (8,776 | ) | $ | (5,513 | ) |

 

*Seeaccompanying notes.*

4

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**MONITRONICS INTERNATIONAL, INC.**

#### **CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**
| ** **                                                                                | ** ** | **Six Months Ended  December 31,** | ** **   |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------|--------------|
| ** **                                                                                | ** ** | **2006**                                          | ** **   | **2005** | ** ** |
| ** **                                                                                | ** ** | **(In thousands)**                           | ** **   |
| **Operating Activities**                                                             |       |                                              |         |   |   |
| Net loss                                                                                  |       | $                                                 | (8,776       | ) | $ | (5,513 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities:          |       |                                              |         |   |   |
| Depreciation and amortization                                                             |       | 46,960                                            |         | 44,782 |   |
| Amortization of deferred financing costs                                                  |       | 1,386                                             |         | 1,388 |   |
| Provision for bad debt                                                                    |       | 1,450                                             |         | 1,900 |   |
| Non-cash interest expense for redeemable preferred  stock                                 |       | 2,290                                             |         | 700 |   |
| Non-cash interest accretion                                                               |       | 344                                               |         | 329 |   |
| Non-cash Adjustment related to put option                                                 |       | (21                                               | )            | 303 |   |
| Changes in current assets and liabilities:                                                |       |                                              |         |   |   |
| Accounts receivable (excluding provision for bad  debt)                                   |       | (2,205                                            | )            | (2,825 | ) |
| Prepaid expenses and other current assets                                                 |       | (1,342                                            | )            | 90 |   |
| Accounts payable                                                                          |       | (1,081                                            | )            | (283 | ) |
| Accrued expenses                                                                          |       | 137                                               |         | 441 |   |
| Accrued interest                                                                          |       | 634                                               |         | (367 | ) |
| Deferred revenue                                                                          |       | (80                                               | )            | (725 | ) |
| Income taxes payable and receivable                                                       |       | 574                                               |         | 135 |   |
| Net cash  provided by operating activities                                                |       | 40,270                                            |         | 40,355 |   |
|                                                                                      |       |                                              |         |   |   |
| **Investing  Activities**                                                                 | ** ** | ** **                                        | ** **   | ** ** | ** ** |
| Purchases of  property and equipment                                                      |       | (1,625                                            | )            | (2,420 | ) |
| Sale of land                                                                              |       | —                                            |         | 40 |   |
| Purchases of  subscriber accounts (net of holdbacks)                                      |       | (45,615                                           | )            | (49,668 | ) |
| Net cash used in  investing activities                                                    |       | (47,240                                           | )            | (52,048 | ) |
|                                                                                      |       |                                              |         |   |   |
| **Financing  Activities**                                                                 | ** ** | ** **                                        | ** **   | ** ** | ** ** |
| Purchase of  treasury stock                                                               |       | (500                                              | )            | — |   |
| Proceeds from  credit facility                                                            |       | 32,200                                            |         | 42,050 |   |
| Payments of  credit facility                                                              |       | (24,576                                           | )            | (28,776 | ) |
| Net cash  provided by financing activities                                                |       | 7,124                                             |         | 13,274 |   |
| Increase  (decrease) in cash and cash equivalents                                         |       | 154                                               |         | 1,581 |   |
| Cash and cash  equivalents at beginning of period                                         |       | 862                                               |         | 190 |   |
| Cash and cash  equivalents at end of period                                               |       | $                                                 | 1,016        |   | $ | 1,771 |   |
| * *                                                                                  | * *   | * *                                          | * *     | * * | * * |
| Significant cash  transactions during the period for:                                     |       |                                              |         |   |   |
| Interest paid                                                                             |       | $                                                 | 21,568  |   | $ | 20,850 |   |
| Non-cash investing  and financing activities:                                             |       |                                              |         |   |   |
| Dividend  election on redeemable preferred stock (see Note 4- Redeemable Preferred  Stock |       | $                                                 | —       |   | $ | 45,212 |   |

 

*See accompanying notes*.

5

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**1.****               Description ofBusiness and Summary of Significant Accounting Policies**

*Description of Business*

MonitronicsInternational, Inc. and its wholly-owned subsidary, Monitronics Canada, Inc.,(collectively “the Company”) provide security alarm monitoring and relatedservices to residential and business subscribers throughout the United Statesand North America. The Company monitors signals arising from burglaries, fires,and other events through security systems installed by independent dealers atsubscribers’ premises.

The accompanyinginterim unaudited financial statements have been prepared in accordance withaccounting principles generally accepted in the United States for interimfinancial information and with the instructions to Form 10-Q and Article 10 ofRegulation S-X Accordingly, they do not include all of the informationand footnotes required by generally accepted accounting principles. In theopinion of management, the accompanying interim unaudited financial statementscontain all adjustments (consisting of normal recurring adjustments) considerednecessary for a fair presentation of the results of operations for the interimperiods.

*Consolidation Policy*

The Companyconsolidates companies in which it owns or controls, directly or indirectly,more than fifty percent of the voting shares. The Company eliminates allmaterial inter-company balances and transactions.

*StockCompensation*

On July 1, 2006,the Company adopted Statement No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123(R)”),issued by the Financial Accounting Standards Board (“FASB”), to account forstock-based employee compensation arrangements. Under the “prospective”transition method, the Company will continue to account for nonvested awardsoutstanding at the date of adoption of SFAS 123(R) in the same manner as theyhad been accounted for under Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*(“APB 25”). All awards granted ormodified after the date of adoption will be accounted for using the measurementand recognition provisions of SFAS 123(R). Proforma disclosure for outstandingawards accounted for under the intrinsic-value method of APB 25 will no longerbe necessary.

*RecentAccounting Pronouncements*

In June 2006, theFASB issued FASB Interpretation 48 (“FIN 48”), *Accountingfor Uncertainty in Income Taxes,* which is an interpretation of FASBStatement No. 109. FIN 48 clarifies the accounting for uncertainty in incometaxes recognized in an entity’s financial statements. FIN 48 prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. FIN 48 is effective for fiscal years beginning after December 15,2006. The Company will adopt FIN 48 on or before July 1, 2007. The Company iscurrently evaluating the requirements of FIN 48 but has not determined what, ifany, impact it will have on the Company’s consolidated financial statements.

**2.****         Non-Current Liabilities**

Non-currentliabilities consist of the following  (inthousands):

 
| ** **                                                            | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                            | ** ** | **2006**              | ** ** | **2006**          | ** ** |
|                                                                  |       |                  |       |              |       |
| Revolving credit  line and term loan payable                          |       | $                     | 253,963    |              | $          | 246,338 |   |
| Senior  subordinated notes payable                                    |       | 160,000               |       | 160,000           |       |
| Subordinated  notes payable                                           |       | 22,299                |       | 22,017            |       |
| Investor put  option (see Note 3 (Related Party Transactions))        |       | 348                   |       | 556               |       |
|                                                                  |       |                  |       |              |       |
| Redeemable  preferred stock (see Note 4 (Redeemable Preferred Stock)) |       | 50,388                |       | 48,098            |       |
|                                                                  |       | 486,998               |       | 477,009           |       |
| Less: discount                                                        |       | 587                   |       | 650               |       |
| Less: current  portion                                                |       | 11,987                |       | 7,185             |       |
|                                                                  |       | $                     | 474,424    |              | $          | 469,174 |   |

 

6

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On August 25, 2003, the Company entered into its existing $320 millioncredit facility agreement comprised of a $175.0 million term loan that maturesin fiscal year 2010 and a $145.0 million revolving credit facility that maturesin fiscal year 2009. Payments under the term loan are payable in quarterlyinstallments from December 31, 2003 through June 30, 2009. The quarterlypayment is calculated based upon the amount of the original facility multipliedby 0.25% for the quarters ended December 31, 2003 through September 30, 2006,1.25% for the quarters ended December 31, 2006 through September 30, 2007 and3.00% for the quarters ended December 31, 2007 through June 30, 2009 with theremaining balance due at maturity.  As ofDecember 31, 2006, the Company had $86.4 million in borrowings outstandingunder the $145 million revolving credit line and had $167.5 million inborrowings outstanding under the term loan. Further, the Company had $58.6million in availability under the revolving credit line of which $37.7 millionwas immediately available as calculated under the covenants in the Company’scredit facility, and is charged a commitment fee of 0.5% on the average dailyunused portion.  The revolving creditline bears interest at a rate of either prime plus 2.25% or LIBOR plus 3.25%.The term loan bears interest at a rate of either prime plus 2.75% or LIBOR plus3.75%.  For the six months ended December31, 2006, borrowings under the credit facility had a weighted average interestrate of 9.0%.  Interest incurred onborrowings is payable monthly in arrears.

On March 28, 2005, the Company amended certain provisions of its creditfacility dated August 25, 2003 that included elimination of mandatoryreductions to the revolving credit facility, a 75 basis point reduction in thevariable interest rate for its revolving credit line and term loan, and a 25basis point reduction in commitment fees at its current borrowing level.

On August 25, 2003, the Company issued $160.0 million of seniorsubordinated notes (the “Senior Subordinated Notes”) at 11.75% at a discount of$0.94 million with a maturity date of September 1, 2010. Interest payments areto be made semi-annually in cash in arrears on March 1 and September 1 of eachyear.

Proceeds from the issuance of the Senior Subordinated Notes andborrowings under the credit facility in August 2003 were used primarily torepay the Company’s prior credit facility and its $12 million seniorsubordinated notes payable, to repurchase $20.5 million principal amount of itssubordinated notes at a repurchase price of approximately $23.2 million and topay debt issuance costs. As part of the August 2003 refinancing, the terms ofthe then-remaining $20.5 million principal amount of the subordinated noteswere amended, and the maturity date was extended to March 1, 2010. Interest onthe subordinated notes originally accrued at 13.5% per annum with interestpayable semi-annually at a rate of 12% per annum with the remaining 1.5%interest per annum added to the outstanding principal amount of thesubordinated notes. The 1.5% interest rate increased to 2.5% per annum onDecember 15, 2003 when the subordinated notes were not repurchased by thatdate, and the increased rate was applied retroactively to August 25, 2003.

The credit facility and subordinated notes have certain financial testswhich must be met on a quarterly basis, including maximum total senior debt andtotal debt to quarterly annualized net operating income, minimum interestcoverage ratio, minimum fixed charge coverage ratio and an annual capitalexpenditure limit. Indebtedness under the credit facility is secured by all ofthe assets of the Company.  As ofDecember 31, 2006, the Company was in compliance with all required financialtests.

On August 18, 2003, the Company entered into an agreement with the HullFamily Limited Partnership (the “Partnership”) and Mr. James R. Hull, theCompany’s then president and chief executive officer, as amended on September23, 2004, that allowed for the put of $500,000 in value of Class A common stockto the Company in each fiscal year beginning in fiscal 2005 and ending June 30,2009.  As of December 31, 2006, thePartnership had sold the Company $1,500,000 worth of Class A common stock.  The fair value of the remaining investor putoption was $0.3 million at December 31, 2006. See Note 3 (Related Party Transactions) to these consolidated financialstatements.

Scheduledmaturities (as defined) of long-term debt at December 31, 2006, utilizing therequired payment schedule of the Senior Subordinated Notes, subordinated notes,credit facility and the fair value of the investor put option are as followsfor fiscal years below (in thousands):

 

7

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| 2007       |   | $       | 4,550   |   |
|------------|--------|---------|---------|--------|
| 2008       |   | 68,500  |    |
| 2009       |   | 107,400 |    |
| 2010       |   | 146,548 |    |
| 2011       |   | 160,000 |    |
| Thereafter |   | —  |    |
|       |   | $       | 486,998 |   |

 

**3.****         RelatedParty Transactions**

Concurrently withthe Senior Subordinated Notes offering, the Company entered into an agreementwith James R. Hull, the Company’s then president and chief executive officer,and the Hull Family Limited Partnership (the “Partnership”) pursuant to whichthe Company paid Mr. Hull a $2 million transaction fee in cash at the closingof the refinancing on August 25, 2003. This fee was capitalized as deferred financing costs. On November 7,2003, the Partnership exercised its right to require the Company to purchase400,000 shares of Class A common stock at a purchase price of $1 million incash.  Based on the fair value of theCompany’s stock, no expense was recorded related to the repurchase of thePartnership’s shares.  The agreement alsogives the Partnership and Mr. Hull a written investor put option to sell up toa combined total of $500,000 in value of Class A common stock to the Company ineach of the five fiscal years ending June 30, 2009 at purchase prices per sharethat are based on a multiple of the Company’s consolidated cash flow. As ofDecember 31, 2006, the Partnership had sold the Company 182,805 shares of ClassA common stock for $1,500,000.  As ofDecember 31, 2006, the outstanding liability for the put option was $0.3million.  The Company will adjust its liabilityand related SG&A expense as the fair value of the put option changes.

On July 14, 2004,the Company completed a series of transactions which it refers to as the “recapitalization.”In the recapitalization, the Company redeemed approximately $5.6 million of theSeries C and C-1 preferred stock held by Windward Capital Partners II, L.P. andWindward Capital LP II, LLC (collectively the “Windward entities”) and thenissued shares of a new Series A preferred or Class A common stock to itspreferred shareholders in exchange for all of their preferred stock, Class Acommon stock and warrants to purchase Class A common stock.  The preferred shareholders determined thenumber of shares to be received in the exchange based on the liquidationpreference of, and accrued but unpaid dividends on, the existing preferredshares as of July 14, 2004 for the shares held by the Windward entities and asof June 30, 2003 for the remaining preferred shares. The Company’s preferredshareholders agreed to value the Class A common stock and new Series A  preferred stock received in the exchange at$6.00 per share.  The valuation was basedon a negotiation amongst the Company’s preferred shareholders and the agreementof New York Life Capital Partners II, L.P. and PPM America Private Equity FundL.P. to subsequently purchase the shares of Class A common stock received bythe Windward entities in the exchange for $6.00 per share.  No independent third party valuations orappraisal opinions were obtained by the preferred shareholders or board ofdirectors during the negotiation process. The Company’s lenders and preferred shareholders consented to therecapitalization as required under the terms of the Company’s applicableagreements.

The Company’spreferred shareholders also negotiated the terms of the new Series A preferredstock issued to Austin Ventures III-A, L.P., Austin Ventures III-B, L.P.,Austin Ventures V, L.P. and Austin Ventures V Affiliates Fund, L.P.  The Company’s board of directors and theholders of at least two-thirds of the outstanding shares of Class A commonstock, Series A preferred stock, Series B preferred stock, Series C preferredstock, Series C-1 preferred stock and Series D-1 preferred stock, each votingas a separate class as required by the Company’s articles of incorporation,approved the amendment and restatement of the Company’s articles ofincorporation to create the new Series A preferred stock.  On November 4, 2005, the holders of theCompany’s Series A preferred stock notified it of their election for the SeriesA preferred stock to begin accruing dividends as permitted under the Company’sarticles of incorporation (the “Dividend Election”).  As a result of theDividend Election, the Company must redeem the Series A preferred stock on June30, 2008 (see Note 4 — Redeemable Preferred Stock).

**4.****         RedeemablePreferred Stock**

As of December 31,2006, there were 8,247,075 shares of Series A preferred stock authorized ofwhich 8,175,075 shares were issued and outstanding.  On November 4, 2005, the holders of theCompany’s Series A preferred stock notified it of their election for the SeriesA preferred stock to begin accruing dividends as permitted under the Company’sarticles of incorporation.  As a resultof the Dividend Election, the Company must redeem the Series A preferred stockon June 30, 2008. The terms of the Series A preferred stock following theDividend Election are described below.

8

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***Accounting Treatment***

As a result of theDividend Election made on November 4, 2005, the Company recorded the Series Apreferred stock as a debt instrument by reclassifying, from additional paid-incapital to a long-term liability, the amount necessary to adjust the Series Apreferred stock to its fair value as of the date of the Dividend Election. TheCompany obtained an independent valuation of the Series A preferred stock todetermine the fair value of the Series A preferred stock. On November 4, 2005,the fair value of the of the Series A preferred stock was $45.2 million. Thefair value of the liability will be accreted to the redemption amount of $57.9million payable at June 30, 2008 using the interest rate implicit at theDividend Election date.  As of December31, 2006, the Company reported a liability for the Series A preferred stock of$50.4 million consisting of $45.2 million as of November 4, 2005, which was thefair value of the Series A Preferred stock, plus accrued interest of $5.2million.  The liquidation preference ofthe Series A preferred stock as of December 31, 2006 is $49.6 million ascalculated per the Company’s articles of incorporation (see LiquidationPreference below).

***Series A Preferred Stock Dividend Preferences***

Dividends willaccrue on the Company’s Series A preferred stock at an annual rate of 8% untilthe first anniversary of the Dividend Election, and thereafter will increase byan additional 2% per annum on each subsequent anniversary of the DividendElection date up to a maximum annual rate of 16%.  If the Company fails to redeem the Series Apreferred stock on June 30, 2008, the maximum dividend rate shall be increasedfrom 16% to the greater of 24% and the maximum rate permitted by law.

The dividend ratewill also increase by an additional 3% per annum above the then-applicablerate and by an additional 1% per annum at the end of each 90-day periodthereafter (up to a maximum annual rate of 24%) following covenant defaults (asdefined below) or if the Company issues senior securities or incurs certainindebtedness that causes the Company’s leverage ratio to exceed an initialmultiple of 5.1 times annualized EBITDA (see Liquidation Preference below)until such noncompliance is cured. If the Company’s leverage ratio exceeds aninitial multiple of 4.8 times annualized EBITDA other than as a result of itsissuance of additional senior securities or indebtedness that triggers theincreased dividends described in the preceding sentence, the dividend rate willincrease by an additional 2% per annum (up to a maximum annual rate of24%). The initial multiples are subject to increases to reflect subsequent debtor equity issuances.

Dividends arepayable solely in cash when and as declared by the Company’s board of directorsand only if sufficient cash is available to make the dividend payment. TheCompany may not pay dividends if a default exists or the payment of dividendswould create a default under its credit facility or the indenture relating tothe Senior Subordinated Notes.

***Voting Rights***

If the Companyundertakes any of the actions described hereunder without first obtaining theconsent of the holders of a majority of the then-outstanding shares of Series Apreferred stock (referred to as a covenant or leverage default), theLiquidation Value will be recalculated at that time using the formula providedin the terms of the Series A preferred stock included in the Company’s articlesof incorporation (see Liquidation Preference below).

Except as providedbelow or otherwise required by law, holders of Series A preferred stock willhave no voting rights.  On mattersspecifically requiring the vote of the Series A preferred stock voting as aseparate class, holders of Series A preferred stock will be entitled to onevote per share of Series A preferred stock held by the holders. The holders ofa majority of the outstanding shares of Series A preferred stock, voting as aseparate class, must approve:

·      Any change in the nature ofthe Company’s business;

·      The issuance of securitiesthat rank senior to, or pari passu with, the Series A preferred stock, or theincurrence of certain indebtedness, subject to limited exceptions;

·      The issuance of additionalSeries A preferred stock other than to holders who received Series A preferredstock in the recapitalization or their permitted transferees;

·      A redemption or repurchaseof company securities that rank junior to, or pari passu or senior to, theSeries A preferred stock, subject to limited exceptions;

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·      The declaration or paymentof dividends or distributions on any company security that ranks junior to, orpari passu or senior to, the Series A preferred stock, subject to limitedexceptions;

·      The Company’s entry intoagreements that prohibit it from performing its obligations in respect of theSeries A preferred stock or which prohibit the exercise of the right of theholders of Series A preferred stock to require a sale of the company or othervoting rights;

·      Acquisitions in excess of$100 million;

·      Amendment of the Company’sarticles of incorporation or bylaws to increase the authorized shares of SeriesA preferred stock or adversely affect or otherwise impair the rights orrelative preferences or priorities of the Series A preferred stock, other thanto establish or amend senior securities otherwise permitted to be issued;

·      The Company’s entry into oramendment of agreements with affiliates, subject to limited exceptions; or

·      The Company’s establishment,acquisition of or ownership of any equity securities of ABRY or its affiliates.

***Conversion Rights***

Following theNovember 4, 2005 Dividend Election, the Company’s Series A preferred stock isno longer convertible into Class A common stock.

***Redemption Rights***

The Company mustredeem the Series A preferred stock upon the closing of a qualified publicoffering at a per share price equal to the Liquidation Value (as defined below)plus accrued and unpaid dividends (the “Redemption Price”). The Company mustalso redeem the Series A preferred stock at the Redemption Price per share onJune 30, 2008 (the “Mandatory Redemption Date”). If the Company has notredeemed the Series A preferred stock by the first anniversary of the MandatoryRedemption Date, the holders of a majority of the outstanding Series Apreferred stock may elect to initiate the sale or liquidation of the Company.The Company may redeem the Series A preferred stock at its option at any timeprior to the Mandatory Redemption Date.

Notwithstandingthe foregoing mandatory and optional redemption provisions, the Company cannotredeem the Series A preferred stock while the Senior Subordinated Notes areoutstanding or if prohibited under its credit facility.

***Liquidation Preference***

The Series Apreferred stock will have a liquidation preference per share based on theLiquidation Value (as defined below) plus accrued and unpaid dividends. As ofDecember 31, 2006, the Series A preferred stock had an aggregate liquidationpreference of $49.6 million consisting of a Liquidation Value of $45.2 millionas of November 4, 2005, which was the fair value of the Series A preferredstock, plus accrued and unpaid dividends of $4.4 million.

If the Companyundertakes any of the actions described under “Voting Rights” above withoutfirst obtaining the consent of the holders of a majority of thethen-outstanding shares of Series A preferred stock (referred to as a covenantor leverage default), the Liquidation Value will be recalculated at that timeusing the formula provided in the terms of the Series A preferred stockincluded in the Company’s articles of incorporation. The Series A preferredstock will then have a new Liquidation Value equal to the amount that would bereceived by the holders of the Series A preferred stock upon a liquidation ofthe Company assuming liquidation proceeds equal to (a) the sum of (i)annualized EBITDA for the most recently completed fiscal quarter multiplied by5.5 as adjusted according to the terms of the Series A preferred stockdepending on the type of covenant or leverage default, plus (ii) company cashin excess of $2.0 million, less (b) company debt (as defined in the articles ofincorporation) (the “Liquidation Value”).

**5.****         Commitments andContingencies**

The Company isparty to various legal proceedings and claims that have arisen in the ordinarycourse of its business. In the opinion of management, the amount of ultimateliability with respect to these actions will not  have a material impact on the Company’sfinancial position or results of operations.

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##### **Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

We are a leadingnational provider of security alarm monitoring services. The followingdiscussion and analysis of our financial condition and results of operationsshould be read in conjunction with our financial statements, and the relatednotes to those financial statements, included in Part I - Item 1 of thisQuarterly Report on Form 10-Q. Those statements in “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” that are nothistorical in nature should be considered to be forward-looking statements thatare inherently uncertain. See “Forward-Looking Statements.”

##### **Forward-Looking Statements**

Certain statementscontained or incorporated by reference in this Quarterly Report on Form 10-Qincluding, without limitation, statements containing the words “may,” “will,” “expect,”“intend,” “estimate,” “anticipate,” “plan,” “foresee,” “believe” or “continue”or the negatives of these terms or variations of them or similar terminology,are forward-looking statements within the meaning of the federal securitieslaws.  Such forward-looking statementsinvolve known and unknown risks, uncertainties and other matters which maycause actual results, performance or achievements to be materially differentfrom any future results, performance or achievements expressed or implied bysuch forward-looking statements. Factors, risks and uncertainties that could cause actual outcomes andresults to be materially different from those projected include, among others,the following:

·                  our high degreeof leverage;

·                  our anticipatedgrowth strategies;

·                  anticipatedtrends and conditions in our business, including trends in the market;

·                  our ability toacquire and integrate additional accounts;

·                  our expectedrate of subscriber attrition;

·                  our ability tocontinue to control costs and maintain quality;

·                  our ability tocompete;

·                  the impact of “falsealarm” ordinances on our results of operations;

·                  changes intechnology and the trend away from the use of public switched telephone networklines to communicate with our monitoring center; and

·                  our ability toobtain additional funds to grow our business.

We have basedthese forward-looking statements largely on our current expectations andprojections about future  events andfinancial trends that we believe may affect our financial condition, results ofoperations, business strategy and financial needs. They can be affected byinaccurate assumptions we might make or by known or unknown risks,uncertainties and assumptions.  Referenceis hereby made to the disclosures contained under the heading “Risk Factors” in“Part I - Item 1A.”  of the Company’sAnnual Report on Form 10-K filed with the Securities and Exchange Commission onSeptember 20, 2006.  In light of theserisks, uncertainties and assumptions, the forward-looking statements may notoccur and actual results could differ materially from those anticipated orimplied in the forward-looking statements. When you consider these forward-lookingstatements, you should keep in mind these risk factors and other cautionarystatements.

Ourforward-looking statements speak only as of the date made. We undertake noobligation to update or revise any forward-looking statements, whether as aresult of new information, future events or otherwise, unless the securitieslaws require us to do so.

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**Overview**

Nearlyall of our revenues are derived from monthly recurring revenues under securityalarm monitoring contracts purchased from independent dealers in our exclusivenationwide network. Our alarm monitoring contracts generally have anon-cancelable initial term of three years, generally allow for periodic priceincreases and provide for automatic renewals. Revenues are recognized as therelated monitoring services are provided. Other revenues are derived primarilyfrom the provision of third-party contract monitoring services and from fieldtechnical repair services.

Costof services primarily consists of direct labor associated with monitoring andservicing subscriber accounts and expenses related to field technical repairservices.  Sales, general andadministrative expenses primarily include the cost of personnel conductingsales and administrative activities and other costs related to sales, administrationand operations.  All direct externalcosts associated with the creation of subscriber accounts are capitalized andamortized over ten years using a 135% declining balance method. Internal costs,including all personnel and related support costs incurred solely in connectionwith subscriber account acquisitions and transitions, are expensed as incurred.

**Attrition**

We purchasesubscriber contracts from our exclusive network of independent dealers. Thesecontracts with our subscribers are typically three-year non-cancelablecontracts with automatic renewal provisions. A portion of our subscriber basecan be expected to cancel its service every year. Subscribers may choose not torenew or terminate their contract for a variety of reasons, includingrelocation, economic reasons, switching to our competitors’ service and serviceissues.

Accountcancellation, otherwise referred to as subscriber attrition, has a directimpact on the number of subscribers we serve and hence our financial results,including revenues, operating income and cash flow. We define our attritionrate as the number of canceled accounts in a given period divided by theaverage of the beginning and ending balance of subscribers for that period. Weconsider an account canceled when a subscriber terminates in accordance eitherwith the terms of the contract, our cancellation policies, or if payment fromthe subscriber is deemed uncollectible. If a subscriber relocates but continuesservice, this is not a cancellation. If the subscriber relocates anddiscontinues service and a new subscriber takes over the service continuing therevenue stream, this is a cancellation and a new owner takeover. Accountscanceled are therefore net of new owner takeovers. We also adjust the number ofcanceled accounts by excluding those that are contractually guaranteed by ourdealers. Our typical dealer contract provides that if a subscriber cancels inthe first year of its contract, the dealer must replace the lost monthlyrevenue attributable to the canceled contract and either replace the canceledaccount with a new one or refund our purchase price. To help ensure the dealer’sobligation to us, we typically hold back a portion of the purchase price forevery account we purchase. In some cases, the amount of the purchase holdbackmay be less than actual attrition experience. In recent years, a substantialportion of the accounts that canceled within this initial 12-month period werereplaced or refunded by the dealers at no additional cost to us.

We also analyzeour attrition by classifying our accounts into annual pools based on the yearof purchase.  We then track the number ofaccounts that cancel as a percentage of the initial number of accountspurchased for each pool for each year subsequent to its purchase. Based on theaverage cancellation rate across our pools, we achieve nearly 0% attrition inthe first year net of canceled accounts that are contractually guaranteed byour dealers. In the next three years, the number of subscribers that cancel asa percentage of the initial number of subscribers in that pool graduallyincreases and historically has peaked during the few months following the endof the initial term which is typically 36 months. The peak is primarily aresult of the buildup of subscribers that moved or no longer had need for theservice prior to the third year but did not cancel their service until the endof their three-year contract. After the fourth year, the number of subscribersthat cancel as a percentage of the initial number of subscribers in that pooldeclines. As a result, we believe our attrition rate decreases as the age ofour accounts increase beyond the initial three-year contract.

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The table belowpresents subscriber data for the twelve months ended December 31, 2006 and 2005:
| ** **                                        | ** ** | **Twelve Months Ended  December 31,** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Beginning balance of  accounts                    |       | 485,933                                              |       | 450,412 |   |
| Accounts purchased                                |       | 71,681                                               |       | 95,130 |   |
| Accounts canceled(1)                              |       | (65,488                                              | )          | (57,428 | ) |
| Accounts guaranteed to  be refunded from holdback |       | (3,319                                               | )          | (2,181 | ) |
| Ending balance of  accounts                       |       | 488,807                                              |       | 485,933 |   |
| Attrition rate                                    |       | 13.4                                                 | %          | 12.3 | % |

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(1) Net ofcanceled accounts that are contractually guaranteed by the dealer and new ownertakeovers.

We saw an expected rise in attrition over the past six months whichresulted in an increase in our trailing twelve-month attrition rate to 13.4%for the period ended December 31, 2006 versus 12.3% for the period endedDecember 31, 2005. This increase in attrition was primarily due tosignificantly more subscribers than typical reaching the end of their initial3-year term during the period due to higher purchase volumes in the summer of2003. As discussed above, our pool attrition data shows that attrition ratespeak during the few months following the end of the initial term and thendecrease beyond that point.

**Resultsof Operations**

*ThreeMonths Ended December 31, 2006 Compared to Three Months Ended December 31, 2005*

*Revenues.*Total revenues were $48.2 million in the three months ended December 31, 2006compared to $46.6 million in the three months ended December 31, 2005, whichwas an increase of $1.6 million, or 3%. This increase was primarilyattributable to an increase in the average revenue per subscriber, as well ashigher field technical service revenue.

*Costof services.*Cost ofservices was $6.8 million for the three months ended December 31, 2006 comparedto $5.7 million for the three months ended December 31, 2005, which was anincrease of $1.1 million, or 19%. As a percentage of revenues, cost of serviceswas 14.1% for the three months ended December 31, 2006 compared to 12.2% forthe three months ended December 31, 2005 due to higher field technical serviceexpense. The increase in attrition and accounts coming to the end of theirinitial term caused us to increase our complimentary service work and upgradesin an effort to retain customers.  Theincrease was partially offset by higher service revenue.

*Sales,general and administrative (SG&A). *SG&Awas $8.9 million for the three months ended December 31, 2006 compared to $9.2million for the three months ended December 31, 2005, which was a decrease of$0.3 million, or 3%. As a percentage of revenues, SG&A was 18.5% for thethree months ended December 31, 2006 versus 19.7% for the three months endedDecember 31, 2005.  The decrease inSG&A expense as a percent of revenue was primarily due to a lower allowancefor doubtful accounts, a reduction in expense related to adjusting the fairvalue of a written put option (as described in Note 3), and lower professionalfees related to routine litigation.

*Amortization.*Amortization of intangibles was $23.1 million in the three months endedDecember 31, 2006 compared to $22.1 million in the three months ended December31, 2005, which was an increase of $1.0 million, or 5%. The increase wasattributable to the purchase of subscriber accounts through our authorizeddealer program.

*Interestexpense*. Interest expense was $13.3 million in the threemonths ended December 31, 2006 compared to $12.2 million in the three monthsended December 31, 2005, which was an increase of $1.1 million, or 9%. Theincrease resulted from increases in variable interest rates and this year’sresults including a full quarter of interest expense related to the Dividend Electionmade by our redeemable preferred shareholders on November 4, 2005 (see Note 4(Redeemable Preferred Stock) to our consolidated financial statements includedin this Quarterly Report on Form 10-Q).

*Netloss.* Net loss was $4.8 million in the three months endedDecember 31, 2006 compared to a net loss of $3.2 million in the three monthsended December 31, 2005.  The increase innet loss was primarily due to higher interest expense.

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*SixMonths Ended December 31, 2006 Compared to Six Months Ended December 31, 2005*

*Revenues.*Total revenues were $95.7 million in the six months ended December 31, 2006compared to $91.6 million in the six months ended December 31, 2005, which wasan increase of $4.1 million, or 4%. This increase was primarily attributable toan increase in the average revenue per subscriber, as well as growth in theaverage number of subscriber accounts and higher field technical servicerevenue.

*Costof services.*Cost ofservices was $12.8 million in the six months ended December 31, 2006 comparedto $11.2 million in six months ended December 31, 2005, which was an increaseof $1.6 million, or 14%. As a percentage of revenues, cost of services was13.3% for the six months ended December 31, 2006 and 12.2% for the six monthsended December 31, 2005 due to higher field technical service expense. Theincrease in attrition and accounts coming to the end of their initial term causedus to increase our complimentary service work and upgrades in an effort to retaincustomers.The increase was partially offset by higher service revenue.

*Sales,general and administrative.*SG&A was $17.7 million in thesix months ended December 31, 2006 compared to $17.9 million in the six monthsended December 31, 2005, which was a decrease of $0.2 million, or 1%.  As a percentage of revenues, SG&A was18.5% for the six months ended December 31, 2006 and 19.5% for the six monthsended December 31, 2005.  The decrease inSG&A expense as a percentage of revenues was primarily due to a lowerallowance for doubtful accounts, a reduction in expense related to adjustingthe fair value of a written put option (as described in Note 3), and lowerprofessional fees related to ongoing legal matters.

*Amortization.*Amortization of intangibles was $45.8 million in the six months ended December31, 2006 compared to $43.6 million in the six months ended December 31, 2005,which was an increase of  $2.2 million,or 5%. The increase was attributable to growth in our purchased subscriberaccounts through our authorized dealer program.

*Interestexpense*. Interest expense was $26.4 million in the six monthsended December 31, 2006 compared to $23.2 million in the six months endedDecember 31, 2005, which was an increase of $3.2 million, or 14%. The increaseresulted from increases in variable rates and this year’s results including afull six months of interest expense related to the Dividend Election made bythe redeemable preferred shareholders on November 4, 2005 (see Note 4 -Redeemable Preferred Stock).

*Netloss. *Net loss was$8.8 million in the six months ended December 31, 2006 compared to a net lossof $5.5 million in the six months ended December 31, 2005.  The increase in net loss was primarily due tohigher interest expense.

**Liquidityand Capital Resources**

*General*.  Our operating strategy requires theavailability of significant funds to finance growth through subscriber accountpurchases. Additional cash requirements include debt service and capitalexpenditures. We have financed our growth from a combination of long-termborrowings, issuance of preferred stock, and cash flows provided by operations.

Major componentsof our working capital include accounts receivable, deferred revenue, purchaseholdbacks, accrued interest payable and the current portion of long-term debt.We expect to experience negative working capital in the future primarily due toaccrued interest payable and purchase holdbacks. Purchase holdbacks aredependent on the number of subscriber accounts we purchase, the timing and amountof our payment of the purchase holdbacks to dealers, and the percentage of thepurchase price we withhold to ensure a dealer’s obligation during the guaranteeperiod. Accrued interest payable is dependent on the level of our debt and thetiming of interest payments.

As of December 31,2006 and June 30, 2006, we had working capital deficits of $27.8 million and$25.0 million, respectively.  Changes inour working capital deficit included an increase in the current portion of long-termdebt resulting from an increase in the repayment rate on our term loanprincipal from 0.250% in each quarter of fiscal year 2006 and in the firstquarter of fiscal year 2007 to 1.250% in each of the last three quarters offiscal year 2007.

Net cash providedby operating activities for the six months ended December 31, 2006 was $40.3million compared to $40.4 million for the six months ended December 31, 2005.

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Net cash used ininvesting activities for the six months ended December 31, 2006 was $47.2million, compared to $52.0 million for the six months ended December 31, 2005.For the six months ended December 31, 2006, capital expenditures were $1.6million versus $2.4 million for the six months ended December 31, 2005. Capitalexpenditures were primarily for upgrading computer systems. Capitalexpenditures are expected to vary based on the growth of our subscriber accountbase and improvements to our technology, operating and financial systems.Purchases of subscriber accounts consist of all direct external paymentsassociated with the creation of subscriber accounts. The portion of thepurchase holdback paid to dealers at the end of the guarantee period isincluded in this amount when paid.  Thedecrease in subscriber account purchases to $45.6 million from $49.7 millionprimarily reflects discontinuing account purchases from our largest dealerduring second quarter of fiscal year 2006.

Our net cashprovided by financing activities for the six months ended December 31, 2006 was$7.1 million compared to $13.3 million for the six months ended December 30,2005.

As of December 31,2006, we had $254.0 million outstanding under our credit facility, bearinginterest at a weighted average rate for the six months ended December 31, 2006of approximately 9.0% per annum, and we had approximately $58.6 million inborrowing availability under our revolving credit line, of which $37.7 millionwas immediately available as calculated under the covenants in our creditfacility.  In addition, we had $182.3 millionin principal amount outstanding of senior subordinated and subordinated notesas of December 31, 2006.

As of December 31,2006, there were 8,247,075 shares of Series A preferred stock authorized ofwhich 8,175,075 shares were issued and outstanding.  On November 4, 2005,the holders of our Series A preferred stock notified us of their election forthe Series A preferred stock to begin accruing dividends as permitted under ourarticles of incorporation (the “Dividend Election”).  As a result of theDividend Election, we must redeem the Series A preferred stock on June 30,2008. If we have not redeemed the Series A preferred stock on June 30, 2008,the dividend rate will increase to the greater of 24% and the maximum ratepermitted by law.  If we have notredeemed the Series A preferred stock by June 30, 2009, the holders of amajority of the outstanding Series A preferred stock may elect to initiate thesale or liquidation of the Company.

As a result of theDividend Election made on November 4, 2005, we recorded the Series A preferredstock as a liability by reclassifying, from additional paid-in capital to along-term liability, the amount necessary to adjust the Series A preferredstock to its fair value as of the Dividend Election date. We obtained anindependent valuation of the Series A preferred stock to determine the fairvalue of the Series A preferred stock. On November 4, 2005, the fair value ofthe Series A preferred stock was $45.2 million. The fair value of the liabilitywill be accreted to the redemption amount of $57.9 million to be paid at June30, 2008 using the interest rate implicit at the Dividend Election date. As of December 31, 2006, we reported a liability for the Series A preferredstock of $50.4 million consisting of $45.2 million as of November 4, 2005,which was the fair value of the Series A Preferred stock, plus accrued interestof $5.2 million.  The liquidation preference of the Series A preferredstock as of December 31, 2006 is $49.6 million as calculated per our articlesof incorporation (see Liquidation Preference in Note 4 - Redeemable PreferredStock to the consolidated financial statements, included in this QuarterlyReport on Form 10-Q).

On March 28, 2005,we amended certain provisions of our credit facility dated August 25, 2003 thatincluded elimination of mandatory reductions to the revolving credit facility,a 75 basis point reduction in the variable interest rate for our revolvingcredit line and term loan, and a 25 basis point reduction in commitment fees atour current borrowing level.

On August 25, 2003,we issued $160.0 million of senior subordinated notes at 11.75% with a maturitydate of September 1, 2010. Interest payments are to be made semi-annually incash in arrears on March 1 and September 1 of each year beginning on March 1,2004.  On December 16, 2004, we completedan exchange offer in which we exchanged new notes that were registered underthe Securities Act of 1933 for the senior subordinated notes.

Further on August25, 2003, we entered into a new credit facility agreement with Fleet NationalBank (“Fleet”) as administrative agent, Bank of America, N.A. as syndicationagent, and a syndicate of lenders, including Fleet and Bank of America, N.A.,as amended on July 14, 2004. Our credit facility is comprised of a $175.0million term loan that matures in fiscal 2010 and a $145.0 million revolvingcredit facility that matures in fiscal 2009. Indebtedness under the creditfacility is secured by all of our assets. Payments under the term loan arepayable in quarterly installments from December 31, 2003 through June 30, 2009.The quarterly payment is calculated based upon the amount of the originalfacility multiplied by 0.25% for the quarters ended December 31, 2003 throughSeptember 30, 2006, 1.25% for the quarters ended December 31, 2006 through September30, 2007 and 3.00% for the quarters ended December 31, 2007 through June 30,2009 with the remaining balance due at maturity. We used the borrowings underthis credit facility together with the proceeds of the senior subordinatednotes offering primarily to

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repay our prior creditfacility, to repay all of our $12 million 12% senior subordinated notes dueJune 30, 2007, and to repurchase $20.5 million principal amount of our 14.5%subordinated notes due March 1, 2010 at a repurchase price of approximately$23.2 million.  In connection with ourAugust 2003 refinancing, we amended the terms of our subordinated notes toextend the maturity date of the then remaining $20.5 million principal amountfrom January 18, 2009 to March 1, 2010. Prior to the amendment, interestaccrued on the subordinated notes at 13.5% per annum with interest payablesemi-annually in cash at a rate of 12% per annum with the remaining 1.5%interest per annum added to the outstanding principal amount of thesubordinated notes. The 1.5% per annum interest rate increased to 2.5% perannum on December 15, 2003 and the increased rate applied retroactively toAugust 25, 2003.

We will requiresubstantial cash flow to fully implement our business strategy and meet ourprincipal and interest obligations with respect to the senior subordinatednotes and our other indebtedness. We anticipate that  cash flow generated from operations andborrowings under our credit facility will provide sufficient liquidity to fundthese requirements for the foreseeable future. Following the August 2003refinancing, we continue to have significant borrowing capacity under ourcredit facility. This capacity coupled with anticipated cash flow fromoperations is expected to meet and satisfy our short-term obligations.

We furtherpreserve our borrowing capacity by following a cash management practice ofmaintaining a low ongoing cash balance. However, our ability to meet our debtservice and other obligations depends on our future performance, which in turnis subject to general economic conditions and other factors, certain of whichare beyond our control. If we are unable to generate sufficient cash flow fromoperations or otherwise to comply with the terms of the indenture governing thesenior subordinated notes or our other debt instruments, we may be required torefinance all or a portion of our existing debt or obtain additional financing.Further, the agreements or indentures governing our credit facility, our seniorsubordinated notes and subordinated notes contain financial covenants relatingto capital expenditure limits, maximum total debt to annualized quarterlyEBITDA, maximum total senior debt to annualized quarterly EBITDA, interestcoverage and fixed charge coverage that may impact our ability to refinance allor a portion of our existing debt or obtain additional financing.  As of December 31, 2006, we were incompliance with all required financial tests.

**CriticalAccounting Policies**

Our discussion andanalysis of results of operations and financial condition are based upon ourfinancial statements, which have been prepared in accordance with U.S.generally accepted accounting principles (“GAAP”). The preparation of financialstatements in accordance with GAAP requires management to use judgment in makingestimates and assumptions that affect the reported amounts of assets,liabilities, revenues, expenses and disclosure of contingent assets andliabilities. We base our estimates and assumptions on historical experience andon various other assumptions that are believed to be reasonable under thecircumstances. These estimates and assumptions are evaluated on an ongoingbasis. Due to the nature of certain assets and liabilities, there areuncertainties associated with some of the judgments, assumptions and estimateswhich are required to be made. Reported results could have been materiallydifferent under a different set of assumptions and estimates for certainaccounting principle applications.

*ConsolidationPolicy. *We consolidatecompanies in which we own or control, directly or indirectly, more than fiftypercent of the voting shares. We eliminate all material inter-company balancesand transactions.

*LongLived Assets—Subscriber Accounts*.  Subscriber accounts relate to the cost ofacquiring portfolios of monitoring service contracts from independent dealers.The subscriber accounts are recorded at cost. All direct external costsassociated with the creation of subscriber accounts are capitalized. Internalcosts, including all personnel and related support costs, incurred solely inconnection with subscriber account acquisitions and transitions are expensed asincurred. The cost of subscriber account pools are amortized using the 10-year135% declining balance method. Subscriber accounts are amortized in poolsbecause of the accounts’ homogeneous characteristics resulting primarily fromthe extremely disciplined due diligence program that we have implemented inwhich a contract must meet certain purchase criteria before we will purchasethat account. All of our customers contract for essentially the same serviceand we are consistent in providing that service regardless of the customers’locations.

A 10-year 135%declining balance amortization method was selected to provide a matching ofamortization expense to individual subscriber revenues based on historicalperformance of our subscriber base. The realizable value and remaining usefullives of these assets could be impacted by changes in subscriber attritionrates, which could have an adverse effect on our earnings.

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We review thesubscriber accounts for impairment or a change in amortization period wheneverevents or changes indicate that the carrying amount of the asset may not berecoverable or the life should be shortened. For purposes of recognition andmeasurement of an impairment loss, we view subscriber accounts as a single poolbecause of the assets’ homogeneous characteristics, which is the lowest levelfor which identifiable cash flows are largely independent of the cash flows ofthe other assets and liabilities. If we determine that an impairment hasoccurred, we write the subscriber accounts down to their fair value.

*IncomeTaxes and Deferred Tax Assets*.  As part of preparing our financialstatements, significant management judgment is required in determining ourprovision for income taxes, our deferred tax assets and liabilities, and theneed for a valuation allowance related to our deferred tax assets. This processinvolves us estimating our actual current tax exposure together with assessingtemporary differences resulting from differing treatment of items, especiallythe amortization of subscriber accounts, which are amortized using a 10-year135% declining balance method for financial reporting purposes and aregenerally amortized using a 10-year straight-line method for tax purposes.These differences result in deferred tax assets and liabilities, which areincluded within our balance sheet. We must then in accordance with FinancialAccounting Standards Board Statement No. 109, *Accountingfor Income Taxes*, assess the realizability of the deferred taxassets. Accordingly, we have fully reserved our net deferred tax assetsprimarily as a result of experiencing a cumulative loss before income taxes forthe three-year period ended June 30, 2006. We also considered possible tax planning strategies. In assessing therealizability of the deferred tax assets, management considers whether it ismore likely than not that some portion, or all of the deferred tax assets, willbe realized.  The ultimate realization ofdeferred tax assets is dependent upon the generation of future taxable income(including reversals of deferred tax liabilities) during the periods in whichthose temporary differences will become deductible.

*Goodwill*.As of December 31, 2006, we had goodwill of $14.8 million, which represents2.9% of our total assets. We test goodwill annually for impairment and recordan impairment charge if the carrying amount exceeds the fair value. We use adiscounted cash flow approach as well as other methods to determine the fairvalue used in our test for impairment of goodwill. The results of thismethodology depend upon a number of estimates and assumptions relating to cashflows, discount rates and other matters. Accordingly, such testing is subjectto certain uncertainties, which could cause the fair value of goodwill tofluctuate from period to period.

**RecentAccounting Pronouncements**

In June 2006, theFASB issued FASB Interpretation 48 (“FIN 48”), *Accountingfor Uncertainty in Income Taxes,* which is an interpretation of FASBStatement No. 109. FIN 48 clarifies the accounting for uncertainty in incometaxes recognized in an entity’s financial statements. FIN 48 prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. FIN 48 is effective for fiscal years beginning after December 15,2006. We will adopt FIN 48 on or before July 1, 2007. We are currentlyevaluating the requirements of FIN 48 but have not determined what, if any,impact it will have on our consolidated financial statements.

##### **Off-Balance Sheet Arrangements**

We do not have anyoff-balance sheet arrangements, as defined in Regulation S-K Item303(a)(4)(ii)(A)-(D), that have or are reasonably likely to have a current orfuture effect on our financial condition, changes in financial condition,revenues or expenses, results of operations, liquidity, capital expenditures orcapital resources that is material to investors.

**Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

We have interestrate risk, in that borrowings under our credit facility are based on variablemarket interest rates. As of December 31, 2006, we had $254.0 million ofvariable rate debt outstanding under our credit facility. Presently, therevolving credit line bears interest at a rate of prime plus 2.25% or LIBORplus 3.25%, with the term loan at a rate of prime plus 2.75% or LIBOR plus3.75%. To control our exposure to interest rates under our facility, we utilizeinterest rate caps. As of December 31, 2006, we were not required to purchaseinterest rate caps. A hypothetical 10% increase in our credit facility’sweighted average interest rate of 9.0% per annum for the six months endedDecember 31, 2006 would correspondingly decrease our earnings and operatingcash flows by approximately $1.1 million.

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Our privatelyissued $22.3 million subordinated notes due March 1, 2010 have a fixed interestrate of 14.5%, but have exposure to changes in the debt’s fair value. Inconnection with our August 2003 refinancing, we amended the terms of thesesubordinated notes to extend the maturity date from January 18, 2009 to March1, 2010 and to increase the interest rate from 13.5% per annum to 14.5% perannum. In addition, we issued $160.0 million aggregate principal amount of oursenior subordinated notes due September 1, 2010 with a fixed interest rate of11.75%, which has exposure to changes in the debt’s fair value.  We believe that the fair value of our totalsubordinated debt is approximately $181.4 million (book value of $182.3million).  The fair value of our totalsubordinated debt is based on the quoted market price of our seniorsubordinated debt.

**Item 4.  Controls and Procedures**

We maintain asystem of controls and procedures designed to provide reasonable assurance asto the reliability of the financial statements and other disclosures includedin this report, as well as to safeguard assets from unauthorized use ordisposition.  We evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures as defined in the Securities Exchange Act of 1934 Rules 13a-15(e)and 15d-15(e) under supervision and with the participation of management,including our Chief Executive Officer and Chief Financial Officer.  Based upon that evaluation, as of the end ofthe period covered by this Quarterly Report on Form 10-Q our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures as defined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934  are effective intimely alerting them to material information required to be included in ourperiodic Securities and Exchange Commission filings. No significant changeswere made to our internal controls over financial reporting or in other factorsthat have materially affected or are reasonably likely to materially affectthese controls during our most recent fiscal quarter. The design of any systemof controls and procedures is based in part upon certain assumptions about thelikelihood of future events.

**PART II .  OTHER INFORMATION**

**Item 1.  Legal Proceedings**

We are party tovarious legal proceedings and claims that have arisen in the ordinary course ofour business. In the opinion of management, the amount of ultimate liabilitywith respect to these actions will not have a material impact on our financialposition or results of operations.

**Item 1A.  Risk Factors**

There have been no material changes in our risk factors from those disclosed in our AnnualReport on Form 10-K for the years ended June 30, 2006.

**Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds**

None.

**Item 3.  Defaults Upon Senior Securities**

None.

**Item4.  Submission of Matters to a Vote ofSecurity Holders**

None.

**Item 5.  Other Information**

None.

**Item 6.  Exhibits**

2.1                                 RecapitalizationAgreement, dated July 14, 2004, among Monitronics International, Inc., AustinVentures III-A, L.P., Austin Ventures III-B, L.P., Austin Ventures V, L.P.,Austin Ventures V Affiliates Fund, Capital Resource Lenders II, L.P., ABRYPartners IV, L.P., ABRY Investment Partnership, L.P., Windward Capital PartnersII, L.P., Windward Capital LP II, LLC, New York Life Capital Partners II, L.P.,PPM America Private Equity Fund LP and The Northwestern Mutual Life 

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Insurance Company (previously filed as Exhibit 2.1 toAmendment No. 3 to the registrant’s Registration Statement on Form S-4 (FileNo. 333-110025) and incorporated herein by reference)

3.1                                 RestatedArticles of Incorporation of Monitronics International, Inc.  (previously filed as Exhibit 3.1 to AmendmentNo. 3 to the registrant’s Registration Statement on Form S-4 (File No.333-110025) and incorporated herein by reference)

3.2                                 Bylawsof Monitronics International, Inc. (previously filed as Exhibit 3.2 to theregistrant’s Registration Statement on Form S-4 (File No. 333-1100025) andincorporated herein by reference)

31.1*                    Certificationof the Chief Executive Officer of Monitronics International, Inc. pursuant toRule 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adoptedpursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2*                    Certificationof the Chief Financial Officer of Monitronics International, Inc. pursuant toRule 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adoptedpursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1**             Certification of theChief Executive Officer of Monitronics International, Inc. pursuant to 18U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-OxleyAct of 2002

32.2**             Certification of theChief Financial Officer of Monitronics International, Inc. pursuant to 18U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-OxleyAct of 2002

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*      Filed herewith.

**   Furnished herewith.

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**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                               |   | MONITRONICS  INTERNATIONAL, INC. |
|-------------------------------|--------|----------------------------------|
|                          |   |                             |   |
|                          |   |                             |   |
|                          |   | By:                              | /s/  Michael R. Haislip |
|                          |   |                             | Michael  R. Haislip |
|                          |   |                             | Chief Executive Officer and President |
|                          |   |                             | (Principal  Executive Officer) |
|                          |   |                             |   |
|                          |   |                             |   |
|                          |   |                             |   |
|                          |   | By:                              | /s/ Michael R. Meyers |
|                          |   |                             | Michael  R. Meyers |
|                          |   |                             | Chief  Financial Officer and Vice President |
| Date:  February 13, 2007 |   |                             | (Principal  Financial and Accounting Officer) |

 

 

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