**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 
| x                                                      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                   |       |                                                                                          |
| **For the  quarterly period ended September 30, 2006** |
| ** **                                             |       | ** **                                                                                    |
| **o**                                                  |       | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

** **

**For the transition period from            to            **

** **

**CommissionFile Number 333-110025**

** **

**Monitronics International, Inc.**

(Exact name of registrantas specified in its charter)

 

| **Texas**                        |   | ** **                               |
|----------------------------------|--------|------------------------------------------|
| (State or other  jurisdiction of |   | **74-2719343**                           |
| incorporation or  organization)  |   | (I.R.S. Employer  Identification Number) |

 

**2350Valley View Lane, Suite 100**

**Dallas, Texas  75234**

(Address of principal executiveoffices)

(ZipCode)

 

**(972) 243-7443**

(Registrant’s telephonenumber, including area code)

 

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes x  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the ExchangeAct.  

 

| Large accelerated filer  o |   | Accelerated  filer  o |   | Non-accelerated  filer  x |
|--------------------------------------|--------|---------------------------------|--------|-------------------------------------|

 

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

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date:

 

| **Title of Each Class**                         |   | **Outstanding  at October 31, 2006** |
|-------------------------------------------------|--------|--------------------------------------|
| 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 September 30, 2006 and June 30, 2006                        |   | 3 |
|                                         |       | Consolidated  Statements of Operations for the three months ended September 30, 2006 and  2005 |   | 4 |
|                                         |       | Consolidated  Statements of Cash Flows for the three months ended September 30, 2006 and  2005 |   | 5 |
|                                         |       | Notes to Consolidated Financial Statements                                                     |   |   |
| Item 2.                                      |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations    |   | 12 |
| Item 3.                                      |       | Quantitative  and Qualitative Disclosures About Market Risk                                    |   | 18 |
| Item 4.                                      |       | Controls and  Procedures                                                                       |   | 18 |
| **Part II  Other  Information**    |       |                                                                                           |
| Item 1.                                      |       | Legal Proceedings                                                                              |   | 18 |
| Item 2.                                      |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                   |   | 18 |
| Item 3.                                      |       | Defaults Upon  Senior Securities                                                               |   | 19 |
| Item 4.                                      |       | Submission of  Matters to a Vote of Security Holders                                           |   | 19 |
| Item 5.                                      |       | Other Information                                                                              |   | 19 |
| Item  6.                                     |       | Exhibits                                                                                       |   | 19 |
| **Signatures**                               |       |                                                                                           |
|                                              |            |                                                                                                |  |  |  |

#####  

#####  

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**PARTI.   FINANCIAL INFORMATION**

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

**MONITRONICSINTERNATIONAL, INC.**

## **CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share data)**
| ** **                                                                                                                    | ** **   | **September 30,**                  | ** **   | **June 30,** | ** **   |
|-------------------------------------------------------------------------------------------------------------------------------|--------------|-----------------------------------------|--------------|-------------------|--------------|
| ** **                                                                                                                    | ** **   | **2006**                                | ** **   | **2006**          | ** **   |
| ** **                                                                                                                    | ** **   | **  (Unaudited)  ** | ** **   | ** **        | ** **   |
| **Assets**                                                                                                                    | *** *** | *** ***                            | *** *** | *** ***      | *** *** |
| Current assets:                                                                                                               |         |                                    |         |              |         |
| Cash and cash  equivalents                                                                                                    |         | $                                       | 1,242        |              | $            | 862 |   |
| Accounts  receivable, less allowance for doubtful accounts of $1,467 as of September  30, 2006 and $1,763 as of June 30, 2006 |         | 6,966                                   |         | 6,888             |         |
| Prepaid expenses  and other current assets                                                                                    |         | 2,021                                   |         | 1,154             |         |
| Total current assets                                                                                                          |         | 10,229                                  |         | 8,904             |         |
|                                                                                                                          |         |                                    |         |              |         |
| Property and equipment,  net                                                                                                  |         | 10,123                                  |         | 10,102            |         |
| Subscriber accounts,  net of accumulated amortization of $450,475 as of September 30, 2006 and  $434,095 as of June 30, 2006  |         | 472,417                                 |         | 470,112           |         |
| Deferred financing costs,  net                                                                                                |         | 8,950                                   |         | 9,643             |         |
| Goodwill                                                                                                                      |         | 14,795                                  |         | 14,795            |         |
| Total assets                                                                                                                  |         | $                                       | 516,514      |              | $            | 513,556 |   |
|                                                                                                                          |         |                                    |         |              |         |
| **Liabilities  and Shareholders’ Net Capital**                                                                           | ** **   | ** **                              | ** **   | ** **        | ** **   |
| Current liabilities:                                                                                                          |         |                                    |         |              |         |
| Accounts payable                                                                                                              |         | $                                       | 1,846        |              | $            | 2,794 |   |
| Accrued expenses                                                                                                              |         | 3,755                                   |         | 3,261             |         |
| Purchase holdbacks                                                                                                            |         | 9,016                                   |         | 8,676             |         |
| Deferred revenue                                                                                                              |         | 5,479                                   |         | 5,405             |         |
| Interest payable                                                                                                              |         | 3,137                                   |         | 6,508             |         |
| Taxes payable                                                                                                                 |         | 360                                     |         | 124               |         |
| Current portion  of long-term debt                                                                                            |         | 8,936                                   |         | 7,185             |         |
| Total current  liabilities                                                                                                    |         | 32,529                                  |         | 33,953            |         |
|                                                                                                                          |         |                                    |         |              |         |
| Non-current  liabilities:                                                                                                     |         |                                    |         |              |         |
| Long-term debt,  less current portion                                                                                         |         | 428,371                                 |         | 421,076           |         |
| Redeemable  preferred stock, net                                                                                              |         | 49,209                                  |         | 48,098            |         |
| Total non-current  liabilities                                                                                                |         | 477,580                                 |         | 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 September 30, 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, 915,099 shares as of September 30, 2006 and 915,099 shares as of  June 30, 2006                     |         | (9,358                                  | )            | (9,358            | )            |
| Accumulated  deficit                                                                                                          |         | (109,367                                | )            | (105,343          | )            |
| Total shareholders’ net  capital                                                                                         |         | 6,405                                   |         | 10,429            |         |
| Total liabilities and shareholders’ net capital                                                                          |         | $                                       | 516,514      |              | $            | 513,556 |   |

 

*Seeaccompanying notes.*

3

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**MONITRONICS INTERNATIONAL, INC.**

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

**(Unaudited)**

** **
| ** **                        | ** ** | **Three Months Ended  September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **(In thousands)**                              | ** ** |
|                              |       |                                                 |       |   |   |
| Revenue                           |       | $                                                    | 47,530     |   | $ | 44,952 |   |
| Cost of services                  |       | 5,990                                                |       | 5,508 |   |
| Gross profit                      |       | 41,540                                               |       | 39,444 |   |
|                              |       |                                                 |       |   |   |
| Operating  expenses:              |       |                                                 |       |   |   |
| Sales, general and administrative |       | 8,790                                                |       | 8,741 |   |
| Depreciation                      |       | 616                                                  |       | 617 |   |
| Amortization                      |       | 22,712                                               |       | 21,483 |   |
|                              |       | 32,118                                               |       | 30,841 |   |
| Operating income                  |       | 9,422                                                |       | 8,603 |   |
|                              |       |                                                 |       |   |   |
| Other expense:                    |       |                                                 |       |   |   |
| Interest expense                  |       | 13,119                                               |       | 10,919 |   |
|                              |       | 13,119                                               |       | 10,919 |   |
| Loss before  income taxes         |       | (3,697                                               | )          | (2,316 | ) |
| Provision from  income taxes      |       | 327                                                  |       | 13 |   |
| Net loss                          |       | $                                                    | (4,024     | ) | $ | (2,329 | ) |

 

*Seeaccompanying notes.*

4

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**MONITRONICSINTERNATIONAL, INC.**

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

**(Unaudited)**
| ** **                                                                       | ** ** | **Three Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                                                                       | ** ** | **(In thousands)**                              | ** ** |
| **Operating Activities**                                                    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Net loss                                                                         |       | $                                                    | (4,024     | ) | $ | (2,329 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities: |       |                                                 |       |   |   |
| Depreciation and amortization                                                    |       | 23,328                                               |       | 22,100 |   |
| Amortization of deferred financing costs                                         |       | 693                                                  |       | 694 |   |
| Provision for bad debt                                                           |       | 660                                                  |       | 925 |   |
| Non-cash interest expense for redeemable preferred  stock                        |       | 1,111                                                |       | — |   |
| Non-cash interest accretion                                                      |       | 31                                                   |       | 27 |   |
| Non-cash expense related to put option                                           |       | 3                                                    |       | 84 |   |
| Changes in current assets and liabilities:                                       |       |                                                 |       |   |   |
| Accounts receivable (excluding provision for bad  debt)                          |       | (738                                                 | )          | (1,500 | ) |
| Prepaid expenses and other current assets                                        |       | (867                                                 | )          | 7 |   |
| Accounts payable                                                                 |       | (948                                                 | )          | 168 |   |
| Accrued expenses                                                                 |       | 494                                                  |       | 333 |   |
| Accrued interest                                                                 |       | (3,371                                               | )          | (4,575 | ) |
| Deferred revenue                                                                 |       | 74                                                   |       | (595 | ) |
| Income taxes payable and receivable                                              |       | 236                                                  |       | 108 |   |
| Net cash  provided by operating activities                                       |       | 16,682                                               |       | 15,447 |   |
|                                                                             |       |                                                 |       |   |   |
| **Investing  Activities**                                                        | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Purchases of  property and equipment                                             |       | (637                                                 | )          | (1,532 | ) |
| Sale of land                                                                     |       | —                                               |       | 40 |   |
| Purchases of  subscriber accounts (net of holdbacks)                             |       | (24,677                                              | )          | (35,712 | ) |
| Net cash used in  investing activities                                           |       | (25,314                                              | )          | (37,204 | ) |
|                                                                             |       |                                                 |       |   |   |
| **Financing  Activities**                                                        | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Proceeds from  credit facility                                                   |       | 24,650                                               |       | 36,450 |   |
| Payments of  credit facility                                                     |       | (15,638                                              | )          | (13,738 | ) |
| Net cash  provided by financing activities                                       |       | 9,012                                                |       | 22,712 |   |
| Increase  (decrease) in cash and cash equivalents                                |       | 380                                                  |       | 955 |   |
| Cash and cash  equivalents at beginning of period                                |       | 862                                                  |       | 190 |   |
| Cash and cash  equivalents at end of period                                      |       | $                                                    | 1,242      |   | $ | 1,145 |   |
| * *                                                                         | * *   | * *                                             | * *   | * * | * * |
| Significant cash  transactions during the period for:                            |       |                                                 |       |   |   |
| Interest paid                                                                    |       | $                                                    | 14,549     |   | $ | 14,669 |   |

* *

*See accompanying notes*

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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 notinclude all of the information and footnotes required by generally acceptedaccounting principles.  In the opinion ofmanagement, the accompanying interim unaudited financial statements contain alladjustments (consisting of normal recurring adjustments) considered necessaryfor a fair presentation of the results of operations for the interim periods.

*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)”) issuedby the Finacial Accounting Standards Board (“FASB”), to account for stock-basedemployee compensation arrangements. Under the “prospective” transition method,the Company will continue to account for nonvested awards outstanding at thedate of adoption of SFAS 123(R) in the same manner as they had been accountedfor under Accounting Principles Board Opinion No. 25, *Accountingfor Stock Issued to Employees*(“APB25”). All awards granted or modified after the date of adoption will beaccounted for using the measurement and recognition provisions of SFAS 123(R).Proforma disclosure for outstanding awards accounted for under theintrinsic-value method of APB 25 will no longer be 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. This interpretation clarifies the accounting for uncertaintyin income taxes recognized in an entity’s financial statements. This Interpretationprescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. FIN 48 is effective for fiscal years beginning afterDecember 15, 2006. The Company will adopt FIN 48 on or before July 1, 2007. TheCompany is currently evaluating the requirements of FIN 48 but has notdetermined what, if any, impact it will have on the Company’s consolidatedfinancial statements.

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

Non-currentliabilities consist of the following  (inthousands):
| ** **                                                            | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                            | ** ** | **2006**               | ** ** | **2006**          | ** ** |
| Revolving credit  line and term loan payable                          |       | $                      | 255,350    |              | $          | 246,687 |   |
| Senior  subordinated notes payable                                    |       | 160,000                |       | 160,000           |       |
| Subordinated  notes payable                                           |       | 22,017                 |       | 22,017            |       |
| Investor put  option (see Note 3 (Related Party Transactions))        |       | 559                    |       | 556               |       |
|                                                                  |       |                   |       |              |       |
| Redeemable  preferred stock (see Note 4 (Redeemable Preferred Stock)) |       | 49,209                 |       | 48,098            |       |
|                                                                  |       | 487,135                |       | 477,009           |       |
| Less: discount                                                        |       | 619                    |       | 650               |       |
| Less: current portion                                                 |       | 8,936                  |       | 7,185             |       |
|                                                                  |       | $                      | 477,580    |              | $          | 469,174 |   |

 

6

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On August 25, 2003, the Company entered into its existing $320 million creditfacility agreement comprised of a $175.0 million term loan that matures infiscal year 2010 and a $145.0 million revolving credit facility that matures infiscal 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 ofSeptember 30, 2006, the Company had $85.6 million in borrowings outstandingunder the $145 million revolving credit line and had $169.8 million inborrowings outstanding under the term loan. Further, the Company had $59.4million in availability under the revolving credit line of which $48.3 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 credit linebears interest at a rate of either prime plus 2.25% or LIBOR plus 3.25%. Theterm loan bears interest at a rate of either prime plus 2.75% or LIBOR plus3.75%.  For the three months endedSeptember 30, 2006, borrowings under the credit facility had a weighted averageinterest rate of 9.0%.  Interest incurredon borrowings 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 also 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 beginning on March 1, 2004.

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 senior subordinatednotes payable, to repurchase $20.5 million principal amount of its subordinatednotes at a repurchase price of approximately $23.2 million and to pay debtissuance costs. As part of the August 2003 refinancing, the terms of thethen-remaining $20.5 million principal amount of the subordinated notes wereamended, and the maturity date was extended to March 1, 2010. Interest on thesubordinated notes originally accrued at 13.5% per annum with interest payablesemi-annually at a rate of 12% per annum with the remaining 1.5% interest perannum added to the outstanding principal amount of the subordinated notes. The1.5% interest rate increased to 2.5% per annum on December 15, 2003 when thesubordinated notes were not repurchased by that date, and the increased ratewas 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 ofSeptember 30, 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 September 30, 2006, thePartnership had sold the Company $1,000,000 worth of Class A common stock.  The fair value of the remaining investor putoption was $0.6 million at September 30, 2006. See Note 3 (Related Party Transactions) to these consolidated financialstatements.

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Scheduledmaturities (as defined) of long-term debt at September 30, 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):

| 2007       |   | $       | 6,749   |   |
|------------|--------|---------|---------|--------|
| 2008       |   | 67,333  |    |
| 2009       |   | 106,786 |    |
| 2010       |   | 146,267 |    |
| 2011       |   | 160,000 |    |
| Thereafter |   | —  |    |
|       |   | $       | 487,135 |   |

 

**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 ofSeptember 30, 2006, the Partnership had sold the Company 129,182 shares ofClass A common stock for $1,000,000.  Asof September 30, 2006, the outstanding liability for the put option was $0.6million.  The Company will adjust itsliability and related SG&A expense as the fair value of the put optionchanges.

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 September 30,2006, 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 

8

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preferred stock notifiedit of their election for the Series A preferred stock to begin accruingdividends as permitted under the Company’s articles of incorporation.  As a result of the Dividend Election, theCompany must redeem the Series A preferred stock on June 30, 2008. The terms ofthe Series A preferred stock following the Dividend Election are describedbelow.

***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 September30, 2006, the Company reported a liability for the Series A preferred stock of$49.2 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 $4.0million.  The liquidation preference ofthe Series A preferred stock as of September 30, 2006 is $48.5 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;

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·      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;

·      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 ofSeptember 30, 2006, the Series A preferred stock had an aggregate liquidationpreference of $48.5 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 $3.3 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”).

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**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 may causeactual results, performance or achievements to be materially different from anyfuture results, performance or achievements expressed or implied by suchforward-looking statements.  Factors,risks and uncertainties that could cause actual outcomes and results to bematerially 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,administration and operations.  Alldirect external costs associated with the creation of subscriber accounts arecapitalized and amortized over ten years using a 135% declining balance method.Internal costs, including all personnel and related support costs incurredsolely in connection with subscriber account acquisitions and transitions, areexpensed 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 base canbe 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.

Account cancellation,otherwise referred to as subscriber attrition, has a direct impact on thenumber of subscribers we serve and hence our financial results, includingrevenues, operating income and cash flow. We define our attrition rate as thenumber of canceled accounts in a given period divided by the average of thebeginning and ending balance of subscribers for that period. We consider anaccount canceled when a subscriber terminates in accordance either with theterms of the contract, our cancellation policies, or if payment from thesubscriber 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 September 30, 2006 and2005:
| ** **                                        | ** ** | **Twelve Months Ended  September 30,** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                              | ** ** | **2005** | ** ** |
| Beginning  balance of accounts                    |       | 486,859                                               |       | 451,462 |   |
| Accounts  purchased                               |       | 67,218                                                |       | 97,315 |   |
| Accounts  canceled (1)                            |       | (63,387                                               | )          | (60,551 | ) |
| Accounts  guaranteed to be refunded from holdback |       | (3,788                                                | )          | (1,367 | ) |
| Ending balance  of accounts                       |       | 486,902                                               |       | 486,859 |   |
| Attrition rate                                    |       | 13.0                                                  | %          | 12.9 | % |

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(1) Net of canceled accountsthat are contractually guaranteed by the dealer and new owner  takeovers.

 

Our 12-month trailing attrition rate increased only slightly on ayear-over-year basis (13.0% versus 12.9%). We saw an expected increase inattrition this summer which resulted in a moderate increase versus the 12-monthperiod ended June 30, 2006 when our attrition rate was 12.2%. This increase insummer attrition was primarily due to significantly more subscribers thantypical reaching the end of their initial 3-year term during the period due tohigher purchase volumes in the summer of 2003. As discussed above, our poolattrition data shows that attrition rates peak during the few months followingthe end of the initial term and then decrease beyond that point.

**Resultsof Operations**

*ThreeMonths Ended September 30, 2006 Compared to Three Months Ended September 30,2005*

*Revenues.*Total revenues were $47.5 million in the three months ended September 30, 2006compared to $45.0 million in the three months ended September 30, 2005, whichwas an increase of $2.5 million, or 6%. This increase was primarilyattributable to an increase in the average revenue per subscriber as well asthe average number of subscriber accounts.

*Costof services.* Cost of services was $6.0 million for the threemonths ended September 30, 2006 compared to $5.5 million for the three monthsended September 30, 2005, which was an increase of $0.5 million, or 9%. As apercentage of revenues, cost of services was 12.6% for the three months endedSeptember 30, 2006 compared to 12.3% for the three months ended September 30,2005 due to higher complementary field technical service expense related toretaining customers and increased costs associated with our lead generation programfor our authorized dealers.

*Sales,general and administrative (SG&A). *SG&Awas $8.8 million for the three months ended September 30, 2006 compared to $8.7million for the three months ended September 30, 2005, which was an increase of$0.1 million, or 1%. As a percentage of revenues, SG&A was 18.5% for thethree months ended September 30, 2006 versus 19.4% for the three months ended September30, 2005.  The decrease in SG&Aexpense as a percent of revenue was principally due to a lower allowance fordoubtful accounts.

*Amortization.*Amortization of intangibles was $22.7 million in the three months endedSeptember 30, 2006 compared to $21.5 million in the three months endedSeptember 30, 2005, which was an increase of $1.2 million, or 6%. The increasewas attributable to the purchase of subscriber accounts through our authorizeddealer program.

*Interestexpense*. Interest expense was $13.1 million in the threemonths ended September 30, 2006 compared to $10.9 million in the three monthsended September 30, 2005, which was an increase of $2.2 million, or 20%.  The increase resulted from the $0.9 millionof interest expense related to the Dividend Election made by our redeemablepreferred shareholders on November 4, 2005 (see Note 4 (Redeemable PreferredStock) to our consolidated financial statements included in this QuarterlyReport on Form 10-Q) and increases in variable interest rates.

*Netloss.*  Net loss was $4.0million in the three months ended September 30, 2006 compared to net loss of$2.3 million in the three months ended September 30, 2005 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.

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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 andamount of our payment of the purchase holdbacks to dealers, and the percentageof the purchase price we withhold to ensure a dealer’s obligation during theguarantee period. Accrued interest payable is dependent on the level of ourdebt and the timing of interest payments.

As of September30, 2006 and June 30, 2006, we had working capital deficits of $22.3 millionand $25.0 million, respectively.  The $2.7million improvement in our working capital was primarily due to a $3.4 millionreduction in interest payable which decreased to $3.1 million as of September30, 2006 compared to $6.5 million as of June 30, 2006. The decrease in interestpayable was primarily due to the semi-annual payment, on September 1, 2006, ofinterest related to our $160 million of senior subordinated notes.

Net cash providedby operating activities for the three months ended September 30, 2006 was $16.7million compared to $15.4 million for the three months ended September 30,2005. The increase in cash provided by operating activities for the threemonths ended September 30, 2006 was primarily due to growth in subscriberrevenues.

Net cash used ininvesting activities for the three months ended September 30, 2006 was $25.3million, compared to $37.2 million for the three months ended September 30,2005. For the three months ended September 30, 2006, capital expenditures were$0.6 million versus $1.5 million for the three months ended September 30, 2005.Capital expenditures were primarily for upgrading computer systems andleasehold improvements for our offices. Capital expenditures are expected tovary based on the growth of our subscriber account base and improvements to ourtechnology, operating and financial systems. Purchases of subscriber accountsconsist of all direct external payments associated with the creation ofsubscriber accounts. The portion of the purchase holdback paid to dealers atthe end of the guarantee period is included in this amount when paid.  The decrease in subscriber account purchasesto $24.7 million primarily reflects discontinuing account purchases from ourlargest dealer during second quarter of fiscal year 2006.

Our net cashprovided by financing activities for the three months ended September 30, 2006was $9.0 million, as compared to $22.7 million for the three months endedSeptember 30, 2005.

As of September30, 2006, we had $255.4 million outstanding under our credit facility, bearinginterest at a weighted average rate for the three months ended September 30,2006 of approximately 9.0% per annum, and we had approximately $59.4 million inborrowing availability under our revolving credit line, of which $48.3 millionwas immediately available as calculated under the covenants in our credit facility.  In addition, we had $182.0 million inprincipal amount outstanding of senior subordinated and subordinated notes asof September 30, 2006.

As of June 30,2006, 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 September 30, 2006, we reported a liability for the Series A preferredstock of $49.2 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 $4.0 million.  The liquidation preference of the Series A preferredstock as of September 30, 2006 is $48.5 million as calculated per our articlesof incorporation (see Liquidation Preference in Note 4 - Redeemable PreferredStock to the consolidated financial statements, included in this Quarterly Reporton Form 10-Q).

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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 amaturity date of September 1, 2010. Interest payments are to be madesemi-annually in cash in arrears on March 1 and September 1 of each yearbeginning on March 1, 2004.  On December16, 2004, we completed an exchange offer in which we exchanged new notes thatwere registered under the Securities Act of 1933 for the senior subordinatednotes.

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 throughSeptember 30, 2007 and 3.00% for the quarters ended December 31, 2007 throughJune 30, 2009 with the remaining balance due at maturity. We used theborrowings under this credit facility together with the proceeds of the seniorsubordinated notes offering primarily to repay our prior credit facility, torepay all of our $12 million 12% senior subordinated notes due June 30, 2007,and to repurchase $20.5 million principal amount of our 14.5% subordinatednotes due March 1, 2010 at a repurchase price of approximately $23.2million.  In connection with our August2003 refinancing, we amended the terms of our subordinated notes to extend thematurity date of the then remaining $20.5 million principal amount from January18, 2009 to March 1, 2010. Prior to the amendment, interest accrued on thesubordinated notes at 13.5% per annum with interest payable semi-annually incash at a rate of 12% per annum with the remaining 1.5% interest per annumadded to the outstanding principal amount of the subordinated notes. The 1.5%per annum interest rate increased to 2.5% per annum on December 15, 2003 andthe increased rate applied retroactively to August 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 as low as possible ongoing cash balance. However, our ability tomeet our debt service and other obligations depends on our future performance,which in turn is subject to general economic conditions and other factors,certain of which are beyond our control. If we are unable to generatesufficient cash flow from operations or otherwise to comply with the terms ofthe indenture governing the senior subordinated notes or our other debtinstruments, we may be required to refinance all or a portion of our existingdebt or obtain additional financing. Further, the agreements or indenturesgoverning our credit facility, our senior subordinated notes and subordinatednotes contain financial covenants relating to capital expenditure limits,maximum total debt to annualized quarterly EBITDA, maximum total senior debt toannualized quarterly EBITDA, interest coverage and fixed charge coverage thatmay impact our ability to refinance all or a portion of our existing debt orobtain additional financing.  As ofSeptember 30, 2006, we were in compliance 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 inmaking estimates 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 

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been materially differentunder a different set of assumptions and estimates for certain accountingprinciple 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.

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 assets primarilyas a result of experiencing a cumulative loss before income taxes for thethree-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 September 30, 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. This interpretation clarifies the accounting for uncertaintyin income taxes recognized in an entity’s financial statements. ThisInterpretation prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. FIN 48 is effective for fiscal yearsbeginning after December 

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15, 2006. We will adoptFIN 48 on or before July 1, 2007. We are currently evaluating the requirementsof FIN 48 but have not determined what, if any, impact it will have on ourconsolidated 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 September 30, 2006, we had $255.4 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 September 30, 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 three months endedSeptember 30, 2006 would correspondingly decrease our earnings and operatingcash flows by approximately $0.6 million.

Our privatelyissued $22.0 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 $176.6 million (book value of $182.0million).  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 in timelyalerting them to material information required to be included in our periodicSecurities and Exchange Commission filings. No significant changes were made toour internal controls over financial reporting or in other factors that havematerially affected or are reasonably likely to materially affect thesecontrols during our most recent fiscal quarter. The design of any system ofcontrols 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 2.  Unregistered Sales of Equity Securities andUse of Proceeds**

None.

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**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    | Recapitalization Agreement, dated July 14, 2004,  among Monitronics International, Inc., Austin Ventures 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., ABRY Partners IV, L.P., ABRY  Investment Partnership, L.P., Windward Capital Partners II, 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 Insurance Company  (previously filed as Exhibit 2.1 to Amendment No. 3 to the registrant’s  Registration Statement on Form S-4 (File No. 333-110025) and incorporated  herein by reference) |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   | 3.1    | Restated Articles of Incorporation of Monitronics  International, Inc.  (previously filed  as Exhibit 3.1 to Amendment No. 3 to the registrant’s Registration Statement  on Form S-4 (File No. 333-110025) and incorporated herein by reference)                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   | 3.2    | Bylaws of Monitronics International, Inc.  (previously filed as Exhibit 3.2 to the registrant’s Registration Statement  on Form S-4 (File No. 333-1100025) and incorporated herein by reference)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   | 31.1*  | Certification of the Chief Executive Officer of  Monitronics International, Inc. pursuant to Rule 15d-14(a) of the Securities  Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   | 31.2*  | Certification of the Chief Financial Officer of  Monitronics International, Inc. pursuant to Rule 15d-14(a) of the Securities  Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   | 32.1** | Certification of the Chief Executive Officer of  Monitronics International, Inc. pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   | 32.2** | Certification of the Chief Financial Officer of  Monitronics International, Inc. pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act 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: November 14,  2006 |                            | (Principal  Financial and Accounting Officer) |   |

 

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