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UNITED STATES

SECURITIES 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, 2005
| | -------------------------------------------------



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



For the transition period from
 to



Commission File Number 333-110025



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Monitronics International, Inc.

(Exact name of registrant as specified in its charter)



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



2350 Valley View
Lane, Suite 100

Dallas, Texas 75234

(Address of principal executive offices)

(Zip Code)



(972) 243-7443

(Registrants telephone number, including area code)



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



Indicate by check mark whether the registrant is an
accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ̈No x



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



Indicate the number of shares outstanding of each of the
issuers classes of common stock, as of the latest practicable date:



|                                               |  |                                
|---------------------------------------------- |  | -------------------------------
|Title of Each Class                            |  | Outstanding at October 31, 2005
|Class A Common Stock, par value $.01 per share |  | 31,090,317                     
|Class B Common Stock, par value $.01 per share |  | None                           



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##### Table of Contents

|                              |  |                                                                                       |  |     
|----------------------------- |  | ------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                       |  | Page
|                              | 
|Part I Financial Information: |  |                                                                                      
|                              |  |                                                                                      
|Item 1.                       |  | Financial Statements                                                                  |  | 3   
|                              |  |                                                                                      
|                              |  | Balance Sheets as of September 30, 2005 and June 30, 2005                             |  | 3   
|                              |  |                                                                                      
|                              |  | Statements of Operations for the three months ended September 30, 2005 and 2004       |  | 4   
|                              |  |                                                                                      
|                              |  | Statements of Cash Flows for the three months ended September 30, 2005 and 2004       |  | 5   
|                              |  |                                                                                      
|                              |  | Notes to Financial Statements                                                         |  | 6   
|                              |  |                                                                                      
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 10  
|                              |  |                                                                                      
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 16  
|                              |  |                                                                                      
|Item 4.                       |  | Controls and Procedures                                                               |  | 16  
|                              | 
|Part II Other Information     |  |                                                                                      
|                              |  |                                                                                      
|Item 1.                       |  | Legal Proceedings                                                                     |  | 16  
|                              |  |                                                                                      
|Item 2.                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 16  
|                              |  |                                                                                      
|Item 3.                       |  | Defaults Upon Senior Securities                                                       |  | 17  
|                              |  |                                                                                      
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                   |  | 17  
|                              |  |                                                                                      
|Item 5.                       |  | Other Information                                                                     |  | 17  
|                              |  |                                                                                      
|Item 6.                       |  | Exhibits                                                                              |  | 17  
|                              | 
|Signatures                    |  |                                                                                      



2



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##### Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements



MONITRONICS INTERNATIONAL, INC.

BALANCE SHEETS



(In thousands, except share data)



|                                                                                                                           |  |                   |         |   |              |   |         |  
|-------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ------------ | - | ------- | -
|                                                                                                                           |  | September 30,2005 |         |   | June 30,2005 |  
|                                                                                                                           |  | (Unaudited)       |         |   |              |  
|Assets                                                                                                                     |  |                   |         |   |              |   |         |  
|Current assets:                                                                                                            |  |                   |         |   |              |   |         |  
|Cash and cash equivalents                                                                                                  |  | $                 | 1,145   |   |              | $ | 190     |  
|Accounts receivable, net                                                                                                   |  |                   | 6,967   |   |              |   | 6,392   |  
|Federal income tax receivable                                                                                              |  |                   | 8,343   |   |              |   | 8,427   |  
|Prepaid expenses and other current assets                                                                                  |  |                   | 1,117   |   |              |   | 1,124   |  
|                                                                                                                           |  |                   |         |   |              |   |         |  
|Total current assets                                                                                                       |  |                   | 17,572  |   |              |   | 16,133  |  
|                                                                                                                           |  |                  
|Property and equipment, net                                                                                                |  |                   | 8,092   |   |              |   | 7,215   |  
|Subscriber accounts, net of accumulated amortization of $381,166 as of September 30, 2005 and $361,727 as of June 30,
2005 |  |                   | 485,751 |   |              |   | 471,212 |  
|Deferred financing costs, net                                                                                              |  |                   | 11,724  |   |              |   | 12,418  |  
|Goodwill                                                                                                                   |  |                   | 14,795  |   |              |   | 14,795  |  
|                                                                                                                           |  |                   |         |   |              |   |         |  
|Total assets                                                                                                               |  | $                 | 537,934 |   |              | $ | 521,773 |  
|                                                                                                                           |  |                   |         |   |              |   |         |  
|                                                                                                                           |  |                  
|Liabilities and Shareholders Net Capital                                                                                  |  |                   |         |   |              |   |         |  
|Current liabilities:                                                                                                       |  |                   |         |   |              |   |         |  
|Accounts payable                                                                                                           |  | $                 | 2,722   |   |              | $ | 2,554   |  
|Accrued expenses                                                                                                           |  |                   | 2,746   |   |              |   | 2,413   |  
|Purchase holdbacks                                                                                                         |  |                   | 8,045   |   |              |   | 7,855   |  
|Deferred revenue                                                                                                           |  |                   | 5,270   |   |              |   | 5,865   |  
|Interest payable                                                                                                           |  |                   | 2,797   |   |              |   | 7,370   |  
|Taxes payable                                                                                                              |  |                   | 57      |   |              |   | 33      |  
|Current portion of long-term debt                                                                                          |  |                   | 1,805   |   |              |   | 1,804   |  
|                                                                                                                           |  |                   |         |   |              |   |         |  
|Total current liabilities                                                                                                  |  |                   | 23,442  |   |              |   | 27,894  |  
|Long-term debt, less current portion                                                                                       |  |                   | 448,631 |   |              |   | 425,809 |  
|Redeemable preferred stock, net                                                                                            |  |                   | 13,342  |   |              |   | 13,342  |  
|Commitments and contingencies                                                                                              |  |                   |         |   |              |   |         |  
|Shareholders net capital:                                                                                                 |  |                   |         |   |              |   |         |  
|Class A common stock, $.01 par value:                                                                                      |  |                   |         |   |              |   |         |  
|Authorized shares  80,000,000                                                                                             |  |                   |         |   |              |   |         |  
|Issued and outstanding shares  31,090,317 shares as of September 30, 2005 and 31,090,317 shares as of June 30,
2005       |  |                   | 311     |   |              |   | 311     |  
|Class B common stock, $.01 par value:                                                                                      |  |                   |         |   |              |   |         |  
|Authorized shares  700,000                                                                                                |  |                   |         |   |              |   |         |  
|Issued and outstanding shares  none                                                                                       |  |                   |        |   |              |   |        |  
|Additional paid-in capital                                                                                                 |  |                   | 156,677 |   |              |   | 156,677 |  
|Treasury stock, at cost, 843,194 shares as of September 30, 2005 and 843,194 shares as of June 30, 2005                    |  |                   | (8,913  | ) |              |   | (8,913  | )
|Accumulated deficit                                                                                                        |  |                   | (95,556 | ) |              |   | (93,347 | )
|                                                                                                                           |  |                   |         |   |              |   |         |  
|Total shareholders net capital                                                                                            |  |                   | 52,519  |   |              |   | 54,728  |  
|                                                                                                                           |  |                   |         |   |              |   |         |  
|Total liabilities and shareholders net capital                                                                            |  | $                 | 537,934 |   |              | $ | 521,773 |  
|                                                                                                                           |  |                   |         |   |              |   |         |  



See accompanying
notes.



3



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##### Table of Contents

MONITRONICS INTERNATIONAL, INC.

STATEMENTS OF OPERATIONS

(Unaudited)



|                                                                     |  |                                  |        |   |      |   |        |  
|-------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ---- | - | ------ | -
|                                                                     |  | Three Months Ended September 30, |       
|                                                                     |  | 2005                             |        |   | 2004 |  
|                                                                     |  | (In thousands)                   |       
|Revenue                                                              |  | $                                | 45,072 |   |      | $ | 40,546 |  
|Cost of services                                                     |  |                                  | 5,508  |   |      |   | 4,806  |  
|                                                                     |  |                                  |        |   |      |   |        |  
|Gross profit                                                         |  |                                  | 39,564 |   |      |   | 35,740 |  
|                                                                     |  |                                 
|Operating expenses:                                                  |  |                                  |        |   |      |   |        |  
|Sales, general and administrative                                    |  |                                  | 8,741  |   |      |   | 7,560  |  
|Depreciation                                                         |  |                                  | 617    |   |      |   | 507    |  
|Amortization                                                         |  |                                  | 21,483 |   |      |   | 18,841 |  
|                                                                     |  |                                  |        |   |      |   |        |  
|                                                                     |  |                                  | 30,841 |   |      |   | 26,908 |  
|                                                                     |  |                                  |        |   |      |   |        |  
|Operating income                                                     |  |                                  | 8,723  |   |      |   | 8,832  |  
|                                                                     |  |                                 
|Other expense:                                                       |  |                                  |        |   |      |   |        |  
|Interest expense                                                     |  |                                  | 10,919 |   |      |   | 9,832  |  
|                                                                     |  |                                  |        |   |      |   |        |  
|                                                                     |  |                                  | 10,919 |   |      |   | 9,832  |  
|                                                                     |  |                                  |        |   |      |   |        |  
|Loss before income taxes                                             |  |                                  | (2,196 | ) |      |   | (1,000 | )
|Provision (benefit) from income taxes                                |  |                                  | 13     |   |      |   | (185   | )
|                                                                     |  |                                  |        |   |      |   |        |  
|Net loss                                                             |  | $                                | (2,209 | ) |      | $ | (815   | )
|                                                                     |  |                                  |        |   |      |   |        |  
|                                                                     |  |                                 
|Preferred dividends accrued                                          |  |                                  |       |   |      |   | (878   | )
|Accretion of redeemable convertible preferred stock redemption value |  |                                  |       |   |      |   | (18    | )
|                                                                     |  |                                  |        |   |      |   |        |  
|Net loss attributed to common stock shareholders                     |  | $                                | (2,209 | ) |      | $ | (1,711 | )
|                                                                     |  |                                  |        |   |      |   |        |  



See accompanying
notes.



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MONITRONICS INTERNATIONAL, INC.

STATEMENTS OF CASH FLOWS

(Unaudited)



|                                                                                |  |                                  |         |   |      |   |          |  
|------------------------------------------------------------------------------- |  | -------------------------------- | ------- | - | ---- | - | -------- | -
|                                                                                |  | Three Months Ended September 30, |        
|                                                                                |  | 2005                             |         |   | 2004 |  
|                                                                                |  | (In thousands)                   |        
|Operating Activities                                                            |  |                                  |         |   |      |   |          |  
|Net loss                                                                        |  | $                                | (2,209  | ) |      | $ | (815     | )
|Adjustments to reconcile net loss to net cash provided by operating activities: |  |                                  |         |   |      |   |          |  
|Depreciation and amortization                                                   |  |                                  | 22,100  |   |      |   | 19,348   |  
|Amortization of deferred financing costs                                        |  |                                  | 694     |   |      |   | 655      |  
|Deferred income taxes                                                           |  |                                  |        |   |      |   | (504     | )
|Provision for bad debt                                                          |  |                                  | 925     |   |      |   | 765      |  
|Non-cash interest accretion                                                     |  |                                  | 27      |   |      |   | 24       |  
|Non-cash expense related to put option                                          |  |                                  | 84      |   |      |   | 470      |  
|Changes in current assets and liabilities:                                      |  |                                  |         |   |      |   |          |  
|Accounts receivable (excluding provision for bad debt)                          |  |                                  | (1,500  | ) |      |   | (1,356   | )
|Prepaid expenses and other current assets                                       |  |                                  | 7       |   |      |   | (262     | )
|Accounts payable                                                                |  |                                  | 168     |   |      |   | (326     | )
|Accrued expenses                                                                |  |                                  | 333     |   |      |   | (241     | )
|Accrued interest                                                                |  |                                  | (4,575  | ) |      |   | (4,389   | )
|Deferred revenue                                                                |  |                                  | (595    | ) |      |   | 111      |  
|Income taxes payable and receivable                                             |  |                                  | 108     |   |      |   | 355      |  
|                                                                                |  |                                  |         |   |      |   |          |  
|Net cash provided by operating activities                                       |  |                                  | 15,567  |   |      |   | 13,835   |  
|                                                                                |  |                                 
|Investing Activities                                                            |  |                                  |         |   |      |   |          |  
|Purchases of property and equipment                                             |  |                                  | (1,532  | ) |      |   | (872     | )
|Sale of land                                                                    |  |                                  | 40      |   |      |   |         |  
|Purchases of subscriber accounts (net of holdbacks)                             |  |                                  | (35,832 | ) |      |   | (33,844  | )
|                                                                                |  |                                  |         |   |      |   |          |  
|Net cash used in investing activities                                           |  |                                  | (37,324 | ) |      |   | (34,716  | )
|                                                                                |  |                                 
|Financing Activities                                                            |  |                                  |         |   |      |   |          |  
|Payment of deferred financing and issuance costs                                |  |                                  |        |   |      |   | (832     | )
|Proceeds from credit facility                                                   |  |                                  | 36,450  |   |      |   | 36,050   |  
|Payments of credit facility                                                     |  |                                  | (13,738 | ) |      |   | (8,738   | )
|Redemption of preferred stock                                                   |  |                                  |        |   |      |   | (5,610   | )
|                                                                                |  |                                  |         |   |      |   |          |  
|Net cash provided by financing activities                                       |  |                                  | 22,712  |   |      |   | 20,870   |  
|                                                                                |  |                                  |         |   |      |   |          |  
|Increase (decrease) in cash and cash equivalents                                |  |                                  | 955     |   |      |   | (11      | )
|Cash and cash equivalents at beginning of period                                |  |                                  | 190     |   |      |   | 1,645    |  
|                                                                                |  |                                  |         |   |      |   |          |  
|Cash and cash equivalents at end of period                                      |  | $                                | 1,145   |   |      | $ | 1,634    |  
|                                                                                |  |                                  |         |   |      |   |          |  
|Significant cash transactions during the period for:                            |  |                                  |         |   |      |   |          |  
|Interest paid                                                                   |  | $                                | 14,669  |   |      | $ | 13,292   |  
|                                                                                |  |                                  |         |   |      |   |          |  
|Non-cash investing and financing activities:                                    |  |                                  |         |   |      |   |          |  
|Recapitalization:                                                               |  |                                  |         |   |      |   |          |  
|Issuance of common stock                                                        |  | $                                |        |   |      | $ | 158,090  |  
|                                                                                |  |                                  |         |   |      |   |          |  
|Issuance of new Series A preferred stock                                        |  | $                                |        |   |      | $ | 13,342   |  
|                                                                                |  |                                  |         |   |      |   |          |  
|Retirement of Series A, B, C, C-1 and D-1 preferred stock                       |  | $                                |        |   |      | $ | (171,432 | )
|                                                                                |  |                                  |         |   |      |   |          |  
|Accrued preferred stock dividends                                               |  | $                                |        |   |      | $ | 878      |  
|                                                                                |  |                                  |         |   |      |   |          |  



See accompanying
notes.



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Monitronics International, Inc.

Notes to Financial Statements

(Unaudited)



1. Description of Business and Summary of Significant Accounting Policies



Description of Business



Monitronics International, Inc. (the Company) provides security alarm monitoring and related services to residential and business subscribers
throughout the United States. The Company monitors signals arising from burglaries, fires, and other events through security systems installed by independent dealers at subscribers premises.



The accompanying interim unaudited financial statements have been prepared in
accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles. In the opinion of management, the accompanying interim unaudited financial statements contain all adjustments (consisting of normal recurring adjustments) considered necessary for a
fair presentation of the results of operations for the interim periods.



Stock Compensation



The Company accounts for
stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations, and complies with
the disclosure provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123). Under APB 25, compensation cost is recognized over the vesting period based on the
difference, if any, on the date of grant between the fair market value of the Companys common stock and the exercise price of the stock option granted. Generally, the Company grants options with an exercise price at least equal to or above the
fair market value of the Companys common stock on the date of the grant and, as a result, generally does not record compensation cost.



The following table illustrates the effect of net loss if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based
employee compensation (in thousands):



|                                                                                                                                                  |  |                                  |        |   |      |   |      |  
|------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ---- | - | ---- | -
|                                                                                                                                                  |  | Three Months Ended September 30, |       
|                                                                                                                                                  |  | 2005                             |        |   | 2004 |  
|Net loss as reported                                                                                                                              |  | $                                | (2,209 | ) |      | $ | (815 | )
|Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net value of related tax
effects |  |                                  | (28    | ) |      |   |     |  
|                                                                                                                                                  |  |                                  |        |   |      |   |      |  
|Pro forma net loss                                                                                                                                |  | $                                | (2,237 | ) |      | $ | (815 | )
|                                                                                                                                                  |  |                                  |        |   |      |   |      |  



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Recent Accounting Pronouncements



On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123
(revised 2004), Share-Based Payment (SFAS 123(R)), which is a revision of SFAS 123. SFAS 123(R) supercedes APB 25, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in SFAS 123(R) is
similar to the approach described in SFAS 123. However, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure
will no longer be an alternative. SFAS 123(R) is effective no later than the beginning of the first fiscal year beginning after December 15, 2005. The Company will to adopt SFAS 123(R) on or before July 1, 2006. The adoption of SFAS
123(R)s fair value method may have a significant impact on the Companys results of operations, although it will have no impact on the Companys overall financial position. The Company will implement SFAS 123(R) using the
prospective method.



2. Long-Term Debt



Long-term debt consists of the following (in thousands):



|                                                              |  |                   |         |              |   |        
|------------------------------------------------------------- |  | ----------------- | ------- | ------------ | - | -------
|                                                              |  | September 30,2005 |         | June 30,2005
|Revolving credit line and term loan payable                   |  | $                 | 269,400 |              | $ | 246,687
|Senior subordinated notes payable                             |  |                   | 160,000 |              |   | 160,000
|Subordinated notes payable                                    |  |                   | 21,470  |              |   | 21,470 
|Investor put option (see Note 3 (Related Party Transactions)) |  |                   | 303     |              |   | 220    
|                                                              |  |                   |         |              |   |        
|                                                              |  |                   | 451,173 |              |   | 428,377
|Less: discount                                                |  |                   | 737     |              |   | 764    
|Less: current portion                                         |  |                   | 1,805   |              |   | 1,804  
|                                                              |  |                   |         |              |   |        
|                                                              |  | $                 | 448,631 |              | $ | 425,809
|                                                              |  |                   |         |              |   |        



On August 25,
2003, the Company entered into its existing credit facility agreement comprised of a $175.0 million term loan that matures in fiscal year 2010 and a $145.0 million revolving credit facility that matures in fiscal year 2009. Payments under the term
loan are payable in quarterly installments from December 31, 2003 through June 30, 2009. The quarterly payment is calculated based upon the amount of the original facility multiplied by 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 and 3.00% for the quarters ended December 31, 2007 through June 30, 2009 with the remaining balance due at maturity. As of
September 30, 2005, the Company had $97.9 million in borrowings outstanding under the $145 million revolving credit line and had $171.5 million in borrowings outstanding under the term loan. Further, the Company had $47.1 million in
availability under the revolving credit line of which $23.9 million was immediately available as calculated under the covenants in the Companys credit facility, and is charged a commitment fee of 0.5% on the average daily unused portion. The
revolving credit line bears interest at a rate of either prime plus 2.25% or LIBOR plus 3.25%. The term loan bears interest at a rate of either prime plus 2.75% or LIBOR plus 3.75%. For the three months ended September 30, 2005, borrowings
under the credit facility had a weighted average interest rate of 7.2%. Interest incurred on borrowings is payable monthly in arrears.



On March 28, 2005, the Company amended certain provisions of its credit facility resulting in the elimination of mandatory reductions to the
revolving credit facility, a 75 basis point reduction in the variable interest rate for the Companys revolving credit line and the term loan, and a 25 basis point reduction in commitment fees at the Companys current borrowing level.



On August 25, 2003, the Company also issued $160.0
million of senior subordinated notes (the Senior Subordinated Notes) at a discount of $0.94 million. The Senior Subordinated Notes accrue interest at 11.75% per annum and mature on September 1, 2010. Interest payments are to be
made semi-annually in cash in arrears on March 1 and September 1 of each year beginning on March 1, 2004. On December 16, 2004, the Company completed an exchange offer in which it exchanged new notes that were registered under
the Securities Act of 1933 for the Senior Subordinated Notes. In accordance with the registration rights agreement associated with these notes,



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the Company incurred special interest on the Senior Subordinated Notes in the amount of $470,000 in connection with the exchange offer.



Proceeds from the issuance of the Senior Subordinated Notes and borrowings
under the credit facility in August 2003 were used primarily to repay the Companys prior credit facility and its $12 million senior subordinated notes payable, to repurchase $20.5 million principal amount of its subordinated notes at a
repurchase price of approximately $23.2 million and to pay debt issuance costs. As part of the August 2003 refinancing, the terms of the then-remaining $20.5 million principal amount of the subordinated notes were amended, and the maturity date was
extended to March 1, 2010. Interest on the subordinated notes originally accrued at 13.5% per annum with interest payable semi-annually at a rate of 12% per annum with the remaining 1.5% interest per annum added to the outstanding
principal amount of the subordinated notes. The 1.5% interest rate increased to 2.5% per annum on December 15, 2003 when the subordinated notes were not repurchased by that date, and the increased rate was applied retroactively to
August 25, 2003.



The credit facility and subordinated
notes have certain financial tests which must be met on a quarterly basis, including maximum total senior debt and total debt to quarterly annualized net operating income, minimum interest coverage ratio, minimum fixed charge coverage ratio and an
annual capital expenditure limit. Indebtedness under the credit facility is secured by all of the assets of the Company. As of September 30, 2005, the Company was in compliance with all required financial tests.



On August 18, 2003, the Company entered into an agreement with the Hull
Family Limited Partnership (the Partnership) and Mr. James R. Hull, the Companys president and chief executive officer, as amended on September 23, 2004, that allowed for the put of $500,000 in value of Class A
common stock to the Company in each fiscal year beginning in fiscal 2005 and ending June 30, 2009. On November 22, 2004, the first of five option exercises was completed when the Partnership sold the Company $500,000 worth of Class A
common stock. The fair value of the remaining investor put option was $0.3 million at September 30, 2005. See Note 3 (Related Party Transactions) to these financial statements.



Scheduled maturities (as defined) of long-term debt at September 30, 2005, utilizing the required payment schedule of
the Senior Subordinated Notes, subordinated notes, credit facility and the fair value of the investor put option are as follows for fiscal years below (in thousands):



|           |  |   |        
|---------- |  | - | -------
|2006       |  | $ | 1,368  
|2007       |  |   | 7,083  
|2008       |  |   | 18,020 
|2009       |  |   | 118,982
|2010       |  |   | 145,720
|Thereafter |  |   | 160,000
|           |  |   |        
|           |  | $ | 451,173
|           |  |   |        



3. Related Party Transactions



Concurrently with the Senior Subordinated Notes offering,
the Company entered into an agreement with James R. Hull, the Companys president and chief executive officer, and the Hull Family Limited Partnership (the Partnership) pursuant to which the Company paid Mr. Hull a $2 million
transaction fee in cash at the closing of 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 purchase 400,000 shares
of Class A common stock at a purchase price of $1 million in cash. Based on the fair value of the Companys stock, no expense was recorded related to the repurchase of the Partnerships shares. The agreement also gives the Partnership
and Mr. Hull a written investor put option to sell up to a combined total of $500,000 in value of Class A common stock to the Company in each of the five fiscal years ending June 30, 2009 at purchase prices per share that are based on
a multiple of the Companys consolidated cash flow. Based on the fair value of the Companys stock at the time of the agreement, the Company recorded no liability in connection with this agreement. The written investor put option was
amended on September 23, 2004, resulting in the Company recording a liability and related sales, general and administrative (SG&A) expense of $0.5 million based on the fair value of the written put option at September 30,
2004. On November 22, 2004, the Partnership exercised the first of five option exercises and sold the Company 57,549 shares of Class A common stock for $500,000. As of September 30, 2005, the outstanding liability for the



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put option was $0.3 million. The Company will prospectively adjust its liability and related SG&A expense as the fair value of the put option changes.



On July 14, 2004, the Company completed a series of
transactions which it refers to as the recapitalization. In the recapitalization, the Company redeemed approximately $5.6 million of the Series C and C-1 preferred stock held by Windward Capital Partners II, L.P. and Windward Capital LP
II, LLC (the Windward entities) and then issued shares of a new Series A preferred or Class A common stock to its preferred shareholders in exchange for all of their preferred stock, Class A common stock and warrants to
purchase Class A common stock. The preferred shareholders determined the number of shares to be received in the exchange based on the liquidation preference of, and accrued but unpaid dividends on, the existing preferred shares as of
July 14, 2004 for the shares held by the Windward entities and as of June 30, 2003 for the remaining preferred shares. The Companys preferred shareholders 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 based on a negotiation amongst the Companys preferred shareholders and the agreement of New York Life Capital Partners II, L.P. and PPM America Private Equity Fund L.P. to
subsequently purchase the shares of Class A common stock received by the Windward entities in the exchange for $6.00 per share. No independent third party valuations or appraisal opinions were obtained by the preferred shareholders or board of
directors during the negotiation process. The Companys lenders and preferred shareholders consented to the recapitalization as required under the terms of the Companys applicable agreements.



The Companys preferred shareholders also negotiated the terms of the
new Series A preferred stock 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 the holders of at least two-thirds of the
outstanding shares of Class A common stock, Series A preferred stock, Series B preferred stock, Series C preferred stock, Series C-1 preferred stock and Series D-1 preferred stock, each voting as a separate class as required by the
Companys articles of incorporation, approved the amendment and restatement of the Companys articles of incorporation to create the new Series A preferred stock.



4. Commitments and Contingencies



The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. In the opinion of management, the amount
of ultimate liability with respect to these actions is not expected to have a material impact on the financial position or results of operations of the Company.



5. Subsequent Event



On November 4, 2005, the holders of the Companys Series A preferred stock notified it of their election for the Series A preferred stock to
begin accruing dividends as permitted under the Companys articles of incorporation. As a result of the dividend election, the Series A preferred stock began accruing dividends on November 4, 2005 at a rate of 8% per annum, and the
dividend rate will increase at a rate of 2% per annum on each subsequent November 4 up to a rate of 16% per annum. The dividend rate will also increase to a maximum of 24% per annum following any covenant or leverage defaults
until the noncompliance is cured.



As a result of the dividend
election, the Company must redeem the Series A preferred stock on June 30, 2008 at a price equal to the liquidation value (calculated as provided in its articles of incorporation) plus any accrued and unpaid dividends. If the Company does not
redeem the Series A preferred stock on June 30, 2008, the maximum dividend rate will increase from 16% to the lesser of 24% and the maximum rate permitted by law. If the Company is unable to redeem the Series A preferred stock on or prior to
June 30, 2009 for any reason, including due to the prohibitions or restrictions contained in its existing debt instruments or articles of incorporation, the holders of the Series A preferred stock may initiate the Companys sale or
liquidation.



Following the dividend election, the Series A
preferred stock is no longer convertible into Class A common stock, and the shares of Series A preferred stock no longer have voting rights except with respect to limited matters provided in the Companys articles of incorporation or
otherwise required by law.



The Company will reflect the effect
of the dividend election in the second quarter of fiscal 2006 by adjusting the Series A preferred stock to its liquidation value of approximately $45 million through a reduction to the Companys additional paid-in capital.



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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations



We are a leading national provider of security alarm monitoring services. The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our financial statements, and the related notes to those financial statements, included in Part IItem 1 of this Quarterly Report on Form 10-Q.



Forward-Looking Statements



Certain statements contained or incorporated by reference in this Quarterly
Report on Form 10-Q including, 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 securities laws. Such forward-looking statements involve known
and unknown risks, uncertainties and other matters which may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.
Factors, risks and uncertainties that could cause actual outcomes and results to be materially different from those projected include, among others, the following:



| |  | our high degree of leverage;
| | - | ----------------------------



| |  | our anticipated growth strategies;
| | - | ----------------------------------



| |  | anticipated trends and conditions in our business, including trends in the market;
| | - | ----------------------------------------------------------------------------------



| |  | our ability to acquire and integrate additional accounts;
| | - | ---------------------------------------------------------



| |  | our expected rate of subscriber attrition;
| | - | ------------------------------------------



| |  | our ability to continue to control costs and maintain quality;
| | - | --------------------------------------------------------------



| |  | our ability to compete;
| | - | -----------------------



| |  | the impact of false alarm ordinances on our results of operations; and
| | - | ------------------------------------------------------------------------



| |  | our ability to obtain additional funds to grow our business.
| | - | ------------------------------------------------------------



We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we
believe may affect our financial condition, results of operations, business strategy and financial needs. They can be affected by inaccurate assumptions we might make or by known or unknown risks, uncertainties and assumptions. Reference is hereby
made to the disclosures contained under the heading Risk Factors in Part IIItem 7. Managements Discussion and Analysis of Financial Condition and Results of Operations of the Companys Annual Report on Form
10-K filed with the Securities and Exchange Commission on September 23, 2005. In light of these risks, uncertainties and assumptions, the forward-looking statements may not occur and actual results could differ materially from those anticipated
or implied in the forward-looking statements. When you consider these forward-looking statements, you should keep in mind these risk factors and other cautionary statements.



Our forward-looking statements speak only as of the date made. We undertake no obligation to update or revise any
forward-looking statements, whether as a result of new information, future events or otherwise, unless the securities laws require us to do so.



Overview



Nearly all of our revenues are derived from monthly recurring revenues under security alarm monitoring contracts purchased from independent dealers in our
exclusive nationwide network. Our alarm monitoring contracts generally have a non-cancelable initial term of three years, generally allow for periodic price increases and provide for automatic renewals during which the subscriber may cancel the
contract upon 30 days proper written notice.



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Revenues are recognized as the related monitoring services are provided. Other revenues are derived primarily from the provision of third-party contract
monitoring services and from field technical repair services.



Cost of services primarily consists of direct labor associated with monitoring and servicing subscriber accounts and expenses related to field technical repair services. Sales, general and administrative expenses primarily include the cost
of personnel conducting sales and administrative activities and other costs related to sales, administration and operations. All direct external costs associated with the creation of subscriber accounts are capitalized and amortized over ten years
using a 135% declining balance method. Internal costs, including all personnel and related support costs incurred solely in connection with subscriber account acquisitions and transitions, are expensed as incurred.



Attrition



We purchase subscriber contracts from our exclusive network of independent dealers. These contracts with our subscribers are
typically three-year non-cancelable contracts with automatic renewal provisions during which the subscriber may cancel the contract upon 30 days proper written notice. A portion of our subscriber base can be expected to cancel its service
every year. Subscribers may choose not to renew or terminate their contract for a variety of reasons, including relocation, cost, switching to our competitors service and service issues. A majority of canceled accounts result from subscriber
relocation or the inability to contact the subscriber.



Account
cancellation, otherwise referred to as subscriber attrition, has a direct impact on the number of subscribers we serve and hence our financial results, including revenues, operating income and cash flow. We define our attrition rate as the number of
canceled accounts in a given period divided by the average of the beginning and ending balance of subscribers for that period. We consider an account canceled when a subscriber terminates in accordance with the terms of the contract or if payment
from the subscriber is deemed uncollectible. If a subscriber relocates but continues his service, this is not a cancellation. If the subscriber relocates and discontinues his service and a new subscriber takes over the service continuing the revenue
stream, this is a cancellation and a new owner takeover. We adjust the number of canceled accounts by excluding those that are contractually guaranteed by our dealers. Our typical dealer contract provides that if a subscriber cancels in the first
year of its contract, the dealer must replace the lost monthly revenue attributable to the canceled contract and either replace the canceled account with a new one or refund our purchase price. To help ensure the dealers obligation to us, we
typically hold back a portion of the purchase price for every account we purchase. In some cases, the amount of the purchase holdback may be less than actual attrition experience. In recent years, a substantial portion of the accounts that canceled
within this initial 12-month period were replaced by the dealers at no additional cost to us.



The table below presents subscriber data for the twelve months ended September 30, 2005 and 2004:



|                                                 |  |                                   |   |  |         |  
|------------------------------------------------ |  | --------------------------------- | - |  | ------- | -
|                                                 |  | Twelve Months Ended September 30, |  
|                                                 |  | 2005                              |   |  | 2004    |  
|Beginning balance of accounts                    |  | 451,462                           |   |  | 413,449 |  
|Accounts purchased                               |  | 97,315                            |   |  | 90,162  |  
|Accounts canceled(1)                             |  | (60,551                           | ) |  | (49,662 | )
|Accounts guaranteed to be refunded from holdback |  | (1,367                            | ) |  | (2,487  | )
|Ending balance of accounts                       |  | 486,859                           |   |  | 451,462 |  
|Attrition rate                                   |  | 12.9                              | % |  | 11.5    | %

---

|(1) | Net of canceled accounts that are contractually guaranteed by the dealer and new owner
takeovers.
|--- | -------------------------------------------------------------------------------------------------



Our trailing twelve-month attrition
rose to 12.9% for the period ended September 30, 2005 from 11.5% for the period ended September 30, 2004. This increase primarily reflects a slight change in policy we adopted in June 2004 to permit subscribers in their annual renewal
period to cancel with proper 30-days written notice. This change resulted in the cancellation of a small number of accounts ahead of schedule. The increased attrition rate has already started to subside and management anticipates the effect of the
change in policy should essentially no longer impact the trailing 12-month attrition rate by the end of the third quarter of fiscal year 2006. This change in policy was made as a result of our comparing the small amount of revenue lost to the level
of customer dissatisfaction created when a one-year renewal



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is enforced and deciding that customer satisfaction is the much greater influence on the level of our future business. The primary three-year term of the
contract remains non-cancelable.



We also analyze our attrition
by classifying our accounts into annual pools based on the year of purchase. We then track the number of accounts that cancel as a percentage of the initial number of accounts purchased for each pool for each year subsequent to its purchase. Based
on the average cancellation rate across our pools, we achieve nearly 0% attrition in the first year net of canceled accounts that are contractually guaranteed by the dealers. In the next three years, the number of subscribers that cancel as a
percentage of the initial number of subscribers in that pool gradually increases and historically has peaked between the third and fourth years. The peak between the third and fourth years is primarily a result of the buildup of subscribers that
moved or no longer had need for the service prior to the third year but did not cancel their service until the end of their three-year contract. After the fourth year, the number of subscribers that cancel as a percentage of the initial number of
subscribers in that pool declines. As a result, we believe our attrition rate decreases as the age of our accounts increase. Our pool analysis also indicates that, on average, over 30% of each pool remains by the end of the tenth year.



Results of Operations



Three Months Ended September 30, 2005 Compared to Three Months Ended
September 30, 2004



Revenues. Total revenues
were $45.1 million in the three months ended September 30, 2005 compared to $40.5 million in the three months ended September 30, 2004, which was an increase of $4.6 million, or 11%. This increase was primarily attributable to an increase
in the number of subscriber accounts to 486,859 as of September 30, 2005 from 451,462 as of September 30, 2004 and a small net increase in average revenue per customer.



Cost of services. Cost of services were $5.5 million for the three months ended September 30, 2005 compared to
$4.8 million for the three months ended September 30, 2004, which was an increase of $0.7 million, or 15%. As a percentage of revenues, cost of services was 12% for both the three months ended September 30, 2005 and September 30,
2004.



Sales, general and administrative (SG&A).SG&A was $8.7 million for the three months ended September 30, 2005 compared to $7.6 million for the three months ended September 30, 2004, which was an increase of $1.1 million, or 14%. As a percentage of revenues, SG&A was
19% for both the three months ended September 30, 2005 and September 30, 2004.



Amortization. Amortization of intangibles was $21.5 million in the three months ended September 30, 2005 compared to $18.9 million in the three months ended September 30, 2004 which was an increase of
$2.6 million, or 14%. The increase was attributable to growth in our purchased subscriber accounts through our authorized dealer program.



Interest expense. Interest expense was $10.9 million in the three months ended September 30, 2005 compared to $9.8 million in the three months
ended September 30, 2004, which was an increase of $1.1 million, or 11%. The increase resulted from higher borrowing under our revolving line of credit throughout the quarter incurred to fund our purchase of subscriber accounts and increases in
variable interest rates. Our average interest rate decreased to 9.9% in the three months ended September 30, 2005 from 10.0% in the three months ended September 30, 2004.



Net loss. Net loss was $2.2 million in the three months ended September 30, 2005 compared to net loss of $0.8
million in the three months ended September 30, 2004 primarily due to higher interest expense.



Liquidity and Capital Resources



General. Our operating strategy requires the availability of significant funds to finance growth through subscriber account purchases. Additional cash requirements include debt service and capital expenditures. We have financed our
growth from a combination of long-term borrowings, issuance of preferred stock and cash flows provided by operations.



Major components of our working capital include accounts receivable, deferred revenue, purchase holdbacks and accrued interest payable. We expect to
experience negative working capital in the future primarily due to accrued interest payable and purchase holdbacks. Purchase holdbacks are dependent on the number of subscriber



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accounts we purchase, the timing and amount of our payment of the purchase holdbacks to dealers, and the percentage of the purchase price we withhold to
ensure a dealers obligation during the guarantee period. Accrued interest payable is dependent on the level of our debt and the timing of interest payments.



As of September 30, 2005 and June 30, 2005, we had working capital deficits of $5.9 million and $11.8 million,
respectively. The $5.9 million improvement in our working capital was primarily due to a $4.6 million reduction in interest payable which decreased to $2.8 million as of September 30, 2005 compared to $7.4 million as of June 30, 2005. The
decrease in interest payable was primarily due to the semi-annual payment, on September 1, 2005, of interest related to our $160 million of senior subordinated notes.



Net cash provided by operating activities for the three months ended September 30, 2005 was $15.6 million, as compared
to $13.8 million for the three months ended September 30, 2004. The increase in cash provided by operating activities for the three months ended September 30, 2005 was primarily due to growth in our subscriber base and the resulting
increases in revenues.



Net cash used in investing activities
for the three months ended September 30, 2005 was $37.3 million, compared to $34.7 million for the three months ended September 30, 2004. For the three months ended September 30, 2005, capital expenditures were $1.5 million versus
$0.9 million for the three months ended September 30, 2004. Capital expenditures were primarily for our central monitoring station, telephone systems, computer systems and leasehold improvements for our offices. Capital expenditures are
expected to vary based on the growth of our subscriber account base and improvements to our technology, operating and financial systems. Purchases of subscriber accounts consist of all direct external payments associated with the purchase of
subscriber accounts. The portion of the purchase holdback paid to dealers at the end of the guarantee period is included in this amount when paid.



Our net cash provided by financing activities for the three months ended September 30, 2005 was $22.7 million, as compared to $20.9 million for the
three months ended September 30, 2004.



As of
September 30, 2005, we had $269.4 million outstanding under our credit facility, bearing interest at a weighted average rate for the three months ended September 30, 2005 of approximately 7.2% per annum, and we had approximately $47.1
million in borrowing availability under our revolving credit line, of which $23.9 million was immediately available as calculated under the covenants in our credit facility. In addition, we had $181.5 million in principal amount outstanding of
senior subordinated and subordinated notes as of September 30, 2005.



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



On July 14, 2004, we completed a recapitalization in which we redeemed approximately $5.6 million of the Series C and Series C-1 preferred stock held
by the Windward entities and then issued shares of a new Series A preferred stock or Class A common stock to our preferred shareholders in exchange for all their shares of preferred stock, Class A common stock and warrants to purchase
Class A common stock. The Windward entities subsequently sold the shares of Class A common stock they received in the exchange to two new investors at $6.00 per share. We financed the total $6.8 million cost of the recapitalization,
including the $5.6 million redemption payment and approximately $1.2 million of fees and expenses, with borrowings under our senior credit facility.



Prior to the recapitalization, we were obligated to accrue cumulative dividends on each series of our previously outstanding preferred stock at varying
rates, but we were prohibited from paying these dividends under the terms of our credit facility and the indenture governing the senior subordinated notes if an event of default existed or would result from such payment. The recapitalization allowed
us to restructure our accrued dividends by converting the accrued dividends into common and preferred stock. Our new Series A preferred stock issued in the recapitalization is not currently accruing dividends, and payment of any dividends after a
dividend election will continue to be prohibited under the terms of our credit facility and the indenture if an event of default exists or would result from such payment. Accordingly, we do not expect to pay any dividends.



On August 25, 2003, we issued $160.0 million of senior subordinated
notes at 11.75% with a maturity date of September 1, 2010. Interest payments are to be made semi-annually in cash in arrears on March 1 and September 1 of each year beginning on March 1, 2004. On December 16, 2004, we
completed an exchange offer in which we



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exchanged new notes that were registered under the Securities Act of 1933 for the senior subordinated notes. In accordance with the registration rights
agreement associated with these notes, we incurred special interest on the senior subordinated notes in the amount of $470,000 in connection with the exchange offer.



Further on August 25, 2003, we entered into a new credit facility agreement with Fleet National Bank
(Fleet) as administrative agent, Bank of America, N.A. as syndication agent, 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 $175.0 million
term loan that matures in fiscal 2010 and a $145.0 million revolving credit facility that matures in fiscal 2009. Indebtedness under the credit facility is secured by all of our assets. Payments under the term loan are payable in quarterly
installments from December 31, 2003 through June 30, 2009. The quarterly payment is calculated based upon the amount of the original facility multiplied by 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 and 3.00% for the quarters ended December 31, 2007 through June 30, 2009 with the remaining balance due at maturity. We used the borrowings under
this credit facility together with the proceeds of the senior subordinated notes offering primarily to repay our prior credit facility, to repay 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% subordinated notes due March 1, 2010 at a repurchase price of approximately $23.2 million. In connection with our August 2003 refinancing, we amended the terms of our subordinated notes to extend the
maturity date of the then remaining $20.5 million principal amount from January 18, 2009 to March 1, 2010. Prior to the amendment, interest accrued on the subordinated notes at 13.5% per annum with interest payable semi-annually in
cash at a rate of 12% per annum with the remaining 1.5% interest per annum added to the outstanding principal amount of the subordinated notes. The 1.5% per annum interest rate increased to 2.5% per annum on December 15, 2003 and
the increased rate applied retroactively to August 25, 2003.



We will require substantial cash flow to fully implement our business strategy and meet our principal and interest obligations with respect to the senior subordinated notes and our other indebtedness. We anticipate that cash flow generated
from operations and borrowings under our credit facility will provide sufficient liquidity to fund these requirements for the foreseeable future. Following the August 2003 refinancing, we continue to have significant borrowing capacity under our
credit facility. This capacity coupled with anticipated cash flow from operations is expected to meet and satisfy our short-term obligations.



We further preserve our borrowing capacity by following a cash management practice of maintaining as low as possible ongoing cash balance. However, our
ability to meet 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 generate sufficient
cash flow from operations or otherwise to comply with the terms of the indenture governing the senior subordinated notes or our other debt instruments, we may be required to refinance all or a portion of our existing debt or obtain additional
financing. Further, the agreements or indentures governing our credit facility, our senior subordinated notes and subordinated notes contain financial covenants relating to capital expenditure limits, maximum total debt to annualized quarterly
EBITDA, maximum total senior debt to annualized quarterly EBITDA, interest coverage and fixed charge coverage that may impact our ability to refinance all or a portion of our existing debt or obtain additional financing. As of September 30,
2005, we were in compliance with all required financial tests.



Critical
Accounting Policies



Our discussion and analysis of
results of operations and financial condition are based upon our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of financial statements in
accordance with GAAP requires management to use judgment in making estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. We base our estimates and
assumptions on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. These estimates and assumptions are evaluated on an ongoing basis. Due to the nature of certain assets and liabilities,
there are uncertainties associated with some of the judgments, assumptions and estimates which are required to be made. Reported results could have been materially different under a different set of assumptions and estimates for certain accounting
principle applications.



Long Lived AssetsSubscriber
Accounts. Subscriber accounts relate to the cost of acquiring portfolios of monitoring service contracts from independent dealers. The subscriber accounts are recorded at cost. All direct external costs associated with the creation of subscriber
accounts are capitalized. Internal costs, including all



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personnel and related support costs, incurred solely in connection with subscriber account acquisitions and transitions are expensed as incurred. The cost of
subscriber account pools are amortized using the 10-year 135% declining balance method. Subscriber accounts are amortized in pools because of the accounts homogeneous characteristics resulting primarily from the extremely disciplined due
diligence program that we have implemented in which a contract must meet certain purchase criteria before we will purchase that account. All of our customers contract for essentially the same service and 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 of amortization expense to individual subscriber revenues based on historical performance of our subscriber base. The realizable value and remaining useful lives of these
assets could be impacted by changes in subscriber attrition rates, which could have an adverse effect on our earnings.



We reviewed the subscriber accounts for impairment or a change in amortization period whenever events or changes indicate that the carrying amount of the
asset may not be recoverable or the life should be shortened. For purposes of recognition and measurement of an impairment loss, we view subscriber accounts as a single pool because of the assets homogeneous characteristics, which is the
lowest level for which identifiable cash flows are largely independent of the cash flows of the other assets and liabilities. If we determine that an impairment has occurred, we write the subscriber accounts down to their fair value.



Income Taxes and Deferred Tax Assets. As part of preparing our
financial statements, significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and the need for a valuation allowance related to our deferred tax assets. This process
involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, especially the amortization of subscriber accounts, which are amortized using a 10-year 135% declining
balance method for financial reporting purposes and are generally amortized using a 10-year straight-line method for tax purposes. These differences result in deferred tax assets and liabilities, which are included within our balance sheet. We must
then in accordance with Financial Accounting Standards Board Statement No. 109, Accounting for Income Taxes, assess the realizability of the deferred tax assets. Accordingly, we have fully reserved our deferred tax asset as a result of
experiencing a cumulative loss before income taxes for the three-year period ended June 30, 2005. We also considered possible tax planning strategies. In assessing the realizability of the deferred tax assets, management considers whether it is
more likely than not that some portion, or all of the deferred tax assets, will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income (including reversals of deferred tax liabilities)
during the periods in which those temporary differences will become deductible.



Goodwill. As of September 30, 2005, we had goodwill of $14.8 million, which represents 2.8% of our total assets. We test goodwill annually for impairment and record an impairment charge if the carrying
amount exceeds the fair value. We use a discounted cash flow approach as well as other methods to determine the fair value used in our test for impairment of goodwill. The results of this methodology depend upon a number of estimates and assumptions
relating to cash flows, discount rates and other matters. Accordingly, such testing is subject to certain uncertainties, which could cause the fair value of goodwill to fluctuate from period to period.



Recent Accounting Pronouncements



On December 16, 2004, the Financial Accounting Standards Board
FASB issued FASB Statement No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)), which is a revision of SFAS 123. SFAS 123(R) supercedes APB 25, and amends FASB Statement No. 95, Statement of Cash
Flows. Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income
statement based on their fair values. Pro forma disclosure will no longer be an alternative. SFAS 123(R) is effective no later than the beginning of the first fiscal year beginning after December 15, 2005. We will adopt SFAS 123(R) on or before
July 1, 2006. The adoption of SFAS 123(R)s fair value method may have a significant impact on our result of operations, although it will have no impact on our overall financial position. We will implement SFAS 123(R) using the
prospective method.



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Off-Balance Sheet Arrangements



We do not have any off-balance sheet arrangements, as defined in Regulation S-K Item 303(a)(4)(ii)(A)-(D), that have or
are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.



Item 3. Quantitative and Qualitative Disclosures About Market Risk



We have interest rate risk, in that borrowings under our credit facility are based on variable market interest rates. As of September 30, 2005, we
had $269.4 million of variable rate debt outstanding under our credit facility. Presently, the revolving credit line bears interest at a rate of prime plus 2.25% or LIBOR plus 3.25%, with the term loan at a rate of prime plus 2.75% or LIBOR plus
3.75%. To control our exposure to interest rates under our facility, we are required to utilize interest rate caps as required by our credit facility if our ratio of fixed interest debt to total debt should fall below 25%. As of September 30,
2005, we were in compliance with this ratio. A hypothetical 10% increase in our credit facilitys weighted average interest rate of 7.2% per annum for the three months ended September 30, 2005 would correspondingly decrease our
earnings and operating cash flows by approximately $0.5 million.



Our privately issued $21.5 million subordinated notes due March 1, 2010 have a fixed interest rate of 14.5%, but have exposure to changes in the debts fair value. In connection with our August 2003 refinancing, we amended the
terms of these subordinated notes to extend the maturity date from January 18, 2009 to March 1, 2010 and to increase the interest rate from 13.5% per annum to 14.5% per annum. In addition, we issued $160.0 million aggregate
principal amount of our senior subordinated notes due September 1, 2010 with a fixed interest rate of 11.75%, which has exposure to changes in the debts fair value. We believe that the fair value of our total subordinated debt is
approximately $183.3 million (book of $181.5 million). The fair value of our total subordinated debt is based on the quoted market price of our senior subordinated debt.



Item 4. Controls and Procedures



We maintain a system of controls and procedures designed to provide reasonable assurance as to the reliability of the financial statements and other disclosures included in this report, as well as to safeguard assets from unauthorized use
or disposition. We evaluated the effectiveness of the design and operation of our disclosure controls and procedures 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 of the period covered by this Quarterly Report on Form 10-Q our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 are effective in timely alerting them to material information required to be included in our periodic Securities and
Exchange Commission filings. No significant changes were made to our internal controls over financial reporting or in other factors that have materially affected or are reasonably likely to materially affect these controls during our most recent
fiscal quarter. The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events.



PART II . OTHER INFORMATION



Item 1. Legal Proceedings



The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. In the opinion of management, the amount of ultimate liability with respect to these actions will not have a material impact
on the financial position or results of operations of the Company.



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds



On September 15, 2005, we granted to employees options to purchase 85,800 shares of our Class A common stock under our 2005 Stock Option Plan at
an exercise price of $6.00 per share and options to purchase 15,500



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shares of our Class A common stock under our 2001 Stock Option Plan at an exercise price of $6.00 per share. These transactions were exempt from the
registration requirements of the Securities Act by virtue of Rule 701 because they were issued in compensatory circumstances to employees in compliance with that Rule.



Item 3. Defaults Upon Senior Securities



None.



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



None.



Item 5. Other Information



On November 4, 2005, the holders of our Series A preferred stock notified us of their election for the Series A preferred stock to begin accruing dividends as permitted under our articles of incorporation. As a result of the dividend
election, the Series A preferred stock began accruing dividends on November 4, 2005 at a rate of 8% per annum, and the dividend rate will increase at a rate of 2% per annum on each subsequent November 4 up to a rate of
16% per annum. The dividend rate will also increase to a maximum of 24% per annum following any covenant or leverage defaults until the noncompliance is cured.



As a result of the dividend election, we must redeem the Series A preferred stock on June 30, 2008 at a price equal to
the liquidation value (calculated as provided in our articles of incorporation) plus any accrued and unpaid dividends. If we do not redeem the Series A preferred stock on June 30, 2008, the maximum dividend rate will increase from 16% to the
lesser of 24% and the maximum rate permitted by law. If we are unable to redeem the Series A preferred stock on or prior to June 30, 2009 for any reason, including due to the prohibitions or restrictions contained in our existing debt
instruments or articles of incorporation, the holders of the Series A preferred stock may initiate our sale or liquidation.



Following the dividend election, the Series A preferred stock is no longer convertible into Class A common stock, and the shares of Series A
preferred stock no longer have voting rights except with respect to limited matters provided in our articles of incorporation or otherwise required by law.



We will reflect the effect of the dividend election in the second quarter of fiscal 2006 by adjusting the Series A preferred stock to its liquidation
value of approximately $45 million through a reduction to our additional paid-in capital.



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. 333-110025) and incorporated herein by
reference)10.1*

Restricted Stock Ownership Agreement, dated April 19, 2002, by and between Monitronics International, Inc. and James R. Hull




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10.2*

Restricted Stock Ownership Agreement, dated April 19, 2002, by and between Monitronics International, Inc. and Michael Meyers10.3*

Restricted Stock Ownership Agreement, dated April 19, 2002, by and between Monitronics International, Inc. and Michael Gregory10.4*

Restricted Stock Ownership Agreement, dated April 19, 2002, by and between Monitronics International, Inc. and Robert Sherman10.5*

Restricted Stock Ownership Agreement, dated April 19, 2002, by and between Monitronics International, Inc. and Ricky L. Hudson10.6*

Restricted Stock Ownership Agreement, dated April 19, 2002, by and between Monitronics International, Inc. and Stephen Hedrick10.7*

Restricted Stock Ownership Agreement, dated April 19, 2002, by and between Monitronics International, Inc. and Barry Johnson10.8*

Correction to First Amendment to Lease Agreement, dated January 14, 2005, by and between Monitronics International, Inc. and AGF Valley View, Ltd.10.9*

Fourth Amendment to Lease Agreement, dated September 6, 2005, by and between Monitronics International, Inc. and MRP/VV, L.P.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 200231.2*

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 200232.1**

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
200232.2**

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 the undersigned thereunto duly authorized.



| |  |  |  |                                 |  |     |  |                                                                                  
| |  |  |  | ------------------------------- |  | --- |  | ---------------------------------------------------------------------------------
| |  |  |  | MONITRONICS INTERNATIONAL, INC.
| |  |  |  |                                
| |  |  |  |                                 |  | By: |  | /s/ James R. Hull                                                                
| |  |  |  |                                 |  |     |  | James R. Hull Chief Executive Officer and President (Principal Executive Officer)



|                        |  |  |  |  |  |                                                                                                           |  |                      
|----------------------- |  |  |  |  |  | --------------------------------------------------------------------------------------------------------- |  | ---------------------
|                        |  |  |  | 
|                        |  |  |  | 
|                        |  |  |  |  |  | By:                                                                                                       |  | /s/ Michael R. Meyers
|Date: November 10, 2005 |  |  |  |  |  | Michael R. Meyers Chief Financial Officer and Vice President (Principal Financial and Accounting Officer)





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