Financial Information

RECONCILIATION OF EBITDA TO GAAP EARNINGS

Management believes that EBITDA (Earnings before Interest, income Tax, Depreciation and Amortization) is a key industry indicator of operating performance and uses this as a measure to benchmark the company’s results. EBITDA is a non-GAAP measure, and the company’s method of calculation may differ and may not be comparable to that used by others. In addition, most companies in the residential security industry purchase home alarm subscriber accounts and capitalize those purchase costs amortizing them over their useful lives, which is usually the term of the subscriber contract. AlarmForce is one of few companies whose growth is internally generated and therefore the accounting treatment is not directly comparable. In the past, a policy of deferring the costs of direct-response marketing programs was selected from amongst alternative methods to account for the company’s costs to create accounts organically, thus facilitating the matching of expense with the recurring revenue from long-term subscriber contracts. Due to the fact that AlarmForce’s annual budget for direct-response marketing expenditure has increased steadily, reflecting acceleration of new subscriber account creation and the discretionary nature of marketing budgets, the Company provides the following reconciliation of Adjusted EBITDA to the GAAP net income figures reported for the three years 2003-2005 below.

Subscriber base	2005	2004*	2003*
	$	$	$
ADJUSTED EBITDA	9,156,566	6,718,327	5,203,087
Less Direct-response marketing expenditures expensed	4,786,242	3,668,187	2,638,307
EBITDA	4,370,324	3,050,140	2,564,780
Less Amortization of property, plant and equipment	2,185,598	1,598,352	1,261,338
Less Amortization of deferred charges	9,592	10,404	10,404
Less Foreign Exchange loss on consolidation	35,145
Less Interest expense	96,850	146,740	211,465
Income before income taxes	1,290,563	804,232	835,828
Less income taxes	480,349	500,632	129,531
Net income	810,214	303,600	706,297

* Restated to reflect the change in accounting policy adopted in 2005

RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS

a) Effective August 1, 2005, the Company decided to change its accounting policy for capitalizing direct response marketing costs. Prior to 2005, all direct response marketing costs were deferred and amortized over four years, the term of the subscriber agreement (pre-2005). With this change, such costs are now recognized as period costs and expensed in the period incurred. Notably, there is no change to Revenue, Gross Margin and Cash Flows as a result of the change in accounting. All comparative figures have been restated to reflect this change in accounting policy.

b) The Company acquired certain subsidiaries with franchise rights and according to section 3465.37 of the CICA handbook, no provision for future income taxes was previously reflected for these acquisitions in the financial statements. In 2005, the Company determined that a retroactive correction of an accounting error should be made to reflect the future income taxes. In conjunction to the same section of the CICA handbook, these franchise rights were grossed up for the future tax liability, and are being amortized over their respective useful lives.

CHANGE IN ESTIMATE

The Company reviews the carrying value of revenue equipment annually to determine and adjust any change in the estimated useful life of the assets. In 2005, the Company increased the amortization expense and correspondingly decreased the carrying value by approximately $278,000 as a result of revised estimates.

REVIEW OF OPERATIONS

Revenue

Total revenue increased from 2004 to 2005 by $ 2,833,715 or 20%, primarily reflecting the increase in MRR. MRR increased by approximately $2,543,877 or 20% in the same period. This is consistent with the increased number of new subscribers in the current year. The average number of subscribers during the year increased from approximately 45,700 to 53,000, up 18%.

Cost of sales

Cost of sales increased by $368,293 or 11% from 2004 to 2005. This is primarily because of increased equipment held in inventory at Head Office to fulfill the continuous demand of peripheral equipment and add-on equipment.

Certain costs of the company’s central monitoring station are relatively fixed and therefore the per-account cost is decreasing as economies of scale are realized from an expanding account base. The company is vertically integrated and manufactures, installs, monitors and services AlarmVoice alarm systems. The alarm system facilitates live two-way voice communication with the Central Station thereby offering immediate response and/or assistance in certain emergencies. The Central Station is located at the driveway alarm Company’s head office in Toronto from which the subscriber accounts are monitored.

Gross margin

Gross margin increased from 2004 to 2005 by $2,465,422 or 22%, due primarily to greater operating efficiency of the central monitoring station. Gross margin as a percentage of total revenue increased from 77% in 2004 to 79% in 2005, which is consistent with increased efficiency of operations, and consistent with the decrease in the per-account monitoring cost as the account base increased.