**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-K**

**ý**                                    ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe fiscal year ended December 31, 2006**

**OR**

**o**                                    TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe transition period from                        to                         **

| **Commission file number: 1-12181-01**                           | ** ** | **Commission  file number: 1-12181**                    |
|------------------------------------------------------------------|------------|---------------------------------------------------------|
| **Protection One, Inc.**                                    | ** ** | **Protection One Alarm  Monitoring, Inc.**         |
| (Exact name of  registrant as specified in its charter)          | ** ** | (Exact name of  registrant as specified in its charter) |
| **Delaware**                                                     | ** ** | **93-1063818**                                          | ** ** | **Delaware** | ** ** | **93-1064579** |
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.)                   |   | (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
| **1035 N. 3rd Street, Suite 101,  Lawrence, KS**            |       | **66044**                                               |   | **1035 N. 3rd Street, Suite 101,  Lawrence, KS** |   | **66044** |
| (Address of  principal  executive offices)                       |       | (Zip Code)                                              |   | (Address of  principal  executive offices) |   | (Zip Code) |

 

**785-856-5500**

(Registrant’s telephonenumber, including area code)

**N/A**

(Former name, formeraddress and former fiscal year, if changed since last report)

Securities registeredpursuant to Section 12(b) of the Act:

| **Title of each class** | ** ** | **Name of each exchange on which registered** |
|-------------------------|------------|-----------------------------------------------|
| None                    |       | None                                          |

 

Securities registeredpursuant to Section 12(g) of the Act:

| **Title of Each Class**                                               |
|-----------------------------------------------------------------------|
| Common Stock, par  value $.01 per share, of Protection One, Inc. |

 

**Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.**

**Yes ****o****  ****No ****x**

**Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 orSection 15(d) of the Exchange Act.**

**Yes ****o****  ****No ****x**

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yes x   No o

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

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

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

Yes o   No x

As ofJune 30, 2006, the aggregate market value of the registrant’s common stockheld by non-affiliates of the registrant was $4,328,033 based on the closingsale price as reported on the OTC Bulletin Board.

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

| **Class**                                | ** ** | **Outstanding at March 10, 2007** |
|------------------------------------------|------------|----------------------------------------|
| Common Stock,  $0.01 par value per share |       | 18,239,953 shares                      |

 

**DOCUMENTS INCORPORATED BYREFERENCE**

| Document                                                                                                                          | ** ** | **Parts Into Which Incorporated**     |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|
| Information Statement for the Annual Meeting of  Stockholders to be held on or before July 15, 2007 (Information  Statement) |       | Part I, II, III and IV |

 

 

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**TABLEOF CONTENTS**

|           | ** ** | ** **                                                                                                             | ** ** | **Page** |
|-----------|------------|------------------------------------------------------------------------------------------------------------------------|------------|----------|
|      | ** ** | **PART I**                                                                                                        |       |     |
| Item 1.   |       | Business                                                                                                               |       | 4        |
| Item 1A.  |       | Risk Factors                                                                                                           |       | 11       |
| Item 1B.  |       | Unresolved Staff Comments                                                                                              |       | 19       |
| Item 2.   |       | Properties                                                                                                             |       | 19       |
| Item 3.   |       | Legal Proceedings                                                                                                      |       | 19       |
| Item 4.   |       | Submission of Matters to a  Vote of Security Holders                                                                   |       | 19       |
|      | ** ** | **PART II**                                                                                                       |       |     |
| Item 5.   |       | Market for Registrant’s  Common Equity and Related Stockholder Matters and Issuer Purchases of Equity  Securities |       | 20       |
| Item 6.   |       | Selected Financial Data                                                                                                |       | 22       |
| Item 7.   |       | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                            |       | 24       |
| Item 7A.  |       | Quantitative and Qualitative  Disclosure About Market Risk                                                             |       | 48       |
| Item 8.   |       | Financial Statements and  Supplementary Data                                                                           |       | 49       |
| Item 9.   |       | Changes in and Disagreements  with Accountants on Accounting and Financial Disclosure                                  |       | 94       |
| Item 9A.  |       | Controls and Procedures                                                                                                |       | 94       |
| Item 9B.  |       | Other Information                                                                                                      |       | 94       |
|      | ** ** | **PART III**                                                                                                      |       |     |
| Item 10.  |       | Directors and Executive  Officers of the Registrants                                                                   |       | 95       |
| Item 11.  |       | Executive Compensation                                                                                                 |       | 95       |
| Item 12.  |       | Security Ownership of  Certain Beneficial Owners and Management and Related Stockholder Matters                        |       | 95       |
| Item 13.  |       | Certain Relationships and  Related Transactions                                                                        |       | 95       |
| Item 14.  |       | Principal Accountant Fees  and Services                                                                                |       | 95       |
|      | ** ** | **PART IV**                                                                                                       |       |     |
| Item  15. |       | Exhibits  and Financial Statement Schedules                                                                            |       | 96       |

 

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**PART 1**

**FORWARD-LOOKINGSTATEMENTS**

This Annual Report on Form 10-K and thematerials incorporated by reference herein include “forward-looking statements”intended to qualify for the safe harbor from liability established by thePrivate Securities Litigation Reform Act of 1995. Statements that are nothistorical fact are forward-looking statements. These forward-lookingstatements generally can be identified by, among other things, the use offorward-looking language such as the words “estimate,” “project,” “intend,” “believe,”“expect,” “anticipate,” “may,” “will,” “would,” “should,” “could,” “seeks,” “plans,”“intends,” or other words of similar import or their negatives. Such statementsinclude those made on matters such as our earnings and financial condition,litigation, accounting matters, our business, our efforts to consolidate andreduce costs, our customer account acquisition strategy and attrition, ourliquidity and sources of funding and our capital expenditures. Allforward-looking statements are subject to certain risks and uncertainties thatcould cause actual results to differ materially from those in theforward-looking statements. The forward-looking statements included herein aremade only as of the date of this report and we undertake no obligation topublicly update such forward-looking statements to reflect subsequent events orcircumstances. Certain factors that could cause actual results to differinclude:  our history of losses, whichare likely to continue; principal and interest payment requirements of ourindebtedness; competition, including competition from companies that are largerthan we are and have greater resources than we do; losses of our customers overtime and difficulty acquiring new customers, changes in technology that maymake our services less attractive or obsolete or require significantexpenditures to upgrade; the development of new services or service innovationsby our competitors; potential liability for failure to respond adequately toalarm activations; changes in management; the potential for environmental orman-made catastrophes in areas of high customer concentration; changes inconditions affecting the economy or security alarm monitoring service providersgenerally; and changes in federal, state or local government or otherregulations or standards affecting our operations. New factors emerge from timeto time, and it is not possible for us to predict all of such factors or theimpact of each such factor on our business or the extent to which any factor,or combination of factors, may cause actual results to differ materially fromthose contained in any forward-looking statements.

See also Item 1A, “RiskFactors” for a discussion of these and other risks and uncertainties that couldcause actual results to differ materially from those contained in ourforward-looking statements.

**INTRODUCTION**

Unless the context otherwise indicates, all referencesin this report to the “Company,” “Protection One,” “we,” “us” or “our” orsimilar words are to Protection One, Inc., its direct wholly ownedsubsidiary, Protection One Alarm Monitoring, Inc. and Protection One AlarmMonitoring’s wholly owned subsidiaries, and accordingly, there are no separatefinancial statements for Protection One Alarm Monitoring, Inc. ProtectionOne, Inc. and Protection One Alarm Monitoring are Delaware corporationsorganized in September 1991.

On December 20, 2006, Protection One, Inc.entered into an Agreement and Plan of Merger with Integrated Alarm ServicesGroup, Inc. (“IASG”) and Tara Acquisition Corp., a wholly owned subsidiaryof Protection One, Inc. (the “Merger Agreement”) pursuant to which we willacquire IASG (the “Merger”). Upon completion of the Merger, which is expectedto close during the second quarter of 2007, holders of IASG common stock willreceive 0.29 shares of Protection One, Inc. common stock for each share ofIASG common stock held. Cash will be paid in lieu of fractional shares. We arecurrently awaiting IASG stockholder approval of the Merger.

As a result of Quadrangle’s increased ownershipinterest from the February 8, 2005 debt-for-equity exchange, we have “pusheddown” Quadrangle’s basis to a proportionate amount of our underlying assets 

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and liabilities acquiredbased on the estimated fair market values of the assets and liabilities. Due tothe impact of the changes resulting from the push down accounting adjustments,the statement of operations and the statement of cash flows data for 2005 isseparated into two periods:  (1) theperiod prior to the February 8, 2005 consummation of the exchangetransaction and (2) the period beginning after that date utilizing the newbasis of accounting. See Item 7, “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” for a discussion of the changein majority owner of the company in February 2004 and the new basis ofaccounting adopted in February 2005.

Stockholders and othersecurity holders or buyers of our securities or our other creditors should notassume that material events subsequent to the date of this Form 10-Khave not occurred.

**ITEM 1.**                BUSINESS

**Overview**

We are a leading national provider of security alarmmonitoring services, providing installation, maintenance and electronicmonitoring of alarm systems to single-family residential, commercial, multifamilyand wholesale customers. We monitor signals originating from alarm systemsdesigned to detect burglary, fire, medical, hold-up and environmentalconditions, and from access control and closed-circuit-television (CCTV)systems. Most of our monitoring services and a large portion of the maintenanceservices we provide our customers are governed by multi-year contracts withautomatic renewal provisions that provide us with recurring monthly revenue, orRMR. As of December 31, 2006 we had approximately one million customers. Basedon information provided by a leading industry publication, we are the thirdlargest provider of electronic security monitoring services in the UnitedStates based on RMR.

Ourbusiness consists of two segments, Protection One Monitoring and NetworkMultifamily. Protection One Monitoring primarily provides residential andcommercial electronic security system installation and alarm monitoringservices directly to homeowners and businesses. Protection One Monitoring alsoprovides wholesale alarm monitoring services to independent alarm companies. NetworkMultifamily provides electronic security system installation and alarmmonitoring services to owners and managers of apartments, condominiums andother multifamily dwellings. We market our services to customers within thesesegments through separate internal sales and installation branch networks. Ourmonitoring and related services revenue for the year ended December 31,2006 and our customer base composition at December 31, 2006 were asfollows:

| ** **                       | ** ** | **Percentage of Total** | ** ** | ** **                                          | ** ** |
|----------------------------------|------------|-----------------------------------|------------|-----------------------------------------------------|------------|
| **Market**                       | ** ** | ** **                        | ** ** | **Monitoring  and Related  Services  Revenue** | ** ** | **Sites** | ** ** |
| Single family and  commercial    |       |                              | 81.7       | %                                                   |       | 51.0 | % |
| Wholesale                        |       |                              | 4.6        |                                                |       | 19.5 |   |
| Protection One  Monitoring Total |       |                              | 86.3       | %                                                   |       | 70.5 | % |
| Network  Multifamily Total       |       |                              | 13.7       |                                                |       | 29.5 |   |
| Total                            |       |                              | 100.0      | %                                                   |       | 100.0 | % |
|                                  |            |                                   |            |                                                     |            |  |  |  |  |

 

For the year ended December 31,2006, we generated consolidated revenue of $270.6 million. Protection OneMonitoring accounted for 87.3% of consolidated revenue, or $236.2 million,while Network Multifamily accounted for 12.7% of consolidated revenue, or $34.4million. Financial information for the past three years for each of ourbusiness segments is presented in Item 7, “Management’s Discussion and Analysisof Financial Condition and Results of Operations—Results of Operations” and inItem 8, Note 14  “Segment Reporting,” andis incorporated herein by reference.

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**Protection OneMonitoring**

Protection One Monitoring provides installation,maintenance and monitoring of electronic security systems to single-family residentialand commercial customers (our retail customers), and alarm monitoring servicesto independent alarm companies (our wholesale customers). Protection OneMonitoring serves approximately 507,000 retail customers with no singlecustomer comprising more than 1% of our total consolidated revenue. ProtectionOne Monitoring serves retail customers from 66 field locations and threecentralized monitoring centers.

Our new retail customers are generated organicallythrough our internal sales force. Our reliance on an internal sales forceenables us to control the sales process from inception and to manage the levelof customer care afforded.

Our wholesale businessserves approximately 800 independent alarm monitoring companies representingapproximately 194,000 customers. Typically, we act as the sole provider ofmonitoring services to independent monitoring companies. For the year ended December 31,2006, our wholesale business accounted for 4.2% of our consolidated revenue.

**Network Multifamily**

Network Multifamilyprovides alarm monitoring services to owners and managers of apartments,condominiums and other multifamily dwellings. We believe Network Multifamily isthe leading national provider of alarm monitoring services to the multifamilysector with approximately 293,000 units in 600 cities.

**Sources of Revenue**

For both Protection One Monitoring and NetworkMultifamily, revenue is primarily generated from providing monitoring services.For the year ended December 31, 2006, revenue generated from monitoringand related services accounted for 91.4% of our total revenue.

Monitoring revenue is generated based on contractsthat we enter into with our residential, commercial and multifamily customers. Thetypical initial contract term for residential and commercial customers is threeto five years, and for multifamily customers is five to ten years, withautomatic renewal provisions where permitted. We generate incrementalcontractual recurring revenue from nearly all of our residential and commercialcustomers by providing additional services, such as maintenance.

For the year ended December 31,2006, other revenue, derived principally from the sale of electronic securitysystems, contributed 8.6% of our total revenue. Electronic security systemstypically are provided at a loss in connection with generating new contractsfor recurring monitoring services.

**Recent Developments**

On December 20, 2006, Protection One, Inc.entered into the Merger Agreement pursuant to which we will acquire IASG in theMerger. Upon completion of the Merger, which is expected to close during thesecond quarter of 2007, holders of IASG common stock will receive 0.29 sharesof Protection One, Inc. common stock for each share of IASG common stockheld. Cash will be paid in lieu of fractional shares.

A special meeting of stockholders of IASG will be heldon March 27, 2007 for the purpose of voting on the Merger. If approved,IASG will become a wholly owned subsidiary of Protection One, Inc. uponconsummation of the Merger.

On February 22, 2007,we commenced an offer to exchange up to $125,000,000 of the outstanding 12%Senior Secured Notes due 2011 of IASG (the “Old Notes”) for newly issued 12%Senior Secured Notes due 2011 of Protection One Alarm Monitoring, Inc.(the “New Notes”) (the “Exchange Offer”). The 

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ExchangeOffer is subject to the fulfillment of certain conditions, including theconsummation of the Merger.

**Industry andCompetition**

According to an industry publication, the market forelectronic security system sales, leasing, installation, monitoring and servicetotaled approximately $27 billion in 2005. Over the past ten years, theindustry has grown at an estimated compounded annual rate of 8.5%. Factorsdriving this growth include heightened security awareness, demographic changes,an increase in dual income households, as well as improved capital spendingdynamics for businesses.

According to thesame industry publication, the industry is comprised of more than 14,000 smalland mid-sized, regional participants, the vast majority of who generate annualrevenue of less than $500,000. We believe our primary competitors with nationalscope include the following:

·       ADTSecurity Services, Inc., a subsidiary of Tyco International, Ltd:

·       BrinksHome Security, a subsidiary of The Brink’s Company;

·       MonitronicsInternational, Inc.; and

·       StanleyConvergent Security Solutions, a subsidiary of The Stanley Works.

Competition in thesecurity alarm industry is based primarily on market visibility, price,reputation for quality of services and systems, services offered and theability to identify and to solicit prospective customers as they move intohomes and businesses. We believe that we compete effectively with othernational, regional and local security alarm companies.

**Operations**

Our operations consistprincipally of installing, servicing and monitoring premise intrusion and firealarms in the United States.

**CentralizedMonitoring, Customer Service and Enhanced Services**

***Customer Security Alarm Systems***

Security alarm systemsinclude many different types of devices installed at customers’ premisesdesigned to detect or react to various occurrences or conditions, such asintrusion or the presence of fire or smoke. These devices are connected to acomputerized control panel that communicates through wire line and/or wirelessphone lines to one of our monitoring facilities. In most systems, controlpanels can identify the nature of the alarm and the areas within the buildingwhere the sensor was activated and can transmit that information to one of ourcentral monitoring stations.

***Customer Contracts***

Our existing alarmmonitoring customer contracts generally have initial terms ranging from threeto ten years in duration, and, in most states, provide for automatic renewalsfor a fixed period (typically one year) unless we or the customer elect tocancel the contract at the end of its term. Since 2002, most new single-familyresidential customers have entered into contracts with an initial term of threeyears, and most new commercial customers have entered into contracts with aninitial term of five years. Network Multifamily contracts have initial termsthat range from five to ten years. Typically, customers sign alarm monitoringcontracts that include a bundled monthly charge for monitoring and extendedservice protection, which covers the costs of normal repairs of the securitysystem. Customers may elect to sign an alarm monitoring contract providing fora reduced monthly charge that excludes extended service 

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protection.A significant percentage of new residential and commercial customers also electto include line security based on cellular technology in their service bundle.

***Primary Monitoring Facilities***

Weprovide monitoring services to our customer base from three monitoringfacilities. The table below provides additional detail about our monitoringfacilities:

| **Location** | ** ** | ** ** | ** ** | **Approximate Number of  Customers Monitored** | ** ** | **Primary Markets**           | ** ** |
|--------------|------------|------------|------------|---------------------------------------------------------------|------------|------------------------------------|------------|
| Irving, TX   |       |       | 348,000    |                                                          |       | Multifamily/Commercial/Residential |       |
| Longwood, FL |       |       | 182,000    |                                                          |       | Wholesale/Residential              |       |
| Wichita, KS  |       |       | 464,000    |                                                          |       | Residential/Commercial/Wholesale   |       |

 

Our monitoring facilities operate 24 hours per day,seven days a week, including all holidays. Each monitoring facilityincorporates the use of communications and computer systems that route incomingalarm signals and telephone calls to operators. Each operator within amonitoring facility monitors a computer screen that presents informationconcerning the nature of the alarm signal, the customer whose alarm has beenactivated and the premises at which such alarm is located. Other non-emergencyadministrative signals are generated by low battery status, arming anddisarming of the alarm monitoring system and test signals, and such signals areprocessed automatically by computer. Depending upon the type of service forwhich the customer has contracted, monitoring facility personnel respond toalarms by relaying information to local fire or police departments, notifyingthe customer, or taking other appropriate action, such as dispatching alarmresponse personnel to the customers’ premises where this service is available.

All of our primarymonitoring facilities are listed by Underwriters Laboratories, Inc. or UL,as protective signaling services stations. UL specifications for monitoringfacilities include building integrity, back-up computer and power systems,staffing and standard operating procedures. In many jurisdictions, applicablelaw requires the security and life safety alarms for certain buildings bemonitored by UL listed facilities. In addition, such listing is required bycertain commercial customers’ insurance companies as a condition to insurancecoverage.

***Backup Monitoring Facility***

Our backup facility is inWichita, Kansas and is a highly secure concrete building. This fully operableresource has the ability to backup all mission critical operations normallyperformed at our primary retail monitoring center. The structure is equippedwith diverse voice and data telecommunication paths, backup power that includesstandby uninterruptible power supplies, access control, video surveillance anddata vaults. In addition, we have deployed hot redundancy for our entirecomplement of equipment essential in the remote monitoring of the retailsecurity systems we offer. Furthermore, we have replicated the computer systemsthat are used to maintain our mission critical applications. This facility waspurchased with the ability to be expanded for future internal growth and isactively used for other business-related operations.

***Wholesale Monitoring***

Through our Longwood andWichita monitoring facilities, we provide wholesale monitoring services toindependent alarm companies. Under the typical arrangement, alarm companiessubcontract monitoring services to us, primarily because they cannotcost-effectively provide their own monitoring service. We may also providebilling and other services. These independent alarm companies retain 

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ownershipof the monitoring contracts and are responsible for every other aspect of therelationship with customers, including field repair service.

***Customer Care Services***

Customer care personnel answer non-emergency telephonecalls typically regarding services, billing and alarm activation issues. Mostbusiness hours customer care functions for our Protection One Monitoring retailcustomers are handled by our branches. During business hours, monitoringfacility personnel receive inbound customer calls forwarded from branches whenthe latter are unable to answer within a specified number of rings. Afterregular business hours, all customer calls are forwarded to our monitoringfacilities.

Customer care personnel inour Protection One Monitoring retail branches and in our monitoring facilities’help desks assist customers in understanding and resolving minor service andoperating issues related to security systems. Branch personnel scheduletechnician appointments. We also operate a dedicated telesales center inWichita to address questions that retail customers or potential customers haveabout our services, as well as to perform outbound sales and marketingactivities.

***Enhanced Services***

As a means ofincreasing revenue and enhancing customer satisfaction, we offer retail andwholesale customers an array of enhanced security services, including extendedservice protection, supervised monitoring services and telephone line securitybased on wireless technology. These services position us as a full serviceprovider and give our sales representatives more features to sell in theirsolicitation of new customers. Enhanced services include:

·       *Extended Service Protection,* which covers the costs ofnormal repairs of the security system during regular business hours.

·       *Supervised Monitoring Service,* which allows the alarm systemto send various types of signals containing information on the use of thesystem, such as which users armed or disarmed the system and at what time ofday. This information is supplied to customers for use in connection with themanagement of their households or businesses. Supervised monitoring service canalso include a daily automatic test feature.

·       *Wireless Back-Up,*which permits the alarm system to sendsignals over a cellular telephone or dedicated radio system in the event thatregular telephone service is interrupted.

·       *Video Verification and Management,*which allows remote activityverification at customer sites via live or recorded video. This is often usedto verify alarm events or to provide a reliable and economic alternative tophysical security.

·       *Inspection Service,*which provides our customers withperiodic verification of their fire alarm system to ensure the system isfunctioning as designed and in accordance with the requirements of the localfire jurisdiction.

·       *Web Controland Notification,*which provides our customers an array of tools tomanage their alarm, video or access control systems, including options forelectronic notification.

**Branch Operations**

We maintain approximately66 field locations in the United States from which we provide some or all ofthe following services:  field repair,customer care, alarm response and sales services. Our nationwide network ofbranches operates in some of the largest cities in the United States and playsa critical role in enhancing customer satisfaction, reducing customer loss andbuilding brand awareness. Repair services 

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generaterevenue primarily through billable field service calls and recurring paymentsunder our extended service protection program. By focusing growth in targetedareas, we hope to increase the density of our customer base, which will permitmore effective scheduling and routing of field service technicians and willcreate economies of scale.

**Sales and Marketing**

Our current customer acquisition strategy for ourProtection One Monitoring retail segment relies primarily on internallygenerated sales. Our internal sales program for our Protection One Monitoringsegment was started in February 2000 on a commission-only basis with agoal of creating accounts at a cost lower than our external programs. Thisprogram utilizes our existing branch infrastructure. The internal sales programfor our Protection One Monitoring segment generated $2.1 million, $1.9 millionand $1.7 million of new RMR in 2006, 2005 and 2004, respectively. We operate adedicated telesales center from which we respond to questions that customers orpotential customers have about our services, support a marketing alliance withBellSouth Corporation (BellSouth) (now part of AT&T) and provide qualitycontrol follow-up calls to customers for whom we recently provided installationor maintenance services.

We are a partner in a marketing alliance withBellSouth to offer monitored security services to the residential,single-family market and to businesses in 17 of the larger metropolitan marketsin the nine-state BellSouth region of the southeastern United States. BellSouthprovides us with information about new owners of single-family residences andbusinesses in its territory and of transfers of existing BellSouth customerswithin its territory. We follow up on the information to create leads for oursales force. We pay BellSouth an upfront royalty for each new contract and arecurring royalty based on a percentage of recurring charges. Approximatelyone-fourth of our new accounts created in 2006 and 2005 and one-fifth of ournew accounts created in 2004 were produced from this arrangement. The marketingalliance agreement may be terminated by either party upon 180 days notice orearlier upon occurrence of certain events.

Our retail sales professionals are responsible foridentifying new prospects and closing new sales of monitoring systems andservices. The sales force also generates revenue from selling equipmentupgrades and add-ons to existing customers and by competing for those customerswho are terminating their relationships with our competitors.

Our Network Multifamily segment utilizes a salariedand commissioned sales force to produce new accounts. Network Multifamilymarkets its services and products primarily to developers, owners and managersof apartment complexes and other multifamily dwellings. Network Multifamilysales and marketing activities consist of national and regional advertising,nationwide professional field sales efforts, prospective acquisition marketingefforts and professional industry-related association affiliations. Servicesare sold directly to the property owner, and payment is based on a monthlyprice on a per-unit basis. Ongoing service for the duration of the leaseincludes providing equipment, maintenance, 24-hour monitoring from ourcentral monitoring station, customer service and individual market support. Propertyowner contracts generally have initial terms ranging from five to ten years induration and provide for automatic renewal for a fixed period (typically fiveyears) unless Network Multifamily or the customer elects to cancel the contractat the end of its term.

We continually evaluateour customer creation and marketing strategy, including evaluating eachrespective channel for economic returns, volume and other factors and may shiftour strategy or focus, including the elimination of a particular channel.

**Attrition**

See Item 7, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations—Attrition,”which is incorporated herein by reference, for more information regarding 

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attritioncalculations, the impact of attrition on our operating results and customerattrition by business segment.

**IntellectualProperty**

We own trademarks relatedto the name and logo for Protection One and Network Multifamily Security aswell as a variety of trade and service marks related to individual services weprovide. While we believe our trademarks and service marks and proprietaryinformation are important to our business, we do not believe our inability touse any one of them, other than the trademarks we own in our name and logo,would have a material adverse effect on our business as a whole.

**Regulatory Matters**

A number of localgovernmental authorities have adopted or are considering various measures aimedat reducing the number of false alarms. See Item 1A, “Risk Factors,” foradditional information. Such measures include:

·       requiringpermits for individual alarm systems and the revocation of such permitsfollowing a specified number of false alarms;

·       imposingfines on alarm customers or alarm monitoring companies for false alarms;

·       imposinglimitations on the number of times the police will respond to alarms at aparticular location after a specified number of false alarms;

·       requiringfurther verification of an alarm signal before the police will respond; and

·       subjectingalarm monitoring companies to fines or penalties for transmitting false alarms.

Our operations are subject to a variety of other laws,regulations, and licensing requirements of federal, state and local authorities.In certain jurisdictions, we are required to obtain licenses or permits, tocomply with standards governing employee selection and training, and to meetcertain standards in the conduct of our business.

The alarm industry is also subject to requirementsimposed by various insurance, approval, listing and standards organizations. Dependingupon the type of customer served, the type of security service provided, andthe requirements of applicable local governmental jurisdiction, adherence tothe requirements and standards of such organizations is mandatory in someinstances and voluntary in others.

Our advertising and sales practices are regulated inthe United States by both the Federal Trade Commission and state consumerprotection laws. In addition, certain administrative requirements and laws ofthe jurisdictions in which we operate also regulate such practices. Such lawsand regulations include restrictions on the manner in which we promote the saleof our security alarm systems and the obligation to provide purchasers of ouralarm systems with rescission rights.

Our alarm monitoringbusiness utilizes wire line and wireless telephone lines, radio frequencies,and broadband data circuits to transmit alarm signals. The cost of telephonelines and the type of equipment which may be used in telephone linetransmissions are currently regulated by both federal and state governments. TheFederal Communications Commission and state public utilities commissionsregulate the operation and utilization of radio frequencies.

**Risk Management**

The nature of the services we provide potentiallyexposes us to greater risks of liability for employee acts or omissions, orsystem failure, than may be inherent in other businesses. Substantially all ofour alarm 

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monitoring agreements andother agreements, pursuant to which we sell our products and services, containprovisions limiting liability to customers in an attempt to reduce this risk.

We carry insurance ofvarious types, including general liability and professional liability insurancein amounts management considers adequate and customary for our industry andbusiness. Our loss experience, and the loss experiences of other securityservice companies, may affect the availability and cost of such insurance. Someof our insurance policies, and the laws of some states, may limit or prohibitinsurance coverage for punitive or certain other types of damages, or liabilityarising from gross negligence.

**Employees**

At December 31, 2006we had approximately 2,500 full and part time employees. Our workforce is notunionized.

**Access to CompanyInformation**

We electronically file our annual report on Form 10-K,quarterly reports on Form 10-Q and current reports on Form 8-Kwith the Securities and Exchange Commission, or SEC. The SEC maintains anInternet site (www.sec.gov) that contains reports, proxy and informationstatements and other information regarding issuers that file electronically.

We make available, free ofcharge, through our website at www.protectionone.com, and by responding torequests addressed to our investor relations department, our annual report on Form 10-K,quarterly reports on Form 10-Q and current reports on Form 8-K.These reports are available as soon as reasonably practicable after suchmaterial is electronically filed with or furnished to the SEC. The informationcontained on our website is not part of this document.

**ITEM 1A:**       RISKFACTORS

You should read thefollowing risk factors in conjunction with discussions of factors discussedelsewhere in this and other of our filings with the SEC. These cautionarystatements are intended to highlight certain factors that may affect ourfinancial condition and results of operations and are not meant to be anexhaustive discussion of risks that apply to public companies with broadoperations, such as us.

***Quadrangle is our principal stockholder and canexercise a controlling influence over us.***

Quadrangle ownsapproximately 97.1% of our outstanding common stock as of March 10, 2007. Pursuantto a stockholder agreement with Quadrangle and subject to Quadranglemaintaining a certain threshold of ownership in us, Quadrangle will be able todirect the election of three of our directors and exercise a controllinginfluence over our business and affairs, including any determinations withrespect to mergers or other business combinations involving us, appointment ofour officers, our acquisition or disposition of material assets and ourincurrence of indebtedness. Similarly, Quadrangle will continue to have thepower to determine matters submitted to a vote of our stockholders without theconsent of other stockholders and to take other actions that might be favorableto Quadrangle, whether or not these actions would be favorable to us or to ourstockholders in general. Following the Merger, Quadrangle will continue to owna majority of the combined company’s stock and will be able to control theelection of a majority of the combined company’s board of directors.

***We have a history of losses, which are likely tocontinue.***

We incurred netlosses of $17.4 million for the year ended December 31, 2006, $15.6million for the period February 9, 2005 through December 31, 2005,$11.4 million for the period January 1, 2005 through 

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February 8,2005, and $323.9 million for the year ended December 31, 2004. Theselosses reflect the following, among other factors:

·       ourcustomer base has declined every year since 1999 and our revenue declined everyyear from 1999 to 2005 with only a slight increase in 2006;

·       substantialcharges incurred by us for amortization of customer accounts;

·       interestincurred on indebtedness;

·       expansionof our internal sales and installation efforts;

·       recapitalizationcosts in 2006, change in control, debt restructuring and corporateconsolidation costs in 2005 and 2004;

·       awrite down of remaining deferred tax assets in 2004; and

·       othercharges required to manage operations.

We will continue to incura substantial amount of interest expense and amortization of customer accountsand we do not expect to attain profitability in the near future.

***Our substantial indebtedness could adversely affectour financial condition.***

We have, and willcontinue to have, a significant amount of indebtedness. As of March 10,2007, the face value of our total indebtedness, including capital leases, wasapproximately $410.8 million. In addition, we will incur additionalindebtedness in connection with the Merger, primarily related to the issuanceof up to $125.0 million in New Notes in connection with the Exchange offer.  Our level of indebtedness could have importantconsequences. For example, it could:

·       limitour ability to borrow money or sell stock to fund our working capital, capitalexpenditures, acquisitions and debt service requirements;

·       limitour flexibility in planning for, or reacting to, changes in our business andfuture business opportunities;

·       makeus more vulnerable to a downturn in our business or in the economy or to anincrease in interest rates;

·       placeus at a disadvantage to some of our competitors, who may be less highlyleveraged than us; and

·       requirea substantial portion of our cash flow from operations to be used for debtpayments, thereby reducing the availability of our cash flow to fund workingcapital, capital expenditures, acquisitions and other general corporatepurposes.

One or a combination of these factors could adverselyaffect our financial condition. Subject to restrictions in the indenturegoverning our notes and our senior secured credit facility, we may incuradditional indebtedness, which could increase the risks associated with ouralready substantial indebtedness.

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***Restrictivecovenants restrict our ability to operate our business and to pursue ourbusiness strategies, and our failure to comply with these covenants couldresult in an acceleration of our indebtedness.***

Our senior creditfacility and the indenture governing our 8.125% senior subordinated notes (the “SeniorSubordinated Notes Indenture”) contain covenants that restrict our ability tofinance future operations or capital needs, to respond to changing business andeconomic conditions or to engage in other transactions or business activitiesthat may be important to our growth strategy or otherwise important to us. Oursenior credit facility and the Senior Subordinated Notes Indenture restrict,among other things, our ability to:

·       incuradditional indebtedness or enter into sale and leaseback transactions;

·       paydividends or make distributions on our capital stock or certain otherrestricted payments or investments;

·       purchaseor redeem stock;

·       issuestock of our subsidiaries;

·       makeinvestments and extend credit;

·       engagein transactions with affiliates;

·       transferand sell assets;

·       effecta consolidation or merger or sell, transfer, lease or otherwise dispose of allor substantially all of our assets; and

·       createliens on our assets to secure debt.

In addition, our senior credit facility requires us tomeet certain financial ratios and to repay outstanding borrowings with portionsof the proceeds we receive from certain sales of property or assets andspecified future debt offerings. Our financial results may be affected byunforeseen adverse events, and we may not be able to meet the financial ratios.

Any breach of thecovenants in our senior credit facility or in the Senior Subordinated NotesIndenture could cause a default under such instruments. If there were an eventof default under any of our debt instruments that was not cured or waived, theholders of the defaulted debt could cause all amounts outstanding with respectto the debt instrument to be due and payable immediately. Our assets and cashflow may not be sufficient to fully repay borrowings under our outstanding debtinstruments if accelerated upon an event of default. If, as or when required,we are unable to repay, refinance or restructure our indebtedness under, oramend the covenants contained in, our senior credit facility, the lenders underour senior credit facility could institute foreclosure proceedings against theassets securing borrowings under our senior credit facility.

***If we are unable torepay or refinance our 8.125% senior subordinated notes prior to July 2008,our outstanding indebtedness under our senior credit facility will become dueand payable.***

The revolving creditfacility and term loan under our senior credit facility are subject to earlymaturity if we do not repay or refinance our 8.125% senior subordinated noteson or before June 30, 2008. We do not expect our business to generate cashflow from operations in an amount sufficient to enable us to repay our 8.125%senior subordinated notes, so we believe that we will need to refinance allsuch indebtedness. We may not, however, be able to refinance our 8.125% seniorsubordinated notes within the limitations set forth in the senior creditfacility on favorable terms or at all. If we do not refinance our 8.125% seniorsubordinated notes on or before June 30, 2008, the aggregate amountoutstanding under the revolving credit facility and term loan will becomeimmediately due and payable. If we are unable to repay, refinance 

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orrestructure our indebtedness under, or amend the covenants contained in, oursenior credit facility, the lenders under our senior credit facility couldinstitute foreclosure proceedings against the assets securing borrowings underthe senior credit facility.

***We rely ontechnology that may become obsolete, which could require significant capitalexpenditures.***

Our monitoring servicesdepend upon the technology (hardware and software) of security alarm systems. Inorder to maintain our customer base that currently uses security alarmcomponents that are or could become obsolete, we will likely be required toupgrade or implement new technologies that could require significant capitalexpenditures. We may not be able to successfully implement new technologies oradapt existing technologies to changing market demands. If we are unable toadapt in response to changing technologies, market conditions or customerrequirements in a timely manner, such inability could adversely affect ourbusiness.

***The failure tosuccessfully integrate IASG’s business and operations in the expected timeframe may adversely affect the combined company’s future results.***

The success of the Merger will depend, in part, on thecombined company’s ability to realize the anticipated benefits from combiningthe businesses of Protection One and IASG. However, to realize theseanticipated benefits, the businesses of Protection One and IASG must besuccessfully combined. If the combined company is not able to achieve theseobjectives, the anticipated benefits of the Merger may not be realized fully orat all or may take longer to realize than expected.

Protection One and IASGhave operated and, until the completion of the Merger, will continue to operateindependently. It is possible that the integration process could result in theloss of key employees, as well as the disruption of each company’s ongoingbusinesses or inconsistencies in standards, controls, procedures and policies,any or all of which could adversely affect the combined company’s ability tomaintain relationships with customers and employees after the merger or toachieve the anticipated benefits of the Merger. Integration efforts between thetwo companies will also divert management attention and resources. Theseintegration matters could have an adverse effect on the combined company.

***Shifts in ourcurrent and future customers’ selection of telecommunications services couldincrease customer attrition and could adversely impact our earnings and cashflow.***

Certain elements of ouroperating model rely on our customers’ selection and continued use oftraditional, land-line telecommunications services, which we use to communicatewith our monitoring operations. In recent years, many customers in our NetworkMultifamily segment have shown a preference for subscribing only to cellulartechnology and have discontinued use of land-line telephone services. Inorder to continue to service existing customers who cancel their land-linetelecommunications services and service new customers who do not subscribeto land-line telecommunications services, customers must upgrade to alternativeand typically more expensive wireless or internet based technologies. Continuedshifts in customers’ preferences regarding telecommunications services couldcontinue to adversely impact attrition and our earnings and cash flow.

***We face increasingcompetition and pricing pressure from other companies in our industry and if weare unable to compete effectively with these companies, our sales andprofitability could be adversely affected.***

We compete with a numberof major domestic security monitoring services companies, as well as a largenumber of smaller, regional competitors. Due in part to this fiercecompetition, we have experienced high rates of customer attrition and have beensubjected to continual and significant pricing pressures. Some of ourcompetitors, either alone or in conjunction with their respective parentcorporate groups, are larger than we are and have greater financial resources,sales, marketing or operational capabilities or 

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brandrecognition that we do. In addition, the innovative nature of our markets mayattract new entrants to the field. We may not be able to compete successfullywith the services of other companies, which could result in the loss ofcustomers and, as a result, decreased revenue and operating results.

***The competitivemarket for the acquisition and creation of accounts may affect our futureprofitability.***

Prior to 2000, we grewvery rapidly by acquiring portfolios of alarm monitoring accounts throughacquisitions and dealer purchases. Our current strategy is to reduce the costof acquiring new accounts by utilizing other customer account acquisitionchannels such as our internal sales force augmented by traditional marketingsupport. The security alarm monitoring industry is highly competitive andhighly fragmented. We compete with several companies that have accountacquisition and loan programs for independent dealers and some of thosecompetitors are larger than we are and have more capital than we do. Increasedcompetition from other alarm monitoring companies could require us to reduceour prices for installations, decrease the monitoring fees we charge ourcustomers and take other measures that could reduce our margins. Thesedecreases and other measures could have a material adverse effect on us.

***Loss of customeraccounts could materially adversely affect our operations.***

We experience theloss of accounts as a result of, among other factors:

·       relocationof customers;

·       customers’inability or unwillingness to pay our charges;

·       adversefinancial and economic conditions;

·       thecustomers’ perceptions of value; and

·       competitionfrom other alarm service companies.

We may experience the lossof newly acquired or created accounts to the extent we do not integrate oradequately service those accounts. Because some acquired accounts are prepaidon an annual, semiannual or quarterly basis, customer loss may not becomeevident for some time after an acquisition is consummated. During 2006, weexperienced a net loss of 18,785 customers, or a 1.9% decrease in our customerbase from January 1, 2006. While our attrition rates have stabilized inour Protection One Monitoring segment, we continue to lose customers at a ratefaster than our rate of adding customers. However, due to price increases,other adjustments and our increasing focus on adding commercial accounts withhigher average RMR, our monitoring and related services revenue increasedslightly (less than 1%) in 2006 compared to 2005. The net loss of customers wasthe primary cause for the decline in monitoring related services revenue of$1.6 million in 2005. We expect account losses to exceed additions until theefforts we are making to acquire new accounts and further reduce our rate ofattrition become more successful than they have been to date. Net losses ofcustomer accounts materially and adversely affect our business, financialcondition and results of operations.

***Our customeracquisition strategies may not be successful, which would adversely affect ourbusiness.***

The customer accountacquisition strategy we are now employing relies primarily on our internalsales force and forming marketing alliances. We have changed our acquisitionstrategy several times over the past few years attempting to decrease the costof adding customers and to decrease the rate of attrition from new accounts. Whileour present strategy resulted in some improvements in 2006 and 2005, thisstrategy may not be successful in the future. If the strategy is notsuccessful, our customer base could continue to decline. If successful, sellingcosts related to this strategy will increase our expenses and uses of cash. Failureto replace customers lost through attrition or increased cash needs to replacethose customers 

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couldhave a material adverse effect on our business, financial condition, results ofoperations and ability to service debt obligations.

***We rely on amarketing alliance for the generation of many new accounts.***

We have established amarketing relationship to offer monitored security services to the residential,single-family market and to businesses in 17 of the larger metropolitan marketsin the southeastern United States. Approximately 25% of our new accountscreated in each of 2006 and 2005 and 20% of our new accounts created in 2004were produced from this arrangement. Termination of this arrangement could havea short term material adverse effect on our ability to generate new customersin this territory.

***Increased adoptionof “false alarm” ordinances by local governments may adversely affect ourbusiness.***

An increasingnumber of local governmental authorities have adopted, or are considering theadoption of, laws, regulations or policies aimed at reducing the perceivedcosts to municipalities of responding to false alarm signals. Such measures couldinclude:

·       requiringpermits for the installation and operation of individual alarm systems and therevocation of such permits following a specified number of false alarms;

·       imposingfines on alarm customers or alarm monitoring companies for false alarms;

·       imposinglimitations on the number of times the police will respond to alarms at aparticular location after a specified number of false alarms;

·       requiringfurther verification of an alarm signal before the police will respond; and

·       subjectingalarm monitoring companies to fines or penalties for transmitting false alarms.

Enactment of thesemeasures could adversely affect our future business and operations. Inaddition, concern over false alarms in communities adopting these ordinancescould cause a decrease in the timeliness of police response to alarmactivations and thereby decrease the propensity of consumers to purchase ormaintain alarm monitoring services.

***Increased adoptionof statutes and governmental policies purporting to void automatic renewalprovisions in our customer contracts, or purporting to characterize certain ofour charges as unlawful, may adversely affect our business.***

Our customer contracts typically contain provisionsautomatically renewing the term of the contract at the end of the initial term,unless cancellation notice is delivered in accordance with the terms of thecontract. If the customer cancels prior to the end of the contract term, otherthan in accordance with the contract, we may charge the customer the charges thatwould have been paid over the remaining term of the contract, or charge anearly cancellation fee.

Several states haveadopted, or are considering the adoption of statutes, consumer protectionpolicies or legal precedents which purport to void the automatic renewalprovisions of our customer contracts, or otherwise restrict the charges we canimpose upon contract cancellation. Such initiatives could compel us to increasethe length of the initial term of our contracts, and increase our chargesduring the initial term, and consequently lead to less demand for our servicesand increase our attrition. Adverse judicial determinations regarding thesematters could cause us to incur legal exposure to customers against whom suchcharges have been imposed, and the risk that certain of our customers may seekto recover such charges through litigation. In addition, the costs of defendingsuch litigation and enforcement actions could have an adverse effect on us.

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***Due to aconcentration of accounts in California, Florida and Texas, we are susceptibleto environmental incidents that may negatively impact our results ofoperations.***

Almost 45% of ourrecurring monthly revenue is derived from customers located in California,Florida and Texas. A major earthquake, hurricane or other environmentaldisaster in an area of high account concentration could disrupt our ability toserve those customers or render those customers uninterested in continuing toretain us to provide alarm monitoring services.

***Declines in rents,occupancy rates and new construction of multifamily dwellings may affect oursales in this marketplace.***

Demand for alarmmonitoring services in the Network Multifamily segment is tied to the generalhealth of the multifamily housing industry. This industry is dependent uponprevailing rent levels and occupancy rates as well as the demand forconstruction of new properties. The real estate market in general is cyclical,however, and, in the event of a decline in the market factors described above,it is likely that demand for our alarm monitoring services to multifamilydwellings would also decline, which could negatively impact our results ofoperations.

***We could faceliability for our failure to respond adequately to alarm activations.***

The nature of the serviceswe provide potentially exposes us to greater risks of liability for employeeacts or omissions or system failures than may be inherent in other businesses. Inan attempt to reduce this risk, our alarm monitoring agreements and otheragreements pursuant to which we sell our products and services containprovisions limiting our liability to customers and third parties. However, inthe event of litigation with respect to such matters, these limitations may notbe enforced. In addition, the costs of such litigation could have an adverseeffect on us.

***Future governmentregulations or other standards could have an adverse effect on our operations.***

Our operations are subjectto a variety of laws, regulations and licensing requirements of federal, stateand local authorities. In certain jurisdictions, we are required to obtainlicenses or permits, to comply with standards governing employee selection andtraining and to meet certain standards in the conduct of our business. The lossof such licenses, or the imposition of conditions to the granting or retentionof such licenses, could have an adverse effect on us. In the event that theselaws, regulations and/or licensing requirements change, we may be required tomodify our operations or to utilize resources to maintain compliance with such rules andregulations. In addition, new regulations may be enacted that could have anadverse effect on us.

***The loss of ourUnderwriter Laboratories listing could negatively impact our competitiveposition.***

All of our alarm monitoringcenters are Underwriters Laboratories (“UL”) listed. To obtain and maintain aUL listing, an alarm monitoring center must be located in a building meeting UL’sstructural requirements, have back-up and uninterruptible power supplies, havesecure telephone lines and maintain redundant computer systems. UL conductsperiodic reviews of alarm monitoring centers to ensure compliance with theirregulations. Non-compliance could result in a suspension of our UL listing. Theloss of our UL listing could negatively impact our competitive position.

***We depend on ourrelationships with alarm system manufacturers and suppliers. If we are not ableto maintain or renew these alliances, our ability to create new customers andto service our existing account base could be negatively affected.***

We currently haveagreements with certain alarm system manufacturers and suppliers of hardwarefor products that we install in customer locations for new systems and torepair existing systems. We may not 

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be ableto maintain or renew our existing product sourcing arrangements on terms andconditions acceptable to us. If we are unable to maintain or renew our existingrelationships, we may incur additional costs creating new customer arrangementsand in servicing existing customers.

***We rely onsubcontractors in certain markets to install, service and repair alarm systems.***

We currently haveagreements with various subcontractors in order to timely and efficientlyinstall, service and repair alarm systems. We may not be able to maintain or renewour subcontractor arrangements on terms and conditions acceptable to us. If weare unable to maintain or renew our existing subcontractor relationships, wemay incur additional costs creating new customer arrangements and in servicingexisting customers and customer satisfaction may suffer, leading to increasedattrition. Also, our reliance on subcontractors increases our costs related toquality assurance and inspections and potentially diminishes our brand identitywith customers.

***Most of our customers’alarm systems communicate with our monitoring center via Public SwitchedTelephone Network lines, or PSTN lines, provided by an incumbent local exchangecarrier, which are losing market share to wireless and Internet-based means ofcommunication.***

The number of PSTN linesprovided by incumbent local exchange carriers have been and are expected tocontinue decreasing. While we offer alarm systems that can communicate signalsto our central stations using various wireless and/or Internet-basedcommunication technologies, such solutions are presently more expensive thantraditional PSTN-based alarm communicators. Higher costs might reduce themarket for new customers of alarm monitoring services, and the trend away fromPSTN lines to alternatives may mean more existing customers will cancel servicewith us. In addition, such shifts to newer communications technologies mayincrease our costs for personnel training.

***We are dependentupon our experienced senior management, who would be difficult to replace.***

The success of ourbusiness is largely dependent upon the active participation of our executiveofficers, who have extensive experience in the industry. As a result, we haveentered into employment agreements with each of our executive officers. Theloss of service of one or more of such officers for any reason may have anadverse effect on our business.

***We have incurredand will continue to incur increased costs as a result of securities laws andregulations relating to corporate governance matters and public disclosures.***

The Sarbanes-Oxley Act of 2002 and the SEC rules implementingthat Act have required changes in some of our corporate governance practicesand may require further changes. These rules and regulations haveincreased our legal and financial compliance costs and have made someactivities more difficult, time-consuming or costly. These rules andregulations could also make it more difficult for us to attract and retainqualified independent members of our board of directors and qualified members ofour management team.

We are taking steps tocomply with the laws and regulations in accordance with the deadlines by whichcompliance is required, however, our estimate of the amount or timing ofadditional costs that we may incur to respond by these deadlines may not beaccurate. Furthermore, we cannot ensure successful outcomes from the review tobe performed in connection with the provisions of Section 404 of the Actregarding management’s assessment of the effectiveness of the Company’sinternal control over financial reporting and the auditor’s attestation to andreport on both management’s assessment and the effectiveness of the Company’sinternal control over financial reporting.

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**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

We have no unresolvedstaff comments as of March 10, 2007.

**ITEM 2.**                PROPERTIES

Wemaintain our executive offices at 1035 N. 3rd Street, Suite 101, Lawrence,Kansas 66044. We operate primarily from the following facilities, although wealso lease office space for our approximately 66 field locations.

| **Location** | ** ** | ** ** | ** ** | **Approximate  Size (sq. ft.)** | ** ** | **Lease/Own** | ** ** | **Principal Purpose** | ** ** |
|--------------|------------|------------|------------|-------------------------------------------|------------|---------------|------------|----------------------------|------------|
| Irving, TX   |       |       | 53,750     |                                      |       |          | Lease      |                       |       | Multifamily  monitoring facility/corporate legal center |   |
| Longwood, FL |       |       | 20,000     | ** **                                |       |          | Lease      | ** **                 |       | Monitoring  facility/administrative functions |   |
| Lawrence, KS |       |       | 15,000     | ** **                                |       |          | Lease      | ** **                 |       | Financial/administrative  headquarters |   |
| Wichita, KS  |       |       | 50,000     | ** **                                |       |          | Own        | ** **                 |       | Monitoring  facility/administrative functions |   |
| Wichita, KS  |       |       | 122,000    | ** **                                |       |          | Own        | ** **                 |       | Backup monitoring  center/administrative functions |   |

 

**ITEM 3.**                LEGALPROCEEDINGS

Information on our legalproceedings is set forth in Item 8, Note 9 “Commitments and Contingencies” ofthe Notes to the Consolidated Financial Statements, which are incorporatedherein by reference.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF STOCKHOLDERS

No matters were submitted to Protection One’sstockholders during the fourth quarter of 2006.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

**Market PriceInformation**

Thetable below sets forth for each of the calendar quarters indicated the high andlow sales prices per share of our common stock, as reported by the OTC BulletinBoard. The quotations reflect inter-dealer prices, without retail mark-up,mark-down or commission and may not represent actual transactions. On February 8,2005 we effectuated a one-share-for-fifty shares reverse stock split. On February 9,2005 our common stock symbol changed from “POIX” to “PONN.”

| ** **     | ** ** | **High(a)** | ** ** | **Low(a)** | ** ** |
|----------------|------------|-------------|------------|------------|------------|
| **2005:**      |       |        |       |       |       |   |   |
| First Quarter  |       |        | $          | 28.50      |       |   | $ | 13.50 |   |
| Second Quarter |       |        | 28.75      |       |       | 18.05 |   |
| Third Quarter  |       |        | 18.10      |       |       | 13.85 |   |
| Fourth Quarter |       |        | 17.95      |       |       | 15.80 |   |
| **2006:**      |       |        |       |       |       |   |   |
| First Quarter  |       |        | $          | 18.00      |       |   | $ | 17.00 |   |
| Second Quarter |       |        | 27.00      |       |       | 14.50 |   |
| Third Quarter  |       |        | 15.08      |       |       | 12.10 |   |
| Fourth Quarter |       |        | 13.15      |       |       | 11.50 |   |

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(a)           Stockprices presented give effect to the one-share-for-fifty shares reverse stocksplit on February 8, 2005.

**DividendInformation**

On May 12, 2006, we paid a cash dividend of $70.5million, or $3.86 per share, to all holders of record of our common stock on May 8,2006, including Quadrangle, which owned approximately 97.1% of the outstandingshares of our common stock at that date. Our board of directors also approved acash payment of $4.5 million or $2.89 for each vested and unvested optionawarded in February 2005 under the 2004 Stock Option Plan, including tomembers of senior management. This payment is referred to as the “compensatorymake-whole payment.”  Approximately $3.2million of the compensatory make-whole payment related to options that had notyet vested and accordingly this amount plus related taxes was recorded as compensationexpense in the second quarter of 2006 and is reflected as recapitalizationcosts in the Consolidated Statement of Operations and Comprehensive Loss. Approximately$1.3 million of the compensatory make-whole payment related to vested optionsand was recorded to additional paid in capital. In addition, the exercise priceof each vested and unvested option was reduced by $0.98. Our board of directorsdecided to pay the compensatory make-whole payment and reduce the optionexercise price because the payment of the May 2006 dividend decreased thevalue of the equity interests of holders of options, as these holders were nototherwise entitled to receive the dividend. Accordingly, our board of directorsawarded the same amount to the option holders, on a per share basis, in theform of the compensatory make-whole payment and the reduced option exerciseprice.

We did not declare or pay any dividends for the yearending December 31, 2005.

The Senior SubordinatedNotes Indenture and our senior credit facility restrict Protection One AlarmMonitoring’s ability to pay dividends or to make other distributions to itscorporate parent. Consequently, these agreements restrict our ability todeclare or pay any dividend on, or make any other distribution in respect of,our capital stock unless we satisfy the financial and other tests set forth insuch agreements.

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**Number ofStockholders**

As of March 10, 2007,there were approximately 831 stockholders of record who held shares of ourcommon stock.

**SecuritiesAuthorized for Issuance Under Equity Compensation Plans**

The information called forby the item relating to “Securities Authorized for Issuance Under EquityCompensation Plans” is set forth under that heading in Item 12, “SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters” and is incorporated herein by reference.

**Performance Graph**

The following chartcompares the cumulative total stockholder returns on the Common Stock since December 31,2001 to (1) the cumulative total returns over the same period of theRussell MicroCap index; and (2) the group of companies selected as ourpeers at the current time. The peer group is comprised of Brinks, IntegratedAlarm Services Group, Inc. and Lifeline Systems, Inc. The annual returnsfor the Peer Group indices are weighted based on the capitalization of eachcompany within the peer group at the beginning of each period for which areturn is indicated. The chart assumes the value of the investment in theCommon Stock and each index was $100 at December 31, 2001 and that alldividends were reinvested.

**COMPARISON OF 5YEAR CUMULATIVE TOTAL RETURN***AmongProtection One, Inc., The Russell MicroCap IndexAnd A Peer Group

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*                    $100 Investedon 12/31/01 in stock or index-including reinvestment of dividends. 

Fiscal year ending December 31.

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**ITEM 6.**                SELECTEDFINANCIAL DATA

Theselected consolidated financial data set forth below should be read inconjunction with Item 7, “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and the audited consolidated financialstatements and notes to the financial statements of Protection One, which canbe found in Item 8. Due to the impact of the changes resulting from the pushdown accounting adjustments described in Item 7, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—SignificantActivities—*New Basis of Accounting in 2005*” below,the statement of operations data and cash flow data presentations for 2005separate our results into two periods:  (1) theperiod prior to the February 8, 2005 consummation of the exchangetransaction and (2) the period beginning after that date utilizing the newbasis of accounting. The results are further separated by a heavy black line toindicate the effective date of the new basis of accounting. All amounts are inthousands, except per share and customer data, unless otherwise noted.

| ** **                                                                                   | ** ** | **SELECTED CONSOLIDATED FINANCIAL DATA** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                   | ** ** | ** **                                              | ** ** | **February 9** | ** ** | ** ** | ** ** | **January 1** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | **Year Ended**                                     | ** ** | **through** | ** ** | ** ** | ** ** | **through** | ** ** | **Year Ended** | ** ** | **Year Ended** | ** ** | **Year Ended** | ** ** |
| ** **                                                                                   | ** ** | **December 31,**                                   | ** ** | **December 31,** | ** ** | ** ** | ** ** | **February 8,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                   | ** ** | **2006**                                                | ** ** | **2005(a)** | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                   | ** ** | **(dollar amounts in thousands)**        | ** ** |
| **Statements of operations data**                                                            |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                                                      |       |                                                    | $          | 270,552 |   |   |   | $ | 234,481 |   |   |   |   |   | $ | 28,543 |   |   |   | $ | 269,259 |   |   |   | $ | 277,085 |   |   |   | $ | 290,580 |   |   |
| Cost of revenue                                                                              |       |                                                    | 101,387    |   |   |   | 81,059 |   |   |   |   |   | 10,714 |   |   |   | 101,579 |   |   |   | 102,205 |   |   |   | 113,158 |   |   |
| Selling, general and administrative expenses                                                 |       |                                                    | 103,916    |   |   |   | 86,014 |   |   |   |   |   | 12,093 |   |   |   | 104,872 |   |   |   | 109,261 |   |   |   | 112,984 |   |   |
| Change in control, restructuring, recapitalization  and corporate consolidation costs        |       |                                                    | 4,472      |   |   |   | 2,339 |   |   |   |   |   | 5,939 |   |   |   | 24,382 |   |   |   | — |   |   |   | — |   |   |
| Amortization of intangibles and depreciation expense                                         |       |                                                    | 41,667     |   |   |   | 43,742 |   |   |   |   |   | 6,638 |   |   |   | 78,455 |   |   |   | 80,252 |   |   |   | 82,440 |   |   |
| Other  charges:                                                                              |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss on impairment of customer accounts(c)                                                   |       |                                                    | —     |   |   |   | — |   |   |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 338,104 |   |   |
| Loss on impairment of goodwill(c)                                                            |       |                                                    | —     |   |   |   | — |   |   |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 103,937 |   |   |
| Operating income (loss)                                                                      |       |                                                    | 19,110     |   |   |   | 21,327 |   |   |   |   |   | (6,841 | ) |   |   | (40,029 | ) |   |   | (14,633 | ) |   |   | (460,043 | ) |   |
| Interest expense, net                                                                        |       |                                                    | (35,900    | ) |   |   | (30,634 | ) |   |   |   |   | (4,544 | ) |   |   | (44,398 | ) |   |   | (40,101 | ) |   |   | (43,023 | ) |   |
| Gain (loss) on retirement of debt                                                            |       |                                                    | —     |   |   |   | (6,657 | ) |   |   |   |   | — |   |   |   | (47 | ) |   |   | — |   |   |   | 19,337 |   |   |
| Other income                                                                                 |       |                                                    | 52         |   |   |   | 688 |   |   |   |   |   | 15 |   |   |   | 147 |   |   |   | 2,829 |   |   |   | 602 |   |   |
| Loss from continuing operations before income taxes                                          |       |                                                    | (16,738    | ) |   |   | (15,276 | ) |   |   |   |   | (11,370 | ) |   |   | (84,327 | ) |   |   | (51,905 | ) |   |   | (483,127 | ) |   |
| Income tax benefit (expense)(d)                                                              |       |                                                    | (667       | ) |   |   | (312 | ) |   |   |   |   | (35 | ) |   |   | (239,579 | ) |   |   | 17,494 |   |   |   | 148,852 |   |   |
| Loss from continuing operations before accounting  change                                    |       |                                                    | (17,405    | ) |   |   | (15,588 | ) |   |   |   |   | (11,405 | ) |   |   | (323,906 | ) |   |   | (34,411 | ) |   |   | (334,275 | ) |   |
| Loss from discontinued operations, net of taxes                                              |       |                                                    | —     |   |   |   | — |   |   |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (2,967 | ) |   |
| Cumulative  effect of accounting change, net of taxes                                        |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Continuing operations(c)                                                                     |       |                                                    | —     |   |   |   | — |   |   |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (541,330 | ) |   |
| Discontinued operations(c)                                                                   |       |                                                    | —     |   |   |   | — |   |   |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (2,283 | ) |   |
| Net loss                                                                                     |       |                                                    | $          | (17,405 | ) |   |   | $ | (15,588 | ) |   |   |   |   | $ | (11,405 | ) |   |   | $ | (323,906 | ) |   |   | $ | (34,411 | ) |   |   | $ | (880,855 | ) |   |
| Net loss from continuing operations before accounting  changes per share of common  stock(b) |       |                                                    | $          | (0.95 | ) |   |   | $ | (0.86 | ) |   |   |   |   | $ | (5.80 | ) |   |   | $ | (164.78 | ) |   |   | $ | (17.53 | ) |   |   | $ | (170.46 | ) |   |
| Weighted average number of shares of common stock  outstanding(b)                            |       |                                                    | 18,233,221 |   |   |   | 18,198,571 |   |   |   |   |   | 1,965,654 |   |   |   | 1,965,654 |   |   |   | 1,962,587 |   |   |   | 1,961,424 |   |   |
| **Consolidated balance sheet data**                                                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Working capital deficit                                                                      |       |                                                    | $          | (4,990 | ) |   |   | $ | (5,067 | ) |   |   |   |   |   |   |   |   | $ | (372,560 | ) |   |   | $ | (148,957 | ) |   |   | $ | (12,071 | ) |   |
| Customer accounts, net(a)                                                                    |       |                                                    | $          | 200,371 |   |   |   | $ | 232,875 |   |   |   |   |   |   |   |   |   | $ | 176,155 |   |   |   | $ | 244,744 |   |   |   | $ | 312,785 |   |   |
| Goodwill, net(a)                                                                             |       |                                                    | $          | 12,160 |   |   |   | $ | 12,160 |   |   |   |   |   |   |   |   |   | $ | 41,847 |   |   |   | $ | 41,847 |   |   |   | $ | 41,847 |   |   |
| Total assets(a)                                                                              |       |                                                    | $          | 443,953 |   |   |   | $ | 436,302 |   |   |   |   |   |   |   |   |   | $ | 461,044 |   |   |   | $ | 809,022 |   |   |   | $ | 837,572 |   |   |
| Long term debt, including capital leases, net of  current portion                            |       |                                                    | $          | 391,991 |   |   |   | $ | 321,293 |   |   |   |   |   |   |   |   |   | $ | 110,340 |   |   |   | $ | 331,874 |   |   |   | $ | 547,798 |   |   |
| Total  stockholders’ equity (deficiency in assets)                                      |       |                                                    | $          | (79,943 | ) |   |   | $ | 8,067 |   |   |   |   |   |   |   |   |   | $ | (177,609 | ) |   |   | $ | 146,174 |   |   |   | $ | 168,147 |   |   |

 

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| ** **                                              | ** ** | **SELECTED CONSOLIDATED FINANCIAL DATA** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                              | ** ** | ** **                                              | ** ** | **February 9** | ** ** | ** ** | ** ** | **January 1** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | **Year Ended**                                     | ** ** | **through** | ** ** | ** ** | ** ** | **through** | ** ** | **Year Ended** | ** ** | **Year Ended** | ** ** | **Year Ended** | ** ** |
| ** **                                              | ** ** | **December 31,**                                   | ** ** | **December 31,** | ** ** | ** ** | ** ** | **February 8,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                              | ** ** | **2006**                                                | ** ** | **2005 (a)** | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                              | ** ** | **(dollar amounts in thousands)**        | ** ** |
| **Cash  flow data**                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash flows  provided by operations                      |       |                                                    | $          | 49,527 |   |   |   | $ | 40,413 |   |   |   |   |   | $ | 3,710 |   |   |   | $ | 61,814 |   |   |   | $ | 59,035 |   |   |   | $ | 43,391 |   |   |
| Cash flows used in  investing activities                |       |                                                    | $          | (36,687 | ) |   |   | $ | (24,151 | ) |   |   |   |   | $ | (2,473 | ) |   |   | $ | (30,369 | ) |   |   | $ | (27,471 | ) |   |   | $ | (20,943 | ) |   |
| Cash flows  provided by (used in) financing  activities |       |                                                    | $          | (8,133 | ) |   |   | $ | (50,134 | ) |   |   |   |   | $ | — |   |   |   | $ | (14,120 | ) |   |   | $ | 1,865 |   |   |   | $ | (24,950 | ) |   |
| **Other  operating data**                               |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of  customers at end of period                   |       |                                                    | 994,012    |   |   |   | 1,012,797 |   |   |   |   |   |   |   |   |   | 1,030,113 |   |   |   | 1,048,320 |   |   |   | 1,073,698 |   |   |

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(a)                 See Item 7 “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Significant Activities—*New Basis of Accounting in 2005*” for a discussion on pushdown accounting in 2005 and the adjusted basis of certain assets andliabilities.

(b)                Loss per share and weighted average number of sharespresented give retroactive effect to the one-share-for-fifty shares reversestock split on February 8, 2005.

(c)                 Impairment charges and the cumulative effect of anaccounting change are the result of our January 1, 2002 implementation ofSFAS Nos. 142, “Accounting for Goodwill and Other Intangible Assets” and 144, “Accountingfor the Impairment and Disposal of Long-Lived Assets.”

(d)                As a result of the February 17, 2004 saletransaction whereby Protection One was sold to POI Acquisition I, Inc. (anaffiliate of Quadrangle), Protection One’s net deferred tax assets were notexpected to be realizable and a non-cash charge against income was recorded in2004 to establish a valuation allowance for those assets.

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Introduction**

In this section weexplain our general financial condition and operating results, including:

·       whatfactors affect our business;

·       whatour earnings and costs were in 2006, 2005 and 2004;

·       whythese earnings and costs differ from year to year;

·       howour earnings and costs affect our overall financial condition;

·       whatwe expect our capital expenditures to be for the years 2007 through 2008;

·       howwe plan to pay for these future capital expenditures; and

·       otheritems that materially affect our financial condition, liquidity or earnings.

As you read this section,please refer to our Consolidated Statements of Operations and ComprehensiveLoss and accompanying notes found in Item 8. These statements show ouroperating results for the year ended December 31, 2006, the periods February 9,2005 through December 31, 2005 and January 1, 2005 through February 8,2005 and the year ended December 31, 2004. In this section we analyze andexplain the significant annual changes of specific line items in theConsolidated Statements of Operations and Comprehensive Loss. We also suggestyou read Item 1A, “Risk Factors,” which will help your understanding of ourfinancial condition, liquidity and operations.

**Overview**

We are a leading national provider of security alarmmonitoring services, providing installation, maintenance and electronicmonitoring of alarm systems to single-family residential, commercial,multifamily and wholesale customers. We monitor signals originating from alarmsystems designed to detect burglary, fire, medical, hold-up and environmentalconditions, and from access control and CCTV systems. Most of our monitoringservices and a large portion of our maintenance services are governed bymulti-year contracts with our customers. These contracts are typically three tofive years in duration for our Protection One Monitoring segment and five toten years for our Network Multifamily segment, have automatic annual renewalprovisions where permitted and provide us with RMR.

Our business consists oftwo primary segments, Protection One Monitoring and Network Multifamily. ProtectionOne Monitoring primarily provides residential and commercial electronic securitysystem installation and alarm monitoring services directly to homeowners andbusinesses. Protection One Monitoring also provides wholesale alarm monitoringservices to independent alarm companies. Network Multifamily provideselectronic security system installation and alarm monitoring services to ownersand managers of apartments, condominiums and other multifamily dwellings. Wemarket our services to these customer segments through separate internal salesand installation branch networks.

**Business Strategy**

Our strategy is toincrease RMR by generating more accounts at a higher average RMR, by acquiringportfolios of security monitoring accounts, and by acquiring securitymonitoring companies. Our overall goal is to strengthen our leadership positionin delivering security monitoring services and related installation services inprincipal markets across the United States in order to improve our returns onthe capital we invest in creating and serving customers. Specific goals include(i) lowering attrition rates; (ii) increasing RMR additions; (iii) reducingacquisition costs for each dollar of RMR created; and (iv) increasing theefficiency of our monitoring and service activities. We plan to achieve theseobjectives 

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bybuilding upon our core strengths, including our national branch platform, ourimproving brand recognition, our internal sales force model and our highlyskilled and experienced management team and workforce.

**SignificantActivities**

***Merger Agreement***

On December 20, 2006, Protection One, Inc. enteredinto the Merger Agreement with IASG and Tara Acquisition Corp., a wholly ownedsubsidiary of Protection One, Inc., pursuant to which we will acquire IASG.Upon completion of the Merger, which is expected to close during the secondquarter of 2007, holders of IASG common stock will receive 0.29 shares ofProtection One, Inc. common stock for each share of IASG common stock held.Cash will be paid in lieu of fractional shares.

A special meeting of stockholders of IASG will be heldon March 27, 2007 for the purpose of voting on the proposed mergeragreement. The board of directors of IASG has declared that the MergerAgreement is advisable and, subject to certain limited exceptions, shallrecommend that the Merger Agreement and the transactions contemplated therebybe approved and adopted by IASG’s stockholders. If approved, IASG will become awholly owned subsidiary of Protection One, Inc. upon the consummation ofthe Merger.

Contemporaneously with the execution of the MergerAgreement, the Company, Tara Acquisition Corp. and the directors and officersof IASG entered into a stockholders agreement (the “Stockholders Agreement”),dated as of December 20, 2006, pursuant to which such directors andofficers have agreed to vote or direct the voting of their shares of IASGcommon stock in favor of the approval and adoption of the Merger Agreement, theMerger and any action required in furtherance thereof. Such stockholders alsogranted to and appointed the Company and certain officers of the Company astheir irrevocable proxies and attorneys-in-fact to vote their shares of IASGstock as indicated in the preceding sentence.

Consummation of the Merger is subject to variousconditions, including, among others, (i) requisite approvals of theholders of IASG common stock, (ii) receipt of regulatory approvals, (iii) theabsence of any law or order prohibiting the closing, (iv) effectiveness ofthe registration statement relating to the shares of Protection One, Inc.common stock to be issued to the stockholders of IASG in the Merger and thelisting of such shares of Protection One, Inc. common stock on the NASDAQStock Market, (v) the exchange by certain holders of Old Notes for NewNotes pursuant to the terms and conditions of a Lock Up and Consent Agreementand (vi) the amendment of our senior credit facility. In addition, eachparty’s individual obligation to consummate the Merger is subject to certainother conditions, including, among others, (i) the accuracy of therepresentations and warranties of the other parties, (ii) compliance ofthe other parties with their respective covenants and agreements and (iii) thedelivery of opinions from tax counsel to Protection One, Inc. and IASG tothe effect that the Merger will constitute a reorganization within the meaningof Section 368(a) of the Internal Revenue Code of 1986, as amended(the “Code”).

On December 18, 2006, Protection One, Inc.and IASG entered into a Lock Up and Consent Agreement (the “Lock Up Agreement”)with holders of approximately 85% of the Old Notes (collectively, the “ConsentingNoteholders”). Pursuant to the Lock Up Agreement and subject to theconsummation of the Merger, each Consenting Noteholder shall, among otherthings, tender its Old Notes in exchange for New Notes.

On February 22, 2007,we commenced the Exchange Offer, pursuant to which we offered to exchange up to$125,000,000 of the outstanding 12% Senior Secured Notes due 2011 of IASG fornewly issued 12% Senior Secured Notes due 2011 of Protection One AlarmMonitoring, Inc. The Exchange Offer is subject to the fulfillment ofcertain conditions, including the consummation of the Merger.

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***Recapitalization***

On May 12, 2006, we completed a recapitalizationof our balance sheet by increasing our debt in order to pay a cash dividend of$70.5 million, or $3.86 per share, to all holders of record of our common stockon May 8, 2006, including Quadrangle, which owned approximately 97.1% ofthe outstanding shares of our common stock at that date. This cash dividend isreferred to as the May 2006 dividend. The payment of the May 2006dividend was financed, in large part, by the April 2006 financingdescribed in Item 8, Note 7 “Debt and Capital Leases.”  Approximately $1.2 million of expense paid tothird party consultants related to the financing is reflected asrecapitalization costs in the Condensed Consolidated Statement of Operationsand Comprehensive Loss.

As part of the recapitalization, our board ofdirectors also approved the compensatory make-whole payment of $4.5 million or$2.89 for each vested and unvested option awarded in February 2005 underthe 2004 Stock Option Plan, including to members of senior management. Approximately$3.2 million of the compensatory make-whole payment related to options that hadnot yet vested and accordingly this amount plus related taxes was recorded ascompensation expense in the second quarter of 2006 and is reflected asrecapitalization costs in the Consolidated Statement of Operations andComprehensive Loss. Approximately $1.3 million of the compensatory make-wholepayment related to vested options and was recorded to additional paid incapital. In addition, the exercise price of each vested and unvested option wasreduced by $0.98. The Company’s board decided to pay the compensatorymake-whole payment and reduce the option exercise price because the payment ofthe May 2006 dividend decreased the value of the equity interests ofholders of options, as these holders were not otherwise entitled to receive thedividend. Accordingly, the Company’s board awarded the same amount to theoption holders, on a per share basis, in the form of the compensatorymake-whole payment and the reduced option exercise price.

Additionally, inconsideration of the adverse impact of the cash dividend on the SARs granted in2005, our board of directors agreed to amend the SARs agreements by effectivelyfixing the exercise price on 439,160 outstanding SARs at $5.02. Therefore, ifthere is not a qualified sale prior to February 8, 2011, the holders ofsuch SARs will be entitled to receive the difference between $7.50 and $5.02per SAR, or $2.48, from us for a total cash outlay of approximately $1.1million on February 8, 2011. As of December 31, 2006, we haveestablished a liability of approximately $138 thousand to reflect the portionof the SARs that have been earned since the date of the amendment through December 31,2006 with the associated expense reflected in general and administrativeexpense. Assuming there is no qualified sale prior to February 8, 2011,the Company expects to record approximately $0.2 million in expense per yearthrough February 8, 2011 related to these SARs. As of December 31,2006, no value has been ascribed to the SARs that have not been modified and novalue will be allocated to those SARs unless and until it becomes probable thata qualified sale will occur.

***Change in Majority Owner***

On February 17, 2004, our former majoritystockholder, Westar Industries, Inc., a wholly owned subsidiary of WestarEnergy, Inc., which we refer to collectively as Westar, consummated the saleof approximately 87% of our common stock to POI Acquisition I, Inc., whichwas formed by Quadrangle Capital Partners LP, Quadrangle Select Partners LP,Quadrangle Capital Partners-A LP and Quadrangle Master Funding Ltd, which werefer to collectively as Quadrangle. The transaction also included theassignment of Westar’s rights and obligations as the lender under our revolvingcredit facility to POI Acquisition, L.L.C., which subsequently assignedone-third of its interest to Quadrangle Master Funding, Ltd.

On November 12, 2004,we entered into a debt-for-equity exchange agreement with Quadrangle thatprovided for the principal balance outstanding under the Quadrangle creditfacility to be reduced by $120.0 million in exchange for the issuance toQuadrangle of 16 million shares of our common stock. The exchange was completedon February 8, 2005 and was accompanied by a one-share-for-fifty-sharesreverse 

26

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stocksplit of our common stock. The newly issued shares, together with sharesalready owned by Quadrangle, resulted in Quadrangle owning approximately 97.3%of our common stock.

***New Basis of Accounting in 2005***

As a result of Quadrangle’s increased ownershipinterest from the February 8, 2005 debt-for-equity exchange, we have “pusheddown” Quadrangle’s basis to a proportionate amount of our underlying assets andliabilities acquired based on the estimated fair market values of the assetsand liabilities. The “push down” accounting adjustments did not impact cashflows. The primary changes to the balance sheet reflect (1) the reductionof deferred customer acquisition costs and revenue, which have been subsumedinto the estimated fair market value adjustment for customer accounts; (2) adjustmentsto the carrying values of debt to estimated fair market value (or Quadrangle’sbasis in the case of the credit facility); (3) adjustments to historicalgoodwill to reflect goodwill arising from the push down accounting adjustments;(4) the recording of a value for our trade names; and (5) an increaseto the equity section from these adjustments. The primary changes to the incomestatement include (1) the reduction in other revenue due to a lower levelof amortization from the reduced amortizable base of deferred customeracquisition revenue; (2) the reduction in other costs of revenue andselling expenses due to a lower level of amortization from the reducedamortizable base of deferred customer acquisition costs; (3) an increasein interest expense due to amortization of debt discounts arising fromdifferences in fair values and carrying values of our debt instruments; and (4) thereduction in amortization related to the reduction in the amortizable base ofcustomer accounts.

Due to the impact of thechanges resulting from the push down accounting adjustments described above,the 2005  statements of operations andcash flows presentations separate our results into two periods:  (1) the period prior to the February 8,2005 consummation of the exchange transaction and (2) the period beginningafter that date utilizing the new basis of accounting. The results are furtherseparated by a heavy black line to indicate the effective date of the new basisof accounting.

**Other SignificantActivities**

***Net Loss***

We incurred a net loss of$17.4 million for the year ended December 31, 2006. This net loss includes$4.5 million in recapitalization costs, described above, including $3.2 millionrelated to the compensatory make-whole payment. The remaining net loss reflectssubstantial charges incurred by us for amortization of customer accounts,interest incurred on indebtedness and other factors discussed below.

**Industry Metrics**

***Recurring Monthly Revenue***

At various times during each year, we measure all ofthe monthly revenue we are entitled to receive under contracts with customersin effect at the end of the period. Our computation of RMR may not becomparable to other similarly titled measures of other companies, and RMRshould not be viewed by investors as an alternative to actual monthly revenue,as determined in accordance with generally accepted accounting principles.

We had approximately $20.0 million of RMR as of December 31,2006 and $19.9 million of RMR as of December 31 for each of the years 2005and 2004. The slight increase is a result of a focused effort by our branchesto increase commercial RMR additions and an increase in RMR additions in theBellSouth region.

Webelieve the presentation of RMR is useful to investors because the measure isused by investors and lenders to value companies such as ours with recurringrevenue streams. Management monitors RMR, 

27

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among other things, to evaluate our ongoingperformance. The table below reconciles our RMR to revenue reflected on ourconsolidated statements of operations (information for the period January 1,2005 through February 8, 2005 was not considered to be material in acomparison of RMR as of fiscal year end and therefore has not been presented).

| ** **                                    | ** ** | **Year Ended**                             | ** ** | **February 9 –** | ** ** | **Year Ended**   | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|---------------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **December 31,**                           | ** ** | **December 31**            | ** ** | **December 31,** | ** ** |
| ** **                                    | ** ** | **2006**                                        | ** ** | **2005**                        | ** ** | **2004**              | ** ** |
| ** **                                    | ** ** | **(dollar amounts in millions)** | ** ** |
| RMR at  December 31                      |       |                                            | $          | 20.0                            |       |                  |       | $ | 19.9 |   |   |   | $ | 19.9 |   |   |
| Amounts excluded  from RMR:                   |       |                                            |       |                            |       |                  |       |   |   |   |   |   |   |
| Amortization of deferred revenue              |       |                                            | 0.8        |                            |       |                  | 0.5        |   |   |   | 0.8 |   |   |
| Other revenue(a)                              |       |                                            | 1.9        |                            |       |                  | 1.9        |   |   |   | 1.7 |   |   |
| Revenue (GAAP  basis):                        |       |                                            |       |                            |       |                  |       |   |   |   |   |   |   |
| December                                      |       |                                            | 22.7       |                            |       |                  | 22.3       |   |   |   | 22.4 |   |   |
| February 9 – November 30, 2005 |       |                                            | —     |                            |       |                  | 212.2      |   |   |   | — |   |   |
| January – November                       |       |                                            | 247.9      |                            |       |                  | —     |   |   |   | 246.9 |   |   |
| Total period  revenue                         |       |                                            | $          | 270.6                           |       |                  |       | $ | 234.5 |   |   |   | $ | 269.3 |   |   |

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(a)           Revenue that is notpursuant to monthly contractual billings.

Our RMR includes amounts billable to customers withpast due balances that we believe are collectible. We seek to preserve therevenue stream associated with each customer contract, primarily to maximizeour return on the investment we made to generate each contract. As a result, weactively work to collect amounts owed to us and to retain the customers at thesame time. In some instances, we may allow up to six months to collect past dueamounts, while evaluating the ongoing customer relationship. After we have madeevery reasonable effort to collect past due balances, we will disconnect thecustomer and include the loss in attrition calculations.

Thefollowing table provides a roll-forward of RMR (beginning RMR, additions,losses, price changes, other changes and ending RMR) by segment and in totalfor the years indicated.

| ** **                                                            | ** ** | **Year Ended December 31**        | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                            | ** ** | **2006**                                         | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                            | ** ** | **Protection**                                   | ** ** | ** ** | ** ** | ** ** | ** ** | **Protection** | ** ** | ** ** | ** ** | ** ** | ** ** | **Protection** | ** ** | **Network** | ** ** | ** ** | ** ** |
| ** **                                                            | ** ** | **One**                                          | ** ** | **Network** | ** ** | ** ** | ** ** | **One** | ** ** | **Network** | ** ** | ** ** | ** ** | **One** | ** ** | **Multi-** | ** ** | ** ** | ** ** |
| ** **                                                            | ** ** | **Monitoring**                                   | ** ** | **Multi-family** | ** ** | **Total** | ** ** | **Monitoring** | ** ** | **Multi-family** | ** ** | **Total** | ** ** | **Monitoring** | ** ** | **family** | ** ** | **Total** | ** ** |
| ** **                                                            | ** ** | **(dollar amounts in thousands)** | ** ** |
| Beginning RMR balance(a)                                              |       |                                             | $          | 17,149 |   |   |   | $ | 2,724 |   |   | $ | 19,873 |   |   | $ | 17,112 |   |   |   | $ | 2,795 |   |   | $ | 19,907 |   |   | $ | 17,255 |   |   |   | $ | 2,834 |   |   | $ | 20,089 |   |
| RMR retail additions                                                  |       |                                             | 2,111      |   |   |   | 151 |   |   | 2,262 |   |   | 1,907 |   |   |   | 91 |   |   | 1,998 |   |   | 1,729 |   |   |   | 160 |   |   | 1,889 |   |
| RMR retail losses, excluding Hurricane Katrina                        |       |                                             | (2,045     | ) |   |   | (320 | ) |   | (2,365 | ) |   | (2,085 | ) |   |   | (187 | ) |   | (2,272 | ) |   | (2,146 | ) |   |   | (213 | ) |   | (2,359 | ) |
| RMR retail reactivations(losses) from Hurricane  Katrina(b)           |       |                                             | 22         |   |   |   | 9 |   |   | 31 |   |   | (72 | ) |   |   | (15 | ) |   | (87 | ) |   | — |   |   |   | — |   |   | — |   |
| Price changes and other                                               |       |                                             | 112        |   |   |   | 32 |   |   | 144 |   |   | 270 |   |   |   | 40 |   |   | 310 |   |   | 222 |   |   |   | 14 |   |   | 236 |   |
| Net change in wholesale RMR, excluding losses from  Hurricane Katrina |       |                                             | 43         |   |   |   | — |   |   | 43 |   |   | 19 |   |   |   | — |   |   | 19 |   |   | 52 |   |   |   | — |   |   | 52 |   |
| RMR wholesale losses from Hurricane Katrina(b)                        |       |                                             | —     |   |   |   | — |   |   | — |   |   | (2 | ) |   |   | — |   |   | (2 | ) |   | — |   |   |   | — |   |   | — |   |
| Ending RMR balance                                                    |       |                                             | $          | 17,392 |   |   |   | $ | 2,596 |   |   | $ | 19,988 |   |   | $ | 17,149 |   |   |   | $ | 2,724 |   |   | $ | 19,873 |   |   | $ | 17,112 |   |   |   | $ | 2,795 |   |   | $ | 19,907 |   |

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(a)                 Beginning RMR balance includes $920, $903 and $850wholesale customer RMR for 2006, 2005 and 2004, respectively, in both theProtection One Monitoring segment and in total. Our Network Multifamily segmentRMR does not contain wholesale customers.

(b)                In September 2005, we suspended billing for ourcustomers in the areas most heavily affected by Hurricane Katrina. For the yearended December 31, 2006, reactivations represent the RMR from thosecustomers whose billing was suspended after the hurricane but has subsequentlybeen reinstated. We did not reactivate any wholesale customers during 2006.  As of December 31, 2006, Protection OneMonitoring has estimated the loss of 2,277 customers, including 379 wholesalecustomers, and Network Multifamily has estimated the loss of 587 customerswhose residences or businesses have been damaged beyond repair and will nolonger need our monitoring services.

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Thetable below reconciles our RMR by segment to revenue reflected in our segmentresults of operations (information for the period January 1, 2005 through February 8,2005 was not considered to be material in a comparison of RMR as of fiscal yearend and therefore has not been presented).

| ** **                                    | ** ** | **Year Ended December 31,**      | ** ** | **February 9 – December 31,** | ** ** | ** ** | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------|------------|------------|------------|--------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                        | ** ** | **2005**                                     | ** ** | ** ** | ** ** | **2004**                                   | ** ** |
| ** **                                    | ** ** | **Protection **                            | ** ** | ** **                                   | ** ** | ** ** | ** ** | **Protection **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Protection ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **One**                                         | ** ** | **Network**                                  | ** ** | ** ** | ** ** | **One**                                    | ** ** | **Network** | ** ** | ** ** | ** ** | ** ** | ** ** | **One** | ** ** | **Network** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Monitoring**                                  | ** ** | **Multi-family**                             | ** ** | **Total**  | ** ** | **Monitoring**                             | ** ** | **Multi-family** | ** ** | **Total** | ** ** | ** ** | ** ** | **Monitoring** | ** ** | **Multi-family** | ** ** | **Total** | ** ** |
| ** **                                    | ** ** | **(dollar amounts in millions)** | ** ** |
| RMR at December 31                       |       |                                            | $          | 17.4                                         |       |       |       | $                                          | 2.6        |   |   | $ | 20.0 |   |   | $ | 17.2 |   |   |   | $ | 2.7 |   |   | $ | 19.9 |   |   |   |   | $ | 17.1 |   |   |   | $ | 2.8 |   |   | $ | 19.9 |   |
| Amounts excluded from  RMR:                   |       |                                            |       |                                         |       |       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Amortization of deferred revenue              |       |                                            | 0.8        |                                         |       |       | 0.0        |                                       |       | 0.8 |   |   | 0.5 |   |   |   | 0.0 |   |   | 0.5 |   |   |   |   | 0.6 |   |   |   | 0.2 |   |   | 0.8 |   |
| Other revenue(a)                              |       |                                            | 1.8        |                                         |       |       | 0.1        |                                       |       | 1.9 |   |   | 1.6 |   |   |   | 0.3 |   |   | 1.9 |   |   |   |   | 1.6 |   |   |   | 0.1 |   |   | 1.7 |   |
| Revenue (GAAP basis):                         |       |                                            |       |                                         |       |       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| December                                      |       |                                            | 20.0       |                                         |       |       | 2.7        |                                       |       | 22.7 |   |   | 19.3 |   |   |   | 3.0 |   |   | 22.3 |   |   |   |   | 19.3 |   |   |   | 3.1 |   |   | 22.4 |   |
| February 9 – November 30, 2005 |       |                                            | —-    |                                         |       |       | —-    |                                       |       | —- |   |   | 183.5 |   |   |   | 28.7 |   |   | 212.2 |   |   |   |   | —- |   |   |   | —- |   |   | —- |   |
| January – November                       |       |                                            | 216.2      |                                         |       |       | 31.7       |                                       |       | 247.9 |   |   | —- |   |   |   | —- |   |   | —- |   |   |   |   | 212.2 |   |   |   | 34.7 |   |   | 246.9 |   |
| Total period  revenue                         |       |                                            | $          | 236.2                                        |       |       |       | $                                          | 34.4       |   |   | $ | 270.6 |   |   | $ | 202.8 |   |   |   | $ | 31.7 |   |   | $ | 234.5 |   |   |   |   | $ | 231.5 |   |   |   | $ | 37.8 |   |   | $ | 269.3 |   |

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(a)                 Revenue that is not pursuant to monthlycontractual billings.

***Monitoring and Related Services Margin***

Ineach of the last three years, monitoring and related service revenue comprisedover 91% of our total revenue. Monitoring and related services revenue in 2006increased slightly over 2005 and was consistent with 2004 revenue.   The table below identifies the monitoringand related services gross margin and gross margin percent for the presentedperiods.

| ** **                                       | ** ** | ** **                                       | ** ** | **2005**                                                | ** ** | **Year Ended**                                   | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                       | ** ** | **Year Ended  December 31, 2006** | ** ** | **February 9 –   December 31** | ** ** | **January 1 –   February 8** | ** ** | **December 31,   2004** | ** ** |
| ** **                                       | ** ** | **(dollar amounts in thousands)** | ** ** |
| Monitoring and  related services revenue         |       |                                             | $          | 247,370                                                 |       |                                                  |       | $ | 219,475 |   |   |   | $ | 26,455 |   |   |   | $ | 247,498 |   |   |
| Cost of  monitoring and related services revenue |       |                                             | 71,823     |                                                    |       |                                                  | 62,243     |   |   |   | 7,400 |   |   |   | 69,598 |   |   |
| Gross margin                                     |       |                                             | $          | 175,547                                                 |       |                                                  |       | $ | 157,232 |   |   |   | $ | 19,055 |   |   |   | $ | 177,900 |   |   |
| Gross margin %                                   |       |                                             | 71.0       | %                                                       |       |                                                  | 71.6       | % |   |   | 72.0 | % |   |   | 71.9 | % |   |

 

Our monitoring and relatedservices gross margin percentage has decreased slightly from the prior perioddue to several factors, the impact of which we expect to continue into the nearto medium term: (i) increased royalty fees paid to BellSouth as we expandour customer base in the alliance territory, (ii) increased third partycosts for cellular service due to the growing number of customers who choose tohave primary or back-up cellular monitoring service, and (iii) increasedpercentage of commercial customers in our base who choose enhanced services,such as open/close and fire inspections.

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***Attrition***

Our customer base reflected a net loss of 18,785customers during 2006 compared to net customer losses of 17,316 and 18,207during 2005 and 2004, respectively. Our Protection One Monitoring segmentincrease of 6,118 customers during 2006 was offset by the loss of 24,903customers in our Network Multifamily segment during 2006. Network Multifamilyhad more contracts reaching the end of the initial contract term in 2006 thanit did in 2005 which we believe has resulted in the increase in customer lossesin 2006. Furthermore, our ability to obtain contract renewals on expiring contracts has been negatively affected by theincreasing preference of occupants of multifamily units to subscribe only forcellular telephone services and not for traditional telephone service, whichour alarm systems have historically used to transport alarm signals to ourmonitoring center. Net losses of customer accounts materially andadversely affect our business, financial condition and results of operations.

Customer attrition has a direct impact on our resultsof operations since it affects our revenue, amortization expense and cash flow.We define attrition as a ratio, the numerator of which is the gross number oflost customer accounts for a given period, net of the adjustment describedbelow, and the denominator of which is the average number of accounts for agiven period. In some instances, we use estimates to derive attrition data. Wemake adjustments to lost accounts primarily for the net change, either positiveor negative, in our wholesale base. In the calculations directly below, we donot reduce the gross accounts lost during a period by “move in” accounts, whichare accounts where a new customer moves into a home installed with our securitysystem and vacated by a prior customer, or “competitive takeover” accounts,which are accounts where the owner of a residence monitored by a competitorrequests that we provide monitoring services.

Asdefined above, customer attrition by business segment at December 31,2006, 2005 and 2004 is summarized below:

| ** **                                      | ** ** | **Customer Account Attrition** | ** ** |
|-------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                      | ** ** | **December 31, 2006**          | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
| ** **                                      | ** ** | **Annualized  Fourth   Quarter**    | ** ** | **Trailing  Twelve  Month** | ** ** | **Annualized  Fourth  Quarter** | ** ** | **Trailing  Twelve  Month** | ** ** | **Annualized  Fourth  Quarter** | ** ** | **Trailing  Twelve  Month** | ** ** |
| Protection One  Monitoring                      |       |                                     | 4.3        | % |   |   | 6.0 | % |   |   | 6.2 | % |   |   | 8.3 | % |   |   | 7.8 | % |   |   | 8.5 | % |   |
| Protection One  Monitoring, excluding wholesale |       |                                     | 11.5       | % |   |   | 12.2 | % |   |   | 12.3 | % |   |   | 13.3 | % |   |   | 12.3 | % |   |   | 12.9 | % |   |
| Network  Multifamily                            |       |                                     | 18.9       | %(a) |   |   | 11.5 | %(a) |   |   | 3.3 | % |   |   | 6.4 | %(c) |   |   | 7.1 | % |   |   | 6.4 | % |   |
| Total Company                                   |       |                                     | 8.6        | % |   |   | 7.7 | % |   |   | 5.3 | % |   |   | 7.7 | % |   |   | 7.6 | % |   |   | 7.8 | % |   |

 

| ** **                                      | ** ** | **Customer Account Attrition**                                           | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **December 31, 2006,   excluding Hurricane   Katrina(b)** | ** ** | **December 31, 2005,   excluding Hurricane   Katrina(b)** | ** ** |
| ** **                                      | ** ** | **Annualized  Fourth   Quarter**                                              | ** ** | **Trailing  Twelve  Month** | ** ** | **Annualized  Fourth  Quarter** | ** ** | **Trailing  Twelve  Month** | ** ** |
| Protection One  Monitoring                      |       |                                                                               | 4.3        | % |   |   | 6.2 | % |   |   | 7.1 | % |   |   | 7.8 | % |   |
| Protection One  Monitoring, excluding wholesale |       |                                                                               | 11.5       | % |   |   | 12.3 | % |   |   | 12.8 | % |   |   | 12.8 | % |   |
| Network  Multifamily                            |       |                                                                               | 18.9       | %(a) |   |   | 11.9 | %(a) |   |   | 4.5 | % |   |   | 5.9 | %(c) |   |
| Total Company                                   |       |                                                                               | 8.6        | % |   |   | 7.9 | % |   |   | 6.3 | % |   |   | 7.2 | % |   |

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(a)           Network Multifamily’sattrition rates include an adjustment for accounts believed to be at-risk ofcanceling because the account had an outstanding balance due of greater than120 days. Prior period results did not include such an adjustment. Without theadjustment, Network Multifamily’s annualized fourth quarter and twelve monthtrailing attrition at December 31, 2006 would have been 14.7% and 10.5%,respectively. The annualized fourth quarter and twelve month trailing attritionat 

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December 31, 2006without the adjustment and excluding Hurricane Katrina would have been 14.7%and 10.8%, respectively.

(b)          In September 2005,we suspended billing for our customers in the areas most heavily affected byHurricane Katrina. Our initial estimate of customers whose homes or businesseswere damaged beyond repair and would no longer need our monitoring services washigher than our actual experience, which has resulted in adjustments to reflectthe 2006 reactivations of 840 retail customers and 969 of our NetworkMultifamily customers. As of December 31, 2006, estimated customer lossesfrom Hurricane Katrina, net of reactivations, is 2,277 customers for ProtectionOne Monitoring, including 379 wholesale customers, and 587 customers forNetwork Multifamily. Our initial estimate of customer losses at September 30,2005 was 4,548 customers for Protection One Monitoring, including 1,194wholesale customers, and 2,563 customers for Network Multifamily.

(c)           Attrition results forNetwork Multifamily exclude the impact on the calculation of our customer basefrom the conversion of our billing system to our new technology platform. Customersare defined differently in the new system and the result was a decrease in thenumber of customers in the new system.

In thetable below, in order to enhance the comparability of our attrition resultswith those of other industry participants, many of which report attrition netof move-in accounts, we define the denominator the same as above but define thenumerator as the gross number of lost customer accounts for a given periodreduced by move-in accounts.

| ** **                                      | ** ** | **Customer Account Attrition** | ** ** |
|-------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                      | ** ** | **December 31, 2006**          | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
| ** **                                      | ** ** | **Annualized  Fourth   Quarter**    | ** ** | **Trailing  Twelve  Month** | ** ** | **Annualized  Fourth  Quarter** | ** ** | **Trailing  Twelve  Month** | ** ** | **Annualized  Fourth  Quarter** | ** ** | **Trailing  Twelve  Month** | ** ** |
| Protection One  Monitoring                      |       |                                     | 2.7        | % |   |   | 4.4 | % |   |   | 4.5 | % |   |   | 6.4 | % |   |   | 6.0 | % |   |   | 6.6 | % |   |
| Protection One  Monitoring, excluding wholesale |       |                                     | 9.4        | % |   |   | 10.0 | % |   |   | 10.0 | % |   |   | 10.8 | % |   |   | 10.0 | % |   |   | 10.4 | % |   |
| Network  Multifamily                            |       |                                     | 18.9       | %(a) |   |   | 11.5 | %(a) |   |   | 3.3 | % |   |   | 6.4 | %(c) |   |   | 7.1 | % |   |   | 6.4 | % |   |
| Total Company                                   |       |                                     | 7.6        | % |   |   | 6.6 | % |   |   | 4.1 | % |   |   | 6.4 | % |   |   | 6.4 | % |   |   | 6.5 | % |   |

 

| ** **                                      | ** ** | **Customer Account Attrition**                                           | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **December 31, 2006,   excluding Hurricane   Katrina(b)** | ** ** | **December 31, 2005,   excluding Hurricane   Katrina(b)** | ** ** |
| ** **                                      | ** ** | **Annualized  Fourth   Quarter**                                              | ** ** | **Trailing  Twelve  Month** | ** ** | **Annualized  Fourth  Quarter** | ** ** | **Trailing  Twelve  Month** | ** ** |
| Protection One  Monitoring                      |       |                                                                               | 2.7        | % |   |   | 4.5 | % |   |   | 5.3 | % |   |   | 6.0 | % |   |
| Protection One  Monitoring, excluding wholesale |       |                                                                               | 9.4        | % |   |   | 10.1 | % |   |   | 10.4 | % |   |   | 10.3 | % |   |
| Network  Multifamily                            |       |                                                                               | 18.9       | %(a) |   |   | 11.9 | %(a) |   |   | 4.5 | % |   |   | 5.9 | %(c) |   |
| Total Company                                   |       |                                                                               | 7.6        | % |   |   | 6.8 | % |   |   | 5.1 | % |   |   | 6.0 | % |   |

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(a)           Network Multifamily’sattrition rates include an adjustment for accounts believed to be at-risk ofcanceling because the account had an outstanding balance due of greater than120 days. Prior period results did not include such an adjustment. Without theadjustment, Network Multifamily’s annualized fourth quarter and twelve monthtrailing attrition at December 31, 2006 would have been 14.7% and 10.5%,respectively. The annualized fourth quarter and twelve month trailing attritionat December 31, 2006 without the adjustment and excluding HurricaneKatrina would have been 14.7% and 10.8%, respectively.

(b)          In September 2005,we suspended billing for our customers in the areas most heavily affected byHurricane Katrina. Our initial estimate of customers whose homes or businesseswere damaged beyond repair and would no longer need our monitoring services washigher than our actual 

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experience which hasresulted in adjustments to reflect the 2006 reactivations of 840 retailcustomers and 969 of our Network Multifamily customers. As of December 31,2006, estimated customer losses from Hurricane Katrina, net of reactivations,is 2,277 customers for Protection One Monitoring, including 379 wholesalecustomers, and 587 customers for Network Multifamily. Our initial estimate ofcustomer losses at September 30, 2005 was 4,548 customers for ProtectionOne Monitoring, including 1,194 wholesale customers, and 2,563 customers forNetwork Multifamily.

(c)           Attrition results forNetwork Multifamily exclude the impact on the calculation of our customer basefrom the conversion of our billing system to our new technology platform. Customersare defined differently in the new system and the result was a decrease in thenumber of customers in the new system.

Our actual attritionexperience shows that the relationship period with any individual customer canvary significantly. Customers discontinue service with us for a variety ofreasons, including relocation, service issues and cost. A portion of thecustomer base can be expected to discontinue service every year.  Any significant change in the pattern of ourhistorical attrition experience would have a material effect on our results ofoperations.

**Sources of Revenue**

For both Protection OneMonitoring and Network Multifamily, revenue is primarily generated fromproviding monitoring services. Monitoring revenue is generated based oncontracts that we enter into with our customers. The typical initial contractterm is three to five years for Protection One Monitoring customers and five toten years for Network Multifamily customers, with automatic renewal provisionswhere permitted. Renewal terms are generally one year for Protection Onecustomers and are longer than one year in the case of Network Multifamily. Manyof our residential and commercial contracts require us to provide additionalservices, such as maintenance services, generating incremental revenue for us. Otherrevenue consists primarily of sales of burglar alarms, closed circuittelevision systems, fire alarms and card access control systems to commercialcustomers.

**Costs of Revenue;Expenses**

Monitoring and related services costs generally relateto the cost of providing monitoring service and include the costs ofmonitoring, billing, customer service and field operations. Other costs ofrevenue consist primarily of equipment and labor charges to install alarmsystems, closed circuit television systems, fire alarms and card access controlsystems sold to our customers.

Selling expenses includeemployee compensation, benefits and recruiting for our internal sales force,advertising, customer signage, marketing materials, trade show expense, andamortization of previously deferred selling costs. General and administrativeexpenses include lease expenses on office space, computers and other officeequipment, telecommunications, costs of debt collection efforts, employeecompensation and benefits, professional service fees and other miscellaneousexpenses. Amortization of intangibles and depreciation includes amortization ofcustomer accounts as well as depreciation on property and equipment.

**Critical AccountingPolicies**

Our discussion andanalysis of results of operations and financial condition are based upon ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America, orGAAP. The preparation of these consolidated financial statements requires us tomake estimates and judgments that affect the reported amounts of assets,liabilities, revenue and expenses, and related disclosure of contingent assetsand liabilities. We evaluate our estimates on an on-going basis, includingthose related to bad debts, inventories, investments, 

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customeraccounts, goodwill, intangible assets, income taxes, contingencies andlitigation. We base our estimates on historical experience and on various otherassumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions orconditions.

***Push DownAccounting***

As described in “SignificantActivities—*New Basis of Accounting in 2005*” above,in 2005 we “pushed down” Quadrangle’s basis to a proportionate amount of ourunderlying assets and liabilities acquired based on the estimated fair marketvalues of the assets and liabilities. The “pushed down” basis as of February 8,2005 was used to value customer accounts, property and equipment, trade name,goodwill, deferred customer acquisition costs and revenue, debt, additionalpaid in capital and deficit as of the restructuring. Additions of assets orliabilities subsequent to February 8, 2005 are initially valued at cost.

***Revenueand Expense Recognition***

Revenue is recognized when security services areprovided. System installation revenue, sales revenue on equipment upgrades anddirect and incremental costs of installations and sales are deferred forresidential customers with monitoring service contracts. For commercialcustomers and our national account customers, revenue recognition is dependentupon each specific customer contract. In instances when we pass title to asystem, we recognize the associated revenue and costs related to the sale ofthe equipment in the period incurred regardless of whether the sale isaccompanied by a service agreement. In cases where we retain title to thesystem, we defer and amortize revenue and direct costs.

Deferred system and upgrade installation revenue arerecognized over the estimated life of the customer utilizing an acceleratedmethod for our residential and commercial customers and a straight-line methodfor our Network Multifamily customers. Deferred costs in excess of deferredrevenue are recognized utilizing a straight-line method over the initialcontract term, typically two to three years for residential systems, five yearsfor commercial systems and five to ten years for Network Multifamily systems. Tothe extent deferred costs are less than deferred revenue, such costs arerecognized over the estimated life of the customer utilizing the same method aswith the related deferred revenue. Therefore, a change in the estimated life ofa customer pool would result in a change in the amount of previously deferredrevenue that would be amortized to income but would also result in a similarchange in the amount of previously deferred costs that are amortized to expense.For example, if we had determined as of January 1, 2006 that the estimatedlife of each pool should be shortened by one year, the amount of previouslydeferred revenue amortized to revenue for the year ended December 31, 2006would have increased by $0.6 million. Similarly, the amount of previouslydeferred cost of revenue would have increased by $0.6 million resulting in nonet impact to gross profit.

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Thetable below reflects the impact of our accounting policy on the respective lineitems of the Statement of Operations for the year ended December 31, 2006,the periods February 9, 2006 through December 31, 2005 and January 1,2005 through February 8, 2005 and for the year ended December 31,2004. The “Total amount incurred” line represents the current amount ofbillings that were made and the current costs that were incurred for the period.We then subtract the deferral amount and add back the amortization of previousdeferral amounts to determine the amount we report on the Statement ofOperations.

| ** ** | ** ** | **For the Year Ended December 31,** | ** ** | **February 9 – December 31,** | ** ** | ** **           | ** ** | **January 1 – February 8,** | ** ** | **For the Year Ended December 31,** | ** ** |
|------------|------------|--------------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------------|------------|------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** ** | ** ** | **2006**                                                     | ** ** | **2005**                                               | ** ** | ** **           | ** ** | **2005**                                             | ** ** | **2004**                                                     | ** ** |
| ** ** | ** ** | **Revenue—  other**                                     | ** ** | **Cost of  revenue—  other**                 | ** ** | **Selling  expense** | ** ** | **Revenue—  other**                             | ** ** | **Cost of  revenue—  other**                       | ** ** | **Selling  expense** | ** ** | ** ** | ** ** | **Revenue—  other** | ** ** | **Cost of  revenue—  other** | ** ** | **Selling  expense** | ** ** | **Revenue—  other** | ** ** | **Cost of  revenue—  other** | ** ** | **Selling  expense** | ** ** |
| ** ** | ** ** | **(dollar amounts in thousands)**             | ** ** |
|            |            |                                                              |            |                                                        |            |                      |            |                                                      |            |                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

| Protection One Monitoring segment:          |   |   |                                     |   |   |   |                     |   |   |                     |   |   |                                                      |   |   |   |                                     |   |   |                     |   |   |   |   |                         |   |   |   |                         |   |   |   |                         |   |   |   |                                     |   |   |   |                     |   |   |                     |   |
|---------------------------------------------|--------|--------|------------------------------------------|--------|--------|--------|--------------------------|--------|--------|--------------------------|--------|--------|-----------------------------------------------------------|--------|--------|--------|------------------------------------------|--------|--------|--------------------------|--------|--------|--------|--------|------------------------------|--------|--------|--------|------------------------------|--------|--------|--------|------------------------------|--------|--------|--------|------------------------------------------|--------|--------|--------|--------------------------|--------|--------|--------------------------|--------|
| Total amount incurred                       |   |   | $ 44,527                            |   |   |   | $ 54,311            |   |   | $ 45,029            |   |   | $ 35,532                                             |   |   |   | $ 42,469                            |   |   | $ 36,359            |   |   |   |   | $ 3,265                 |   |   |   | $ 3,663                 |   |   |   | $ 3,645                 |   |   |   | $ 34,291                            |   |   |   | $ 39,207            |   |   | $ 33,647            |   |
| Amount deferred                             |   |   | (29,092                                  | )      |   |   | (38,244                  | )      |   | (18,059                  | )      |   | (24,193                                                   | )      |   |   | (29,947                                  | )      |   | (15,309                  | )      |   |   |   | (2,147                       | )      |   |   | (2,579                       | )      |   |   | (1,470                       | )      |   |   | (20,698                                  | )      |   |   | (25,075                  | )      |   | (14,192                  | )      |
| Amount amortized                            |   |   | 7,249                                    |   |   |   | 11,887                   |   |   | 11,983                   |   |   | 3,579                                                     |   |   |   | 5,623                                    |   |   | 5,893                    |   |   |   |   | 798                          |   |   |   | 1,487                        |   |   |   | 1,550                        |   |   |   | 6,496                                    |   |   |   | 11,678                   |   |   | 11,575                   |   |
| Amount included in Statement of Operations  |   |   | $ 22,684                            |   |   |   | $ 27,954            |   |   | $ 38,953            |   |   | $ 14,918                                             |   |   |   | $ 18,145                            |   |   | $ 26,943            |   |   |   |   | $ 1,916                 |   |   |   | $ 2,571                 |   |   |   | $ 3,725                 |   |   |   | $ 20,089                            |   |   |   | $ 25,810            |   |   | $ 31,030            |   |
| Network Multifamily  segment:               |   |   |                                     |   |   |   |                     |   |   |                     |   |   |                                                      |   |   |   |                                     |   |   |                     |   |   |   |   |                         |   |   |   |                         |   |   |   |                         |   |   |   |                                     |   |   |   |                     |   |   |                     |   |
| Total amount incurred                       |   |   | $      300 |   |   |   | $   2,539 |   |   | $   2,182 |   |   | $      167                  |   |   |   | $   1,638                 |   |   | $   1,912 |   |   |   |   | $  (156            | )      |   |   | $    169 |   |   |   | $    237 |   |   |   | $      695 |   |   |   | $   3,421 |   |   | $   2,287 |   |
| Amount deferred                             |   |   | 19                                       |   |   |   | (2,016                   | )      |   | (176                     | )      |   | (167                                                      | )      |   |   | (1,579                                   | )      |   | (27                      | )      |   |   |   | 156                          |   |   |   | (160                         | )      |   |   | (9                           | )      |   |   | (619                                     | )      |   |   | (3,293                   | )      |   | (160                     | )      |
| Amount amortized                            |   |   | 179                                      |   |   |   | 1,087                    |   |   | 44                       |   |   | 88                                                        |   |   |   | 612                                      |   |   | 28                       |   |   |   |   | 172                          |   |   |   | 734                          |   |   |   | 36                           |   |   |   | 1,596                                    |   |   |   | 6,043                    |   |   | 338                      |   |
| Amount included in Statement of Operations  |   |   | $      498 |   |   |   | $   1,610 |   |   | $   2,050 |   |   | $         88 |   |   |   | $      671 |   |   | $   1,913 |   |   |   |   | $    172 |   |   |   | $    743 |   |   |   | $    264 |   |   |   | $   1,672                 |   |   |   | $   6,171 |   |   | $   2,465 |   |
| Total Company:                              |   |   |                                     |   |   |   |                     |   |   |                     |   |   |                                                      |   |   |   |                                     |   |   |                     |   |   |   |   |                         |   |   |   |                         |   |   |   |                         |   |   |   |                                     |   |   |   |                     |   |   |                     |   |
| Total amount incurred                       |   |   | $ 44,827                            |   |   |   | $ 56,850            |   |   | $ 47,211            |   |   | $ 35,699                                             |   |   |   | $ 44,107                            |   |   | $ 38,271            |   |   |   |   | $ 3,109                 |   |   |   | $ 3,832                 |   |   |   | $ 3,882                 |   |   |   | $ 34,986                            |   |   |   | $ 42,628            |   |   | $ 35,934            |   |
| Amount deferred                             |   |   | (29,073                                  | )      |   |   | (40,260                  | )      |   | (18,235                  | )      |   | (24,360                                                   | )      |   |   | (31,526                                  | )      |   | (15,336                  | )      |   |   |   | (1,991                       | )      |   |   | (2,739                       | )      |   |   | (1,479                       | )      |   |   | (21,317                                  | )      |   |   | (28,368                  | )      |   | (14,352                  | )      |
| Amount amortized                            |   |   | 7,428                                    |   |   |   | 12,974                   |   |   | 12,027                   |   |   | 3,667                                                     |   |   |   | 6,235                                    |   |   | 5,921                    |   |   |   |   | 970                          |   |   |   | 2,221                        |   |   |   | 1,586                        |   |   |   | 8,092                                    |   |   |   | 17,721                   |   |   | 11,913                   |   |
| Amount reported in  Statement of Operations |   |   | $ 23,182                            |   |   |   | $ 29,564            |   |   | $ 41,003            |   |   | $ 15,006                                             |   |   |   | $ 18,816                            |   |   | $ 28,856            |   |   |   |   | $ 2,088                 |   |   |   | $ 3,314                 |   |   |   | $ 3,989                 |   |   |   | $ 21,761                            |   |   |   | $ 31,981            |   |   | $ 33,495            |   |

 

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In addition to the amountsreflected in the table above relating to our costs incurred to create newaccounts, we also capitalized purchases of rental equipment in the amount of$2.8 million and $0.8 million for the year ended December 31, 2006 and theperiod February 8, 2005 through December 31, 2005, respectively.

***Valuation of Intangible Assets***

As discussed in “—*New Basis of Accounting in2005*” above, because Quadrangle acquired substantially all of ourcommon stock, resulting in a new basis of accounting, new values for intangibleassets were recorded in the first quarter of 2005 based on estimates of fairmarket values. New values were recorded for customer accounts, trade names andgoodwill.

Customer accounts were valued by segment based on acombination of (1) the income approach utilizing our projections of cashflow, operating margins and customer attrition and (2) the market approachbased on available industry transaction data generally expressed as a multipleof recurring monthly revenue. Trade name values were based on the identifiablerevenue associated with each segment and were valued based on the incomeapproach. Goodwill represents the excess of the purchase price over the fairvalue of net assets acquired. Goodwill and trade names are tested forimpairment on at least an annual basis or as circumstances warrant.

Customer accountsare tested on a periodic basis or as circumstances warrant. For purposes ofthis impairment testing, goodwill is considered to be directly related to theacquired customer accounts. Factors we consider important that could trigger animpairment review include the following:

·       highlevels of customer attrition;

·       continuingrecurring losses above our expectations; and

·       adverseregulatory rulings.

An impairment test of customer accounts would have tobe performed when the undiscounted expected future operating cash flows byasset group, which consists primarily of capitalized customer accounts andrelated goodwill, is less than the carrying value of that asset group. An impairmentwould be recognized if the fair value of the customer accounts is less than thenet book value of customer accounts.

We completed our annualimpairment testing during the third quarter of 2006 and determined that noimpairment of our non-amortizable intangible assets was required as of July 1,2006. No impairment charge was recorded in 2005 or 2004.

***Customer Account Amortization***

The choice of an amortization life and method is basedon our estimates and judgments about the amounts and timing of expected futurerevenue from customer accounts and average customer account life. Amortizationmethods and selected periods were determined because, in our opinion, theywould adequately match amortization cost with anticipated revenue. We evaluatethe appropriateness of the amortization life and method of each of our customeraccount pools based on the actual historical attrition experience of each pooland, when deemed necessary, perform a lifing study on our customer accounts toassist us in determining appropriate lives of our customer accounts. Theseanalyses are needed in light of the inherent declining revenue curve over thelife of a pool of customer accounts. We have identified two distinct pools ofcustomer accounts, as shown in the table below, each of which had distinctattributes that effected differing attrition characteristics. For theProtection One Monitoring pool, the result of lifing studies indicated to usthat we can expect attrition to be greatest in years one through five of assetlife and that a declining balance (accelerated) method would therefore bestmatch the future amortization cost with the estimated revenue stream from thesecustomer pools. We switch from the declining balance 

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method to thestraight-line method in the year the straight-line method results in greateramortization expense.

Ouramortization rates consider the average estimated remaining and historicalprojected attrition rates. The amortization method for each customer pool is asfollows:

| Pool                       | ** ** | **Method**                      |
|----------------------------|------------|---------------------------------|
| Protection One  Monitoring |       | Ten-year 135% declining balance |
| Network  Multifamily       |       | Nine-year straight-line         |

 

We recorded approximately$32.5 million of customer account amortization for the year ended December 31,2006. We recorded approximately $32.6 million and $5.6 million of customer accountamortization for the periods February 9, 2005 through December 31,2005 and January 1, 2005 through February 8, 2005, respectively. Thisamount would change if we changed the estimated life or amortization rate forcustomer accounts. For example, if we had determined that the estimatedremaining life as of January 1, 2006 of each customer pool should bereduced by one year, the amortization expense would have been approximately$35.2 million for the year ended December 31, 2006.

***Income Taxes***

As part of the process of preparing our consolidatedfinancial statements, we are required to estimate our income taxes in each ofthe jurisdictions in which we operate. Significant management judgment isrequired in determining our provision for income taxes and our deferred taxassets and liabilities. This process involves us estimating our actual currenttax exposure together with assessing temporary differences resulting fromdiffering treatment of items, such as depreciation and amortization, for taxand accounting purposes. These differences result in deferred tax assets andliabilities, which are included within our consolidated balance sheet. We mustthen assess the likelihood that our deferred tax assets will be recovered. Tothe extent we believe that recovery is not likely, we must establish avaluation allowance. As of December 31, 2006, we believe that recovery ofour deferred tax assets is not likely and those assets are fully reservedthrough the valuation allowance.

We currently do not expectto be in a position to record tax benefits for losses incurred in the future.

***New accounting standards***

In December 2004, the FASB issued SFAS No. 123R,which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,”and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees.”  SFAS No. 123Rrequires compensation costs related to share-based payment transactions to berecognized in financial statements based on the fair value on the grant date ofthe equity or liability instruments used. Compensation cost will be recognizedover the period that an employee provides service for that award, resulting ina decrease in net earnings. We adopted the provisions of this Statement, asamended, using the modified prospective method beginning in fiscal 2006. Compensationcosts are now recognized for awards that are issued beginning in 2006 and forawards that have been granted prior to December 31, 2005 but have yet toreach the end of the requisite service period. Exclusive of the make-wholepayment in May 2006, the amount of expense recognized in the year ended December 31,2006 was approximately $1.4 million.

In February 2007, the FASB issued Statement ofFinancial Accounting Standards No. 159, The Fair Value Option forFinancial Assets and Financial Liabilities (SFAS 159). SFAS 159 is effectivefor financial statements issued for fiscal years beginning after November 15,2007 and interim periods within those fiscal years. SFAS 159 permits themeasurement of specified financial instruments and warranty and insurancecontracts at fair value on a contract-by-contract basis, with changes in fairvalue recognized in earnings 

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each reporting period. Wedo not anticipate that adoption of this statement will have a material impacton our consolidated financial statements.

In September 2006, the FASB issued Statement ofFinancial Accounting Standards No. 157, Fair Value Measurements, (SFAS157). SFAS 157 defines fair value, establishes a framework for measuring fairvalue in generally accepted accounting principles and expands disclosures aboutfair value measurements. SFAS 157 is effective for financial statements issuedfor fiscal years beginning after November 15, 2007 and interim periodswithin those fiscal years. We do not anticipate that adoption of this statementwill have a material impact on our consolidated financial statements.

In June 2006, the FASB issued FASB Interpretation(“FIN”) 48, “Accounting for Uncertainty in Income Taxes—an interpretation ofFASB Statement No. 109.”  Thisinterpretation clarifies the accounting for uncertainty in income taxesrecognized in an entity’s financial statements. This interpretation iseffective for fiscal years beginning after December 15, 2006. ProtectionOne, Inc. will be required to adopt this interpretation in the firstquarter of 2007. We do not anticipate that adoption of this statement will havea material impact on our consolidated financial statements.

We adopted StaffAccounting Bulletin 108, or SAB 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*, effective December 31, 2006. SAB 108 requires quantificationof misstatements using both a balance sheet and an income statement approach (“dualmethod” approach) and evaluation of whether either approach results in an errorthat is material in light of relevant quantitative and qualitative factors. Theadoption of this statement did not have a material impact on our consolidatedfinancial statements.

**Results ofOperations**

***Protection One Consolidated***

For the year ended December 31, 2006, we incurreda consolidated net loss of $17.4 million or loss per share of common stock of$0.95. For the periods February 9, 2005 through December 31, 2005 andJanuary 1, 2005 through February 8, 2005, we incurred consolidatednet losses of $15.6 million and $11.4 million, respectively, or losses pershare of common stock of $0.86 and $5.80, respectively. For the year ended December 31,2004, we incurred a consolidated net loss of $323.9 million, or loss per shareof common stock of $164.78. We recorded an operating profit in 2006 and for theperiod February 9, 2005 through December 31, 2005 of $19.1 millionand $21.3 million, respectively. These operating profits are primarily theresult of reduced amortization of customer accounts related to the push downaccounting described in “—*New Basis of Accounting in2005*” above, and a reduction in general and administrative expensesfrom pre-push down periods. Prior to the push down accounting, we recordedoperating losses. Net interest expense of $35.9 million and recapitalizationcosts of $4.5 million contributed to the net loss for the year ended December 31,2006.  Net interest expense of $30.6million and a loss on retirement of debt of $6.7 million contributed to the netloss for the period February 9, 2005 through December 31, 2005. Thenet loss in the period January 1, 2005 through February 8, 2005includes $5.9 million for change in control and debt restructuring costs. Theloss in 2004 includes net income tax expense of $239.6 million, primarily dueto a valuation allowance established on our deferred tax assets and also includes$24.4 million in change in control and debt restructuring transaction-relatedcosts and $3.5 million in retention bonuses.

Monitoring and relatedservices revenue increased slightly (less than 1%) in 2006, primarily as aresult of our improved customer retention, price increases implemented during 2005, an increase in commercial RMRand an increase in RMR in the BellSouth region. Cost of monitoring and relatedservices revenue increased approximately 3.1% in 2006 compared to 2005. Monitoringand related services margin as a percentage of related revenue was at or above71% in 2006, 2005 and 2004. Our monitoring and related services gross marginpercentage has decreased slightly from the prior period due to several factors,the 

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impactof which we expect to continue into the near to medium term: (i) increasedroyalty fees paid to BellSouth as we expand our customer base in the allianceterritory, (ii) increased third party costs for cellular service due tothe growing number of customers who choose to have primary or back-up cellularmonitoring service, and (iii) increased percentage of commercial customersin our base who choose enhanced services, such as open/close and fireinspections which typically have lower gross margins than our standard monitoringservices. Net interest expense in 2006 increased approximately 2.0% dueprimarily to the April 2006 add-on financing, described in Item 8, Note 7 “Debtand Capital Leases,” and increases in interest rates for our variable rateborrowings. Interest expense includes approximately $5.5 million and $6.4million of amortized debt discounts for the year ended December 31, 2006and the period February 9, 2005 through December 31, 2005,respectively.

***Protection One Monitoring***

Wepresent the table below to show how Protection One Monitoring’s operatingresults have changed over the periods presented. Next to each period’s resultsof operations, we provide the relevant percentage of total revenue so that youcan make comparisons about the relative change in revenue and expenses. As aresult of the push down accounting adjustments described in “—*New Basis of Accounting in 2005*” above, the information inpost-push down periods (year ended December 31, 2006 and period February 9,2005 through December 31, 2005) and the pre-push down periods (period January 1,2005 through February 8, 2005 and year ended December 31, 2004)presented in the following table may not be comparable.

| ** **                                                                      | ** ** | **For the year ended  December 31,** | ** ** | **February 9 through  December 31,** | ** ** | **January 1 through  February 8,** | ** ** | **For the year ended  December 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2006**                                                 | ** ** | **2005**                                            | ** ** | **2004**                                          | ** ** |
| ** **                                                                      | ** ** | **(dollar amounts in thousands)**                        | ** ** |
| Revenue                                                                         |       |                                                     |       |                                                |       |                                              |       |                                                     |       |   |   |   |   |   |   |   |   |   |
| Monitoring and related services                                                 |       | $                                                        | 213,472    |                                                | 90.4       | %                                                 | $          | 187,857                                                  |       | 92.6 | % |   | $22,564 |   | 92.2 | % | $211,424 |   | 91.3 | % |
| Other                                                                           |       | 22,684                                                   |       | 9.6                                                 |       | 14,918                                            |       | 7.4                                                      |       |   | 1,916 |   | 7.8 |   | 20,089 |   | 8.7 |   |
| Total Revenue                                                                   |       | 236,156                                                  |       | 100.0                                               |       | 202,775                                           |       | 100.0                                                    |       |   | 24,480 |   | 100.0 |   | 231,513 |   | 100.0 |   |
| Cost of revenue  (exclusive of amortization and depreciation shown below)       |       |                                                     |       |                                                |       |                                              |       |                                                     |       |   |   |   |   |   |   |   |   |   |
| Monitoring and related services                                                 |       | 64,140                                                   |       | 27.2                                                |       | 55,498                                            |       | 27.4                                                     |       |   | 6,627 |   | 27.1 |   | 61,762 |   | 26.7 |   |
| Other                                                                           |       | 27,954                                                   |       | 11.8                                                |       | 18,145                                            |       | 8.9                                                      |       |   | 2,571 |   | 10.5 |   | 25,810 |   | 11.1 |   |
| Total cost of revenue (exclusive of amortization and  depreciation shown below) |       | 92,094                                                   |       | 39.0                                                |       | 73,643                                            |       | 36.3                                                     |       |   | 9,198 |   | 37.6 |   | 87,572 |   | 37.8 |   |
| Operating Expenses                                                              |       |                                                     |       |                                                |       |                                              |       |                                                     |       |   |   |   |   |   |   |   |   |   |
| Selling expenses                                                                |       | 38,953                                                   |       | 16.5                                                |       | 26,943                                            |       | 13.3                                                     |       |   | 3,725 |   | 15.2 |   | 31,030 |   | 13.4 |   |
| General and administrative expenses                                             |       | 55,974                                                   |       | 23.7                                                |       | 48,845                                            |       | 24.1                                                     |       |   | 6,922 |   | 28.3 |   | 61,096 |   | 26.4 |   |
| Change in control and debtrestructuring costs                                   |       | —                                                   |       | —                                              |       | —                                            |       | —                                                   |       |   | 5,939 |   | 24.3 |   | 22,839 |   | 9.9 |   |
| Recapitalization costs                                                          |       | 4,452                                                    |       | 1.9                                                 |       | —                                            |       | —                                                   |       |   | — |   | — |   | — |   | — |   |
| Amortization of intangibles and depreciation expense                            |       | 35,238                                                   |       | 14.9                                                |       | 37,954                                            |       | 18.7                                                     |       |   | 6,112 |   | 24.9 |   | 73,560 |   | 31.8 |   |
| Total operating expenses                                                        |       | 134,617                                                  |       | 57.0                                                |       | 113,742                                           |       | 56.1                                                     |       |   | 22,698 |   | 92.7 |   | 188,525 |   | 81.5 |   |
| Operating profit  (loss)                                                        |       | $                                                        | 9,445      |                                                | 4.0        | %                                                 | $          | 15,390                                                   |       | 7.6 | % |   | $(7,416 | ) | (30.3 | )% | $(44,584 | ) | (19.3 | )% |

 

 

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***2006 Compared to 2005.******  ***Protection One Monitoring hada net increase of 6,118 customers in 2006 compared to a net decrease of 4,848customers in 2005. Protection One Monitoring’s net increase of 15,263 wholesalecustomers exceeded the net decrease of 9,145 retail customers. The averagecustomer base was 697,814 for 2006 compared to 697,179 for 2005.

Furtheranalysis of the change in the Protection One Monitoring customer account baseis shown in the table below.

| ** **                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Beginning  Balance, January 1,                     |       | 694,755  |       | 699,603  |       | 712,491  |       |
| Customer  additions, excluding wholesale                |       | 54,574   |       | 53,974   |       | 52,584   |       |
| Customer losses,  excluding wholesale(a)                |       | (62,201  | )          | (69,620  | )          | (70,178  | )          |
| Changes in  wholesale customer and other adjustments(b) |       | 13,745   |       | 10,798   |       | 4,706    |       |
| Ending Balance,  December 31,                      |       | 700,873  |       | 694,755  |       | 699,603  |       |

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(a)           2005 includes estimatedcustomer losses of 2,738 resulting from Hurricane Katrina

(b)          2005 includes estimatedwholesale customer losses of 379 resulting from Hurricane Katrina.

**Monitoringand related service revenue**increased 1.4% in 2006compared to 2005. We believe our focus on customer retention coupled with priceincreases and growth in our commercial customer base contributed to theincrease. This revenue consists primarily of contractual revenue derived fromproviding monitoring and maintenance service.

**Otherrevenue**includes $7.2 million in amortization of previouslydeferred revenue for the year ended December 31, 2006 compared to $3.6million and $0.8 million for the post-push down and pre-push down periods in2005, respectively. In 2006, we experienced a $3.2 million increase in outrightcommercial sales arrangements which result in immediate revenue recognition. Otherrevenue is generated from our internal installations of new alarm systems andconsists primarily of sales of burglar alarms, closed circuit televisionsystems, fire alarms and card access control systems to commercial customers,as well as amortization of previously deferred revenue.

**Costof monitoring and related services revenue**increased3.2% in 2006 compared to 2005. These costs generally relate to the cost ofproviding monitoring service and include the costs of monitoring, billing,customer service and field operations. Cost of monitoring and related servicesrevenue as a percentage of the related revenue increased to 30.0% in 2006 from29.5% in 2005. See “Monitoring and RelatedServices Margin,” above, for additional information related to the increase inthe cost of monitoring and related services revenue.

**Costof other revenue**includes $11.9 million inamortization of previously deferred customer acquisition costs for the yearended December 31, 2006 compared to $5.6 million and $1.5 million for thepost-push down and pre-push down periods in 2005, respectively. We alsoexperienced a $1.8 million increase in cost of other revenue for our outrightcommercial sales in 2006 compared to 2005. Cost of other revenue consistsprimarily of equipment and labor charges to install alarm systems, CCTVsystems, fire alarms and card access control systems sold to our customers, aswell as amortization of previously deferred customer acquisition costs.

**Sellingexpense**includes $12.0 million in amortization ofpreviously deferred customer acquisition costs for the year ended December 31,2006 compared to $5.9 million and $1.5 million for the post-push down andpre-push down periods in 2005, respectively. Other selling expenses haveincreased over 2005 levels by approximately $3.7 million due to increases inwages, benefits, commissions and other expenses related to an increase in thenumber of sales managers and salespeople in our internal sales force.

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**Generaland administrative expense**increased slightly (lessthan 0.5%) in 2006 compared to 2005. An increase in bad debt expense of $1.1million was partially offset by a reduction in outside legal services of $0.9million. In addition, share-based compensation, exclusive of those costsreflected as recapitalization costs, of approximately $1.4 million was expensedin 2006 because we adopted SFAS 123R as of January 1, 2006. Expenserelated to share-based compensation was not required in 2005. Share-basedcompensation costs and increases in other general and administrative expenseswere offset by expense allocated to Network Multifamily for the cost ofadministrative functions absorbed by Monitoring as part of the NetworkMultifamily consolidation. The period January 1,2005 through February 8, 2005 includes $0.4 million in retention bonusexpense. Excluding the impacts of share-based compensation in 2006 and of theretention bonus expense in 2005, general and administrative expenses declinedapproximately $0.8 million in 2006 compared to 2005.

**Recapitalizationcosts**in 2006 include approximately $1.2 million infees to third party consultants in connection with the amendment to the seniorcredit facility and approximately $3.2 million related to the compensatory make-wholepayment described in “Significant Activities—*Recapitalization*,”above.

**Changein control and debt restructuring costs**for the 2005pre-push down period include $5.6 million in fees paid upon completion of therestructuring as well as legal and other fees related to the debtrestructuring.

**Amortizationof intangibles and depreciation**expense for the yearended December 31, 2006 includes amortization of customer accounts over aten-year life on an accelerated basis and depreciation of fixed assets on astraight-line basis over the useful life of the asset. Annual amortizationexpense of customer accounts has decreased in the post push down period due toa push down adjustment reducing the gross customer account asset that is beingamortized.

***2005 compared to 2004.  ***Wehad a net decrease of 4,848 customers in 2005, compared to a net decrease of12,888 customers in 2004. Our net increase of 11,861 wholesale customers wasexceeded by the net decrease in retail customers, including those lost due toHurricane Katrina. The average customer base was 697,179 for 2005 compared to706,047 for 2004. Net losses of customer accounts materially and adverselyaffect our financial condition and results of operations.

**Monitoringand related service revenue**was not impacted by thepush down accounting adjustments and decreased less than 1% in 2005 compared to2004. We believe our focus on customer retention coupled with price increasesin 2004 and 2005 resulted in a slowdown in the loss of monitoring and relatedservice revenue. This revenue consists primarily of contractual revenue derivedfrom providing monitoring and maintenance service.

**Other revenue**includes $3.6 million and $0.8 million inamortization of previously deferred revenue for the post-push down and pre-pushdown periods in 2005, respectively, and $6.5 million for 2004. In 2005, weexperienced a $1.1 million decrease in outright commercial sales arrangementswhich results in immediate revenue recognition. Other revenue is generated fromour internal installations of new alarm systems and consists primarily of salesof burglar alarms, closed circuit television systems, fire alarms and cardaccess control systems to commercial customers, as well as amortization ofpreviously deferred revenue.

**Cost of monitoring and related services revenue**was not impacted by the push down account adjustments and increased less than1% in 2005 compared to 2004. These costs generally relate to the cost ofproviding monitoring service and include the costs of monitoring, billing,customer service and field operations. Cost of monitoring and related servicesrevenue as a percentage of the related revenue increased to 29.5% in 2005 from29.2% in 2004.

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**Cost of otherrevenue**includes $5.6million and $1.5 million in amortization of previously deferred customeracquisition costs for the post-push down and pre-push down periods in 2005,respectively, and $11.7 million for 2004. We also experienced a $0.5 milliondecrease in cost of other revenue related to the decrease in outrightcommercial sales in 2005 compared to 2004. Cost of other revenue consistsprimarily of equipment and labor charges to install alarm systems, CCTVsystems, fire alarms and card access control systems sold to our customers, aswell as amortization of previously deferred customer acquisition costs.

**Selling expense**includes $5.9 million and $1.5 million inamortization of previously deferred customer acquisition costs for thepost-push down and pre-push down periods in 2005, respectively, and $11.6million for 2004. Other selling expenses increased over 2004 levels by approximately $3.4 million due toincreases in wages, benefits, commissions and other expenses related to anincrease in the number of salespeople.

**General andadministrative expense**decreasedin 2005, generally due to a $1.6 million reduction in insurance premiums,primarily related to director and officer policies and general and professionalliability policies and a $2.1 million reduction in system charges. As of December 31,2004 (with respect to human resources software) and February 17, 2005(with respect to financial systems software), we no longer incur systemprocessing charges from our former parent company related to our usage of itssoftware. Insurance premium reductions are a result of our improved financialcondition, including the debt restructuring activities, which were foundfavorable by insurance markets. The 2005 pre-push down period includes $0.4million in retention bonus expense  and2004 includes $2.8 million in retention bonus expense.

**Change in controland debt restructuring costs**forthe 2005 pre-push down period include $5.6 million in fees paid upon completionof the restructuring as well as legal and other fees related to the debtrestructuring. In 2004 we made change of control payments to executive officersin the amount of $9.5 million, incurred $1.6 million in expenses for thewrite-off of director and officer insurance upon the change of control in February 2004,paid $3.5 million to the advisor to our board of directors and incurredapproximately $8.2 million for legal and advisory fees related to the sale andrestructuring efforts.

**Amortization of intangibles and depreciation expense**for the post-push down period is based on the newlyrecorded values of the customer accounts and fixed assets and their associatedestimated remaining lives, which resulted in a decrease of $31.9 million inamortization of customer accounts for 2005. The remaining lives of fixed assetswere generally decreased which resulted in an increase of $2.4 million indepreciation expense in 2005. The customer accounts are amortized over a tenyear life on an accelerated basis while the remaining asset lives for thecomponents of fixed assets have generally been shortened.

***Network Multifamily***

The following table provides information forcomparison of the Network Multifamily operating results for the periodspresented. Next to each year’s results of operations, we provide the relevantpercentage of total revenue so that comparisons about the relative change inrevenue and expenses can be made. As a result of the push down accountingadjustments described in “—*New Basis of Accounting in2005*” above, the post-push down results for the year ended December 31,2006 and period February 9, 2005 through December 31, 2005 may not becomparable to the pre-push down results for the period January 1, 2005through February 8, 2005 and the year ended December 31, 2004.

In August 2005, Network Multifamily andProtection One began efforts to consolidate management and other functions. Approximatelyforty positions were eliminated at Network Multifamily, including thePresident, Senior Vice President-Sales, Senior Vice President-Legal and Vice President-Finance.Approximately $2.3 million in severance and retention costs were expensed forthe year ended December 31, 2005. In addition, Network Multifamilycompleted conversion of its billing system to Mastermind, which is the billingsystem used by Protection One Alarm Monitoring, Inc. and conversion of 

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its general ledger,inventory management, accounts payable and payroll software to Lawson, which isthe same software currently used by Protection One Alarm Monitoring, Inc.

| ** **                                                                      | ** ** | **For the year ended  December 31,** | ** ** | **February 9 through  December 31,** | ** ** | ** ** | ** ** | **January 1 through  February 8,** | ** ** | **For the year ended  December 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------|------------|------------|------------|---------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2006**                                                 | ** ** | **2005**                                            | ** ** | **2004**   | ** ** |
| ** **                                                                      | ** ** | **(dollar amounts in thousands)**         | ** ** |
| Revenue                                                                         |       |                                                     |       |                                                |       |       |       |                                              |       |                                                     |       |   |   |   |   |   |   |   |   |
| Monitoring and related services                                                 |       | $                                                        | 33,898     |                                                | 98.5       | %          | $          | 31,618                                            |       | 99.7                                                     | %          |   |   | $ | 3,891 |   | 95.8 | % | $ | 36,074 |   | 95.6 | % |
| Other                                                                           |       | 498                                                      |       | 1.5                                                 |       | 88         |       | 0.3                                               |       |                                                     |       | 172 |   | 4.2 |   | 1,672 |   | 4.4 |   |
| Total Revenue                                                                   |       | 34,396                                                   |       | 100.0                                               |       | 31,706     |       | 100.0                                             |       |                                                     |       | 4,063 |   | 100.0 |   | 37,746 |   | 100.0 |   |
| Cost of revenue  (exclusive of amortization and depreciation shown below)       |       |                                                     |       |                                                |       |       |       |                                              |       |                                                     |       |   |   |   |   |   |   |   |   |
| Monitoring and related services                                                 |       | 7,683                                                    |       | 22.3                                                |       | 6,745      |       | 21.3                                              |       |                                                     |       | 773 |   | 19.0 |   | 7,836 |   | 20.8 |   |
| Other                                                                           |       | 1,610                                                    |       | 4.7                                                 |       | 671        |       | 2.1                                               |       |                                                     |       | 743 |   | 18.3 |   | 6,171 |   | 16.3 |   |
| Total cost of revenue (exclusive of amortization and  depreciation shown below) |       | 9,293                                                    |       | 27.0                                                |       | 7,416      |       | 23.4                                              |       |                                                     |       | 1,516 |   | 37.3 |   | 14,007 |   | 37.1 |   |
| Operating  Expenses                                                             |       |                                                     |       |                                                |       |       |       |                                              |       |                                                     |       |   |   |   |   |   |   |   |   |
| Selling expenses                                                                |       | 2,050                                                    |       | 6.0                                                 |       | 1,913      |       | 6.0                                               |       |                                                     |       | 264 |   | 6.5 |   | 2,465 |   | 6.5 |   |
| General and administrative  expenses                                            |       | 6,939                                                    |       | 20.2                                                |       | 8,313      |       | 26.2                                              |       |                                                     |       | 1,182 |   | 29.1 |   | 10,281 |   | 27.2 |   |
| Change in control and debt restructuring  costs                            |       | —                                                   |       | —                                              |       | —     |       | —                                            |       |                                                     |       | — |   | — |   | 1,543 |   | 4.1 |   |
| Corporate consolidation costs                                                   |       | 20                                                       |       | —                                              |       | 2,339      |       | 7.4                                               |       |                                                     |       | — |   | — |   | — |   | — |   |
| Amortization of intangibles and depreciation expense                            |       | 6,429                                                    |       | 18.7                                                |       | 5,788      |       | 18.3                                              |       |                                                     |       | 526 |   | 12.9 |   | 4,895 |   | 13.0 |   |
| Total operating  expenses                                                       |       | 15,438                                                   |       | 44.9                                                |       | 18,353     |       | 57.9                                              |       |                                                     |       | 1,972 |   | 48.5 |   | 19,184 |   | 50.8 |   |
| Operating income                                                                |       | $                                                        | 9,665      |                                                | 28.1       | %          | $          | 5,937                                             |       | 18.7                                                     | %          |   |   | $ | 575 |   | 14.2 | % | $ | 4,555 |   | 12.1 | % |

 

***2006 compared to 2005.*****  **Excluding conversion adjustments described below,Network Multifamily had a net decrease of 20,310 customers in 2006 as comparedto a net decrease of 11,339 customers in 2005. The “Conversion adjustments”line item in the table below reflects the impact of the conversion of ourbilling system to our new technology platform, MAS. Customers are defineddifferently in the new system and the result is a decrease in the number ofcustomers in the new system. Network Multifamily identified a 1,129 decrease inthe number of customers in 2005 and, in the second quarter 2006, identified theexistence of duplicate accounts resulting in an additional decrease of 4,593customers for a total decrease of 5,722 customers from the conversion.   There was no impact on either revenue oraccounts receivable resulting from conversion adjustments. Network Multifamilyhad more contracts reaching the end of the initial contract term in 2006 thanit did in 2005 which we believe has resulted in the increase in customer lossesin 

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2006 reflected in the table below. Demand for our services from owners and managersof multifamily properties has been negatively affected by the increasingpreference of occupants of multifamily units to subscribe only for cellulartelephone services and not for traditional telephone service, which our alarmsystems have historically used to transport alarm signals to our monitoringcenter. We began marketing a new product in the third quarter of 2005 whichwill allow monitoring of multifamily units without a landline in each unit,which we believe will improve the rate of site additions. The average NetworkMultifamily customer base was 305,591 for 2006 compared to 324,276 for 2005. Thechange in Network Multifamily’s customer base for the period is shown below. 

| ** **                          | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|
| ** **                          | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Beginning  Balance, January 1, |       | 318,042                                |       | 330,510 |   | 335,829 |   |
| Customer  additions                 |       | 14,726                                 |       | 9,444 |   | 16,103 |   |
| Customer  losses(a)                 |       | (35,036                                | )          | (20,783 | ) | (21,422 | ) |
| Conversion  adjustments             |       | (4,593                                 | )          | (1,129 | ) | — |   |
| Ending Balance                      |       | 293,139                                |       | 318,042 |   | 330,510 |   |

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(a)    Customerlosses in 2006 are net of reactivation of 969 customers that were affected byHurricane Katrina and 2005 includes estimated customer losses of 1,556resulting from Hurricane Katrina.

**Monitoring andrelated services revenue**decreased4.5% in 2006 compared to 2005 as a result of the decline in the customer base. Thisrevenue consists primarily of contractual revenue derived from providingmonitoring and maintenance service.

**Other revenue**includes $0.2 million in amortization of previouslydeferred revenue for the year ended December 31, 2006 compared to $0.1million and $0.2 million for the post-push down and pre-push down periods in2005, respectively. This revenue consists primarily of amortization ofpreviously deferred revenue associated with the installation of alarm systemsand revenue from the sale of access control systems.

**Cost of monitoringand related services revenue**increased2.2% in 2006 compared to 2005. This cost includes monitoring, billing, customerservice and field operations related to providing our monitoring services. Costof monitoring and related services revenue as a percentage of the relatedrevenue increased to 22.7% in 2006 from 21.2% in 2005.

**Cost of otherrevenue** includes $1.1million in amortization of previously deferred customer acquisition costs forthe year ended December 31, 2006 compared to $0.6 million and $0.7 millionin the post-push down and pre-push down periods in 2005, respectively. Thiscost also includes the cost to install access control systems.

**Selling expense**includes approximately $44.0 thousand inamortization of previously deferred customer acquisition costs for the yearended December 31, 2006 compared to $28.0 thousand and $36.0 thousand forthe post-push down and pre-push down periods in 2005, respectively. Otherselling expense decreased approximately 5.1% in 2006 compared to 2005 due inpart to the corporate consolidation efforts described above.

**General andadministrative expense**decreasedapproximately 26.9% in 2006 compared to 2005 primarily due to the corporateconsolidation efforts described above.

**Corporateconsolidation costs**includeseverance and retention payments for those employees whose responsibilitieswere consolidated into the parent company.

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**Amortization ofintangibles and depreciation expense**represents amortization of customer accounts over a nine-year life anddepreciation of fixed assets over their useful life on a straight-line basis.

***2005 compared to2004.****  *Excludingconversion adjustments described above, we had a net decrease of 11,339customers in 2005 compared to a net decrease of 5,319 customers in 2004. Thisdecrease is due primarily to fewer customer additions. Demand for our servicesfrom owners and managers of multifamily properties was negatively affected bythe increasing preference of occupants of multifamily units to subscribe onlyfor cellular telephone services and not for traditional telephone service,which our alarm systems have historically used to transport alarm signals toour monitoring center. We are marketing a new product which will allowmonitoring of multifamily units without a landline in each unit, which webelieve will improve the rate of site additions. The average customer base was324,276 for 2005 compared to 333,170 for 2004.

**Monitoring andrelated service revenue**wasnot impacted by the push down accounting adjustments and decreased 1.6% in 2005compared to 2004. This revenue consists primarily of contractual revenuederived from providing monitoring and maintenance service. The decline was dueto the decrease in the customer base and a decrease in repair billings.

**Other revenue**includes $0.1 million and $0.2 million inamortization of previously deferred revenue for the post-push down and pre-pushdown periods in 2005, respectively, and $1.6 million for 2004. This revenueconsist primarily of amortization of previously deferred revenue associatedwith the installation of alarm systems and revenue from the sale of accesscontrol systems.

**Cost of monitoringand related services revenue**wasnot impacted by the push down accounting adjustments and generally relates tothe cost of providing monitoring service and includes the costs of monitoring,billing, customer service and field operations. This cost decreasedapproximately 4.1% in 2005 compared to 2004. Cost of monitoring and relatedservice revenue as a percentage of the related revenue decreased to 21.2% in2005 from 21.7% in 2004.

**Cost of otherrevenue**includes $0.6million and $0.7 million in amortization of previously deferred customeracquisition for the post-push down and pre-push down periods in 2005,respectively, and $6.0 million for 2004. This cost also includes the cost toinstall access control systems.

**Selling expense**includes approximately $28.0 thousand and $36.0thousand in amortization of previously deferred customer acquisition costs forthe post-push down and pre-push down periods in 2005, respectively, and $0.3million for 2004. Other selling expenses remained consistent with 2004 expenses.

**General andadministrative expense**decreasedin 2005 generally due to the consolidation efforts described above.

**Change in controland debt restructuring expense**for2004 include change in control payments made as a result of the sale by Westar.

**Corporateconsolidation costs**for thepost-push down period in 2005 include severance and retention payments expensefor those employees whose responsibilities were consolidated into the parentcompany.

**Amortization of intangibles and depreciation expense**for the post-push down period is based on the newlyrecorded values of the customer accounts and fixed assets and their associatedestimated remaining lives. The customer accounts were amortized over a nineyear life on a straight-line basis, while the remaining asset lives for thecomponents of fixed assets generally was shortened.

**Liquidity andCapital Resources**

We expect to generate cash flow in excess of thatrequired for operations and for interest payments. On April 26, 2006, weentered into an amended and restated bank credit agreement increasing our 

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outstanding term loanborrowings under the senior credit facility by approximately $66.8 million to$300.0 million. See Item 8, Note 7 “Debt and Capital Leases,” for furtherdiscussion relating to the increased borrowing and dividend payment. Theapplicable margin with respect to the amended term loan was reduced by 0.5% to1.5% for a base rate borrowing and 2.5% for a Eurodollar borrowing. Subsequentto year end the applicable margin was further reduced by 0.25% to 1.25% for abase rate borrowing and 2.25% for a Eurodollar borrowing. The senior creditfacility continues to include a $25.0 million revolving credit facility, ofwhich approximately $22.9 million remains available as of March 10, 2007after reducing total availability by approximately $2.1 million for anoutstanding letter of credit. We intend to use any other proceeds fromborrowings under the senior credit facility, from time to time, for workingcapital, general corporate purposes and for the purchase of portfolios ofsecurity monitoring accounts and security monitoring companies. The revolvingcredit facility matures in 2010 and the term loan matures in 2012, subject toearlier maturity if we do not refinance our 8.125% senior subordinated notesbefore July 2008. It is anticipated that the Merger transaction will notrequire a significant outlay of cash unless the holders of IASG’s notes notsubject to lockup choose not to exchange their notes for Protection One AlarmMonitoring notes. Approximately 85% of the note holders have agreed to anexchange transaction.

In an effort to limit our exposure to interest raterisk on our senior credit facility, which bears interest at a variable rate, wepurchased interest rate caps in the aggregate amount of $0.9 million during thesecond quarter of 2005. Our objective is to protect against increases ininterest expense caused by fluctuation in LIBOR. One interest rate cap providesprotection on a $75 million tranche of our long term debt over a five-year periodif LIBOR exceeds 6%. A second interest rate cap provides protection on aseparate $75 million tranche of our long term debt over a three-year period ifLIBOR exceeds 5%.

Our long-term debt instruments contain restrictionsbased on “EBITDA.”  EBITDA is generallyderived by adding to income (loss) before income taxes, interest expense,depreciation expense and amortization expense. However, under the indenturerelated to our 8.125% senior subordinated notes and our senior credit facilityvarious and numerous additional adjustments to EBITDA are sometimes required.

Thesenior credit facility and the Senior Subordinated Notes Indenture contain thefollowing financial tests that must be satisfied in order for us to incuradditional indebtedness, pay dividends, make loans or advances or sell assets.

| **Debt Instrument**  | ** ** | ** **                                                                                                                                            | ** ** | **Financial Covenant and Current Test** |
|---------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|
| Senior credit facility    |       | Consolidated total debt  on last day of period/consolidated EBITDA for most recent four fiscal  quarters less than 5.75 to 1.0                        |
|                      |       | Consolidated  EBITDA for most recent four fiscal quarters/consolidated interest expense for  most recent four fiscal quarters greater than 2.0 to 1.0 |
| Senior Subordinated Notes |       | Current fiscal quarter  EBITDA/current fiscal quarter interest expense greater than 2.25 to 1.0                                                       |

 

At December 31, 2006, we were in compliance withthe financial covenants and other maintenance tests for our senior creditfacility but we did not meet the interest coverage ratio incurrence test underthe Senior Subordinated Notes Indenture relating to our ability to incuradditional ratio indebtedness. Althoughwe did not satisfy the interest coverage ratio test under the 8.125% seniorsubordinated notes indenture at December 31, 2006, the failure to satisfysuch ratio test did not render the notes, or any other debt, callable.  The interest coverage ratio test under thisindenture is an incurrence based test (not a maintenance test), and we cannotbe deemed to be in default solely due to failure to meet the interest coverageratio test. Although continued failure to meet the interest ratiocoverage test would result in restrictions on our ability to incur additionalratio indebtedness, we may borrow additional funds under 

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other permittedindebtedness provisions of the indenture, which borrowings are currentlyexpected to provide sufficient liquidity for our operations.

These debt instrumentsalso restrict our ability to pay dividends to stockholders, but do nototherwise restrict our ability to fund cash obligations.

***Cash Flow***

***Operating Cash Flowsfor the Year Ended December 31, 2006.***   Ouroperating activities provided net cash flows of $49.5 million, $40.4 million,$3.7 million and $61.8 million for the year ended December 31, 2006, forthe periods February 9, 2005 through December 31, 2005 and January 1,2005 through February 8, 2005, and the year ended December 31, 2004,respectively.   We received $45.9 millionin cash from Westar under the tax sharing settlement in 2004. Cash interestpayments were $30.9 million compared to $25.2 million, $6.5 million and $45.0million for the periods February 9, 2005 through December 31, 2005and January 1, 2005 through February 8, 2005, and the year ended December 31,2004, respectively. We made recapitalization payments of $4.5 million in 2006. Wemade corporate consolidation, change in control, debt restructuring andretention and severance payments of $2.3 million and $9.1 million for theperiods February 9, 2005 through December 31, 2005 and January 1,2005 through February 8, 2005, respectively, compared to $25.1 million forsuch costs in 2004.

***Investing CashFlows for the Year Ended December 31, 2006.******  ***We used a net $36.7 millionfor our investing activities for the year ended December 31, 2006. Weinvested a net $29.4 million in cash to install and acquire new accounts,invested $4.6 million to acquire fixed assets, invested $2.8 million innon-monitored leased equipment, increased restricted cash by $0.2 million andreceived $0.3 million from the sale of accounts and other assets. We used a net$24.2 million and $2.5 million for our investing activities in the periods February 9,2005 through December 31, 2005 and January 1, 2005 through February 8,2005, respectively. We invested a net $22.5 million in cash to install andacquire new accounts, invested $5.7 million to acquire fixed assets, invested$0.8 million in non-monitored leased equipment, increased our restricted cashby $0.6 million and we received an aggregate of $5.4 million from thedisposition of marketable securities and other assets and from the redemptionof preferred stock in the period February 9, 2005 through December 31,2005. We invested a net $2.2 million in cash to install and acquire newaccounts and $0.3 million to acquire fixed assets in the period January 1,2005 through February 8, 2005. We used a net $30.4 million for ourinvesting activities in 2004. In 2004, proceeds from the sale of other assetsprovided cash of $0.4 million and we invested a net $21.4 million in cash toinstall and acquire new accounts and $9.3 million to acquire fixed assets.

***Financing CashFlows for the Year Ended December 31, 2006.******  ***Financing activities used anet $8.1 million in the year ended December 31, 2006. We used $2.8 millionto retire debt, distributed $70.5 million to shareholders and $1.3 million tovested option holders, used $0.3 million for debt issuance costs and received$66.8 million in proceeds from additional borrowings under our senior creditfacility. Financing activities used a net $50.1 million in cash in the period February 9,2005 through December 31, 2005. We used $293.7 million to retire debt,$7.2 million for debt and stock issuance costs, $0.9 million for interest ratecaps and received $250.0 million for our new senior credit facility and $1.8million in proceeds from the sale of common stock. Financing activities usednet cash flows of $14.1 million in 2004, primarily to retire $14.5 million ofour outstanding debt.

***CapitalExpenditures.******  ***Asdiscussed above, we made capital expenditures of approximately $36.8 million in2006. Of such amount we invested approximately $29.4 million in net customeracquisition costs, $2.8 million in non-monitored leased equipment and $4.6million for fixed assets. Assuming we have available funds, capitalexpenditures for 2007 and 2008 are expected to be approximately $38.2 millionand $41.5 million, respectively, of which approximately $5.0 million and $5.5million, respectively, would be used for fixed asset purchases, with thebalance to be used for customer acquisition costs and non-

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monitored leased equipment.These estimates are prepared for planning purposes and are revised from time totime. Actual expenditures for these and other items not presently anticipatedmay vary materially from these estimates during the course of the yearspresented.

***Tax Matters.******  ***In 2004, we determined thatmost of our deferred tax assets would not be realizable, and we recorded anon-cash charge to income in the approximate amount of $285.9 million toestablish a valuation allowance equal to the amount of net deferred tax assetsdetermined not to be realizable. We currently do not expect to be in a positionto record tax benefits for losses incurred in the future and accordingly, wecontinue to record a valuation allowance for our deferred tax assets.

**Off Balance SheetArrangements**

We had no off-balancesheet arrangements at December 31, 2006, other than as discussed below.

**MaterialCommitments**

Wehave the following future, material, long-term commitments as of December 31,2006:

| ** **                                                               | ** ** | **Payment Due by Period**         | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                               | ** ** | **Total**                                        | ** ** | **Less  than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| ** **                                                               | ** ** | **(dollar amounts in thousands)** | ** ** |
| **At December 31, 2006:**                                           | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **Contractual Obligations**                                              | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Long-Term Debt  Obligations(a)                                           |       | $                                                | 408,090    |   | $ | 3,000 |   | $ | 405,090 |   |   | $ | — | ** ** |   |   | $ | — | ** ** |   |
| Interest  Obligations on Long-Term Debt and Capital Lease Obligations(a) |       | 57,573                                           |       | 32,363 |   | 25,182 |   |   | 28 | ** ** |   |   | — | ** ** |   |
| Operating Leases  Obligations                                            |       | 16,224                                           |       | 5,284 |   | 6,578 |   |   | 3,619 | ** ** |   |   | 743 | ** ** |   |
| Capital Leases  Obligations                                              |       | 2,758                                            |       | 832 |   | 1,650 | ** ** |   | 276 | ** ** |   |   | — | ** ** |   |
| Purchase  Obligations(b)                                                 |       | 7,500                                            |       | 3,750 |   | 3,750 | ** ** |   | — | ** ** |   |   | — | ** ** |   |
| Total                                                                    |       | $                                                | 492,145    |   | $ | 45,229 |   | $ | 442,250 |   |   | $ | 3,923 | ** ** |   |   | $ | 743 | ** ** |   |

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(a)           Assumes (i) paymentof 8.125% senior subordinated notes at contractual maturity date of January 15,2009; and (ii) senior credit facility subject to early maturity date of June 30,2008. Interest rate used to calculate interest obligation on variable ratesenior credit facility is the weighted average rate at December 31, 2006.

(b)          Contract tariff fortelecommunication services.

Thetable below shows our total commercial commitments and the expected expirationper period:

| ** **                       | ** ** | **Amount of Commitment Expiration Per Period** | ** ** |
|----------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **Total**                                                               | ** ** | **2007** | ** ** | **2008-2009** | ** ** | **2010-2011** | ** ** | **Thereafter** | ** ** |
| ** **                       | ** ** | **(dollar amounts in thousands)**                        | ** ** |
| **At December 31, 2006:**   | ** ** | ** **                                                              | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **Other Commercial Commitments** | ** ** | ** **                                                              | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Standby letters  of credit       |       | 2,110                                                                   |       | 2,110 |   |   | — | ** ** |   |   | — | ** ** |   |   | — | ** ** |   |
| Total commercial  commitments    |       | $                                                                       | 2,110      |   | $ | 2,110 |   |   | $ | — | ** ** |   |   | $ | — | ** ** |   |   | $ | — | ** ** |   |
|                                  |            |                                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Credit Ratings**

As of March 10,2007, our public debt was rated as follows:

| ** **     | ** ** | **Senior credit  facility** | ** ** | **8.125% Senior  Subordinated  Notes Due 2009** | ** ** | **Outlook** | ** ** |
|----------------|------------|----------------------------------|------------|----------------------------------------------------------------|------------|-------------|------------|
| S & P |       |                             | B+         |                                                           |       |        | B-         |   |   | Negative |   |
| Moody’s   |       |                             | B1         |                                                           |       |        | Caa1       |   |   | Stable |   |

 

**ITEM 7A. QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

OurSenior credit facility is a variable rate debt instrument, and as of March 10,2007, we had borrowings of $297.8 million outstanding. Interest rate capspurchased in the second quarter of 2005 cap LIBOR (i) for three years at5.0% on a $75 million tranche of borrowings and (ii) for five years at 6%on a separate $75 million tranche. Depending on the level of LIBOR, a 100 basispoint change in the debt benchmark rate would affect pretax income as indicatedin the table below.

| **LIBOR**                          | ** ** | ** **                          | ** ** | **Increase in pretax  income due to 100bp decrease in  interest rates** | ** ** | **Decrease in pretax  income due to 100bp  increase in interest rates** | ** ** |
|------------------------------------|------------|-------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|
| ** **                         | ** ** | **(dollars in millions)** | ** ** |
| Below 4.0%                         |       |                                | $          | 3.0                                                                                                             |       |                                                                                                            |       | $ | (3.0 | ) |   |
| 4.5%      |       |                                | $          | 3.0                                                                                                             |       |                                                                                                            |       | $ | (2.6 | ) |   |
| 5.0%                               |       |                                | $          | 3.0                                                                                                             |       |                                                                                                            |       | $ | (2.2 | ) |   |
| 5.5%                               |       |                                | $          | 2.6                                                                                                             |       |                                                                                                            |       | $ | (1.9 | ) |   |
| 6.0%                               |       |                                | $          | 2.2                                                                                                             |       |                                                                                                            |       | $ | (1.5 | ) |   |

 

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**ITEM8.**                FINANCIALSTATEMENTS AND SUPPLEMENTATY DATA

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Stockholders of Protection One, Inc.:

We have audited the accompanying consolidated balancesheets of Protection One, Inc. and subsidiaries (the “Company”) as of December 31,2006 and 2005 and the related consolidated statements of operations andcomprehensive loss, stockholders’ equity (deficiency in assets) and cash flowsfor the year ended December 31, 2006, for each of the periods February 9,2005 through December 31, 2005 and January 1, 2005 through February 8,2005 and the year ended December 31, 2004. Our audits also included theconsolidated financial statement schedule listed in Item 15(a)2. Theseconsolidated financial statements and the consolidated financial statementschedule are the responsibility of the Company’s management. Our responsibilityis to express an opinion on the consolidated financial statements and theconsolidated financial statement schedule based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believe ouraudits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of ProtectionOne, Inc. and subsidiaries as of December 31, 2006 and 2005, and theresults of their operations and their cash flows for the year ended December 31,2006, for each of the periods February 9, 2005 through December 31,2005 and January 1, 2005 through February 8, 2005 and for the yearended December 31, 2004, in conformity with accounting principlesgenerally accepted in the United States of America. Also, in our opinion, suchconsolidated financial statement schedule, when considered in relation to thebasic consolidated financial statements taken as a whole, presents fairly inall material respects the information set forth therein.

As discussed in Note 3 tothe consolidated financial statements, the Company changed its method ofaccounting for share-based compensation upon its adoption of Statement of FinancialAccounting Standards No. 123R, “Share-Based Payment,” on January 1,2006.

/s/ DELOITTE & TOUCHE LLP

KansasCity, Missouri

March 15, 2007

49

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**PROTECTION ONE,INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(Dollar amounts in thousands, except for per share amounts)**
|                                                                                                                                                                                                          | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                               | ** ** | **2006**              | ** ** |   | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                                                                                                               | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                                                                                          |       |                  |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                                                |       | $                     | 24,600     |   |   |   | $ | 19,893 |   |
| Receivables, net                                                                                                                                                                                         |       | 29,018                |       |   |   | 29,861 |   |
| Inventories, net                                                                                                                                                                                         |       | 4,553                 |       |   |   | 4,466 |   |
| Prepaid expenses                                                                                                                                                                                         |       | 3,316                 |       |   |   | 3,183 |   |
| Other                                                                                                                                                                                                    |       | 3,160                 |       |   |   | 3,183 |   |
| Total current assets                                                                                                                                                                                     |       | 64,647                |       |   |   | 60,586 |   |
| Restricted cash                                                                                                                                                                                          |       | 1,900                 |       |   |   | 1,597 |   |
| Property and  equipment, net                                                                                                                                                                             |       | 22,430                |       |   |   | 21,553 |   |
| Customer  accounts, net                                                                                                                                                                                  |       | 200,371               |       |   |   | 232,875 |   |
| Goodwill                                                                                                                                                                                                 |       | 12,160                |       |   |   | 12,160 |   |
| Trade name                                                                                                                                                                                               |       | 25,812                |       |   |   | 25,812 |   |
| Deferred customer  acquisition costs                                                                                                                                                                     |       | 105,954               |       |   |   | 73,198 |   |
| Other                                                                                                                                                                                                    |       | 10,679                |       |   |   | 8,521 |   |
| Total Assets                                                                                                                                                                                             |       | $                     | 443,953    |   |   |   | $ | 436,302 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY (DEFICIENCY IN ASSETS)**                                                                                                                                    | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                                                                                                     |       |                  |       |   |   |   |   |
| Current portion of long-term debt and capital leases                                                                                                                                                     |       | $                     | 3,861      |   |   |   | $ | 2,356 |   |
| Accounts payable                                                                                                                                                                                         |       | 3,561                 |       |   |   | 2,726 |   |
| Accrued liabilities                                                                                                                                                                                      |       | 25,201                |       |   |   | 24,100 |   |
| Deferred revenue                                                                                                                                                                                         |       | 37,014                |       |   |   | 36,471 |   |
| Total current liabilities                                                                                                                                                                                |       | 69,637                |       |   |   | 65,653 |   |
| Long-term debt  and capital leases, net of current portion                                                                                                                                               |       | 391,991               |       |   |   | 321,293 |   |
| Deferred customer  acquisition revenue                                                                                                                                                                   |       | 60,781                |       |   |   | 39,873 |   |
| Deferred tax  liability                                                                                                                                                                                  |       | 251                   |       |   |   | — |   |
| Other liabilities                                                                                                                                                                                        |       | 1,236                 |       |   |   | 1,416 |   |
| Total Liabilities                                                                                                                                                                                        |       | 523,896               |       |   |   | 428,235 |   |
| Commitments and  contingencies (see Note 9)                                                                                                                                                              |       |                  |       |   |   |   |   |
| Stockholders’ equity:                                                                                                                                                                               |       |                  |       |   |   |   |   |
| Preferred stock,  $.10 par value, 5,000,000 shares authorized                                                                                                                                            |       | —                |       |   |   | — |   |
| Common stock,  $.01 par value, 150,000,000 shares authorized, 18,239,953   shares issued at December 31, 2006 and 18,198,571 shares issued at  December 31, 2005      |       | 182                   |       |   |   | 182 |   |
| Additional  paid-in capital                                                                                                                                                                              |       | 89,545                |       |   |   | 159,939 |   |
| Accumulated other  comprehensive loss                                                                                                                                                                    |       | (318                  | )          |   |   | (107 | ) |
| Deficit                                                                                                                                                                                                  |       | (169,352              | )          |   |   | (151,947 | ) |
| Total stockholders’ equity (deficiency in assets)                                                                                                                                                   |       | (79,943               | )          |   |   | 8,067 |   |
| Total Liabilities and  Stockholders’ Equity (Deficiency in Assets)                                                                                                                                  |       | $                     | 443,953    |   |   |   | $ | 436,302 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

50

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**PROTECTION ONE,INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS(Dollar amounts in thousands, except for per share amounts)**
|                                                                                                                                 | ** ** | **Year Ended  December 31,** | ** ** | **February 9 –  December 31,** | ** ** | **January 1 –  February 8,** | ** ** | **Year Ended  December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **2006**                               | ** ** | **2005**                                      | ** ** | **2004**                                    | ** ** |
| Revenue:                                                                                                                        |       |                                   |       |                                          |       |                                        |       |                                   |       |   |   |   |   |   |   |   |   |   |
| Monitoring and related  services                                                                                                |       |                                   | $          | 247,370                                       |       |                                        |       | $                                      | 219,475    |   |   |   |   | $ | 26,455 |   |   |   | $ | 247,498 |   |   |
| Other                                                                                                                           |       |                                   | 23,182     |                                          |       |                                        | 15,006     |                                   |       |   |   | 2,088 |   |   |   | 21,761 |   |   |
| Total revenue                                                                                                                   |       |                                   | 270,552    |                                          |       |                                        | 234,481    |                                   |       |   |   | 28,543 |   |   |   | 269,259 |   |   |
| Cost of revenue (exclusive of amortization and  depreciation shown below):                                                      |       |                                   |       |                                          |       |                                        |       |                                   |       |   |   |   |   |   |   |   |   |   |
| Monitoring and related  services                                                                                                |       |                                   | 71,823     |                                          |       |                                        | 62,243     |                                   |       |   |   | 7,400 |   |   |   | 69,598 |   |   |
| Other                                                                                                                           |       |                                   | 29,564     |                                          |       |                                        | 18,816     |                                   |       |   |   | 3,314 |   |   |   | 31,981 |   |   |
| Total cost of revenue  (exclusive of   amortization and depreciation shown   below)                                             |       |                                   | 101,387    |                                          |       |                                        | 81,059     |                                   |       |   |   | 10,714 |   |   |   | 101,579 |   |   |
| Operating expenses:                                                                                                             |       |                                   |       |                                          |       |                                        |       |                                   |       |   |   |   |   |   |   |   |   |   |
| Selling                                                                                                                         |       |                                   | 41,003     |                                          |       |                                        | 28,856     |                                   |       |   |   | 3,989 |   |   |   | 33,495 |   |   |
| General and administrative  (exclusive of $3.2 million of compensation costs included in  recapitalization costs for 2006) |       |                                   | 62,913     |                                          |       |                                        | 57,158     |                                   |       |   |   | 8,104 |   |   |   | 71,377 |   |   |
| Change in control and  debt restructuring   costs                                                                               |       |                                   | —     |                                          |       |                                        | —     |                                   |       |   |   | 5,939 |   |   |   | 24,382 |   |   |
| Corporate consolidation  costs                                                                                                  |       |                                   | 20         |                                          |       |                                        | 2,339      |                                   |       |   |   | — |   |   |   | — |   |   |
| Recapitalization costs                                                                                                          |       |                                   | 4,452      |                                          |       |                                        | —     |                                   |       |   |   | — |   |   |   | — |   |   |
| Amortization and  depreciation                                                                                                  |       |                                   | 41,667     |                                          |       |                                        | 43,742     |                                   |       |   |   | 6,638 |   |   |   | 78,455 |   |   |
| Total operating expenses                                                                                                        |       |                                   | 150,055    |                                          |       |                                        | 132,095    |                                   |       |   |   | 24,670 |   |   |   | 207,709 |   |   |
| Operating income (loss)                                                                                                         |       |                                   | 19,110     |                                          |       |                                        | 21,327     |                                   |       |   |   | (6,841 | ) |   |   | (40,029 | ) |   |
| Other expense (income):                                                                                                         |       |                                   |       |                                          |       |                                        |       |                                   |       |   |   |   |   |   |   |   |   |   |
| Interest expense                                                                                                                |       |                                   | 37,412     |                                          |       |                                        | 29,260     |                                   |       |   |   | 2,722 |   |   |   | 26,806 |   |   |
| Related party interest                                                                                                          |       |                                   | —     |                                          |       |                                        | 1,951      |                                   |       |   |   | 1,942 |   |   |   | 18,082 |   |   |
| Interest income                                                                                                                 |       |                                   | (1,512     | )                                             |       |                                        | (577       | )                                      |       |   |   | (120 | ) |   |   | (490 | ) |   |
| Loss on retirement of  debt                                                                                                     |       |                                   | —     |                                          |       |                                        | 6,657      |                                   |       |   |   | — |   |   |   | 47 |   |   |
| Other                                                                                                                           |       |                                   | (52        | )                                             |       |                                        | (688       | )                                      |       |   |   | (15 | ) |   |   | (147 | ) |   |
| Total other expenses                                                                                                            |       |                                   | 35,848     |                                          |       |                                        | 36,603     |                                   |       |   |   | 4,529 |   |   |   | 44,298 |   |   |
| Loss before income taxes                                                                                                        |       |                                   | (16,738    | )                                             |       |                                        | (15,276    | )                                      |       |   |   | (11,370 | ) |   |   | (84,327 | ) |   |
| Income tax expense                                                                                                              |       |                                   | (667       | )                                             |       |                                        | (312       | )                                      |       |   |   | (35 | ) |   |   | (239,579 | ) |   |
| Net loss                                                                                                                        |       |                                   | $          | (17,405                                       | )          |                                        |       | $                                      | (15,588    | ) |   |   |   | $ | (11,405 | ) |   |   | $ | (323,906 | ) |   |
| Other comprehensive  income (loss), net of tax:                                                                                 |       |                                   |       |                                          |       |                                        |       |                                   |       |   |   |   |   |   |   |   |   |   |
| Reclassification  adjustment for realized   gain on marketable securities                                                       |       |                                   | —     |                                          |       |                                        | (162       | )                                      |       |   |   | — |   |   |   | — |   |   |
| Unrealized gain on  marketable securities                                                                                       |       |                                   | —     |                                          |       |                                        | —     |                                   |       |   |   | — |   |   |   | 84 |   |   |
| Unrealized loss on  interest rate cap                                                                                           |       |                                   | (211       | )                                             |       |                                        | (107       | )                                      |       |   |   | — |   |   |   | — |   |   |
| Comprehensive loss                                                                                                              |       |                                   | $          | (17,616                                       | )          |                                        |       | $                                      | (15,857    | ) |   |   |   | $ | (11,405 | ) |   |   | $ | (323,822 | ) |   |
| Basic and diluted per  share information:                                                                                       |       |                                   |       |                                          |       |                                        |       |                                   |       |   |   |   |   |   |   |   |   |   |
| Net loss per common share                                                                                                       |       |                                   | $          | (0.95                                         | )          |                                        |       | $                                      | (0.86      | ) |   |   |   | $ | (5.80 | ) |   |   | $ | (164.78 | ) |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

51

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**PROTECTION ONE,INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Dollaramounts in thousands)**

| ** **                                                                                          | ** ** | **Year Ended  December 31,** | ** ** | **February 9 –  December 31,** | ** ** | **January 1 –  February 8,** | ** ** | **Year Ended  December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                          | ** ** | **2006**                               | ** ** | **2005**                                           | ** ** | **2004**                                         | ** ** |
| Cash flows from operating activities:                                                               |       |                                   |       |                                               |       |                                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Net loss                                                                                            |       |                                   | $          | (17,405                                            | )          |                                             |       | $                                      | (15,588    | ) |   |   | $ | (11,405 | ) |   |   | $ | (323,906 | ) |   |
| Adjustments to reconcile net loss to net cash  provided by operating activities:                    |       |                                   |       |                                               |       |                                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Loss on retirement  of debt                                                                         |       |                                   | —     |                                               |       |                                             | 6,657      |                                   |       |   | — |   |   |   | 47 |   |   |
| Senior notes  received in tax sharing settlement                                                    |       |                                   | —     |                                               |       |                                             | —     |                                   |       |   | — |   |   |   | (26,640 | ) |   |
| (Gain) loss on  sale of assets                                                                      |       |                                   | (244       | )                                                  |       |                                             | (766       | )                                      |       |   | 8 |   |   |   | (93 | ) |   |
| Amortization and  depreciation                                                                      |       |                                   | 41,667     |                                               |       |                                             | 43,742     |                                   |       |   | 6,638 |   |   |   | 78,455 |   |   |
| Amortization of  debt costs, discounts and premium                                                  |       |                                   | 6,496      |                                               |       |                                             | 7,524      |                                   |       |   | 2 |   |   |   | 681 |   |   |
| Amortization of  deferred customer acquisition costs in excess of amortization of deferred  revenue |       |                                   | 17,573     |                                               |       |                                             | 8,489      |                                   |       |   | 2,837 |   |   |   | 21,542 |   |   |
| Amortization of  stock based compensation                                                           |       |                                   | 1,408      |                                               |       |                                             | —     |                                   |       |   | — |   |   |   | — |   |   |
| Deferred income  taxes                                                                              |       |                                   | 251        |                                               |       |                                             | —     |                                   |       |   | — |   |   |   | 286,309 |   |   |
| Provision for  doubtful accounts                                                                    |       |                                   | 3,099      |                                               |       |                                             | 1,664      |                                   |       |   | 272 |   |   |   | 729 |   |   |
| Other                                                                                               |       |                                   | (135       | )                                                  |       |                                             | (119       | )                                      |       |   | (15 | ) |   |   | (69 | ) |   |
| Changes in assets and liabilities, net of effects of  acquisitions and dispositions:                |       |                                   |       |                                               |       |                                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Receivables                                                                                         |       |                                   | (2,256     | )                                                  |       |                                             | (6,868     | )                                      |       |   | (263 | ) |   |   | (1,278 | ) |   |
| Related party tax  receivable                                                                       |       |                                   | —     |                                               |       |                                             | —     |                                   |       |   | — |   |   |   | 26,087 |   |   |
| Other assets                                                                                        |       |                                   | (3,363     | )                                                  |       |                                             | 6,050      |                                   |       |   | 5,500 |   |   |   | (3,951 | ) |   |
| Accounts payable                                                                                    |       |                                   | 836        |                                               |       |                                             | (4,359     | )                                      |       |   | 5,114 |   |   |   | (3,139 | ) |   |
| Deferred revenue                                                                                    |       |                                   | 308        |                                               |       |                                             | 1,007      |                                   |       |   | 1,346 |   |   |   | 638 |   |   |
| Other liabilities                                                                                   |       |                                   | 1,292      |                                               |       |                                             | (7,020     | )                                      |       |   | (6,324 | ) |   |   | 6,402 |   |   |
| Net cash provided  by operating activities                                                          |       |                                   | 49,527     |                                               |       |                                             | 40,413     |                                   |       |   | 3,710 |   |   |   | 61,814 |   |   |
| Cash flows from investing activities:                                                               |       |                                   |       |                                               |       |                                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Installations and  purchases of new accounts                                                        |       |                                   | (27        | )                                                  |       |                                             | —     |                                   |       |   | — |   |   |   | (14 | ) |   |
| Deferred customer  acquisition costs                                                                |       |                                   | (58,495    | )                                                  |       |                                             | (46,862    | )                                      |       |   | (4,218 | ) |   |   | (42,720 | ) |   |
| Deferred customer  acquisition revenue                                                              |       |                                   | 29,073     |                                               |       |                                             | 24,360     |                                   |       |   | 1,991 |   |   |   | 21,317 |   |   |
| Purchase of rental  equipment                                                                       |       |                                   | (2,776     | )                                                  |       |                                             | (772       | )                                      |       |   | — |   |   |   | — |   |   |
| Purchase of  property and equipment                                                                 |       |                                   | (4,557     | )                                                  |       |                                             | (5,680     | )                                      |       |   | (250 | ) |   |   | (9,323 | ) |   |
| Net increase in  restricted cash                                                                    |       |                                   | (212       | )                                                  |       |                                             | (631       | )                                      |       |   | — |   |   |   | — |   |   |
| Proceeds from  disposition of marketable securities                                                 |       |                                   | —     |                                               |       |                                             | 660        |                                   |       |   | — |   |   |   | — |   |   |
| Proceeds from  redemption of preferred stock                                                        |       |                                   | —     |                                               |       |                                             | 4,399      |                                   |       |   | — |   |   |   | — |   |   |
| Proceeds from  disposition of assets and sale of customer accounts                                  |       |                                   | 307        |                                               |       |                                             | 375        |                                   |       |   | 4 |   |   |   | 371 |   |   |
| Net cash used in  investing activities                                                              |       |                                   | (36,687    | )                                                  |       |                                             | (24,151    | )                                      |       |   | (2,473 | ) |   |   | (30,369 | ) |   |
| Cash flows from financing activities:                                                               |       |                                   |       |                                               |       |                                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Payments on  long-term debt                                                                         |       |                                   | (2,839     | )                                                  |       |                                             | (212,714   | )                                      |       |   | — |   |   |   | (14,500 | ) |   |
| Payments on credit  facility                                                                        |       |                                   | —     |                                               |       |                                             | (81,000    | )                                      |       |   | — |   |   |   | — |   |   |
| Distribution to  shareholders                                                                       |       |                                   | (70,490    | )                                                  |       |                                             | —     |                                   |       |   | — |   |   |   | — |   |   |
| Make-whole payment  to vested option holders                                                        |       |                                   | (1,312     | )                                                  |       |                                             | —     |                                   |       |   | — |   |   |   | — |   |   |
| Proceeds from  long-term debt                                                                       |       |                                   | 66,767     |                                               |       |                                             | 250,000    |                                   |       |   | — |   |   |   | — |   |   |
| Proceeds from sale  of common stock                                                                 |       |                                   | —     |                                               |       |                                             | 1,750      |                                   |       |   | — |   |   |   | — |   |   |
| Proceeds from  trademark licensing fees                                                             |       |                                   | —     |                                               |       |                                             | —     |                                   |       |   | — |   |   |   | 160 |   |   |
| Issuance costs and  other                                                                           |       |                                   | —     |                                               |       |                                             | (270       | )                                      |       |   | — |   |   |   | — |   |   |
| Payment for  interest rate caps                                                                     |       |                                   | —     |                                               |       |                                             | (922       | )                                      |       |   | — |   |   |   | — |   |   |
| Debt issue costs                                                                                    |       |                                   | (259       | )                                                  |       |                                             | (6,978     | )                                      |       |   | — |   |   |   | — |   |   |
| Funding from  parent                                                                                |       |                                   | —     |                                               |       |                                             | —     |                                   |       |   | — |   |   |   | 220 |   |   |
| Net cash used in  financing activities                                                              |       |                                   | (8,133     | )                                                  |       |                                             | (50,134    | )                                      |       |   | — |   |   |   | (14,120 | ) |   |
| Net increase  (decrease) in cash and cash equivalents                                               |       |                                   | 4,707      |                                               |       |                                             | (33,872    | )                                      |       |   | 1,237 |   |   |   | 17,325 |   |   |
| Cash and cash equivalents:                                                                          |       |                                   |       |                                               |       |                                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Beginning of  period                                                                                |       |                                   | 19,893     |                                               |       |                                             | 53,765     |                                   |       |   | 52,528 |   |   |   | 35,203 |   |   |
| End of period                                                                                       |       |                                   | $          | 24,600                                             |       |                                             |       | $                                      | 19,893     |   |   |   | $ | 53,765 |   |   |   | $ | 52,528 |   |   |
| Cash paid for  interest                                                                             |       |                                   | $          | 30,949                                             |       |                                             |       | $                                      | 25,209     |   |   |   | $ | 6,451 |   |   |   | $ | 45,003 |   |   |
| Cash paid for  taxes, exclusive of benefits received from parent in 2004                            |       |                                   | $          | 295                                                |       |                                             |       | $                                      | 438        |   |   |   | $ | 6 |   |   |   | $ | 327 |   |   |
| Non-cash investing and financing activity:                                                          |       |                                   |       |                                               |       |                                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Vehicle additions  under capital leases                                                             |       |                                   | $          | 3,261                                              |       |                                             |       | $                                      | —     |   |   |   | $ | — |   |   |   | $ | — |   |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

52

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**PROTECTION ONE,INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIENCY IN ASSETS)**

**(Dollaramounts in thousands)**

| ** **                                              | ** ** | **Common Stock** | ** ** | **Treasury** | ** ** | **Additional  Paid-In** | ** ** | ** **  | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Total  Stockholders’  Equity  (Deficiency in** | ** ** |
|---------------------------------------------------------|------------|-----------------------|------------|--------------|------------|-------------------------|------------|-------------|------------|---------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                              | ** ** | **Shares**            | ** ** | **Amount**   | ** ** | **Stock**               | ** ** | **Capital** | ** ** | **Deficit**                           | ** ** | **Income(Loss)**                                           | ** ** | **Assets)** | ** ** |
| **Common  Stock**                                       | ** ** | ** **            | ** ** |         | ** ** | ** **              |       | ** **  |       | ** **                            | ** ** | ** **                                                 | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| ***January 1, 2004***                              |       | 1,965,654             |       |         | $          | 26                      |       |        | $          | (34,612                               | )          | $                                                          | 1,380,689  |   | $ | (1,200,007 | ) |   | $ | 78 |   |   |   | $ | 146,174 |   |   |
| Exercise of options and  warrants                       |       | —                |       |         | —     |                    |       | —      |       | 39                                    |       | —                                                     |       |   | — |   |   |   | 39 |   |   |
| Unrealized gain-marketable securities                   |       | —                |       |         | —     |                    |       | —      |       | —                                |       | —                                                     |       |   | 84 |   |   |   | 84 |   |   |
| Net loss                                                |       | —                |       |         | —     |                    |       | —      |       | —                                |       | (323,906                                                   | )          |   | — |   |   |   | (323,906 | ) |   |
| ***December 31, 2004***                            |       | 1,965,654             |       |         | $          | 26                      |       |        | $          | (34,612                               | )          | $                                                          | 1,380,728  |   | $ | (1,523,913 | ) |   | $ | 162 |   |   |   | $ | (177,609 | ) |   |
| Net loss                                                |       | —                |       |         | —     |                    |       | —      |       | —                                |       | (11,405                                                    | )          |   | — |   |   |   | (11,405 | ) |   |
| ***February 8, 2005***                             |       | 1,965,654             |       |         | $          | 26                      |       |        | $          | (34,612                               | )          | $                                                          | 1,380,728  |   | $ | (1,535,318 | ) |   | $ | 162 |   |   |   | $ | (189,014 | ) |   |
| Debt for equity exchange                                |       | 16,000,000            |       |         | 160        |                    |       | —      |       | 119,840                               |       | —                                                     |       |   | — |   |   |   | 120,000 |   |   |
| Stock purchased                                         |       | 232,917               |       |         | 2          |                    |       | —      |       | 1,748                                 |       | —                                                     |       |   | — |   |   |   | 1,750 |   |   |
| Partial shares adjustment from reverse stock split      |       | —                |       |         | (6         | )                       |       | —      |       | 6                                     |       | —                                                     |       |   | — |   |   |   | — |   |   |
| Push down accounting  adjustments                       |       | —                |       |         | —     |                    |       | 34,612      |       | (1,342,113                            | )          | 1,398,959                                                  |       |   | — |   |   |   | 91,458 |   |   |
| Stock issuance costs                                    |       | —                |       |         | —     |                    |       | —      |       | (270                                  | )          | —                                                     |       |   | — |   |   |   | (270 | ) |   |
| Unrealized loss-marketable securities, net of tax       |       | —                |       |         | —     |                    |       | —      |       | —                                |       | —                                                     |       |   | (162 | ) |   |   | (162 | ) |   |
| Unrealized loss-interest rate caps, net of tax          |       | —                |       |         | —     |                    |       | —      |       | —                                |       | —                                                     |       |   | (107 | ) |   |   | (107 | ) |   |
| Net loss                                                |       | —                |       |         | —     |                    |       | —      |       | —                                |       | (15,588                                                    | )          |   | — |   |   |   | (15,588 | ) |   |
| ***December 31, 2005***                            |       | 18,198,571            |       |         | $          | 182                     |       |        | $          | —                                |       | $                                                          | 159,939    |   | $ | (151,947 | ) |   | $ | (107 | ) |   |   | $ | 8,067 |   |   |
| Exercise of options                                     |       | 40,882                |       |         | —     |                    |       | —      |       | —                                |       | —                                                     |       |   | — |   |   |   | — |   |   |
| Vesting of restricted stock units                       |       | 500                   |       |         | —     |                    |       | —      |       | —                                |       | —                                                     |       |   | — |   |   |   | — |   |   |
| Distribution to shareholders and vested option  holders |       | —                |       |         | —     |                    |       | —      |       | (71,802                               | )          | —                                                     |       |   | — |   |   |   | (71,802 | ) |   |
| Amortization of stock  compensation expense             |       | —                |       |         | —     |                    |       | —      |       | 1,408                                 |       | —                                                     |       |   | — |   |   |   | 1,408 |   |   |
| Unrealized loss-interest rate caps, net of tax          |       | —                |       |         | —     |                    |       | —      |       | —                                |       | —                                                     |       |   | (211 | ) |   |   | (211 | ) |   |
| Net loss                                                |       | —                |       |         | —     |                    |       | —      |       | —                                |       | (17,405                                                    | )          |   | — |   |   |   | (17,405 | ) |   |
| *** ***                                            |       | 18,239,953            |       |         | $          | 182                     |       |        | $          | —                                |       | $                                                          | 89,545     |   | $ | (169,352 | ) |   | $ | (318 | ) |   |   | $ | (79,943 | ) |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**PROTECTION ONE,INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1. The Company:**

The Company is a publicly-traded security alarmmonitoring company. The Company is principally engaged in the business ofproviding security alarm monitoring services, which includes sales,installation and related servicing of security alarm systems for residentialand business customers. On February 17, 2004, the Company’s formermajority owner, Westar Industries, Inc., a Delaware corporation, referredto as Westar Industries, a wholly owned subsidiary of Westar Energy, Inc.,which together with Westar Industries is referred to as Westar, soldapproximately 87% of the issued and outstanding shares of the Company’s commonstock, par value $0.01 per share, to POI Acquisition I, Inc., a subsidiaryof POI Acquisition, L.L.C. and Quadrangle Master Funding Ltd. POI Acquisition,L.L.C., Quadrangle Master Funding Ltd and POI Acquisition I, Inc. areentities formed by Quadrangle Capital Partners LP, Quadrangle Select PartnersLP, Quadrangle Capital Partners-A LP and Quadrangle Master Funding Ltd,collectively referred to as Quadrangle. Westar retained approximately 1% of theCompany’s common stock, representing shares underlying restricted stock units (“RSUs”)granted to current and former employees of Westar. In the event that theseshares of common stock subject to RSUs are no longer subject to RSUs butcontinue to be held by Westar, Westar is obligated to deliver such shares toQuadrangle without any further consideration paid by Quadrangle. As part of thesale transaction, Westar Industries also assigned its rights and obligations asthe lender under the revolving credit facility to POI Acquisition, L.L.C.,which subsequently assigned one-third of its interest to Quadrangle MasterFunding, Ltd. Quadrangle paid an aggregate of approximately $154.7 million toWestar as consideration for both the common stock and the revolving creditfacility, including accrued interest of $2.2 million, with approximately$2.1 million of the payments being consideration for the common stock.

In November 2004, the Company received $73.0million pursuant to a tax sharing settlement agreement with Westar thatterminated the existing Westar tax sharing agreement, generally settled allclaims with Westar relating to the existing tax sharing agreement and generallysettled all claims between Quadrangle and Westar relating to the Westar saletransaction. Contemporaneously, the Company entered into a debt-for-equityexchange agreement with Quadrangle that provided for the principal balanceoutstanding under the Quadrangle credit facility to be reduced by $120.0million in exchange for the issuance to Quadrangle of 16 million shares of theCompany’s common stock.  The exchange wascompleted on February 8, 2005. The newly issued shares, together withshares already owned by Quadrangle, resulted in Quadrangle owning approximately97.3% of the Company’s common stock. As of March 10, 2007, Quadrangle’sownership of the Company’s common stock is at approximately 97.1% due to theissuance of common stock pursuant to options exercised in 2006. See Note 3, “Share-BasedEmployee Compensation” for additional information.

As a result of Quadrangle’s increased ownershipinterest, the Company ‘‘pushed down’’ Quadrangle’s basis to a proportionateamount of the Company’s underlying assets and liabilities acquired based on theestimated fair market values of the assets and liabilities as of February 8,2005. The “push down” accounting adjustments did not impact cash flows.  The primary changes to the balance sheetreflected (1) the reduction of deferred customer acquisition costs andrevenue, which had been subsumed into the estimated fair market valueadjustment for customer accounts; (2) adjustments to the carrying valuesof debt to estimated fair market value (or Quadrangle’s basis in the case ofthe credit facility); (3) adjustments to historical goodwill to reflectgoodwill arising from the push down accounting adjustments; (4) therecording of a value for our trade names; and (5) an increase to theequity section from these adjustments. The primary changes to the incomestatement included (1) the reduction in other revenue due to a lower levelof amortization from the reduced amortizable base of deferred customer 

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acquisition revenue; (2) thereduction in other costs of revenue and selling expenses due to lower level ofamortization from the reduced amortizable base of deferred customer acquisitioncosts; (3) an increase in interest expense due to amortization of debt discountsarising from differences in fair values and carrying values of the Company’sdebt instruments; and (4) the reduction in amortization related to thereduction in the amortizable base of customer accounts.

The purchase price paid as a result of eachtransaction described above has been allocated to a proportionate amount of theCompany’s underlying assets and liabilities based upon Quadrangle’s acquiredinterests (86.8% on February 17, 2004 and 10.5% on February 8, 2005)in the respective fair market values of assets and liabilities at the date ofeach transaction. The following represents the approximate fair valuesattributable to the assets acquired and liabilities assumed in Quadrangle’sacquisition of substantially all of the Company’s outstanding common stock. Thesevalues exclude the proportionate share of the historical cost basisattributable to the minority interest holders representing 2.7% of the Company.

Allocation of proportionate share to major componentsof assets and liabilities acquired (dollar amounts in millions):

| Current assets,  net of current liabilities    |   | $      | 24.9   |   |
|------------------------------------------------|--------|--------|--------|--------|
| Property and  equipment                        |   | 29.6   |   |
| Customer accounts                              |   | 293.7  |   |
| Goodwill                                       |   | 11.0   |   |
| Trade name                                     |   | 25.8   |   |
| Other long term  assets                        |   | 12.1   |   |
| Long term debt                                 |   | (274.9 | )      |
| Total consideration  paid for equity interests |   | $      | 122.2  |   |

 

Due to the impact of the changes resulting from thepush down accounting adjustments described above, the 2005 statements ofoperations and cash flows presentations separate the Company’s results into twoperiods:  (1) the period ending withthe February 8, 2005 consummation of the exchange transaction and (2) theperiod beginning after that date utilizing the new basis of accounting. Theresults are further separated by a heavy black line to indicate the effectivedate of the new basis of accounting.

On May 12, 2006, the Company completed arecapitalization of its balance sheet by increasing its debt in order to pay acash dividend of $70.5 million, or $3.86 per share, to all holders of record ofits common stock on May 8, 2006, including Quadrangle, which ownedapproximately 97.1% of the outstanding shares of the Company’s common stock atthat date. This cash dividend is referred to as the May 2006 dividend. Thepayment of the May 2006 dividend was financed, in large part, by the April 2006financing described in Note 7, “Debt and Capital Leases.”   Approximately $1.2 million of expense paidto third party consultants related to the financing is reflected asrecapitalization costs in the Consolidated Statement of Operations andComprehensive Loss.

As part of the recapitalization, the Company’s boardof directors also approved a cash payment of $4.5 million or $2.89 for eachvested and unvested option awarded in February 2005 under the 2004 StockOption Plan, including to members of senior management. This payment isreferred to as the compensatory make-whole payment. Approximately $3.2 millionof this compensatory make-whole payment related to options that had not yetvested and accordingly this amount plus related taxes was recorded ascompensation expense in the second quarter of 2006 and is reflected asrecapitalization costs in the Consolidated Statement of Operations andComprehensive Loss. Approximately $1.3 million of the compensatory make-wholepayment related to vested options and was recorded to additional paid incapital. The Company also reduced the exercise price of each vested andunvested option by $0.98. The Company’s board decided to pay the compensatorymake-whole payment and reduce the option exercise 

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price because the paymentof the May 2006 dividend decreased the value of the equity interests ofholders of options, as these holders were not otherwise entitled to receive thedividend. Accordingly, the Company’s board awarded the same amount to theoption holders, on a per share basis, in the form of the compensatorymake-whole payment and the reduced option exercise price. See additionalrelated discussion in Note 3, “Share-Based Employee Compensation.”

The Company completed its corporate consolidationefforts whereby Network Multifamily management and other support functions wereconsolidated with Protection One. The consolidation was effective January 1,2006 and included conversion of Network Multifamily’s billing and generalledger software. Approximately forty positions were eliminated, including thePresident, Senior Vice President-Sales, Senior Vice President-Legal and VicePresident-Finance. The Company accrued approximately $2.3 million for severanceand retention expenses related to this consolidation and paid approximately$2.2 million of this amount as of December 31, 2005. Additional expense ofapproximately $20.0 thousand was incurred in January 2006 and theremaining accrued amounts were paid at that time.

The Company prepares itsfinancial statements in conformity with accounting principles generallyaccepted in the United States of America, which require management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosures of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenue and expensesduring the reporting period. Actual results could differ from those estimates. Theaccompanying consolidated financial statements include the accounts ofProtection One’s wholly owned subsidiaries. Inter-company balances have beeneliminated in consolidation.

*Definitive MergerAgreement*

On December 20, 2006, Protection One, Inc.entered into the Merger Agreement pursuant to which the Company will acquireIASG. Upon completion of the Merger, which is expected to close during thesecond quarter of 2007, holders of IASG common stock will receive 0.29 sharesof Protection One, Inc. common stock for each share of IASG common stockheld. Cash will be paid in lieu of fractional shares.

A special meeting of stockholders of IASG will be heldon March 27, 2007 for the purpose of voting on the Merger. If approved,IASG will become a wholly owned subsidiary of Protection One, Inc. uponthe consummation of the Merger.

On February 22, 2007,the Company commenced an offer to exchange up to $125,000,000 of theoutstanding 12% Senior Secured Notes due 2011 of IASG (the “Old Notes”) fornewly issued 12% Senior Secured Notes due 2011 of Protection One AlarmMonitoring, Inc. (the “New Notes”) (the “Exchange Offer”). The ExchangeOffer is subject to the fulfillment of certain conditions, including theconsummation of the Merger.

**2. Summary ofSignificant Accounting Policies:**

*(a) Stock BasedCompensation*

Effective January 1, 2006, the Company adoptedthe provisions of Statement of Financial Accounting Standards No. 123R (“SFAS123R”), “Share-Based Payment,” which requires the measurement and recognitionof compensation expense for all share-based payment awards to employees anddirectors based on estimated fair values. SFAS 123R supersedes the Company’sprevious accounting methodology using the intrinsic value method underAccounting Principles Board Opinion No. 25 (“APB 25”), “Accounting forStock Issued to Employees.”  With respectto stock option awards granted under the plans that had an exercise price equalto or greater than the market value of the Common Stock on the date of thegrant, the Company, under the intrinsic value method used in connection withAPB 25, had not recognized any 

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share-based compensationexpense related to stock option awards granted to employees in the Company’sConsolidated Statements of Operations and Comprehensive Loss.

See Note 3, “Share-BasedEmployee Compensation” for additional information.

***Pro Forma Share-Based Employee Compensation Expense***

Prior to January 1, 2006, the Company accountedfor share-based employee compensation arrangements in accordance with theprovisions and related interpretations of APB 25. Had compensation cost forshare-based awards been determined consistent with SFAS No. 123R, the netloss and loss per share would have been adjusted to the following pro formaamounts:

| ** **                                                                                                         | ** ** | **2005**                                                                                  | ** ** | **2004**                                   | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                         | ** ** | **February 9 –  December 31**                                              | ** ** | **January 1 –  February 8** | ** ** | **Year ended  December 31** | ** ** |
| ** **                                                                                                         | ** ** | **(dollar amounts in thousands except per share  amounts)** | ** ** |
| Loss available  for common stock, as reported                                                                      |       |                                                                                      | $          | (15,588                                    | )          |   |   |   |   | $ | (11,405 | ) |   |   | $ | (323,906 | ) |   |
| Add: Stock-based  employee compensation expense included in reported net loss, net of related  tax effects         |       |                                                                                      | —     |                                       |       |   |   |   | — |   |   |   | 34 |   |   |
| Deduct: Total  stock option expense determined under fair value method for all awards, net  of related tax effects |       |                                                                                      | (2,169     | )                                          |       |   |   |   | (16 | ) |   |   | (672 | ) |   |
| Loss available  for common stock, pro forma                                                                        |       |                                                                                      | $          | (17,757                                    | )          |   |   |   |   | $ | (11,421 | ) |   |   | $ | (324,544 | ) |   |
| Net loss per  common share (basic and diluted):                                                                    |       |                                                                                      |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| As reported                                                                                                        |       |                                                                                      | $          | (0.86                                      | )          |   |   |   |   | $ | (5.80 | ) |   |   | $ | (164.78 | ) |   |
| Pro forma                                                                                                          |       |                                                                                      | $          | (0.98                                      | )          |   |   |   |   | $ | (5.81 | ) |   |   | $ | (165.11 | ) |   |

 

*(b) RevenueRecognition*

Revenue is recognized when security services areprovided. System installation revenue, sales revenue on equipment upgrades anddirect and incremental costs of installations and sales are deferred forresidential customers with monitoring service contracts. For commercialcustomers and our national account customers, revenue recognition is dependentupon each specific customer contract. In instances when the Company passestitle to a system, the Company recognizes the associated revenue and costsrelated to the sale of the equipment in the period incurred regardless of whetherthe sale is accompanied by a service agreement. In cases where the Companyretains title to the system, the Company defers and amortizes revenue anddirect costs.

The Company follows Staff Accounting Bulletin 104, orSAB104, which requires the Company to defer certain system sales andinstallation revenue and expenses, primarily equipment, direct labor and directand incremental sales commissions incurred. Deferred system and upgradeinstallation revenue is recognized over the expected life of the customerutilizing an accelerated method for residential and commercial customers and astraight-line method for Network Multifamily customers. Deferred costs inexcess of deferred revenue are recognized over the initial contract term,utilizing a straight-line method, typically three to five years for ProtectionOne Monitoring and five to ten years for Network Multifamily systems. To theextent deferred costs are less than deferred revenues, such costs arerecognized over the estimated life of the customer.

The Company follows SFAS 13, “Accounting for Leases,”for its arrangements whereby security equipment that does not requiremonitoring is leased to customers, typically over a five year initial leaseterm. This equipment typically consists of closed circuit television equipmentand card access control 

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equipment. The Companyrecords these arrangements as operating leases and records revenue on astraight line basis over the life of the lease.

Deferred revenue alsoresults from customers who are billed for monitoring and extended serviceprotection in advance of the period in which such services are provided, on amonthly, quarterly or annual basis. Revenue from monitoring activities arerecognized in the period such services are provided.

*(c) Inventories*

Inventories, primarilycomprised of alarm systems and parts, are stated at the lower of average costor market. Inventory is shown net of an obsolescence reserve of $0.9 millionand $2.5 million at December 31, 2006 and 2005, respectively. This reserveis determined based primarily upon current usage of the individual partsincluded in inventory.

*(d) Property andEquipment*

Property and equipment arestated at cost or at the fair value at February 8, 2005 to reflect the newbasis of accounting and are depreciated using the straight-line method overestimated useful lives. Gains or losses from retirements and dispositions ofproperty and equipment are recognized in income in the period realized. Repairand maintenance costs are expensed as incurred. See Note 5, “Property andEquipment,” for additional information regarding push down accounting relatedto property and equipment.

Estimated useful lives of property and equipment areas follows:
| Furniture and fixtures                                        |   | 4-7  years                                                 |
|---------------------------------------------------------------|--------|------------------------------------------------------------|
| Data processing and  telecommunication equipment and software |   | 1-7  years                                                 |
| Rental equipment                                              |   | estimated  customer life;  generally 7 years               |
| Leasehold improvements                                        |   | Lesser  of lease term or useful life; generally 5-10 years |
| Vehicles                                                      |   | 2-5  years                                                 |
| Buildings                                                     |   | 19-40 years                                                |

 

*(e) Income Taxes*

The Company recognizes a liability or asset for thedeferred tax consequences of temporary differences between the tax basis ofassets and liabilities and their reported amounts in the financial statements. Thesetemporary differences will result in taxable or deductible amounts in futureyears when reported amounts of the assets or liabilities are recovered orsettled. The deferred tax assets are periodically reviewed for recoverabilityand a valuation allowance is recorded to reduce the deferred tax assets to anamount that is more likely than not realizable.

The Company currently doesnot have any federal taxable earnings and does not expect to have taxableearnings in the foreseeable future. Income tax expense shown on the statementsof operations represents state taxes paid by the Company’s subsidiaries.

*(f) ComprehensiveLoss*

Comprehensive losscomprises net loss and other comprehensive income (loss). Other comprehensiveincome (loss) includes the unrealized gains and losses associated withavailable-for-sale investment securities and interest rate caps.

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*(g) CustomerAccounts*

Additions to customer accounts are stated at cost andare amortized over the estimated customer life. Internal costs incurred insupport of acquiring customer accounts are expensed as incurred. Upon adoptionof push down accounting as a result of Quadrangle’s increased ownership in theCompany, new values for customer accounts were recorded as of February 8,2005 to reflect the estimated fair value of these accounts.

The choice of an amortization life is based onestimates and judgments about the amounts and timing of expected future revenuefrom customer accounts and average customer account life. Selected periods weredetermined because, in management’s opinion, they would adequately matchamortization cost with anticipated revenue. The Company evaluates theappropriateness of the amortization life and method of each of its customeraccount pools based on the actual historical attrition experience of each pooland, when deemed necessary, performs a lifing study on its customer accounts toassist it in determining appropriate lives of its customer accounts. Theseanalyses are needed in light of the inherent declining revenue curve over thelife of a pool of customer accounts. The Company has identified two distinctpools of customer accounts, each of which had distinct attributes that effectdiffering attrition characteristics. For the Protection One Monitoring pool,the results of lifing studies indicated that the Company can expect attritionto be greatest in years one through five of asset life and that a decliningbalance (accelerated) method would therefore best match the future amortizationcosts with the estimated revenue stream from these customer pools. The Companyswitches from the declining balance method to the straight-line method in theyear the straight-line method results in greater amortization expense.

The amortization rates consider the average estimatedremaining life and historical and projected attrition rates. The amortizationmethod for each customer pool is as follows:

| **Pool**                   | ** ** | **Method**                           |
|----------------------------|------------|--------------------------------------|
| Protection One  Monitoring |       | Ten–year 135% declining balance |
| Network  Multifamily       |       | Nine–year straight-line         |

 

The Company is required toperform impairment tests for long-lived assets prospectively when the Companydetermines that indicators of impairment are present. Declines in market valueof its business or the value of its customer accounts that may be incurredprospectively may also require additional impairment charges. No impairmentcharges were recorded in the periods presented herein.

*(h) Goodwill andTrade Name*

The new basis ofaccounting resulted in new recorded values for trade names and for goodwill asof February 8, 2005 to reflect their estimated fair values. Neither ofthese intangible assets is amortizable and they are therefore subject to annualimpairment testing. The Company had established July 1 as its annualimpairment testing date and completed its annual impairment testing during thethird quarter of 2006 and 2005 and determined that no impairment of itsnon-amortizable intangible assets was required as of each testing date. Animpairment test is also completed if events or changes in circumstancesindicate that the assets might be impaired.

*(i) Cash and CashEquivalents*

All highly liquidinvestments purchased with a remaining maturity of three months or less at thedate acquired are cash equivalents. These investments, consisting of moneymarket funds and 30-day commercial paper or certificates of deposit, arestated at cost, which approximates market.

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*(j) Restricted Cash*

Restricted cash on theaccompanying balance sheet represents a trust account established as collateralfor the benefit of the former insurer of the Company’s workers’ compensationclaims and collateral for the Company’s surety bonding requirements. Theworkers’ compensation collateral is required to support reserves established onclaims filed during the period covered by the former insurer. The Companyreceives interest income earned by the trust. The surety bond collateral isrequired by the Company’s liability insurance carrier. The funds have beendeposited into a money market account which earns interest income.

*(k) Receivables*

Gross receivables, which consist primarily of tradeaccounts receivable, of $36.3 million at December 31, 2006 and $34.9million at December 31, 2005 have been reduced by allowances for doubtfulaccounts of $7.3 million and $5.0 million, respectively.

The Company’s policy for Protection One Monitoring isto establish a reserve for a percentage of a customer’s total receivablebalance when any portion of that receivable balance is greater than 30 dayspast due. This percentage, which is based on the Company’s historicalcollections experience, is increased as any portion of the receivable agesuntil it is fully reserved and written off when it is 120 days past due and theaccount is disconnected and turned over to a collection agency. Additionally,once the customer’s balance is greater than 120 days past due, all otherreceivable balances associated with that customer, irrespective of how manydays past due, are deemed to be 120 days past due and fully reserved. Incertain instances, based upon the discretion of the local general manager,credit can be extended and the account may remain active.

The Company’s policy forNetwork Multifamily’s reserve is based on the specific identification approach.

*(l) AdvertisingCosts*

Printed materials areexpensed as incurred. Broadcast advertising costs are expensed upon the firstbroadcast of the respective advertisement. Total advertising expense was $3.4million for the year ended December 31, 2006. Total advertising expensewas $2.3 million and $0.1 million for the periods February 9, 2005 throughDecember 31, 2005, and January 1, 2005 through February 8, 2005,respectively. Total advertising expense was $2.5 million during the year ended December 31,2004.

*(m) DerivativeFinancial Instruments*

The Company’s interestrate caps are recorded in the consolidated balance sheet at fair value and havebeen designated as cash flow hedges. Changes in the fair value are recognizedin other comprehensive income (loss) until the hedge transaction is recognizedin earnings.  The unamortized costs ofthe cap agreements are included in other assets. The Company amortizes thecosts of the interest rate caps to interest expense over the respective livesof the agreements with any ineffectiveness in the hedging relationshiprecognized immediately in earnings. Payments to be received as a result of thecap agreements, if any, are accrued as a reduction of interest expense.

*(n) Concentrationsof Credit Risk*

Financial instrumentswhich potentially subject the Company to concentrations of credit risk consistprincipally of trade receivables from a large number of customers, includingboth residential and commercial, dispersed across a wide geographic base. TheCompany extends credit to its customers in the normal course of business,performs periodic credit evaluations and maintains allowances for the potential

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creditlosses. The Company has customers located throughout the United States withalmost 45% of its recurring monthly revenue derived from customers located inCalifornia, Florida and Texas. A major earthquake, hurricane or otherenvironmental disaster in an area of high account concentration could disruptthe Company’s ability to serve those customers or render those customersuninterested in continuing alarm monitoring services.

*(o) Loss Per Share*

Lossper share is presented in accordance with SFAS No. 128 “Earnings PerShare.”  Weighted average sharesoutstanding were as follows:

| ** **                           | ** ** | **December 31,** | ** ** | **February 9 –  December 31,** | ** ** | **January 1 –  February 8,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2006**              | ** ** | **2005**                                      | ** ** | **2004**                                    | ** ** |
| Weighted average  shares outstanding |       |                  | 18,233,221 |                                          |       |                                        | 18,198,571 |                  |       | 1,965,654 |   |   | 1,965,654 |   |   |
|                                      |            |                       |            |                                               |            |                                             |            |                       |            |  |  |  |  |  |  |

 

For the year ended December 31,2006, the Company had outstanding stock options that represented 0.8 milliondilutive potential common shares. For the period February 9, 2005 through December 31,2005, the Company had outstanding stock options that represented 1.0 milliondilutive potential common shares. No outstanding stock options and warrantsrepresent dilutive potential common shares for the period January 1, 2005through February 8, 2005 or for the year ended December 31, 2004. Thesesecurities were not included in the computation of diluted earnings per sharesince to do so would have been antidilutive for all periods presented.

*(p)  New Accounting Standards*

In December 2004, the FASB issued SFAS No. 123R,which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,”and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees.”  SFAS No. 123Rrequires compensation costs related to share-based payment transactions to berecognized in financial statements based on the fair value on the grant date ofthe equity or liability instruments used. Compensation cost will be recognizedover the period that an employee provides service for that award, resulting ina decrease in net earnings. The Company adopted the provisions of thisStatement effective January 1, 2006, as more fully described in Note 3.

In February 2007, the FASB issued Statement ofFinancial Accounting Standards No. 159, The Fair Value Option forFinancial Assets and Financial Liabilities (SFAS 159). SFAS 159 is effectivefor financial statements issued for fiscal years beginning afterNovember 15, 2007 and interim periods within those fiscal years. SFAS 159permits the measurement of specified financial instruments and warranty andinsurance contracts at fair value on a contract-by-contract basis, with changesin fair value recognized in earnings each reporting period. The Company doesnot anticipate that adoption of this statement will have a material impact onits consolidated financial statements.

In September 2006, the FASB issued Statement ofFinancial Accounting Standards No. 157, Fair Value Measurements, (SFAS157). SFAS 157 defines fair value, establishes a framework for measuring fairvalue in generally accepted accounting principles and expands disclosures aboutfair value measurements. SFAS 157 is effective for financial statements issuedfor fiscal years beginning after November 15, 2007 and interim periodswithin those fiscal years.  The Companydoes not anticipate that adoption of this statement will have a material impacton its consolidated financial statements.

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In June 2006, the FASB issued FASB Interpretation(“FIN”) 48, “Accounting for Uncertainty in Income Taxes—an interpretation ofFASB Statement No. 109.”  Thisinterpretation clarifies the accounting for uncertainty in income taxesrecognized in an entity’s financial statements. The interpretation prescribes arecognition threshold and a measurement attribute for the financial statementrecognition and measurement of tax positions taken or expected to be taken in atax return. For the benefits of a tax position taken to be recognized, the taxposition must be more-likely-than-not to be sustained upon examination bytaxing authorities. This interpretation is effective for fiscal years beginningafter December 15, 2006. Protection One, Inc. will be required to adoptthis interpretation in the first quarter of 2007. The Company does notanticipate that adoption of this statement will have a material impact on itsconsolidated financial statements.

The Company adopted StaffAccounting Bulletin 108, or SAB 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*, effective December 31, 2006.  SAB 108 requires quantification of misstatementsusing both a balance sheet and an income statement approach (“dual method”approach) and evaluation of whether either approach results in an error that ismaterial in light of relevant quantitative and qualitative factors. The adoptionof this statement did not have a material impact on the Company’s consolidatedfinancial statements.

*(q) Prior YearReclassification*

A reclassification hasbeen made to prior year information to reflect interest income separately frominterest expense to conform with the current year presentation.

**3. Share-BasedEmployee Compensation:**

Effective January 1, 2006, the Company adoptedthe provisions of Statement of Financial Accounting Standards No. 123R (“SFAS123R”), “Share-Based Payment,” which requires the measurement and recognitionof compensation expense for all share-based payment awards to employees anddirectors based on estimated fair values. SFAS 123R supersedes the Company’sprevious accounting methodology using the intrinsic value method underAccounting Principles Board Opinion No. 25 (“APB 25”), “Accounting forStock Issued to Employees.”  With respectto stock option awards granted under the plans that had an exercise price equalto or greater than the market value of the Common Stock on the date of thegrant, the Company, under the intrinsic value method used in connection withAPB 25, had not recognized any share-based compensation expense related tostock option awards granted to employees in the Company’s ConsolidatedStatements of Operations and Comprehensive Loss.

The Company had thefollowing stock option plans under which shares were available for grant at December 31,2006:  the 2004 Stock Option Plan (the “2004Plan”) and the 1997 Long-Term Incentive Plan (the “LTIP”).  The 1994 Stock Option Plan is no longeractive.

***2004 Stock Option Plan***

The 2004 Plan was approved by the Protection Onestockholders and became effective upon the consummation of the debt-for-equityexchange on February 8, 2005. Under the 2004 Plan, certain executiveofficers and selected management employees were granted options in 2005, whichare subject to vesting, exercise and delivery restriction described below, topurchase an aggregate of 1,782,947 shares of common stock. A total of 1,996,184shares are reserved for issuance under the 2004 Plan subject to such adjustmentas may be necessary to reflect changes in the number or kinds of shares ofcommon stock or other securities of the Company. To the extent an optionexpires or is canceled, forfeited, settled in cash or otherwise terminated orconcluded without a delivery of shares to which the option related, theundelivered shares will again be available for options. The options initiallygranted under the 2004 Plan will vest ratably each month during the 48 monthsafter the date of grant, subject to accelerated vesting, in 

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the case of certain seniorexecutive officers, under certain circumstances following a qualified sale. Underthe option agreements applicable to the options granted, any shares of stockpurchased through the exercise of options generally will be issued anddelivered to the option holder, and any net payment that may be due to suchholder in accordance with the 2004 Plan, will be paid to such holder upon theearlier of: (1) specified dates following the occurrence of certainpermissible distribution events (as defined in the Company’s Stock AppreciationRights Plan) and (2) February 8, 2011, provided that if an optionholder’s right to receive stock is converted pursuant to the 2004 Plan into aright to receive cash, the amount of cash payable will be credited withinterest at 6% per annum, compounded annually, from the date such conversion iseffective until the applicable payment date.

On July 25, 2006 anadditional 42,500 options were granted under the 2004 Plan.

***1997 Long-Term Incentive Plan***

The 1997 LTIP, approved by the Protection Onestockholders on November 24, 1997, provides for the award of incentivestock options to directors, officers and key employees. Under the LTIP, 114,000shares are reserved for issuance, subject to such adjustment as may benecessary to reflect changes in the number or kinds of shares of common stockor other securities of Protection One. The LTIP provides for the granting ofoptions that qualify as incentive stock options under the Internal Revenue Codeand options that do not so qualify.

Each option has a term of ten years and typicallyvests ratably over three years. The purchase price of the shares issuablepursuant to the options is equal to (or greater than) the fair market value ofthe common stock at the date of the option grant.

The vesting of optionsgranted to our senior management was previously accelerated because of thechange in control of the Company when Westar sold its interest in the Companyto Quadrangle.

***Share-Based Employee Compensation Expense***

The Company adopted SFAS 123R using the modifiedprospective transition method. Under this transition method, compensation costsare recognized for awards that are issued beginning in 2006 and for awards thathave been granted prior to December 31, 2005 but have yet to reach the endof the requisite service period. In accordance with the modified prospectivetransition method, the Company’s Consolidated Financial Statements for priorperiods have not been restated to reflect the impact of SFAS 123R.

Exclusive of the impact of the modification to theoptions granted in 2005 discussed in Note 1, “The Company,” share-basedcompensation related to stock options granted to employees of approximately$1.4 million, or $0.08 per share (basic and fully diluted), was recorded ingeneral and administrative expense for the year ended December 31, 2006. Notax benefit was recorded since the Company does not have taxable income and iscurrently reserving its tax assets. There were no amounts capitalized relatingto share-based employee compensation for the year ended December 31, 2006.

The amount of expense to be recognized over theremaining service period of the modified 2005 options and the 2006 options asof December 31, 2006 is expected to be approximately $2.5 million through July 2010.

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Thetable below summarizes stock options and warrants for the Company’s commonstock outstanding as of December 31, 2006. All non-vested options at December 31,2006 are expected to vest in the future.

| **Description**    | ** ** | ** **     | ** ** | **Exercise  Price/Range of  Exercise Prices** | ** ** | **Number of  Shares of  Common  Stock** | ** ** | **Weighted-  Average  Remaining  Contractual  Life in years** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate  Intrinsic  Value  (Dollars in  Thousands)** | ** ** |
|--------------------|------------|----------------|------------|---------------------------------------------------------|------------|---------------------------------------------------|------------|-------------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------------------------------|------------|
| *Exercisable*      |       |           |       |                                                    |       |                                              |       |                                                                    |       |                                   |       |                                                          |       |   |   |
| 1998 Options       |       | $              | 550.00     |                                                    | 3,860      |                                              |       |                                                                    |       |                                   | $          | 550.00                                                        |       |   |   |   |   |
| 1999 Options       |       | 262.50-446.375 |       | 1,750                                                   |       |                                              |       |                                                                    |       | 433.77                                 |       |                                                          |       |   |   |
| 2000 Options       |       | 71.875         |       | 2,321                                                   |       |                                              |       |                                                                    |       | 71.56                                  |       |                                                          |       |   |   |
| 2001 Options       |       | 60.30-71.00    |       | 34,550                                                  |       |                                              |       |                                                                    |       | 66.73                                  |       |                                                          |       |   |   |
| 2001 Warrants      |       | 65.825         |       | 5,000                                                   |       |                                              |       |                                                                    |       | 65.83                                  |       |                                                          |       |   |   |
| 2002 Options       |       | 103.50-137.50  |       | 6,800                                                   |       |                                              |       |                                                                    |       | 115.82                                 |       |                                                          |       |   |   |
| 2003 Options       |       | 60.00          |       | 266                                                     |       |                                              |       |                                                                    |       | 60.00                                  |       |                                                          |       |   |   |
| 2005 Options       |       | 6.52           |       | 714,463                                                 |       |                                              |       |                                                                    |       | 6.52                                   |       |                                                          |       |   |   |
| 2006 Options       |       | 14.02          |       | 4,427                                                   |       |                                              |       |                                                                    |       | 14.02                                  |       |                                                          |       |   |   |
|               |       |           |       | 773,437                                                 |       |                                              | 4.1  years |                                                                    |       | 14.41                                  |       |                                                          | $          | 3,987 |   |   |
| *Not  exercisable* |       |           |       |                                                    |       |                                              |       |                                                                    |       |                                   |       |                                                          |       |   |   |
| 2005 Options       |       | 6.52           |       | 844,365                                                 |       |                                              |       |                                                                    |       | 6.52                                   |       |                                                          |       |   |   |
| 2006 Options       |       | 14.02          |       | 38,073                                                  |       |                                              |       |                                                                    |       | 14.02                                  |       |                                                          |       |   |   |
| * *           |       |           |       | 882,438                                                 |       |                                              | 4.1  years |                                                                    |       | 6.84                                   |       |                                                          | $          | 4,712 |   |   |
| *Outstanding*      |       |           |       | 1,655,875                                               |       |                                              | 4.1 years  |                                                                    |       | $                                      | 10.41      |                                                          |       | $ | 8,699 |   |   |
|                    |            |                |            |                                                         |            |                                                   |            |                                                                         |            |                                        |            |                                                               |            |  |  |  |  |  |  |  |

 

A summary of the Company’s nonvested stock optionsactivity for the year ended December 31, 2006 follows:

| ** **                            | ** ** | **Shares** | ** ** | **Weighted-  Average  Grant-Date  Fair Value** | ** ** | **Total Grant-  Date Fair**

**Value  (Dollars in  Thousands)** | ** ** |
|---------------------------------------|------------|------------|------------|-----------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| Nonvested at  January 1, 2006    |       | 1,234,339  |       |                                                | $          | 5.40                                                                           |       |   |   | $ | 6,662 |   |   |
| Granted                               |       | 42,500     |       |                                                | 9.52       |                                                                           |       |   | 405 |   |   |
| Vested—2003  options             |       | (266       | )          |                                                | 40.00      |                                                                           |       |   | (10 | ) |   |
| Vested—2005  options             |       | (129,903   | )          |                                                | 5.39       |                                                                           |       |   | (700 | ) |   |
| Cash paid on  nonvested options(a)    |       | —     |       |                                                | —     |                                                                           |       |   | (3,183 | ) |   |
| Vested—modified  2005 options(a) |       | (259,805   | )          |                                                | 2.51       |                                                                           |       |   | (653 | ) |   |
| Vested—2006  options             |       | (4,427     | )          |                                                | 9.52       |                                                                           |       |   | (42 | ) |   |
| Forfeited                             |       | —     |       |                                                | —     |                                                                           |       |   | — |   |   |
| Nonvested at  December 31, 2006  |       | 882,438    |       |                                                | $          | 2.81                                                                           |       |   |   | $ | 2,479 |   |   |

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(a)           The weighted-averagegrant-date fair value of options granted during the first quarter of 2005 was$5.39 per option. The terms of the options granted in 2005 under the 2004 Planincluded antidilution provisions and were modified accordingly because of thedistribution made in May 2006. The compensatory make-whole payment of $4.5million or $2.89 per option described in Note 1, “The Company,” resulted in areduction of the fair value of the original award by the amount of cashreceived resulting in an adjusted grant-date fair value of $2.51. Approximately$3.2 million of the $4.5 million cash payment related to nonvested options andwas reflected as recapitalization costs in the second quarter of 2006.

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TheCompany estimated fair value of the options on the date of grant using theBlack-Scholes option-pricing model with the assumptions included in the tablebelow. The Company uses historical data, among other factors, to estimate theexpected price volatility, the expected option life and the expected forfeiturerate. The risk-free rate is based on the U.S. Treasury yield curve in effect atthe time of grant for the estimated life of the option. The followingassumptions were used to estimate the fair value of options granted July 25,2006 and February 8, 2005 and to estimate the fair value of the May 12,2006 modification of the options granted in 2005:

| ** **                       | ** ** | **July 25, 2006** | ** ** | **May 12, 2006** | ** ** | **February 8, 2005** | ** ** |
|----------------------------------|------------|-----------------------------|------------|----------------------------|------------|--------------------------------|------------|
| Expected stock  price volatility |       |                        | 72.7       | %                          |       |                           | 75.1       | % |   |   | 82.1 | % |   |
| Risk free  interest rate         |       |                        | 4.96       | %                          |       |                           | 5.08       | % |   |   | 3.8 | % |   |
| Expected option  life            |       |                        | 6 years    |                       |       |                           | 4.75 years |   |   |   | 6 years |   |   |
| Expected dividend yield          |       |                        | —     |                       |       |                           | —     |   |   |   | — |   |   |

 

The following table summarizes the Company’sactivities with respect to its stock option plans for the years presented:

| ** **                               | ** ** | **Warrants  And Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Grant Date  Fair Value  (Dollars in  Thousands)** | ** ** |
|------------------------------------------|------------|--------------------------------|------------|----------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| Outstanding at  December 31, 2003   |       |                           | 91,626     |                                   |       | $                                                                                     | 146.65     |   |   |   |   |   |
| Surrendered                              |       |                           | (6,142     | )                                      |       | 128.50                                                                                |       |   |   |   |   |
| Outstanding at  December 31, 2004   |       |                           | 85,484     |                                   |       | 147.95                                                                                |       |   |   |   |   |
| Granted                                  |       |                           | 1,782,947  |                                   |       | 7.50                                                                                  |       |   | $ | 9,610 |   |   |
| Surrendered                              |       |                           | (175,030   | )                                      |       | 29.47                                                                                 |       |   |   |   |   |
| Outstanding at  December 31, 2005   |       |                           | 1,693,401  |                                   |       | 12.32                                                                                 |       |   |   |   |   |
| Granted                                  |       |                           | 42,500     |                                   |       | 14.02                                                                                 |       |   | $ | 405 |   |   |
| Exercised  (intrinsic value of $428,928) |       |                           | (40,882    | )                                      |       | 7.50                                                                                  |       |   |   |   |   |
| Surrendered                              |       |                           | (39,144    | )                                      |       | 60.06                                                                                 |       |   |   |   |   |
| Outstanding at  December 31, 2006   |       |                           | 1,655,875  |                                   |       | $                                                                                     | 10.41      |   |   |   |   |   |

 

No cash was received forthe option exercises in 2006 as the option holders elected to utilize acashless exercise in which they surrendered vested options in lieu of a cashpayment for the exercise price.

***Restricted ShareUnits***

Annual grants of RSUs areawarded to the Company’s independent board member as part of the Company’sindependent director compensation plan approved in March 2005. An award of2,000 RSUs was granted on March 28, 2005 with a per unit fair value of$7.50. An award of 1,000 RSUs was granted on April 15, 2006 with a perunit fair value of $17.25. The RSUs vest ratably over a 4-year period,provided, however, that any and all unvested RSUs shall be immediatelyforfeited in the event the board member ceases to serve on the Company’s board.A total of 500 RSUs vested and converted to common shares during the year endedDecember 31, 2006 and 2,500 RSUs remained unvested as of December 31,2006.

***Stock AppreciationRights Plan***

On February 8, 2005,pursuant to a management incentive plan, the Company’s senior management teamreceived an aggregate of 1,996,183 Stock Appreciation Rights, or SARs. The SARsvest and become payable upon the earlier of (1) a qualified sale asdefined in the SAR Plan, which generally means Quadrangle’s sale of at least60% of its equity interest in Protection One, provided that if the qualifiedsale is not a permissible distribution event (as defined in the SAR Plan) thepayment will be made, with 

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interest,in connection with a subsequent permissible distribution event, and (2) February 8,2011. The exercise price of the SARs was $4.50 on the grant date and increasesby 9% per annum, which is referred to as the fixed return, compounded annually,beginning on February 8, 2006. If Quadrangle sells less than 60% of itsequity interest in Protection One, the exercise price applicable to anequivalent percentage of management’s SARs would be based on the fixed returnthrough the date of such sale. Each SAR that vests and becomes payable inconnection with a qualified sale will generally entitle the holder of a SAR toreceive the difference between the exercise price and the lesser of (1) thevalue of the consideration paid for one share of stock in such qualified sale,or the fair market value of one share of stock if the qualified sale is not asale to a third party and (2) $7.50, provided that if a SAR holder’s rightto receive stock is converted pursuant to the SAR Plan into a right to receivecash from a grantor trust that Protection One may establish, the amount of cashpayable will be credited with interest at 6% per annum, compounded annually,from the date such conversion is effective until the applicable payment date.

The SAR Plan provides thatthe exercise price of the SARs shall be equitably adjusted or modified asnecessary to preserve the intended economic benefit of the original grant inthe event there is, among other things, a recapitalization, and the SAR Planprovides that the exercise price of the SARs may be adjusted or modified uponthe occurrence of any event that makes adjustment or modification appropriateand equitable to prevent inappropriate penalties or windfalls with respect tothe terms of the SAR Plan and the holders of the SARs. On May 12, 2006,after determining that the $70.5 million cash dividend declared on April 27,2006 would adversely impact the SARs granted in 2005, the Protection One boardof directors agreed to amend the SARs agreements by effectively fixing theexercise price on 439,160 outstanding SARs (the modified SARs) at $5.02. Therefore,if there is not a qualified sale prior to February 8, 2011, the holders ofthese modified SARs will be entitled to receive the difference between $7.50and $5.02 per SAR, or $2.48, from Protection One for a total cash outlay ofapproximately $1.1 million on February 8, 2011.

In November 2006, theProtection One board of directors approved the reallocation of SARs forfeitedby a former executive officer to the other SAR Plan participants, Messrs. Ginsburg,Nevin and Pefanis. As proposed by Protection One’s Chief Executive Officer andapproved by its board of directors, the SARs were reallocated to the applicablenamed executive officers in proportion to the number of SARs that they heldimmediately before the reallocation. Except for a reallocation upon anyforfeiture by a former executive officer, the SAR Plan does not allow for anygrant of additional SARs.

As of December 31,2006, Protection One has established a liability of approximately $138,300 toreflect the portion of the modified SARs that have been earned since the dateof the modification through December 31, 2006 with the associated expensereflected in general and administrative expense. Assuming there is no qualifiedsale prior to February 8, 2011, Protection One expects to recordapproximately $0.2 million in expense per year through February 8, 2011related to these SARs. As of December 31, 2006 and 2005, no value has beenascribed to the SARs that have not been modified and no value will be allocatedto those SARs unless and until it becomes probable that a qualified sale willoccur.

**4. Accrued Liabilities:**

Thefollowing reflects the components of accrued liabilities as of the periodsindicated (dollar amounts in thousands):

| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Accrued interest                                 |       | $                     | 5,452      |   | $ | 5,342 |   |
| Accrued vacation  pay                            |       | 3,504                 |       | 3,436 |   |
| Accrued salaries,  bonuses and employee benefits |       | 6,103                 |       | 5,445 |   |
| Other accrued  liabilities                       |       | 10,142                |       | 9,877 |   |
| Total accrued  liabilities                       |       | $                     | 25,201     |   | $ | 24,100 |   |

 

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**5. Property andEquipment:**

The followingreflects the Company’s carrying value in property and equipment as of thefollowing periods (in thousands):

| ** **                             | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Furniture,  fixtures and equipment     |       |                        | $          | 4,685                       |       |   |   | $ | 4,290 |   |   |
| Data processing  and telecommunication |       |                        | 26,576     |                        |       |   | 24,408 |   |   |
| Leasehold  improvements                |       |                        | 3,102      |                        |       |   | 2,762 |   |   |
| Vehicles                               |       |                        | 7,290      |                        |       |   | 8,991 |   |   |
| Vehicles under  capital leases         |       |                        | 3,261      |                        |       |   | — |   |   |
| Buildings and  other                   |       |                        | 5,583      |                        |       |   | 5,473 |   |   |
| Rental equipment                       |       |                        | 3,549      |                        |       |   | 772 |   |   |
|                                   |       |                        | 54,046     |                        |       |   | 46,696 |   |   |
| Less accumulated  depreciation         |       |                        | (31,616    | )                           |       |   | (25,143 | ) |   |
| Property and equipment,  net           |       |                        | $          | 22,430                      |       |   |   | $ | 21,553 |   |   |

 

Depreciation expense was$9.1 million for the year ended December 31, 2006. Depreciation expensewas $11.1 million for the period February 9, 2005 through December 31,2005 and $1.0 million for the period January 1, 2005 through February 8,2005.  Depreciation expense was $9.9million for the year ended December 31, 2004.

**Fixed Assets underOperating Leases**

Rentalequipment is comprised of commercial security equipment that does not requiremonitoring services by the Company and is leased to customers, typically over a5-year initial lease term. Accumulated depreciation of approximately $0.3million and $16,000 was recorded on these assets as of December 31, 2006and 2005, respectively. The following is a schedule by year of minimum futurerental receipts on non-cancelable operating leases as of December 31, 2006(dollar amounts in thousands):

| 2007                          |   | $   | 636    |   |
|-------------------------------|--------|-----|--------|--------|
| 2008                          |   | 636 |   |
| 2009                          |   | 636 |   |
| 2010                          |   | 618 |   |
| 2011                          |   | 223 |   |
| Total minimum future  rentals |   | $   | 2,749  |   |

 

**6. IntangibleAssets:**

Thefollowing reflects the Company’s carrying value in customer accounts as of thefollowing periods:

| ** **                | ** ** | **Protection One  Monitoring**              | ** ** | **Network Multifamily** | ** ** | **Total Company** | ** ** |
|---------------------------|------------|--------------------------------------------------|------------|------------------------------|------------|------------------------|------------|
| ** **                | ** ** | **12/31/2006**                                   | ** ** | **12/31/2005**               | ** ** | **12/31/2006**         | ** ** | **12/31/2005** | ** ** | **12/31/2006** | ** ** | **12/31/2005** | ** ** |
| ** **                | ** ** | **(dollar amounts in thousands)** | ** ** |
| Customer accounts         |       | $                                                | 260,345    |                         | $          | 260,319                |       | $ | 51,872 |   | $ | 51,872 |   | $ | 312,217 |   | $ | 312,191 |   |
| Accumulated  amortization |       | $                                                | (95,263    | )                            | $          | (68,495                | )          | $ | (16,583 | ) | $ | (10,821 | ) | $ | (111,846 | ) | $ | (79,316 | ) |
| Customer accounts,  net   |       | $                                                | 165,082    |                         | $          | 191,824                |       | $ | 35,289 |   | $ | 41,051 |   | $ | 200,371 |   | $ | 232,875 |   |

 

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Amortizationexpense was $32.5 million for the year ended December 31, 2006, $32.6million for the period February 9, 2005 through December 31, 2005,$5.6 million for the period January 1, 2005 through February 8, 2005and $68.6 million for the year ended December 31, 2004. The table belowreflects the estimated aggregate customer account amortization expense for eachof the five succeeding fiscal years on the existing customer account base as ofDecember 31, 2006:

| ** **                       | ** ** | **2007**                                         | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** |
|----------------------------------|------------|--------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                       | ** ** | **(dollar amounts in thousands)** | ** ** |
| Estimated  amortization  expense |       | $                                                | 29,687     |     | $          | 28,726   |       | $        | 28,301     |     | $          | 28,253 |   | $ | 28,145 |   |
|                                  |            |                                                  |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

 

Thenew basis of accounting resulted in new recorded values for trade names and forgoodwill as of February 8, 2005 for both segments. Neither of theseintangible assets is amortizable and they are therefore subject to annualimpairment testing and when circumstances dictate. The Company completed itsannual impairment tests during the third quarters of 2006 and 2005 anddetermined that no impairment of its non-amortizable intangible assets wasrequired. The following table reflects these amounts as of the following dates(dollar amounts in thousands):

| ** ** | ** ** | **Protection One Monitoring** | ** ** | **Network Multifamily** | ** ** | **Total Company** | ** ** |           |
|------------|------------|-----------------------------------------|------------|------------------------------|------------|------------------------|------------|----------------|
| ** ** | ** ** | **12/31/2006**                          | ** ** | **12/31/2005**               | ** ** | **12/31/2006**         | ** ** | **12/31/2005** | ** ** | **12/31/2006** | ** ** | **12/31/2005** | ** ** |   |
| Trade name |       |                                    | $          | 22,987                       |       |                   |       | $              | 22,987 |   |   |   | $ | 2,825 |   |   |   | $ | 2,825 |   |   |   | $ | 25,812 |   |   |   | $ | 25,812 |   |   |
| Goodwill   |       |                                    | $          | 7,430                        |       |                   |       | $              | 7,430 |   |   |   | $ | 4,730 |   |   |   | $ | 4,730 |   |   |   | $ | 12,160 |   |   |   | $ | 12,160 |   |   |

 

**7. Debt and CapitalLeases:**

Long-termdebt and the fixed or weighted average interest rates and capital leases are asfollows (dollar amounts in thousands):

| ** **                                                                            | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                            | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| Senior credit  facility, maturing March 31, 2012, variable 7.86%(a)              |       |                  | $          | 297,750               |       |   |   | $ | 233,823 |   |   |
| Senior  subordinated notes, maturing January 2009, fixed 8.125%, face value(b)   |       |                  | 110,340    |                  |       |   | 110,340 |   |   |
| Unamortized  discount on senior subordinated notes(b)                                 |       |                  | (14,997    | )                     |       |   | (20,514 | ) |   |
| Capital leases                                                                        |       |                  | 2,759      |                  |       |   | — |   |   |
|                                                                                  |       |                  | 395,852    |                  |       |   | 323,649 |   |   |
| Less current  portion (including $861 in capital leases as of December 31, 2006) |       |                  | (3,861     | )                     |       |   | (2,356 | ) |   |
| Total long-term debt and  capital leases                                              |       |                  | $          | 391,991               |       |   |   | $ | 321,293 |   |   |

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(a)           Represents the weightedaverage annual interest rate before fees at December 31, 2006. At December 31,2005, the weighted average annual interest rate before fees was 7.4%. See “Seniorcredit facility” below, for additional discussion regarding an amendment in April 2006in connection with additional financing under the senior credit facility,including a change in the maturity date of the term loan to March 31, 2012from April 18, 2011 and a reduction in the applicable margin. The seniorcredit facility is secured by substantially all assets of the Company andrequires quarterly principal payments of $0.75 million.

(b)          See “Valuation of Debt”below regarding the discount amount associated with the debt instruments. Theeffective rate to the Company due to the accretion of debt discounts isapproximately 15.9% on the senior subordinated notes.

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**Valuation of Debt**

Asdiscussed in Note 1, “The Company,” because Quadrangle acquired substantiallyall of the Company’s common stock, a new basis of accounting was established atFebruary 8, 2005, and a new value for the Company’s 8.125% seniorsubordinated notes due 2009 was determined based on its estimated fair marketvalue. The discount is being amortized using the effective interest rate methodover the remaining life of the debt.

**Senior creditfacility**

On April 26, 2006, the Company entered into an amendedand restated bank credit agreement increasing the outstanding term loanborrowings by approximately $66.8 million to $300.0 million. Borrowings underthe bank credit agreement bear interest at a rate calculated according to abase rate or a Eurodollar rate, at the Company’s discretion, plus an applicablemargin. The applicable margin with respect to the amended term loan was reducedby 0.5% to 1.5% for a base rate borrowing and 2.5% for a Eurodollar borrowing. Subsequentto year end the applicable margin was further reduced by 0.25% to 1.25% for abase rate borrowing and 2.25% for a Eurodollar borrowing. Depending on theCompany’s leverage ratio at the time of borrowing, the applicable margin withrespect to a revolving loan may range from 1.25% to 2.25% for a base rateborrowing and 2.25% to 3.25% for a Eurodollar borrowing. The incrementalproceeds from the amended term loan, together with approximately $10 million ofexcess cash were used to make an aggregate special cash distribution in May 2006of approximately $75 million, including a dividend to holders of the Company’scommon stock and to make related payments to members of management of theCompany who hold options for the Company’s common stock. The senior creditfacility continues to include a $25.0 million revolving credit facility, ofwhich approximately $22.9 million remains available as of March 10, 2007after reducing total availability by approximately $2.1 million for anoutstanding letter of credit. The revolving credit facility matures in 2010 andthe term loan matures March 31, 2012, subject to earlier maturity if theCompany does not refinance its 8.125% senior subordinated notes due 2009 beforeJuly 2008.

The bank credit agreement required the Company toenter into a hedge agreement to provide interest rate protection on at least$70.0 million of the term loans for not less than two years. The hedgingrequirement under the amended and restated bank credit agreement did not change.To satisfy this requirement and to further limit its exposure to interest raterisk on the variable rate senior credit facility, the Company entered into twoseparate interest rate cap agreements in May 2005 for a one-time aggregatecost of approximately $0.9 million. The Company’s objective is to protect againstincreases in interest expense caused by fluctuation in the LIBOR interest rate.One interest rate cap provides protection on $75 million of the Company’s longterm debt over a five-year period ending May 24, 2010 if LIBOR exceeds 6%.A second interest rate cap provides protection on $75 million of the Company’slong term debt over a three-year period ending May 23, 2008 if LIBORexceeds 5%.

The unamortized cost ofthe cap agreements at December 31, 2006 and 2005 was $0.8 million and $0.9million, respectively. The fair market value of the cap agreements was $0.5million and $0.8 million at December 31, 2006 and 2005, respectively,which is included in other assets. The Company amortizes the costs of theinterest rate caps to interest expense over the respective lives of theagreements. In 2006, the Company amortized approximately $76,000 to interestexpense and was entitled to receive approximately $143,000 as a result of thecap agreements for a net reduction to interest expense of approximately $67,000.There was no ineffectiveness in the hedging relationship of the interest ratecaps.

**Senior SubordinatedNotes**

In 1998, the Companyissued $350 million aggregate principal amount of unsecured 8.125% seniorsubordinated notes and has since repurchased approximately $239.7 million ofthe notes. Interest on these 

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notes ispayable semi-annually on January 15 and July 15. The notes areredeemable at the Company’s option, in whole or in part, at a predefined price.

**Capital Leases**

TheCompany acquired vehicles in 2006 under a capital lease arrangement whereby itleases vehicles over a 4-year lease term. Accumulated depreciation onthese assets as of December 31, 2006 was approximately $423,000. Thefollowing is a schedule of future minimum lease payments under capital leasestogether with the present value of net minimum lease payments as of December 31,2006 (in thousands):

| 2007                                            |   | $     | 981    |   |
|-------------------------------------------------|--------|-------|--------|--------|
| 2008                                            |   | 980   |   |
| 2009                                            |   | 964   |   |
| 2010                                            |   | 325   |   |
| Total minimum  lease payments                   |   | 3,250 |   |
| Less: Estimated  executory costs                |   | (216  | )      |
| Net minimum lease  payments                     |   | 3,034 |   |
| Less: Amount  representing interest             |   | (275  | )      |
| Present value of net  minimum lease payments(a) |   | $     | 2,759  |   |

 

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(a)           Reflectedin the condensed consolidated balance sheet as current and non-currentobligations under debt and capital leases of $861 and $1,898, respectively.

**Debt Maturities**

Excludingcapital lease agreements described above, debt maturities over the succeedingfive years and thereafter are as follows (dollar amounts in thousands):

| 2007       |   | $       | 3,000   |   |
|------------|--------|---------|---------|--------|
| 2008       |   | 294,750 | (a)     |
| 2009       |   | 110,340 | (b)     |
| 2010       |   | —  |    |
| 2011       |   | —  |    |
| Thereafter |   | —  |    |
| Total      |   | $       | 408,090 |   |

 

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(a)           Assumes (i) paymentof 8.125% senior subordinated notes at contractual maturity date of January 15,2009; and (ii) senior credit facility subject to early maturity date of June 30,2008.

(b)          Faceamount of $110,340 excludes discount of $14,997 at December 31, 2006.

**Debt Covenants**

The indenture relating to the Company’s 8.125% seniorsubordinated notes due 2009 and the amended and restated bank credit agreementcontain certain covenants and restrictions, including with respect to theCompany’s ability to incur debt and pay dividends, based on earnings beforeinterest, taxes, depreciation, and amortization, or EBITDA. The definition ofEBITDA varies between the indenture and the amended and restated bank creditagreement. EBITDA is generally derived by adding to income (loss) before incometaxes, the sum of interest expense, depreciation and amortization expense,including 

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amortization of deferredcustomer acquisition costs less amortization of deferred customer acquisitionrevenue. However, under the varying definitions, additional adjustments aresometimes required.

TheCompany’s amended and restated senior credit agreement and the indenturerelating to its 8.125% senior subordinated notes due 2009 contain the financialcovenants and current tests, respectively, summarized below:

| **Debt Instrument**                               | ** ** | **Financial Covenant and Current Test**                                                                                                                                                                                                                                                              |
|---------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Senior credit facility  (as amended and restated) |       | Consolidated total debt  on last day of period/ consolidated EBITDA for most recent four fiscal  quarters—less than 5.75 to 1.0 and Consolidated EBITDA for most recent four  fiscal quarters/consolidated interest expense for most recent four fiscal  quarters—greater than 2.00 to 1.0 |
| 8.125% Senior Subordinated Notes                  |       | Current fiscal quarter EBITDA/current fiscal quarter  interest expense—greater than 2.25 to 1.0                                                                                                                                                                                                 |

 

At December 31, 2006,the Company was in compliance with the financial covenants and othermaintenance tests for its senior credit facility but did not meet the interestcoverage ratio incurrence test under its 8.125% senior subordinated notesindenture relating to its ability to incur additional ratio indebtedness. Although the Company did not satisfy theinterest coverage ratio test under the 8.125% senior subordinated notesindenture at December 31, 2006, its failure to satisfy such ratio test didnot render the notes, or any other debt, callable.  The interest coverage ratio test under thisindenture is an incurrence based test (not a maintenance test), and the Companycannot be deemed to be in default solely due to failure to meet the interestcoverage ratio test. Although continued failure to meet the interestratio coverage test would result in restrictions on its ability to incuradditional ratio indebtedness, the Company may borrow additional funds underother permitted indebtedness provisions of the indenture, which borrowings arecurrently expected to provide sufficient liquidity for its operations.

**8. Related PartyTransactions**

**QuadrangleManagement Agreements**

On April 18, 2005, the Company entered intomanagement agreements with each of Quadrangle Advisors LLC (“QA”) andQuadrangle Debt Recovery Advisors LLC (“QDRA,” and together with QA, the “Advisors”),pursuant to which the Advisors, affiliates of Quadrangle, will provide businessand financial advisory and consulting services to the Company in exchange forannual fees of $1.0 million (in the case of QA) and $0.5 million (in the caseof QDRA), payable in advance in quarterly installments. The Quadranglemanagement agreements also provide that when and if the Advisors advise orconsult with the Company’s board of directors or senior executive officers withrespect to an acquisition by the Company, divesture (if the Company does notengage a financial advisor with respect to such divesture) or financingtransaction, they may also invoice the Company for, and the Company shall pay,additional fees in connection with any such transaction in an amount not toexceed 0.667% (in the case of QA) and 0.333% (in the case of QDRA) of theaggregate value of such transaction. For the year ended December 31, 2006,approximately $1.5 million was expensed related to these agreements. For theperiod February 9, 2005 through December 31, 2005, approximately $1.4million was expensed related to these agreements.

The Quadrangle managementagreements are effective as of February 8, 2005 and shall continue ineffect from year to year unless amended or terminated by mutual consent of theparties, subject to automatic termination in certain specified situations andsubject to termination at any time upon ninety days notice by either party.   The Company expects to terminate theQuadrangle management agreements in connection with the completion of themerger with IASG. Upon such termination, the members of the 

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Company’sboard of directors who are affiliated with Quadrangle are expected to beginreceiving compensation for their services as members of board of directorsequal to that provided to the Company’s independent director.

**AdministrativeServices and Management Services Agreements**

Westar Energy provided administrative services at itsfully loaded cost to the Company pursuant to an agreement which is referred toas the administrative services agreement, that included accounting, tax, audit,human resources, legal, purchasing and facilities services. The agreementterminated effective February 17, 2005. The Company expensed approximately$0.1 million for the period February 9, 2005 through February 17,2005 and $0.1 million for the period January 1, 2005 through February 8,2005 for these services.

Westar Energy has claimedthat the Company should reimburse Westar Energy for as much as $1.2 million foran allocation of the costs incurred by Westar in the development of theapplication systems shared with the Company under the administrative serviceagreement. See Note 9, “Commitments and Contingencies—Administrative ServicesAgreement,” for further discussion related to the claim.

**Credit Facility**

TheQuadrangle credit facility was repaid in full on April 18, 2005 inconnection with the consummation of the bank credit agreement. The followingtable indicates the amount of interest accrued and paid on the credit facilityfor the periods listed (dollar amounts in millions).

| ** **       | ** ** | **February 9 –** | ** ** | **January 1 –** | ** ** |
|------------------|------------|---------------------------------|------------|--------------------------------|------------|
| ** **       | ** ** | **April 18, 2005**    | ** ** | **February 8, 2005** | ** ** |
| Interest Accrued |       |                            | $          | 1.5                            |       |   |   | $ | 1.9 |   |   |
| Interest Paid    |       |                            | $          | 1.5                            |       |   |   | $ | 1.9 |   |   |

 

The Company also paidQuadrangle a one-time fee of $1.15 million in April 2005 upon consummationof the debt-for-equity exchange in connection with the amendment to the creditfacility.

**Quadrangle DebtRestructuring Reimbursement**

In addition to interestaccrued and paid under the Quadrangle credit facility, discussed above, theCompany expensed $0.2 million for legal expenses incurred by Quadrangle for theperiod January 1, 2005 through February 8, 2005. Pursuant tocontractual requirements, the Company also paid the costs for the financial andlegal advisors for both the senior and subordinated debt holders relating tothe restructuring of the Company’s indebtedness.

**Board of Directorsand Amended Bylaws**

If and for so long as POI Acquisition, L.L.C. owns atleast 40% of the outstanding shares of the Company’s common stock, it shallhave the right to elect to increase the size of the board by one director,which it shall be entitled to designate.

In accordance with thestockholders agreement, the Company amended its bylaws following therestructuring to prevent it from voluntarily filing for bankruptcy, merging orconsolidating with another entity until February 8, 2007 or from sellingall or substantially all of its assets without the written consent ofQuadrangle Master Funding Ltd. The stockholders agreement also includes votingagreements, certain restrictions on the transfer of the Company’s common stock,drag-along rights in favor of POI Acquisition, L.L.C. and tag-along rights infavor of Quadrangle Master Funding Ltd, all upon customary terms and subject tocertain customary exceptions (including exceptions for certain transfers amongaffiliates). In addition, the stockholders agreement provides the Quadrangleparties with the right to participate on a 

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proportionalbasis in any future equity issuance by the Company, except for issuancespursuant to registered public offerings, business combination transactions orofficer, employee, director or consultant arrangements.

**Registration RightsAgreement**

As a condition to theconsummation of the debt-for-equity exchange, the Company entered into aregistration rights agreement with POI Acquisition, L.L.C. and QuadrangleMaster Funding Ltd. The registration rights agreement provides, among otherthings, that the Company will register, upon notice, shares of its common stockowned by such parties. Under the registration rights agreement, POIAcquisition, L.L.C. is permitted up to four demand registrations and QuadrangleMaster Funding Ltd is permitted up to two demand registrations, subject tocertain conditions described in the agreement. POI Acquisition, L.L.C. andQuadrangle Master Funding Ltd also received piggyback registration rightswhereby they shall have the opportunity to register their securities pursuantto any registration statement the Company may file in the future, subject tocertain conditions. The Company is also obligated to pay certain of theirexpenses pursuant to the registration of their securities under theregistration rights agreement.

**Change in Controland Debt Restructuring Payments**

Upon the change of controlon February 17, 2004, $11.0 million was paid to executive management, $3.5million was paid to the financial advisor to the Company’s Special Committee ofits board of directors and $1.6 million of expense was recorded for directorand officer insurance that lapsed upon the change of control. In addition toits own financial and legal advisors, the Company also agreed to pay thefinancial advisory and legal fees incurred on behalf of Quadrangle and certainholders of the Company’s publicly-held debt. For the year ended December 31,2004 the Company incurred expenses relating to these advisors of approximately$8.2 million. For the period from January 1, 2005 through February 8,2005, the Company recorded expense of $5.9 million, including $5.6 million infees paid on February 8, 2005 upon completion of the restructuring.

**9. Commitments andContingencies:**

**Security ResponseNetwork and Homesafe Security Arbitration**

The Company is a defendantin an arbitration proceeding brought by two former Protection One dealers,Security Response Network and Homesafe Security, Inc. and the owner ofthese companies, Mr. Ira Beer. Mr. Beer alleges breach of contract,improper calculation of holdback amounts, and other causes of action. On February 16,2007, the arbitrator rendered a Tentative Arbitration Award, awarding theplaintiffs damages for approximately 50 customer accounts purportedly sold tothe Company by plaintiffs, plus interest, plaintiffs’ costs and reasonableattorney fees. The award directs counsel for the parties to submit to thearbitrator their respective calculations of these amounts. On March 1,2007 the Company received plaintiffs’ brief, which calculates total damages,including interest, of $107,994, attorneys’ fees of $176,776 and costs of$31,855. The Company intends to file its reply brief, contesting certain ofplaintiffs’ calculations, no later than the March 23, 2007 deadlineimposed by the arbitrator. In the opinion of management, this matter will nothave a material adverse effect on the Company’s consolidated financialposition, results of operations or liquidity.

**Scardino Litigation**

On April 17, 2006, the Company was named adefendant in a litigation proceeding brought by Frank and Anne Scardino arisingout of a June 2005 fire at their home in Villanova, Pennsylvania (*Frank and Anne Scardino v. Eagle Systems, Inc., Eagle Monitoring, Inc.and Protection One Alarm Monitoring, Inc. d/b/a*

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*Dynawatch*,Delaware County, Pennsylvania Court of Common Pleas, Cause No. 06-4485).The complaint alleges that the defendants failed to provide contracted firedetection and monitoring services, breaching their contractual and warrantyobligations in violation of Pennsylvania Unfair Trade Practices and ConsumerProtection Law, resulting in alleged damages to plaintiffs in excess of $3.0million. Under the Unfair Trade Practices and Consumer Protection Law,claimants may be entitled to seek treble damages, attorneys’ fees and costs. Thecomplaint also alleged negligence and gross negligence; however, the Company’sPreliminary Objections to these counts were granted by the court, and wereaccordingly dismissed.

The litigation is at a preliminary stage and theCompany is investigating to determine the facts and circumstances involved inthis matter. The Company has notified its liability insurance carriers of the claimand has answered the remaining counts. Discovery has commenced in the matter.

The Company does notbelieve that it breached its contractual obligations or otherwise violated itsduties in connection with this matter. In the opinion of management, the finaloutcome of such litigation will not have a material adverse effect on ourfinancial condition, results of operations or liquidity.

**General Claims andDisputes**

The Company is a party toclaims and matters of litigation incidental to the normal course of itsbusiness. Additionally, the Company receives notices of consumer complaintsfiled with various state agencies. The Company has developed a disputeresolution process for addressing these administrative complaints. The ultimateoutcome of such matters cannot presently be determined; however, in the opinionof management, the resolution of such matters will not have a material adverseeffect upon the Company’s consolidated financial position, results ofoperations or liquidity.

**AdministrativeServices Agreement**

Westar Energy, the Company’sformer majority stockholder, has claimed that the Company is obligated toreimburse Westar Energy for as much as $1.2 million for an allocation of thecosts incurred by Westar in the development of the application systems sharedwith the Company under the administrative services agreement.  The Company disputes these claims. In theopinion of management, this matter will not have a material adverse effect onthe Company’s consolidated financial position, results of operations orliquidity.

**Tax SharingAgreement**

The Company is potentiallyentitled to certain contingent payments, depending on whether Westar claims andreceives certain additional tax benefits in the future with respect to the February 17,2004 sale transaction. While these potential contingent payments, if any, couldbe significant, the Company is unable to determine at this time whether Westarwill claim any such benefits or, if Westar were to claim any such benefits, theamount of the benefits that Westar would claim or when or whether Westar wouldactually receive any such benefits. Due to this uncertainty, the Company hasnot recorded any tax benefit with respect to any such potential contingentpayments.

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**10. Income Taxes**

Componentsof income tax (expense) benefit are as follows (dollar amounts in thousands):

| ** ** | ** ** | **Year Ended**   | ** ** | **2005**                   | ** ** | **Year Ended**       | ** ** |
|------------|------------|-----------------------|------------|----------------------------|------------|---------------------------|------------|
| ** ** | ** ** | **December 31,** | ** ** | **February 9 –** | ** ** | **January 1 –** | ** ** | **December 31,** | ** ** |
| ** ** | ** ** | **2006**              | ** ** | **December 31**       | ** ** | **February 8**       | ** ** | **2004** | ** ** |
| Federal    |       |                  |       |                       |       |                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Current    |       |                  | $          | —                     |       |                      |       | $ | — |   |   |   |   |   | $ | — |   |   |   | $ | 46,913 |   |   |
| Deferred   |       |                  | —     |                       |       |                      | —     |   |   |   |   |   | — |   |   |   | (286,309 | ) |   |
| State      |       |                  |       |                       |       |                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Current    |       |                  | (416       | )                          |       |                      | (312       | ) |   |   |   |   | (35 | ) |   |   | (183 | ) |   |
| Deferred   |       |                  | (251       | )                          |       |                      | —     |   |   |   |   |   | — |   |   |   | — |   |   |
| Total      |       |                  | $          | (667                       | )          |                      |       | $ | (312 | ) |   |   |   |   | $ | (35 | ) |   |   | $ | (239,579 | ) |   |

 

Thedifference between the income tax (expense) benefit at the federal statutoryrate and income tax (expense) benefit in the accompanying statements ofoperations is as follows:

| ** **                                                              | ** ** | **Year ended  December 31,** | ** ** | **February 9 –  December 31,** | ** ** | **January 1 –  February 8,** | ** ** | **Year ended  December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                              | ** ** | **2006**                               | ** ** | **2005**                                      | ** ** | **2004**                                    | ** ** |
| Federal statutory  tax rate                                             |       |                                   | 35         | %                                             |       |                                        | 35         | %                                      |       |   | 35 | % |   |   | 35 | % |   |
| State income tax  benefit, net of   federal expense                     |       |                                   | 4          |                                          |       |                                        | 1          |                                   |       |   | 2 |   |   |   | 4 |   |   |
| Non-deductible  change in control,   debt restructuring costs and other |       |                                   | (4         | )                                             |       |                                        | (2         | )                                      |       |   | (20 | ) |   |   | (5 | ) |   |
| Valuation allowance                                                     |       |                                   | (39        | )                                             |       |                                        | (36        | )                                      |       |   | (17 | ) |   |   | (318 | ) |   |
| Other                                                                   |       |                                   | —     |                                          |       |                                        | —     |                                   |       |   | — |   |   |   | — |   |   |
|                                                                    |       |                                   | (4         | )%                                            |       |                                        | (2         | )%                                     |       |   | 0 | % |   |   | (284 | )% |   |

 

Management believes the Company’s net deferred taxassets are not likely realizable and therefore a valuation allowance has beenestablished against the deferred tax assets, as can be seen in the table below.The remaining deferred tax liability represents the state deferred taxliability which cannot be offset by the state deferred tax asset of subsidiarycompanies with taxable income that are subject to tax in states that requireseparate company income tax filing. In assessing whether deferred taxes arerealizable, management considers whether it is more likely than not that someportion or all deferred tax assets will be realized. The ultimate realizationof deferred tax assets is dependent upon the generation of future taxableincome during the periods in which those temporary differences becomedeductible. Management considers the projected future taxable income and taxplanning strategies in making this assessment.

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Deferredincome tax assets and liabilities were composed of the following (dollaramounts in thousands):

| ** **                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax  asset, current:                        |       |     |       |     |       |
| Accrued liabilities                                  |       | $        | 3,632      |     | $          | 3,178 |   |
| Accounts receivable, due to allowance                |       | 2,792    |       | 1,872    |       |
| Other                                                |       | 373      |       | 1,213    |       |
| Valuation allowance                                  |       | (6,797   | )          | (6,263   | )          |
|                                                 |       | $        | —     |     | $          | — |   |
| Deferred tax  asset, noncurrent:                     |       |     |       |     |       |
| Net operating loss carryforwards(a)                  |       | $        | 26,652     |     | $          | 27,599 |   |
| Property & equipment                        |       | 11,115   |       | 7,140    |       |
| Deferred customer acquisition costs (net of revenue) |       | (17,306  | )          | (12,530  | )          |
| Customer accounts                                    |       | (5,924   | )          | (12,252  | )          |
| Goodwill                                             |       | 6,087    |       | 6,870    |       |
| Other intangibles                                    |       | (641     | )          | 118      |       |
| Debt                                                 |       | (5,118   | )          | (7,411   | )          |
| Other                                                |       | 919      |       | 544      |       |
| Valuation allowance                                  |       | (16,035  | )          | (10,078  | )          |
|                                                 |       | $        | (251)      |     | $          | — |   |

 

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(a)           Federal net operatingloss carryforwards of $5,753, $2,814, $45,561 and $15,683 will expire in the years2026, 2025, 2024 and 2023, respectively. Total state net operating losses ofapproximately the same amount have various expiration dates.

The Company had a tax sharing agreement with WestarEnergy during the period that Westar owned a controlling interest in theCompany. Pursuant to this agreement, Westar Energy made payments to the Companyfor current tax benefits utilized by Westar Energy in its consolidated taxreturn irrespective of whether the Company would realize these current benefitson a separate return basis. As of December 31, 2003, other than for netoperating loss carryforwards, no valuation allowance had been established bythe Company because the tax sharing agreement utilized a parent company downapproach in the allocation of income tax expense among members of theconsolidated tax group and, consistent with that approach, no valuationallowance had been allocated to the Company. As a result of the February 17,2004 sale transaction, $285.9 million of the Company’s net deferred tax assetswere not expected to be realizable, and the Company therefore recorded anon-cash charge against income in 2004 to establish a valuation allowance forthese assets.

On November 12, 2004, the Company entered into atax sharing settlement agreement with Westar and Quadrangle that, among otherthings, terminated the Westar tax sharing agreement and settled all of itsclaims with Westar relating to the tax sharing agreement. In accordance withthe Westar tax sharing settlement, among other things, Westar agreed to pay theCompany approximately $45.9 million in cash and transfer to it 7.375% seniornotes of the Company, due 2005, with aggregate principal and accrued interestof approximately $27.1 million for total consideration of $73.0 million. As aresult of the Westar tax sharing settlement, the Company recorded a 2004 taxbenefit of $46.9 million. The tax sharing settlement also provided for a mutualgeneral release, except with respect to certain indemnification obligationspursuant to the purchase agreement between Quadrangle and Westar and certainalarm monitoring and other service agreements between the Company and Westar.In addition, Westar and POI Acquisition I, Inc. joined in makingSection 338(h)(10) elections under the Code. As part of thesettlement, the parties mutually agreed to the purchase price allocation to beused for the election.

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The Company is alsopotentially entitled to certain contingent payments, depending on whetherWestar claims and receives certain additional tax benefits in the future withrespect to the February 17, 2004 sale transaction. See Note 9, “Commitmentsand Contingencies—Tax Sharing Agreement” for additional information.

**11.**          EmployeeBenefit Plans:

*401(k) Plans*

The Company maintains a tax-qualified, definedcontribution plan that meets the requirements of Section 401(k) ofthe Internal Revenue Code for each of its segments.

*Protection**   One 401(k) Plan.*   TheCompany makes contributions to the Protection One 401(k) Plan, whichcontributions are allocated among participants based upon the respectivecontributions made by the participants through salary reductions during theapplicable plan year. The Company’s matching contribution may be made in commonstock, in cash or in a combination of both stock and cash. For the year ended December 31,2006, the periods February 9, 2005 through December 31, 2005 and January 1,2005 through February 8, 2005 and for the year ended December 31,2004, Protection One made matching cash contributions to the plan of $1.3million, $0.9 million, $0.1 million and $1.0 million, respectively. The fundsof the plan are deposited with a trustee and at each participant’s option inone or more investment funds, including a Company stock fund. Contributions tothe Company stock fund were suspended during 2003, and have not resumed as of March 10,2007. The plan was amended effective January 1, 2001 requiring the Companyto match employees’ contributions up to specified maximum limits.

*Network**   Multifamily401(k) Plan.*   As part of the corporate consolidationprocess described in Note 1, “The Company,” the Network Multifamily 401(k) planwas merged with the Protection One 401(k) plan as of March 1, 2006. Forthe period February 9, 2005 through December 31, 2005 and for theyear ended December 31, 2004, the Company made matching cash contributionsto the plan of $0.2 million. The funds of the plan were deposited with atrustee and at each participant’s option in one or more investment funds.

*ManagementEmployment Agreements and Key Employee Retention Plan*

In July and August 2004, the Company’ssenior executives entered into new employment agreements to ensure that theCompany will have their continued services during and after the period of theCompany’s anticipated restructuring. The previous employment agreements withthese senior executives would have expired on or about August 17, 2004. Thenew employment agreements supersede and replace these previous employmentagreements.

These employment agreements provide for, among otherthings, minimum annual base salaries, bonus awards, payable in cash orotherwise, and participation in all of the Company’s employee benefit plans andprograms in effect for the benefit of senior executives, including stock option,401(k) and insurance plans, and reimbursement for all reasonable expensesincurred in connection with the conduct of the business of the Company,provided the executive officers properly account for any such expenses inaccordance with Company policies. The employment agreements also containprovisions providing for compensation to the senior executives undercertain circumstances after a change in control of the Company and in certainother circumstances.

In order to retain theservices of senior management and selected key employees who may have feltuncertain about the Company’s future ownership and direction due to theprevious discussions with the Company’s creditors regarding the restructuringof the Company’s indebtedness, the Company’s Board of Directors authorizedsenior management in June 2004 to implement a new key employee retentionplan. The new retention plan applied to approximately 30 senior managers andselected key employees and provided incentives for such individuals to remainwith the Company through the restructuring. These new 

77

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retentionagreements superseded and replaced previous retention agreements which providedadditional severance upon a change in control. The aggregate payout under theplan was approximately $3.9 million of which approximately $3.5 million wasaccrued for and approximately $0.7 million was paid as of December 31,2004. The remaining $3.2 million was paid in January and February of2005.

*Retention BonusProgram.*

Included with theretention plan and******pursuant to the terms oftheir new employment agreements, Messrs. Ginsburg, Nevin, Pefanis,Williams and Griffin were each entitled to receive two retention bonuses. TheCompany accrued $1.9 million as general and administrative expense in 2004 andan additional $0.2 million of expense in January 2005 for these retentionbonuses. The first retention bonus was paid on January 5, 2005, and thesecond was paid in February 2005 upon the completion of thedebt-for-equity exchange. Each retention bonus payment was equal to a specifiedpercentage of each executive officer’s annual base salary at the followingrates:  Richard Ginsburg—75.0%, Darius G.Nevin—72.5%, Peter J. Pefanis—67.5%, Steve V. Williams—67.5%, and J. EricGriffin—50.0%.

**12.**          Leases:

TheCompany leases office facilities and equipment for lease terms maturing through2013. Future minimum lease payments under non-cancelable operating leases areas follows (dollar amounts in thousands):

| **Year ended December 31,** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------|------------|
| 2007                                       |       | $          | 5,284      |   |
| 2008                                       |       | 3,937      |       |
| 2009                                       |       | 2,641      |       |
| 2010                                       |       | 2,171      |       |
| 2011                                       |       | 1,448      |       |
| Thereafter                                 |       | 743        |       |
|                                       |       | $          | 16,224     |   |

 

Total rent expense for theyear ended December 31, 2006, the periods February 9, 2005 through December 31,2005, and January 1, 2005 through February 8, 2005, and for the yearended December 31, 2004, was $5.3 million, $4.9 million, $0.6 million and$7.2 million, respectively.

**13.**          FairMarket Value of Financial Instruments:

For certain of the Company’s financial instruments,including cash and cash equivalents, accounts receivable, accounts payable andother accrued liabilities, the carrying amounts approximate fair market valuedue to their short maturities.

Thefair value of the Company’s debt instruments are estimated based on quotedmarket prices except for the senior credit facility, which had no availablequote and was estimated by the Company based on the terms of the facility andcomparison to similar debt. At December 31, the fair value and carryingamount of the Company’s debt for the years indicated were as follows (dollaramounts in thousands):

| ** **                          | ** ** | **Fair Value** | ** ** | **Carrying Value** | ** ** |
|-------------------------------------|------------|---------------------|------------|-------------------------|------------|
| ** **                          | ** ** | **2006**            | ** ** | **2005**                | ** ** | **2006** | ** ** | **2005** | ** ** |
| Senior credit  facility             |       | $                   | 297,750    |                    | $          | 233,823 |   | $ | 297,750 |   | $ | 233,823 |   |
| Senior  Subordinated Notes (8.125%) |       | 107,582             |       | 106,478                 |       | 95,343 |   | 89,826 |   |
|                                |       | $                   | 405,332    |                    | $          | 340,301 |   | $ | 393,093 |   | $ | 323,649 |   |

 

78

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The estimated fair valuesmay not be representative of actual values of the financial instruments thatcould have been realized at year-end or may be realized in the future.

**14.**          SegmentReporting:

The Company’s operating segments are defined ascomponents for which separate financial information is available that isevaluated regularly by the chief operating decision maker. The operatingsegments are managed separately because each operating segment represents astrategic business unit that serves different markets.

Protection One’s reportable segments includeProtection One Monitoring and Network Multifamily. Protection One Monitoringprovides residential, commercial, and wholesale security alarm monitoringservices, which include sales, installation and related servicing of securityalarm systems for residential and business customers in the United States ofAmerica. Network Multifamily provides security alarm services to apartments,condominiums and other multifamily dwellings.

The accounting policies of the operating segments arethe same as those described in Note 2, “Summary of Significant AccountingPolicies.”  The Company manages itsbusiness segments based on earnings before interest, income taxes,depreciation, amortization (including amortization of deferred customeracquisition costs and revenue) and other items, referred to as Adjusted EBITDA.

Reportablesegments (dollar amounts in thousands):

| ** **                                                                    | ** ** | **For the year ended December 31, 2006** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                                    | ** ** | **Protection**                                                         | ** ** | **Network** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                    | ** ** | **One**                                                                | ** ** | **Multi-** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                    | ** ** | **Monitoring(**1)                                                      | ** ** | **family(**2) | ** ** | **Adjustments(**3) | ** ** | **Consolidated** | ** ** |
| Revenue                                                                       |       |                                                                   | $          | 236,156 |   |   | $ | 34,396 | ** ** |   | **$** | ** ** | ** ** |   |   | $ | 270,552 | ** ** |   |
| Adjusted  EBITDA(4)                                                           |       |                                                                   | 67,163     |   |   | 17,067 | ** ** |   | ** ** |   |   |   | 84,230 | ** ** |   |
| Amortization of  intangibles and depreciation expense                         |       |                                                                   | 35,238     |   |   | 6,429 | ** ** |   | ** ** |   |   |   | 41,667 | ** ** |   |
| Amortization of  deferred costs in excess of amortization of deferred revenue |       |                                                                   | 16,621     |   |   | 952 | ** ** |   | ** ** |   |   |   | 17,573 | ** ** |   |
| Corporate  consolidation costs                                                |       |                                                                   | —     |   |   | 20 | ** ** |   | ** ** |   |   |   | 20 | ** ** |   |
| Recapitalization  costs                                                       |       |                                                                   | 4,452      |   |   | — |   |   |   |   |   |   | 4,452 | ** ** |   |
| Segment assets                                                                |       |                                                                   | 389,039    |   |   | 60,461 |   |   | (5,547 | ) |   |   | 443,953 | ** ** |   |
| Expenditures for  property, exclusive of rental equipment                     |       |                                                                   | 4,047      |   |   | 510 | ** ** |   | ** ** |   |   |   | 4,557 | ** ** |   |
| Investment in new  accounts and rental equipment, net                         |       |                                                                   | 30,014     |   |   | 2,211 | ** ** |   | ** ** |   |   |   | 32,225 | ** ** |   |
|                                                                               |            |                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

79

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| ** **                                                                              | ** ** | **2005**                                   | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                              | ** ** | **Protection One Monitoring(1)** | ** ** | **Network Multifamily(2)** | ** ** | ** ** | ** ** | **Consolidated** | ** ** |
| ** **                                                                              | ** ** | **February 9 –**            | ** ** | ** ** | ** ** | **January 1 –** | ** ** | **February 9 –** | ** ** | ** ** | ** ** | **January 1 –** | ** ** | ** ** | ** ** | **February 9  –** | ** ** | ** ** | ** ** | **January 1  –** | ** ** |
| ** **                                                                              | ** ** | **December  31**                           | ** ** | ** ** | ** ** | **February  8** | ** ** | **December  31** | ** ** | ** ** | ** ** | **February  8** | ** ** | **Adjustments(3)** | ** ** | **December  31** | ** ** | ** ** | ** ** | **February  8** | ** ** |
| Revenue                                                                                 |       |                                       | $          | 202,775 |   |   |   |   |   | $ | 24,480 |   |   |   | $ | 31,706 |   |   |   |   |   | $ | 4,063 |   |   |   | $ |   |   |   |   | $ | 234,481 |   |   |   |   |   | $ | 28,543 |   |   |
| Adjusted EBITDA(4)                                                                      |       |                                       | 61,281     |   |   |   |   |   | 7,228 |   |   |   | 14,616 |   |   |   |   |   | 1,780 |   |   |   |   |   |   |   | 75,897 |   |   |   |   |   | 9,008 |   |   |
| Amortization of intangibles and depreciation   expense                                  |       |                                       | 37,954     |   |   |   |   |   | 6,112 |   |   |   | 5,788 |   |   |   |   |   | 526 |   |   |   |   |   |   |   | 43,742 |   |   |   |   |   | 6,638 |   |   |
| Amortization of deferred costs in excess of  amortization of deferred revenue |       |                                       | 7,937      |   |   |   |   |   | 2,239 |   |   |   | 552 |   |   |   |   |   | 598 |   |   |   |   |   |   |   | 8,489 |   |   |   |   |   | 2,837 |   |   |
| Change of control and debt restructuring  costs                                         |       |                                       | —     |   |   |   |   |   | 5,939 |   |   |   | — |   |   |   |   |   | — |   |   |   |   |   |   |   | — |   |   |   |   |   | 5,939 |   |   |
| Corporate consolidation costs                                                           |       |                                       | —     |   |   |   |   |   | — |   |   |   | 2,339 |   |   |   |   |   | — |   |   |   |   |   |   |   | 2,339 |   |   |   |   |   | — |   |   |
| Key employee retention plan expense                                                     |       |                                       | —     |   |   |   |   |   | 354 |   |   |   | — |   |   |   |   |   | 81 |   |   |   |   |   |   |   | — |   |   |   |   |   | 435 |   |   |
| Segment assets                                                                          |       |                                       | 389,007    |   |   |   |   |   | — |   |   |   | 64,529 |   |   |   |   |   | — |   |   |   | (17,234 | ) |   |   | 436,302 |   |   |   |   |   | — |   |   |
| Expenditures for property, exclusive of rental  equipment                               |       |                                       | 5,516      |   |   |   |   |   | 249 |   |   |   | 164 |   |   |   |   |   | 1 |   |   |   |   |   |   |   | 5,680 |   |   |   |   |   | 250 |   |   |
| Investment in new  accounts and rental equipment, net                                   |       |                                       | 21,835     |   |   |   |   |   | 1,902 |   |   |   | 1,439 |   |   |   |   |   | 325 |   |   |   |   |   |   |   | 23,274 |   |   |   |   |   | 2,227 |   |   |

 

| ** **                                                                    | ** ** | **For the year ended December 31, 2004** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                                    | ** ** | **Protection **                                                   | ** ** | **Network** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                    | ** ** | **One**                                                                | ** ** | **Multi-** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                    | ** ** | **Monitoring(**1)                                                      | ** ** | **family(**2) | ** ** | **Adjustments(**3) | ** ** | **Consolidated** | ** ** |
| Revenue                                                                       |       |                                                                   | $          | 231,513 |   |   | $ | 37,746 | ** ** |   | $ |   | ** ** |   |   | $ | 269,259 | ** ** |   |
| Adjusted  EBITDA(4)                                                           |       |                                                                   | 71,414     |   |   | 16,402 | ** ** |   | ** ** |   |   |   | 87,816 | ** ** |   |
| Amortization of  intangibles and depreciation expense                         |       |                                                                   | 73,560     |   |   | 4,895 | ** ** |   | ** ** |   |   |   | 78,455 | ** ** |   |
| Amortization of  deferred costs in excess of amortization of deferred revenue |       |                                                                   | 16,757     |   |   | 4,785 | ** ** |   | ** ** |   |   |   | 21,542 | ** ** |   |
| Change in  control, debt restructuring and retention bonus expense            |       |                                                                   | 25,681     |   |   | 2,167 | ** ** |   | ** ** |   |   |   | 27,848 | ** ** |   |
| Segment assets                                                                |       |                                                                   | 446,689    |   |   | 82,676 |   |   | (68,321 | ) |   |   | 461,044 | ** ** |   |
| Expenditures for  property                                                    |       |                                                                   | 8,830      |   |   | 493 | ** ** |   | ** ** |   |   |   | 9,323 | ** ** |   |
| Investment in new  accounts, net                                              |       |                                                                   | 18,585     |   |   | 2,832 | ** ** |   | ** ** |   |   |   | 21,417 | ** ** |   |
|                                                                               |            |                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Includes allocation ofholding company expenses reducing Adjusted EBITDA by $3.7 million, $3.5million, $0.3 million and $3.0 million for the year ended December 31,2006, the periods February 9, 2005 through December 31, 2005 and January 1,2005 through February 8, 2005, and for the year ended December 31,2004, respectively.

(2)          Includes allocation ofholding company expenses reducing Adjusted EBITDA by $0.9 million, $0.9million, $0.1 million and $0.7 million for the year ended December 31,2006, the periods February 9, 2005 through December 31, 2005 and January 1,2005 through February 8, 2005, and for the year ended December 31,2004, respectively.

(3)          Adjustment to eliminateintersegment accounts receivable.

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(4)          AdjustedEBITDA is used by management in evaluating segment performance and allocatingresources, and management believes it is used by many analysts following thesecurity industry. This information should not be considered as an alternativeto any measure of performance as promulgated under accounting principlesgenerally accepted in the United States of America (“GAAP”), such as income(loss) before income taxes or cash flow from operations. Items excluded fromAdjusted EBITDA are significant components in understanding and assessing theconsolidated financial performance of the Company. See the table below for thereconciliation of Adjusted EBITDA to consolidated income (loss) before incometaxes. The Company’s calculation of Adjusted EBITDA may be different from thecalculation used by other companies and comparability may be limited.Management believes that presentation of a non-GAAP financial measure such asAdjusted EBITDA is useful because it allows investors and management toevaluate and compare the Company’s operating results from period to period in ameaningful and consistent manner in addition to standard GAAP financialmeasures.

| ** **                                                                    | ** ** | **Consolidated**                     | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                    | ** ** | **Year Ended**                  | ** ** | **February 9 –** | ** ** | **January 1 –** | ** ** | **Year Ended** | ** ** |
| ** **                                                                    | ** ** | **December 31,**                | ** ** | **December 31** | ** ** | **February 8** | ** ** | **December 31,** | ** ** |
| ** **                                                                    | ** ** | **2006**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                    | ** ** | **(Dollars in thousands)** | ** ** |
| Loss before  income taxes                                                     |       |                                 | $          | (16,738 | ) |   |   | $ | (15,276 | ) |   |   |   |   | $ | (11,370 | ) |   |   | $ | (84,327 | ) |   |
| Plus:                                                                         |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense                                                              |       |                                 | 35,900     |   |   |   | 30,634 |   |   |   |   |   | 4,544 |   |   |   | 44,398 |   |   |
| Amortization of  intangibles and depreciation expense                         |       |                                 | 41,667     |   |   |   | 43,742 |   |   |   |   |   | 6,638 |   |   |   | 78,455 |   |   |
| Amortization of  deferred costs in excess of amortization of deferred revenue |       |                                 | 17,573     |   |   |   | 8,489 |   |   |   |   |   | 2,837 |   |   |   | 21,542 |   |   |
| Amortization of  stock based compensation costs                               |       |                                 | 1,408      |   |   |   | — |   |   |   |   |   | — |   |   |   | — |   |   |
| Recapitalization  costs                                                       |       |                                 | 4,452      |   |   |   | — |   |   |   |   |   | — |   |   |   | — |   |   |
| Change in control  and debt restructuring costs                               |       |                                 | —     |   |   |   | — |   |   |   |   |   | 5,939 |   |   |   | 24,382 |   |   |
| Key employee  retention plan expense(a)                                       |       |                                 | —     |   |   |   | — |   |   |   |   |   | 435 |   |   |   | 3,466 |   |   |
| Corporate  consolidation costs(b)                                             |       |                                 | 20         |   |   |   | 2,339 |   |   |   |   |   | — |   |   |   | — |   |   |
| Loss on  retirement of debt                                                   |       |                                 | —     |   |   |   | 6,657 |   |   |   |   |   | — |   |   |   | 47 |   |   |
| Less:                                                                         |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other income                                                                  |       |                                 | (52        | ) |   |   | (688 | ) |   |   |   |   | (15 | ) |   |   | (147 | ) |   |
| Adjusted EBITDA                                                               |       |                                 | $          | 84,230 |   |   |   | $ | 75,897 |   |   |   |   |   | $ | 9,008 |   |   |   | $ | 87,816 |   |   |

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(a)           The Company enteredinto agreements with selected individuals to retain their services through saleand restructuring activities. The cost of these agreements is recorded ingeneral and administrative expense.

(b)          NetworkMultifamily severance and retention expense related to corporate consolidation.

**15.**          SummarizedCombined Financial Information of the Subsidiary Guarantors of Debt:

Protection One Alarm Monitoring, Inc., awholly-owned subsidiary of the Company, is the primary obligor for alloutstanding debt securities (see Note 7, “Debt and Capital Leases”). These debtsecurities are fully and unconditionally guaranteed by Protection One, Inc.and wholly owned subsidiaries of Protection One Alarm Monitoring, Inc. Thefollowing tables present condensed consolidating financial information forProtection One, Inc., Protection One Alarm Monitoring, Inc., and allother subsidiaries. Condensed financial information for Protection One, Inc.and Protection One Alarm Monitoring, Inc. on a stand-alone basis ispresented using the equity method of accounting for subsidiaries in which theyown or control twenty percent or more of the voting shares.

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**Condensed Consolidating Statement of OperationsFor the Year Ended December 31, 2006(amounts in thousands)**

| ** **                                                                                                                                      | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| Revenue:                                                                                                                                        |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Monitoring and related services                                                                                                                 |       | $                              | —     |                                       |       | $                          | 202,393    |             |       |             | $          | 44,977 |   |   |   | $ | — |   |   |   | $ | 247,370 |   |   |
| Other                                                                                                                                           |       | —                         |       |                                       | 22,684     |                       |       |             | 498        |             |       |   | — |   |   |   | 23,182 |   |   |
| Total revenue                                                                                                                                   |       | —                         |       |                                       | 225,077    |                       |       |             | 45,475     |             |       |   | — |   |   |   | 270,552 |   |   |
| Cost of revenue                                                                                                                                 |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Monitoring and related services                                                                                                                 |       | —                         |       |                                       | 58,804     |                       |       |             | 13,019     |             |       |   | — |   |   |   | 71,823 |   |   |
| Other                                                                                                                                           |       | —                         |       |                                       | 27,954     |                       |       |             | 1,610      |             |       |   | — |   |   |   | 29,564 |   |   |
| Total cost of revenue                                                                                                                           |       | —                         |       |                                       | 86,758     |                       |       |             | 14,629     |             |       |   | — |   |   |   | 101,387 |   |   |
| Operating  expenses                                                                                                                             |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Selling                                                                                                                                         |       | —                         |       |                                       | 38,683     |                       |       |             | 2,320      |             |       |   | — |   |   |   | 41,003 |   |   |
| General and administrative (exclusive of $3.2  million of compensation costs included in Recapitalization costs for  Protection One, Inc.) |       | 6,003                          |       |                                       | 53,056     |                       |       |             | 3,854      |             |       |   | — |   |   |   | 62,913 |   |   |
| Corporate consolidation costs                                                                                                                   |       | —                         |       |                                       | —     |                       |       |             | 20         |             |       |   | — |   |   |   | 20 |   |   |
| Recapitalization costs                                                                                                                          |       | 3,267                          |       |                                       | 1,185      |                       |       |             | —     |             |       |   | — |   |   |   | 4,452 |   |   |
| Amortization and depreciation                                                                                                                   |       | 7                              |       |                                       | 34,436     |                       |       |             | 7,224      |             |       |   | — |   |   |   | 41,667 |   |   |
| Holding company allocation                                                                                                                      |       | (4,595                         | )          |                                       | 3,676      |                       |       |             | 919        |             |       |   | — |   |   |   | — |   |   |
| Corporate overhead allocation                                                                                                                   |       | —                         |       |                                       | (4,523     | )                          |       |             | 4,523      |             |       |   | — |   |   |   | — |   |   |
| Total operating expenses                                                                                                                        |       | 4,682                          |       |                                       | 126,513    |                       |       |             | 18,860     |             |       |   | — |   |   |   | 150,055 |   |   |
| Operating income  (loss)                                                                                                                        |       | (4,682                         | )          |                                       | 11,806     |                       |       |             | 11,986     |             |       |   | — |   |   |   | 19,110 |   |   |
| Other expense (income)                                                                                                                          |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Interest expense(a)                                                                                                                             |       | —                         |       |                                       | 36,557     |                       |       |             | 855        |             |       |   | — |   |   |   | 37,412 |   |   |
| Interest income                                                                                                                                 |       | —                         |       |                                       | (1,508     | )                          |       |             | (4         | )                |       |   | — |   |   |   | (1,512 | ) |   |
| Other                                                                                                                                           |       | —                         |       |                                       | (134       | )                          |       |             | 82         |             |       |   | — |   |   |   | (52 | ) |   |
| Equity (earnings) loss in subsidiary                                                                                                            |       | 12,723                         |       |                                       | (10,386    | )                          |       |             | —     |             |       |   | (2,337 | ) |   |   | — |   |   |
| Total other  expense                                                                                                                            |       | 12,723                         |       |                                       | 24,529     |                       |       |             | 933        |             |       |   | (2,337 | ) |   |   | 35,848 |   |   |
| Income (loss)  from continuing operations before income taxes                                                                                   |       | (17,405                        | )          |                                       | (12,723    | )                          |       |             | 11,053     |             |       |   | 2,337 |   |   |   | (16,738 | ) |   |
| Income tax  expense                                                                                                                             |       | —                         |       |                                       | —     |                       |       |             | (667       | )                |       |   | — |   |   |   | (667 | ) |   |
| Net income (loss)                                                                                                                               |       | $                              | (17,405    | )                                          |       | $                          | (12,723    | )                |       |             | $          | 10,386 |   |   |   | $ | 2,337 |   |   |   | $ | (17,405 | ) |   |

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(a)           Protection One AlarmMonitoring, Inc. allocated $855 of its interest expense to NetworkMultifamily.

82

----

**CondensedConsolidating Statement of OperationsFor the Period February 9, 2005 through December 31, 2005(dollar amounts in thousands)**

| ** **                                                    | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| Revenue:                                                      |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Monitoring and related services                               |       | $                              | —     |                                       |       | $                          | 178,346    |             |       |             | $          | 41,129 |   |   |   | $ | — |   |   |   | $ | 219,475 |   |   |
| Other                                                         |       | —                         |       |                                       | 14,918     |                       |       |             | 88         |             |       |   | — |   |   |   | 15,006 |   |   |
| Total revenue                                                 |       | —                         |       |                                       | 193,264    |                       |       |             | 41,217     |             |       |   | — |   |   |   | 234,481 |   |   |
| Cost of revenue:                                              |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Monitoring and related services                               |       | —                         |       |                                       | 51,401     |                       |       |             | 10,842     |             |       |   | — |   |   |   | 62,243 |   |   |
| Other                                                         |       | —                         |       |                                       | 18,145     |                       |       |             | 671        |             |       |   | — |   |   |   | 18,816 |   |   |
| Total cost of  revenue                                        |       | —                         |       |                                       | 69,546     |                       |       |             | 11,513     |             |       |   | — |   |   |   | 81,059 |   |   |
| Operating  expenses                                           |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Selling                                                       |       | —                         |       |                                       | 26,690     |                       |       |             | 2,166      |             |       |   | — |   |   |   | 28,856 |   |   |
| General and administrative                                    |       | 4,590                          |       |                                       | 43,822     |                       |       |             | 8,746      |             |       |   | — |   |   |   | 57,158 |   |   |
| Corporate consolidation costs                                 |       | —                         |       |                                       | —     |                       |       |             | 2,339      |             |       |   | — |   |   |   | 2,339 |   |   |
| Amortization and depreciation                                 |       | 4                              |       |                                       | 37,140     |                       |       |             | 6,598      |             |       |   | — |   |   |   | 43,742 |   |   |
| Holding company allocation                                    |       | (4,371                         | )          |                                       | 3,497      |                       |       |             | 874        |             |       |   | — |   |   |   | — |   |   |
| Corporate overhead allocation                                 |       | —                         |       |                                       | (897       | )                          |       |             | 897        |             |       |   | — |   |   |   | — |   |   |
| Total operating  expenses                                     |       | 223                            |       |                                       | 110,252    |                       |       |             | 21,620     |             |       |   | — |   |   |   | 132,095 |   |   |
| Operating income  (loss)                                      |       | (223                           | )          |                                       | 13,466     |                       |       |             | 8,084      |             |       |   | — |   |   |   | 21,327 |   |   |
| Other expense (income)                                        |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Interest expense(a)                                           |       | —                         |       |                                       | 28,520     |                       |       |             | 740        |             |       |   | — |   |   |   | 29,260 |   |   |
| Related party interest                                        |       | —                         |       |                                       | 1,951      |                       |       |             | —     |             |       |   | — |   |   |   | 1,951 |   |   |
| Interest income                                               |       | —                         |       |                                       | (570       | )                          |       |             | (7         | )                |       |   | — |   |   |   | (577 | ) |   |
| Loss on retirement of debt                                    |       | —                         |       |                                       | 6,657      |                       |       |             | —     |             |       |   | — |   |   |   | 6,657 |   |   |
| Other                                                         |       | 19,566                         |       |                                       | (20,288    | )                          |       |             | 34         |             |       |   | — |   |   |   | (688 | ) |   |
| Equity earnings in subsidiary                                 |       | (4,201                         | )          |                                       | (7,005     | )                          |       |             | —     |             |       |   | 11,206 |   |   |   | — |   |   |
| Total other  expense                                          |       | 15,365                         |       |                                       | 9,265      |                       |       |             | 767        |             |       |   | 11,206 |   |   |   | 36,603 |   |   |
| Income (loss)  from continuing operations before income taxes |       | (15,588                        | )          |                                       | 4,201      |                       |       |             | 7,317      |             |       |   | (11,206 | ) |   |   | (15,276 | ) |   |
| Income tax  expense                                           |       | —                         |       |                                       | —     |                       |       |             | (312       | )                |       |   | — |   |   |   | (312 | ) |   |
| Net income (loss)                                             |       | $                              | (15,588    | )                                          |       | $                          | 4,201      |             |       |             | $          | 7,005 |   |   |   | $ | (11,206 | ) |   |   | $ | (15,588 | ) |   |

----

(a)           Protection One AlarmMonitoring, Inc. allocated $740 of its interest expense to NetworkMultifamily.

83

----

**CondensedConsolidating Statement of OperationsFor the Period January 1, 2005 through February 8, 2005(dollar amounts in thousands)**

| ** **                                                         | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| Revenue:                                                           |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Monitoring and related services                                    |       | $                              | —     |                                       |       | $                          | 21,455     |             |       |             | $          | 5,000 |   |   |   | $ | — |   |   |   | $ | 26,455 |   |   |
| Other                                                              |       | —                         |       |                                       | 1,916      |                       |       |             | 172        |             |       |   | — |   |   |   | 2,088 |   |   |
| Total revenue                                                      |       | —                         |       |                                       | 23,371     |                       |       |             | 5,172      |             |       |   | — |   |   |   | 28,543 |   |   |
| Cost of revenue:                                                   |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Monitoring and related services                                    |       | —                         |       |                                       | 6,151      |                       |       |             | 1,249      |             |       |   | — |   |   |   | 7,400 |   |   |
| Other                                                              |       | —                         |       |                                       | 2,571      |                       |       |             | 743        |             |       |   | — |   |   |   | 3,314 |   |   |
| Total cost of  revenue                                             |       | —                         |       |                                       | 8,722      |                       |       |             | 1,992      |             |       |   | — |   |   |   | 10,714 |   |   |
| Operating  expenses                                                |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Selling                                                            |       | —                         |       |                                       | 3,699      |                       |       |             | 290        |             |       |   | — |   |   |   | 3,989 |   |   |
| General and administrative                                         |       | 792                            |       |                                       | 6,054      |                       |       |             | 1,258      |             |       |   | — |   |   |   | 8,104 |   |   |
| Change of control and debt restructuring costs                     |       | 5,939                          |       |                                       | —     |                       |       |             | —     |             |       |   | — |   |   |   | 5,939 |   |   |
| Amortization and depreciation                                      |       | —                         |       |                                       | 6,058      |                       |       |             | 580        |             |       |   | — |   |   |   | 6,638 |   |   |
| Holding company allocation                                         |       | (437                           | )          |                                       | 350        |                       |       |             | 87         |             |       |   | — |   |   |   | — |   |   |
| Corporate overhead allocation                                      |       | —                         |       |                                       | (110       | )                          |       |             | 110        |             |       |   | — |   |   |   | — |   |   |
| Total operating  expenses                                          |       | 6,294                          |       |                                       | 16,051     |                       |       |             | 2,325      |             |       |   | — |   |   |   | 24,670 |   |   |
| Operating income  (loss)                                           |       | (6,294                         | )          |                                       | (1,402     | )                          |       |             | 855        |             |       |   | — |   |   |   | (6,841 | ) |   |
| Other expense (income)                                             |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Interest expense(a)                                                |       | —                         |       |                                       | 2,619      |                       |       |             | 103        |             |       |   | — |   |   |   | 2,722 |   |   |
| Related party interest                                             |       | —                         |       |                                       | 1,942      |                       |       |             | —     |             |       |   | — |   |   |   | 1,942 |   |   |
| Interest income                                                    |       | —                         |       |                                       | (120       | )                          |       |             | —     |             |       |   | — |   |   |   | (120 | ) |   |
| Other                                                              |       | —                         |       |                                       | (15        | )                          |       |             | —     |             |       |   | — |   |   |   | (15 | ) |   |
| Equity (earnings) loss in subsidiary                               |       | 5,111                          |       |                                       | (717       | )                          |       |             | —     |             |       |   | (4,394 | ) |   |   | — |   |   |
| Total other expense                                                |       | 5,111                          |       |                                       | 3,709      |                       |       |             | 103        |             |       |   | (4,394 | ) |   |   | 4,529 |   |   |
| Income (loss)  from continuing operations before income taxes |       | (11,405                        | )          |                                       | (5,111     | )                          |       |             | 752        |             |       |   | 4,394 |   |   |   | (11,370 | ) |   |
| Income tax  expense                                                |       | —                         |       |                                       | —     |                       |       |             | (35        | )                |       |   | — |   |   |   | (35 | ) |   |
| Net income (loss)                                                  |       | $                              | (11,405    | )                                          |       | $                          | (5,111     | )                |       |             | $          | 717 |   |   |   | $ | 4,394 |   |   |   | $ | (11,405 | ) |   |

----

(a)           ProtectionOne Alarm Monitoring, Inc. allocated $103 of its interest expense toNetwork Multifamily.

84

----

**Condensed Consolidating Statement of OperationsFor the year ended December 31, 2004(dollar amounts in thousands)**

| ** **                                           | ** ** | **Protection   One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| Revenue:                                             |       |                                 |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |
| Monitoring and related services                      |       | $                                    | —     |                                       | $          | 201,228                    |       |             | $          | 46,270           |       |   |   | $ | — |   |   |   | $ | 247,498 |   |   |
| Other                                                |       | —                               |       | 20,089                                     |       |                       | 1,672      |             |       |             | —     |   |   |   | 21,761 |   |   |
| Total revenue                                        |       | —                               |       | 221,317                                    |       |                       | 47,942     |             |       |             | —     |   |   |   | 269,259 |   |   |
| Cost of revenue:                                     |       |                                 |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |
| Monitoring and related services                      |       | —                               |       | 57,292                                     |       |                       | 12,306     |             |       |             | —     |   |   |   | 69,598 |   |   |
| Other                                                |       | —                               |       | 25,810                                     |       |                       | 6,171      |             |       |             | —     |   |   |   | 31,981 |   |   |
| Total cost of revenue                                |       | —                               |       | 83,102                                     |       |                       | 18,477     |             |       |             | —     |   |   |   | 101,579 |   |   |
| Operating  expenses:                                 |       |                                 |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |
| Selling                                              |       | —                               |       | 30,733                                     |       |                       | 2,762      |             |       |             | —     |   |   |   | 33,495 |   |   |
| General and administrative                           |       | 4,752                                |       | 56,124                                     |       |                       | 10,501     |             |       |             | —     |   |   |   | 71,377 |   |   |
| Change in control and debt restructuring costs       |       | 22,839                               |       | —                                     |       |                       | 1,543      |             |       |             | —     |   |   |   | 24,382 |   |   |
| Amortization and depreciation                        |       | 2                                    |       | 73,046                                     |       |                       | 5,407      |             |       |             | —     |   |   |   | 78,455 |   |   |
| Holding company allocation                           |       | (3,720                               | )          | 2,976                                      |       |                       | 744        |             |       |             | —     |   |   |   | — |   |   |
| Corporate overhead allocation                        |       | —                               |       | (1,123                                     | )          |                       | 1,123      |             |       |             | —     |   |   |   | — |   |   |
| Total operating expense                              |       | 23,873                               |       | 161,756                                    |       |                       | 22,080     |             |       |             | —     |   |   |   | 207,709 |   |   |
| Operating income  (loss)                             |       | (23,873                              | )          | (23,541                                    | )          |                       | 7,385      |             |       |             | —     |   |   |   | (40,029 | ) |   |
| Other expense (income):                              |       |                                 |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |
| Interest expense(a)                                  |       | —                               |       | 23,230                                     |       |                       | 3,576      |             |       |             | —     |   |   |   | 26,806 |   |   |
| Related party interest                               |       | —                               |       | 18,082                                     |       |                       | —     |             |       |             | —     |   |   |   | 18,082 |   |   |
| Interest income                                      |       | —                               |       | (486                                       | )          |                       | (4         | )                |       |             | —     |   |   |   | (490 | ) |   |
| Loss on retirement of debt                           |       | —                               |       | 47                                         |       |                       | —     |             |       |             | —     |   |   |   | 47 |   |   |
| Other                                                |       | —                               |       | (147                                       | )          |                       | —     |             |       |             | —     |   |   |   | (147 | ) |   |
| Equity loss in subsidiary                            |       | 302,029                              |       | 231                                        |       |                       | —     |             |       |             | (302,260   | ) |   |   | — |   |   |
| Total other expense                                  |       | 302,029                              |       | 40,957                                     |       |                       | 3,572      |             |       |             | (302,260   | ) |   |   | 44,298 |   |   |
| Loss from  continuing operations before income taxes |       | (325,902                             | )          | (64,498                                    | )          |                       | 3,813      |             |       |             | 302,260    |   |   |   | (84,327 | ) |   |
| Income tax  (expense) benefit                        |       | 1,996                                |       | (237,531                                   | )          |                       | (4,044     | )                |       |             |       |   |   |   | (239,579 | ) |   |
| Net income (loss)                                    |       | $                                    | (323,906   | )                                          | $          | (302,029                   | )          |             | $          | (231             | )          |   |   | $ | 302,260 |   |   |   | $ | (323,906 | ) |   |

----

(a)           Protection One AlarmMonitoring, Inc. allocated $3,576 of its interest expense to NetworkMultifamily.

85

----

**Condensed Consolidating Balance Sheet (Deficiency inAssets)December 31, 2006(dollar amounts in thousands)**

| ** **                                                              | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                              | ** ** | ** **                     | ** ** | ** **                                 | ** ** |                       | ** ** | ** **       |       |             | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Current Assets                                                          |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |
| Cash and cash equivalents                                               |       | $                              | —     |                                       | $          | 24,569                     |       |             | $          | 31               |       |   |   | $ | — |   |   |   | $ | 24,600 |   |   |
| Receivables, net                                                        |       | —                         |       | 22,848                                     |       |                       | 6,170      |             |       |             | —     |   |   |   | 29,018 |   |   |
| Inventories, net                                                        |       | —                         |       | 3,115                                      |       |                       | 1,438      |             |       |             | —     |   |   |   | 4,553 |   |   |
| Prepaid expenses                                                        |       | 33                             |       | 3,185                                      |       |                       | 98         |             |       |             | —     |   |   |   | 3,316 |   |   |
| Other                                                                   |       | —                         |       | 2,701                                      |       |                       | 459        |             |       |             | —     |   |   |   | 3,160 |   |   |
| Total current assets                                                    |       | 33                             |       | 56,418                                     |       |                       | 8,196      |             |       |             | —     |   |   |   | 64,647 |   |   |
| Restricted cash                                                         |       | —                         |       | 1,900                                      |       |                       | —     |             |       |             | —     |   |   |   | 1,900 |   |   |
| Property and equipment,  net                                            |       | 4                              |       | 20,991                                     |       |                       | 1,435      |             |       |             | —     |   |   |   | 22,430 |   |   |
| Customer accounts, net                                                  |       | —                         |       | 161,386                                    |       |                       | 38,985     |             |       |             | —     |   |   |   | 200,371 |   |   |
| Goodwill                                                                |       | —                         |       | 6,142                                      |       |                       | 6,018      |             |       |             | —     |   |   |   | 12,160 |   |   |
| Trade name                                                              |       | —                         |       | 22,987                                     |       |                       | 2,825      |             |       |             |       |   |   |   | 25,812 |   |   |
| Deferred customer  acquisition costs                                    |       | —                         |       | 97,948                                     |       |                       | 8,006      |             |       |             | —     |   |   |   | 105,954 |   |   |
| Other                                                                   |       | —                         |       | 8,809                                      |       |                       | 1,870      |             |       |             | —     |   |   |   | 10,679 |   |   |
| Accounts receivable  (payable)  from (to) associated  companies         |       | (67,580                        | )          | 70,316                                     |       |                       | (2,736     | )                |       |             | —     |   |   |   | — |   |   |
| Investment in POAMI                                                     |       | (11,697                        | )          | —                                     |       |                       | —     |             |       |             | 11,697     |   |   |   | — |   |   |
| Investment in subsidiary  guarantors                                    |       | —                         |       | 58,238                                     |       |                       | —     |             |       |             | (58,238    | ) |   |   | — |   |   |
| Total assets                                                            |       | $                              | (79,240    | )                                          | $          | 505,135                    |       |             | $          | 64,599           |       |   |   | $ | (46,541 | ) |   |   | $ | 443,953 |   |   |
| **Liabilities and Stockholder  Equity (Deficiency in Assets)**          | ** ** | ** **                     | ** ** | ** **                                 | ** ** |                       | ** ** | ** **       |       |             | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Current liabilities:                                                    |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |
| Current portion of  long-term  debt and capital leases                  |       | $                              | —     |                                       | $          | 3,861                      |       |             | $          | —           |       |   |   | $ | — |   |   |   | $ | 3,861 |   |   |
| Accounts payable                                                        |       | —                         |       | 3,172                                      |       |                       | 389        |             |       |             | —     |   |   |   | 3,561 |   |   |
| Accrued liabilities                                                     |       | 703                            |       | 23,518                                     |       |                       | 980        |             |       |             | —     |   |   |   | 25,201 |   |   |
| Deferred revenue                                                        |       | —                         |       | 33,538                                     |       |                       | 3,476      |             |       |             | —     |   |   |   | 37,014 |   |   |
| Total current liabilities                                               |       | 703                            |       | 64,089                                     |       |                       | 4,845      |             |       |             | —     |   |   |   | 69,637 |   |   |
| Long-term debt, net of  current  portion                                |       | —                         |       | 391,991                                    |       |                       | —     |             |       |             | —     |   |   |   | 391,991 |   |   |
| Deferred customer  acquisition  revenue                                 |       | —                         |       | 59,850                                     |       |                       | 931        |             |       |             | —     |   |   |   | 60,781 |   |   |
| Deferred tax liability                                                  |       | —                         |       | —                                     |       |                       | 251        |             |       |             | —     |   |   |   | 251 |   |   |
| Other                                                                   |       | —                         |       | 902                                        |       |                       | 334        |             |       |             | —     |   |   |   | 1,236 |   |   |
| Total Liabilities                                                       |       | 703                            |       | 516,832                                    |       |                       | 6,361      |             |       |             | —     |   |   |   | 523,896 |   |   |
| Stockholders’ Equity (Deficiency  in Assets)                       |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |
| Common stock                                                            |       | 182                            |       | 2                                          |       |                       | 1          |             |       |             | (3         | ) |   |   | 182 |   |   |
| Additional paid in  capital                                             |       | 89,545                         |       | 1,416,051                                  |       |                       | 194,913    |             |       |             | (1,610,964 | ) |   |   | 89,545 |   |   |
| Accumulated other  comprehensive loss                                   |       | (318                           | )          | (318                                       | )          |                       | —     |             |       |             | 318        |   |   |   | (318 | ) |   |
| Deficit                                                                 |       | (169,352                       | )          | (1,427,432                                 | )          |                       | (136,676   | )                |       |             | 1,564,108  |   |   |   | (169,352 | ) |   |
| Total stockholders’  equity (deficiency in assets)                 |       | (79,943                        | )          | (11,697                                    | )          |                       | 58,238     |             |       |             | (46,541    | ) |   |   | (79,943 | ) |   |
| Total liabilities and stockholders’ equity  (deficiency in assets) |       | $                              | (79,240    | )                                          | $          | 505,135                    |       |             | $          | 64,599           |       |   |   | $ | (46,541 | ) |   |   | $ | 443,953 |   |   |

 

86

----

 

**Condensed Consolidating Balance SheetDecember 31, 2005(dollar amounts in thousands)**

| ** **                                                    | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                    | ** ** | ** **                     |       | ** **                                 |       |                       | ** ** | ** **       |       |             | ** ** | ** ** |   |   | ** ** | ** ** |   |   |
| Current Assets                                                |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |
| Cash and cash equivalents                                     |       | $                              | —     |                                       | $          | 19,468                     |       |             | $          | 425              |       |   |   | $ | — |   |   |   | $ | 19,893 |   |   |   |
| Receivables, net                                              |       | —                         |       | 23,526                                     |       |                       | 6,335      |             |       |             | —     |   |   |   | 29,861 |   |   |   |
| Inventories, net                                              |       | —                         |       | 2,790                                      |       |                       | 1,676      |             |       |             | —     |   |   |   | 4,466 |   |   |   |
| Prepaid expenses                                              |       | 28                             |       | 2,497                                      |       |                       | 658        |             |       |             | —     |   |   |   | 3,183 |   |   |   |
| Other                                                         |       | —                         |       | 3,173                                      |       |                       | 10         |             |       |             | —     |   |   |   | 3,183 |   |   |   |
| Total current assets                                          |       | 28                             |       | 51,454                                     |       |                       | 9,104      |             |       |             | —     |   |   |   | 60,586 |   |   |   |
| Restricted cash                                               |       | —                         |       | 1,597                                      |       |                       | —     |             |       |             | —     |   |   |   | 1,597 |   |   |   |
| Property and equipment, net                                   |       | 10                             |       | 19,823                                     |       |                       | 1,720      |             |       |             | —     |   |   |   | 21,553 |   |   |   |
| Customer accounts, net                                        |       | —                         |       | 187,570                                    |       |                       | 45,305     |             |       |             | —     |   |   |   | 232,875 |   |   |   |
| Goodwill                                                      |       | —                         |       | 6,142                                      |       |                       | 6,018      |             |       |             | —     |   |   |   | 12,160 |   |   |   |
| Trade name                                                    |       | —                         |       | 22,987                                     |       |                       | 2,825      |             |       |             |       |   |   |   | 25,812 |   |   |   |
| Deferred customer acquisition costs                           |       | —                         |       | 66,253                                     |       |                       | 6,945      |             |       |             | —     |   |   |   | 73,198 |   |   |   |
| Other                                                         |       | —                         |       | 8,518                                      |       |                       | 3          |             |       |             | —     |   |   |   | 8,521 |   |   |   |
| Accounts receivable (payable) from (to) associated  companies |       | 7,752                          |       | 9,481                                      |       |                       | (17,233    | )                |       |             | —     |   |   |   | — |   |   |   |
| Investment in POAMI                                           |       | 1,237                          |       | —                                     |       |                       | —     |             |       |             | (1,237     | ) |   |   | — |   |   |   |
| Investment in subsidiary guarantors                           |       | —                         |       | 47,852                                     |       |                       | —     |             |       |             | (47,852    | ) |   |   | — |   |   |   |
| Total assets                                                  |       | $                              | 9,027      |                                       | $          | 421,677                    |       |             | $          | 54,687           |       |   |   | $ | (49,089 | ) |   |   | $ | 436,302 |   |   |   |
| **Liabilities and Stockholder Equity**                        | ** ** | ** **                     |       | ** **                                 |       |                       | ** ** | ** **       |       |             | ** ** | ** ** |   |   | ** ** | ** ** |   |   |
| Current  liabilities:                                         |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |
| Current portion of long-term debt                             |       | $                              | —     |                                       | $          | 2,356                      |       |             | $          | —           |       |   |   | $ | — |   |   |   | $ | 2,356 |   |   |   |
| Accounts payable                                              |       | —                         |       | 2,601                                      |       |                       | 125        |             |       |             | —     |   |   |   | 2,726 |   |   |   |
| Accrued liabilities                                           |       | 960                            |       | 21,492                                     |       |                       | 1,648      |             |       |             | —     |   |   |   | 24,100 |   |   |   |
| Deferred revenue                                              |       | —                         |       | 33,159                                     |       |                       | 3,312      |             |       |             | —     |   |   |   | 36,471 |   |   |   |
| Total current liabilities                                     |       | 960                            |       | 59,608                                     |       |                       | 5,085      |             |       |             | —     |   |   |   | 65,653 |   |   |   |
| Long-term debt, net of current portion                        |       | —                         |       | 321,293                                    |       |                       | —     |             |       |             | —     |   |   |   | 321,293 |   |   |   |
| Deferred customer acquisition revenue                         |       | —                         |       | 38,746                                     |       |                       | 1,127      |             |       |             | —     |   |   |   | 39,873 |   |   |   |
| Other                                                         |       | —                         |       | 793                                        |       |                       | 623        |             |       |             | —     |   |   |   | 1,416 |   |   |   |
| Total Liabilities                                             |       | 960                            |       | 420,440                                    |       |                       | 6,835      |             |       |             | —     |   |   |   | 428,235 |   |   |   |
| Stockholders’ Equity                                     |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |   |   |   |   |   |
| Common stock                                                  |       | 182                            |       | 2                                          |       |                       | 1          |             |       |             | (3         | ) |   |   | 182 |   |   |   |
| Additional paid in capital                                    |       | 159,939                        |       | 1,416,051                                  |       |                       | 202,457    |             |       |             | (1,618,508 | ) |   |   | 159,939 |   |   |   |
| Accumulated other comprehensive loss                          |       | (107                           | )          | (107                                       | )          |                       | —     |             |       |             | 107        |   |   |   | (107 | ) |   |   |
| Deficit                                                       |       | (151,947                       | )          | (1,414,709                                 | )          |                       | (154,606   | )                |       |             | 1,569,315  |   |   |   | (151,947 | ) |   |   |
| Total stockholders’ equity                               |       | 8,067                          |       | 1,237                                      |       |                       | 47,852     |             |       |             | (49,089    | ) |   |   | 8,067 |   |   |   |
| Total liabilities  and stockholders’ equity              |       | $                              | 9,027      |                                       | $          | 421,677                    |       |             | $          | 54,687           |       |   |   | $ | (49,089 | ) |   |   | $ | 436,302 |   |   |   |
|                                                               |            |                                |            |                                            |            |                            |            |                  |            |                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

87

----

**CondensedConsolidating Statement of Cash FlowsFor the Year Ended December 31, 2006(amounts in thousands)**

| ** **                                               | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** **  | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** **  | **Consolidated** | ** ** |
|----------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|-------------|----------------------------|------------|------------------|-------------|------------------|------------|
| **Net  cash provided by (used in) operating activities** | ** ** | **$**                          | **(3,530** | **)**                                      |        | **$**                      | **36,128** | ** **       |        |             | **$**      | **16,929** | ** ** |   |   | **$** | **—** | ** ** |   |   | **$** | **49,527** | ** ** |   |
| Cash flows from  investing activities:                   |       |                           |       |                                       |        |                       |       |             |        |             |       |   |   | ** ** |   |   |   |   |   |
| Purchases of new accounts                                |       | —                         |       |                                       | —      |                       |       |             | (27         | )                |       |   | — | ** ** |   |   | (27 | ) |   |
| Deferred customer acquisition  costs                     |       | —                         |       |                                       | (56,303     | )                          |       |             | (2,192      | )                |       |   | — | ** ** |   |   | (58,495 | ) |   |
| Deferred customer acquisition  revenue                   |       | —                         |       |                                       | 29,092      |                       |       |             | (19         | )                |       |   | — | ** ** |   |   | 29,073 |   |   |
| Purchase of property and  equipment                      |       | —                         |       |                                       | (3,957      | )                          |       |             | (600        | )                |       |   | — | ** ** |   |   | (4,557 | ) |   |
| Purchase of rental equipment                             |       | —                         |       |                                       | (2,776      | )                          |       |             | —      |             |       |   | — | ** ** |   |   | (2,776 | ) |   |
| Additional investment in restricted cash                 |       | —                         |       |                                       | (212        | )                          |       |             | —      |             |       |   |   | ** ** |   |   | (212 | ) |   |
| Proceeds from disposition of  assets                     |       | —                         |       |                                       | 295         |                       |       |             | 12          |             |       |   | — | ** ** |   |   | 307 |   |   |
| **Net  cash used in investing activities**               | ** ** | **—**                     | ** ** |                                       | **(33,861** | **)**                      |       |             | **(2,826**  | **)**            |       |   | **—** | ** ** |   |   | **(36,687** | **)** |   |
| Cash flows from  financing activities:                   |       |                           |       |                                       |        |                       |       |             |        |             |       |   |   | ** ** |   |   |   |   |   |
| Payments on long-term debt                               |       | —                         |       |                                       | (2,839      | )                          |       |             | —      |             |       |   | — | ** ** |   |   | (2,839 | ) |   |
| Distribution to shareholders                             |       | (70,490                        | )          |                                       | —      |                       |       |             | —      |             |       |   | — | ** ** |   |   | (70,490 | ) |   |
| Make-whole payment to vested  option holders             |       | (1,312                         | )          |                                       | —      |                       |       |             | —      |             |       |   | — | ** ** |   |   | (1,312 | ) |   |
| Proceeds from borrowings                                 |       | —                         |       |                                       | 66,767      |                       |       |             | —      |             |       |   | — | ** ** |   |   | 66,767 |   |   |
| Debt issue costs                                         |       | —                         |       |                                       | (259        | )                          |       |             | —      |             |       |   | — | ** ** |   |   | (259 | ) |   |
| To (from) related companies                              |       | 75,332                         |       |                                       | (60,835     | )                          |       |             | (14,497     | )                |       |   | — | ** ** |   |   | — |   |   |
| **Net  cash provided by (used in) financing activities** | ** ** | **3,530**                      | ** ** |                                       | **2,834**   | ** **                 |       |             | **(14,497** | **)**            |       |   | **—** | ** ** |   |   | **(8,133** | **)** |   |
| Net increase  (decrease) in cash and cash equivalents    |       | —                         |       |                                       | 5,101       |                       |       |             | (394        | )                |       |   | — | ** ** |   |   | 4,707 |   |   |
| Cash and cash  equivalents:                              |       |                           |       |                                       |        |                       |       |             |        |             |       |   |   | ** ** |   |   |   |   |   |
| Beginning of period                                      |       | —                         |       |                                       | 19,468      |                       |       |             | 425         |             |       |   | — | ** ** |   |   | 19,893 |   |   |
| End of period                                            |       | $                              | —     |                                       |        | $                          | 24,569     |             |        |             | $          | 31 |   |   |   | $ | — | ** ** |   |   | $ | 24,600 |   |   |

 

88

----

**Condensed Consolidating Statement of Cash FlowsFor the Period February 9, 2005 through December 31, 2005(dollar amounts in thousands)**

| ** **                                                           | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** **  | **Consolidated** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|-------------|------------------|------------|
| **Net  cash provided by (used in) operating activities**             | ** ** |                           | **$**      | **(1,853**                                 | **)**      |                       | **$**      | **29,541**       | ** **  |             | **$**      | **12,725** | ** ** |   |   | **$** | **—** | ** ** |   |   | **$** | **40,413** | ** ** |   |
| Cash flows from  investing activities:                               |       |                           |       |                                       |       |                       |       |             |        |             |       |   |   | ** ** |   |   |   |   |   |
| Deferred customer acquisition  costs                                 |       |                           | —     |                                       |       | (45,257                    | )          |             | (1,605      | )                |       |   | — | ** ** |   |   | (46,862 | ) |   |
| Deferred customer acquisition revenue                                |       |                           | —     |                                       |       | 24,193                     |       |             | 167         |             |       |   | — | ** ** |   |   | 24,360 |   |   |
| Investment in non-monitored leased equipment                         |       |                           | —     |                                       |       | (772                       | )          |             | —      |             |       |   | — | ** ** |   |   | (772 | ) |   |
| Purchase of property and  equipment                                  |       |                           | —     |                                       |       | (5,400                     | )          |             | (280        | )                |       |   | — | ** ** |   |   | (5,680 | ) |   |
| Increase in restricted cash                                          |       |                           | —     |                                       |       | (631                       | )          |             | —      |             |       |   | — | ** ** |   |   | (631 | ) |   |
| Proceeds from redemption of preferred stock                          |       |                           | —     |                                       |       | 4,399                      |       |             | —      |             |       |   | — | ** ** |   |   | 4,399 |   |   |
| Proceeds from disposition of marketable securities  and other assets |       |                           | —     |                                       |       | 946                        |       |             | 89          |             |       |   | — | ** ** |   |   | 1,035 |   |   |
| **Net  cash used in investing  activities**                          | ** ** |                           | **—** | ** **                                 |       | **(22,522**                | **)**      |             | **(1,629**  | **)**            |       |   | **—** | ** ** |   |   | **(24,151** | **)** |   |
| Cash flows from  financing activities:                               |       |                           |       |                                       |       |                       |       |             |        |             |       |   |   | ** ** |   |   |   |   |   |
| Payments on long-term debt                                           |       |                           | —     |                                       |       | (212,714                   | )          |             | —      |             |       |   | — | ** ** |   |   | (212,714 | ) |   |
| Payment on credit facility                                           |       |                           | —     |                                       |       | (81,000                    | )          |             | —      |             |       |   | — | ** ** |   |   | (81,000 | ) |   |
| Proceeds from borrowings                                             |       |                           | —     |                                       |       | 250,000                    |       |             | —      |             |       |   | — | ** ** |   |   | 250,000 |   |   |
| Proceeds from sale of common  stock                                  |       |                           | 1,750      |                                       |       | —                     |       |             | —      |             |       |   | — | ** ** |   |   | 1,750 |   |   |
| Debt issue costs                                                     |       |                           | —     |                                       |       | (6,978                     | )          |             | —      |             |       |   | — | ** ** |   |   | (6,978 | ) |   |
| Stock issue costs                                                    |       |                           | (270       | )                                          |       | —                     |       |             | —      |             |       |   | — | ** ** |   |   | (270 | ) |   |
| Payment for interest rate cap                                        |       |                           | —     |                                       |       | (922                       | )          |             | —      |             |       |   | — | ** ** |   |   | (922 | ) |   |
| To (from) related companies                                          |       |                           | 373        |                                       |       | 10,806                     |       |             | (11,179     | )                |       |   | — | ** ** |   |   | — |   |   |
| **Net  cash provided by (used in) financing activities**             | ** ** |                           | **1,853**  | ** **                                 |       | **(40,808**                | **)**      |             | **(11,179** | **)**            |       |   | **—** | ** ** |   |   | **(50,134** | **)** |   |
| Net decrease in  cash and cash equivalents                           |       |                           | —     |                                       |       | (33,789                    | )          |             | (83         | )                |       |   | — | ** ** |   |   | (33,872 | ) |   |
| Cash and cash  equivalents:                                          |       |                           |       |                                       |       |                       |       |             |        |             |       |   |   | ** ** |   |   |   |   |   |
| Beginning of period                                                  |       |                           | —     |                                       |       | 53,257                     |       |             | 508         |             |       |   | — | ** ** |   |   | 53,765 |   |   |
| End of period                                                        |       |                           | $          | —                                     |       |                       | $          | 19,468           |        |             | $          | 425 |   |   |   | $ | — | ** ** |   |   | $ | 19,893 |   |   |

 

89

----

**CondensedConsolidating Statement of Cash FlowsFor the Period January 1, 2005 through February 8, 2005(dollar amounts in thousands)**

| ** **                                                         | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| **Net  cash provided by (used in) operating activities**           | ** ** |                           | **$**      | **(6,787**                                 | **)**      |                       |       | **$**            | **8,265**  | ** **       |       |   | **$** | **2,232** | ** ** |   |   | **$** | **—** | ** ** |   |   | **$** | **3,710** | ** ** |   |
| Cash flows from  investing activities:                             |       |                           |       | ** **                                 |       |                       |       |             |       |             |       |   |   |   |   | ** ** |   |   |   |   |   |
| Deferred customer acquisition  costs                               |       |                           | —     | ** **                                 |       |                       | (4,049     | )                |       |             | (169       | ) |   |   | — | ** ** |   |   | (4,218 | ) |   |
| Deferred customer acquisition revenue                              |       |                           | —     | ** **                                 |       |                       | 2,147      |             |       |             | (156       | ) |   |   | — | ** ** |   |   | 1,991 |   |   |
| Purchase of property and  equipment                                |       |                           | —     | ** **                                 |       |                       | (249       | )                |       |             | (1         | ) |   |   | — | ** ** |   |   | (250 | ) |   |
| Proceeds from disposition of assets and sale of  customer accounts |       |                           | —     | ** **                                 |       |                       | —     |             |       |             | 4          |   |   |   | — | ** ** |   |   | 4 |   |   |
| **Net  cash used in investing activities**                         | ** ** |                           | **—** | ** **                                 |       |                       | **(2,151** | **)**            |       |             | **(322**   | **)** |   |   | **—** | ** ** |   |   | **(2,473** | **)** |   |
| Cash flows from  financing activities:                             |       |                           |       | ** **                                 |       |                       |       |             |       |             |       |   |   |   |   | ** ** |   |   |   |   |   |
| To (from) related companies                                        |       |                           | 6,787      | ** **                                 |       |                       | (4,801     | )                |       |             | (1,986     | ) |   |   | — | ** ** |   |   | — |   |   |
| **Net  cash provided by (used in) financing activities**           | ** ** |                           | **6,787**  | ** **                                 |       |                       | **(4,801** | **)**            |       |             | **(1,986** | **)** |   |   | **—** | ** ** |   |   | **—** | ** ** |   |
| Net increase  (decrease) in cash and  cash equivalents             |       |                           | —     | ** **                                 |       |                       | 1,313      |             |       |             | (76        | ) |   |   | — | ** ** |   |   | 1,237 |   |   |
| Cash and cash  equivalents:                                        |       |                           |       | ** **                                 |       |                       |       |             |       |             |       |   |   |   |   | ** ** |   |   |   |   |   |
| Beginning of period                                                |       |                           | —     | ** **                                 |       |                       | 51,944     |             |       |             | 584        |   |   |   | — | ** ** |   |   | 52,528 |   |   |
| End of period                                                      |       |                           | $          | —                                     | ** ** |                       |       | $                | 53,257     |             |       |   | $ | 508 |   |   |   | $ | — | ** ** |   |   | $ | 53,765 |   |   |

 

90

----

**CondensedConsolidating Statement of Cash FlowsDecember 31, 2004(dollar amounts in thousands)**

| ** **                                                         | ** ** | **Protection  One, Inc.** | ** **  | **Protection  One Alarm  Monitoring** | ** **  | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------|-------------|--------------------------------------------|-------------|----------------------------|------------|------------------|------------|------------------|------------|
| **Net  cash provided by (used in) operating activities**           | ** ** | **$**                          | **(17,875** | **)**                                      |        | **$**                      | **68,750** | ** **       |       |             | **$**      | **10,939** | ** ** |   |   | **$** | **—** | ** ** |   |   | **$** | **61,814** | ** ** |   |
| Cash flows from  investing activities:                             |       |                           |        |                                       |        |                       |       |             |       |             |       |   |   | ** ** |   |   |   |   |   |
| Installation and purchases of new accounts                         |       | —                         |        |                                       | —      |                       |       |             | (14        | )                |       |   | — | ** ** |   |   | (14 | ) |   |
| Deferred customer acquisition  costs                               |       | —                         |        |                                       | (39,267     | )                          |       |             | (3,453     | )                |       |   | — | ** ** |   |   | (42,720 | ) |   |
| Deferred customer acquisition revenue                              |       | —                         |        |                                       | 20,697      |                       |       |             | 620        |             |       |   | — | ** ** |   |   | 21,317 |   |   |
| Purchase of property and  equipment                                |       | (13                            | )           |                                       | (8,666      | )                          |       |             | (644       | )                |       |   | — | ** ** |   |   | (9,323 | ) |   |
| Proceeds from disposition of assets and sale of  customer accounts |       | —                         |        |                                       | 329         |                       |       |             | 42         |             |       |   | — | ** ** |   |   | 371 |   |   |
| **Net  cash used in investing activities**                         | ** ** | **(13**                        | **)**       |                                       | **(26,907** | **)**                      |       |             | **(3,449** | **)**            |       |   | **—** | ** ** |   |   | **(30,369** | **)** |   |
| Cash flows from  financing activities:                             |       |                           |        |                                       |        |                       |       |             |       |             |       |   |   | ** ** |   |   |   |   |   |
| Payment on long-term debt                                          |       | —                         |        |                                       | (14,500     | )                          |       |             | —     |             |       |   | — | ** ** |   |   | (14,500 | ) |   |
| Proceeds from sale of trademark                                    |       | —                         |        |                                       | 160         |                       |       |             | —     |             |       |   | — | ** ** |   |   | 160 |   |   |
| Funding from Westar                                                |       | (53                            | )           |                                       | 273         |                       |       |             | —     |             |       |   | — | ** ** |   |   | 220 |   |   |
| Due to (from) related companies                                    |       | 17,941                         |        |                                       | (9,663      | )                          |       |             | (8,278     | )                |       |   | — | ** ** |   |   | — |   |   |
| **Net  cash provided by (used in) financing activities**           | ** ** | **17,888**                     | ** **  |                                       | **(23,730** | **)**                      |       |             | **(8,278** | **)**            |       |   | **—** | ** ** |   |   | **(14,120** | **)** |   |
| Net increase  (decrease) in cash and  cash equivalents             |       | —                         |        |                                       | 18,113      |                       |       |             | (788       | )                |       |   | — | ** ** |   |   | 17,325 |   |   |
| Cash and cash  equivalents:                                        |       |                           |        |                                       |        |                       |       |             |       |             |       |   |   | ** ** |   |   |   |   |   |
| Beginning of period                                                |       | —                         |        |                                       | 33,831      |                       |       |             | 1,372      |             |       |   | — | ** ** |   |   | 35,203 |   |   |
| End of period                                                      |       | $                              | —      |                                       |        | $                          | 51,944     |             |       |             | $          | 584 |   |   |   | $ | — | ** ** |   |   | $ | 52,528 |   |   |

91

----

**16. UnauditedQuarterly Financial Information:**

Thefollowing is a summary of the unaudited quarterly financial information for2006 and 2005, respectively (in thousands, except per share amounts):

| ** **                                                      | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                      | ** ** | **March 31**      | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| ***2006***                                                      |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                         |       |                   | $          | 66,676 |   |   | $ | 67,150 |   |   | $ | 67,620 |   |   |   | $ | 69,106 |   |   |
| Net loss                                                        |       |                   | $          | (2,507 | ) |   | $ | (6,663 | ) |   | $ | (3,540 | ) |   |   | $ | (4,695 | ) |   |
| Basic and diluted  loss per share                               |       |                   | $          | (0.14 | ) |   | $ | (0.36 | ) |   | $ | (0.19 | ) |   |   | $ | (0.26 | ) |   |
| Weighted average number  of shares of common  stock outstanding |       |                   | 18,213     |   |   | 18,240 |   |   | 18,240 |   |   |   | 18,240 |   |   |

 

| ** **                                                      | ** ** | ** **                | ** ** | ** ** | ** ** | ** **                 | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------|------------|------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                                      | ** ** | **January 1 –** | ** ** | ** ** | ** ** | **February 9 –** | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **February 8**       | ** ** | ** ** | ** ** | **March 31**          | ** ** | **June 30**       | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| ***2005***                                                      |       |                      |       |       |       |                       |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                         |       |                      | $          | 28,543     |       |                       |       |                   |       | $ | 36,911 |   |   | $ | 65,441 |   |   | $ | 65,623 |   |   |   | $ | 66,506 |   |   |
| Net loss                                                        |       |                      | $          | (11,405    | )          |                       |       |                   |       | $ | (3,242 | ) |   | $ | (7,891 | ) |   | $ | (2,212 | ) |   |   | $ | (2,243 | ) |   |
| Basic and diluted  loss per share                               |       |                      | $          | (5.80      | )          |                       |       |                   |       | $ | (0.18 | ) |   | $ | (0.43 | ) |   | $ | (0.12 | ) |   |   | $ | (0.13 | ) |   |
| Weighted average number  of shares  of common stock outstanding |       |                      | 1,966      |       |       |                       |       |                   | 18,199     |   |   | 18,199 |   |   | 18,199 |   |   |   | 18,199 |   |   |

 

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**PROTECTION ONE,INC. AND SUBSIDIARIESSCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS(Dollar amounts in thousands)**

| **Description**                                        | ** ** | ** ** | ** ** | **Balance at  Beginning  of period** | ** ** | **Charged to  costs and  expenses** | ** ** | **Deductions(a)** | ** ** | **Balance at  End of Period** | ** ** |
|--------------------------------------------------------|------------|------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|-------------------|------------|----------------------------------------------|------------|
| **Year ended December 31,  2004**                 |       |       |       |                                           |       |                                          |       |              |       |                                         |       |   |   |   |   |   |   |
| Allowances  deducted from assets for doubtful accounts |       |       | $          | 6,899                                          |       |                                          |       | $                 | 729        |                                         |       |   | $ | (2,052 | ) |   |   | $ | 5,576 |   |   |
| **Year ended December 31,  2005**                 |       |       |       |                                           |       |                                          |       |              |       |                                         |       |   |   |   |   |   |   |
| Allowances  deducted from assets for doubtful accounts |       |       | $          | 5,576                                          |       |                                          |       | $                 | 1,936      |                                         |       |   | $ | (2,533 | ) |   |   | $ | 4,979 |   |   |
| **Year ended December 31,  2006**                 |       |       |       |                                           |       |                                          |       |              |       |                                         |       |   |   |   |   |   |   |
| Allowances deducted from  assets for doubtful accounts |       |       | $          | 4,979                                          |       |                                          |       | $                 | 3,099      |                                         |       |   | $ | (820 | ) |   |   | $ | 7,258 |   |   |

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(a)           Results fromwrite-offs.

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**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

There have been no changesin or disagreements with our accountants on any matter of accounting principlesor practices, financial statement disclosure, or auditing scope of procedureduring the two most recent fiscal years.

**ITEM 9A.**        CONTROLSAND PROCEDURES

As of December 31, 2006, the end of the periodcovered by this report, the Company’s management, under the supervision andwith the participation of our chief executive officer and our chief financialofficer, performed an evaluation of the effectiveness of the design andoperation of our disclosure controls and procedures. Based on this evaluation,our chief executive officer and chief financial officer concluded that, as ofsuch date, our disclosure controls and procedures  (a) were effective to ensure thatinformation required to be disclosed by us in reports filed or submitted underthe Exchange Act is timely recorded, processed, summarized and reported and (b) include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by us in reports filed or submitted under the ExchangeAct is accumulated and communicated to management, including its chiefexecutive officer and chief financial officer, as appropriate to allow timelydecisions regarding required disclosure. Our management, including our chiefexecutive officer and chief financial officer, recognize that any set ofcontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving management’s control objectives.

During the fourth fiscalquarter ended December 31, 2006, no change in our internal control overfinancial reporting occurred that, in our judgment, either materially affected,or is reasonably likely to materially affect, our internal control overfinancial reporting.

**ITEM 9B.**       OTHERINFORMATION

There were no items required to be disclosed in areport on Form 8-K during the fourth quarter that were not reported.

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**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANTS

Information relating toour directors, nominees for directors and executive officers is set forth underthe heading “Election of Directors” in the Proxy Statement or InformationStatement relating to the Annual Meeting of Stockholders to be held in 2007,which will be filed with the Securities and Exchange Commission no later than April 14,2007, and which is incorporated herein by reference.

**ITEM 11.**         EXECUTIVECOMPENSATION

Information relating toour executive officers and executive compensation is set forth under theheading “Executive Officers; Executive Compensation and Related Information” inthe Proxy Statement or Information Statement relating to the Annual Meeting ofStockholders to be held in 2007, which will be filed with the Securities andExchange Commission no later than April 14, 2007, and which isincorporated herein by reference.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information relating tothe security ownership of certain beneficial owners and management is set forthunder the heading “Security Ownership of Certain Beneficial Owners,” “SecurityOwnership of Management and Directors” and “Equity Compensation PlanInformation” in the Proxy Statement or Information Statement relating to theAnnual Meeting of Stockholders to be held in 2007, which will be filed with theSecurities and Exchange Commission no later than April 14, 2007, and whichis incorporated herein by reference.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

Information relating tocertain relationships and related transactions concerning directors andexecutive officers is set forth under the heading “Certain Relationships andRelated Transactions” in the Proxy Statement or Information Statement relatingto the Annual Meeting of Stockholders to be held in 2007, which will be filedwith the Securities and Exchange Commission no later than April 14, 2007,and which is incorporated herein by reference.

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES

Information relating to our principal accountant feesand services is set forth under the heading “Relationship with IndependentPublic Accountants” in the Proxy Statement or Information Statement relating tothe Annual Meeting of Stockholders to be held in 2007, which will be filed withthe Securities and Exchange Commission no later than April 14, 2007, andwhich is incorporated herein by reference.

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**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT

(a)   1.   Thefollowing financial statements are included in Item 8, “Financial Statementsand Supplementary Data.”

Consolidated Balance Sheets

Consolidated Statements of Operations andComprehensive Loss

Consolidated Statements of Cash Flows

ConsolidatedStatements of Stockholders’ Equity (Deficiency in Assets)

2.   Thefollowing financial statement schedule is included in Item 8, “FinancialStatements and Supplementary Data.”

Schedule II—Valuation and Qualifying Accounts.

Allother schedules for which provision is made in the applicable accountingregulations of the Commission are not required under the related instructionsor are inapplicable and, therefore, have been omitted.

3.   The following documents are filed orfurnished as a part of this report:

| Exhibit No. | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                                                                                                                    |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1              |       | Agreement and Plan of Merger, dated as of  December 20, 2006 by and among Protection One, Inc., Integrated  Alarm Services Group, Inc. and Tara Acquisition Corp. (incorporated by  reference to Exhibit 2.1 of the Current Report on Form 8-K  dated December 21, 2006).                                                                         |
| 3.1              |       | Amended and Restated Certificate of Incorporation of  Protection One, Inc. (“POI”), effective as of February 8, 2005  (incorporated by reference to Exhibit 3.1 to the Annual Report on  Form 10-K filed by POI and Monitoring for the year ended  December 31, 2004, as amended (the “Fiscal 2004 Form 10-K, as  amended”)). |
| 3.2              |       | Certificate of Incorporation of Protection One Alarm  Monitoring, Inc. (“Monitoring”), as amended (incorporated by reference  to Exhibit 3.2 to the Registration Statement on Form S-3  (Registration Number 333-09401) originally filed by Monitoring and,  inter alia, POI on August 1, 1996 (the “August 1996 Form S-3”)). |
| 3.3              |       | By-laws of Protection One, Inc., as amended and  restated March 17, 2005 (incorporated by reference to Exhibit 3.1  of the Current Report on Form 8-K dated March 17, 2005).                                                                                                                                                                           |
| 3.4              |       | By-laws of Protection One Alarm  Monitoring, Inc., as amended and restated June 24, 2004 (incorporated  by reference to Exhibit 3.1 to the Quarterly Report on Form 10-Q  filed by POI and Monitoring for the quarter ended June 30, 2004).                                                                                                            |
| 4.1              |       | Indenture, dated as of December 21, 1998, among  Monitoring, as issuer, POI, as guarantor, and The Bank of New York, as  trustee (incorporated by reference to Exhibit 4.8 to the Annual Report  on Form 10-K filed by POI and Monitoring for the year ended  December 31, 1998 (the “Fiscal 1998 Form 10-K”)).                              |
| 10.1             |       | 1997 Long-Term Incentive Plan of POI, as amended  (incorporated by reference to Exhibit 10.3 to the Fiscal 2004  Form 10-K, as amended).*                                                                                                                                                                                                                             |
| 10.2             |       | 2004 Stock Option Plan (incorporated by reference to  Exhibit 10.3 of the Current Report on Form 8-K filed by POI  and Monitoring dated February 8, 2005).*                                                                                                                                                                                                      |
| 10.3             |       | Form of Award Agreement for Named Executive  Officers under 2004 Stock Option Plan (incorporated by reference to  Exhibit 10.4 of the Current Report on Form 8-K dated  February 8, 2005).*                                                                                                                                                                 |

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| 10.4  |   | Form of Award Agreement for Non-Named Executive  Officers under 2004 Stock Option Plan (incorporated by reference to  Exhibit 10.5 of the Current Report on Form 8-K dated  February 8, 2005).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.5  |   | Stock Appreciation Rights Plan (incorporated by  reference to Exhibit 10.6 of the Current Report on Form 8-K  dated February 8, 2005).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.6  |   | Form of Award Agreement under Stock  Appreciation Rights Plan (incorporated by reference to Exhibit 10.7 of  the Current Report on Form 8-K dated February 8, 2005).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.7  |   | Employment Agreement dated July 23, 2004  between Protection One, Inc., Protection One Alarm Monitoring, Inc and  Richard Ginsburg (incorporated by reference to Exhibit 10.1 to the  Quarterly Report on Form 10-Q filed by POI and Monitoring dated  August 16, 2004).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.8  |   | Employment Agreement dated July 23, 2004  between Protection One, Inc., Protection One Alarm Monitoring, Inc and  Darius G. Nevin (incorporated by reference to Exhibit 10.1 to the  Quarterly Report on Form 10-Q filed by POI and Monitoring dated  August 16, 2004).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.9  |   | Employment Agreement dated July 23, 2004  between Protection One, Inc., Protection One Alarm Monitoring, Inc and  Peter J. Pefanis (incorporated by reference to Exhibit 10.1 to the  Quarterly Report on Form 10-Q filed by POI and Monitoring dated  August 16, 2004).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.10 |   | Employment Agreement dated July 23, 2004  between Protection One, Inc., Protection One Alarm Monitoring, Inc and  J. Eric Griffin (incorporated by reference to Exhibit 10.58 to the  Fiscal 2004 Form 10-K, as amended).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.11 |   | First Amendment to Employment Agreement dated  February 8, 2005 between Protection One, Inc., Protection One Alarm  Monitoring, Inc and J. Eric Griffin (incorporated by reference to  Exhibit 10.59 to the Fiscal 2004 Form 10-K, as amended).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.12 |   | Employment Agreement dated July 23, 2004  between Protection One, Inc., Protection One Alarm Monitoring, Inc and  Joseph Sanchez.*+                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.13 |   | First Amendment to Employment Agreement dated February 8,  2005 between Protection One, Inc., Protection One Alarm Monitoring, Inc  and Joseph Sanchez.*+                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.14 |   | Exchange Agreement dated as of November 12,  2004 by and among the Company, POI Acquisition L.L.C., POI Acquisition  I, Inc. and Quadrangle Master Limited Funding Ltd (incorporated by  reference to Exhibit 10.5 to the Quarterly Report on Form 10-Q  filed by POI and Monitoring for the quarter ended September 30, 2004).                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.15 |   | Stockholders Agreement, dated as of February 8,  2005, by and between the Company and Quadrangle (incorporated by reference to  Exhibit 10.1 of the Current Report on Form 8-K dated  February 8, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.16 |   | Registration Rights Agreement, dated as of  February 8, 2005, by and between the Company and Quadrangle  (incorporated by reference to Exhibit 10.2 of the Current Report on  Form 8-K dated February 8, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.17 |   | Form of Management Stockholder Agreement, dated  as of February 8, 2005 (incorporated by reference to Exhibit 10.8  of the Current Report on Form 8-K dated February 8, 2005).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.18 |   | Amended and Restated Credit Agreement, dated as of  April 26, 2006, by and among Protection One Alarm Monitoring, Inc.,  Protection One, Inc., the several banks and other financial institutions  or entities from time to time parties to the Amended and Restated Credit  Agreement, Bear, Stearns & Co. Inc., as sole lead arranger and sole  bookrunner, LaSalle Bank National Association, as syndication agent, Harris  Nesbitt Financing, Inc., LaSalle Bank National Association and U.S. Bank  National Association, as co-documentation agents, and Bear Stearns Corporate  Lending Inc., as administrative agent (incorporated by reference to Exhibit 10.1  of the Current Report on Form 8-K dated April 26, 2006). |

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| 10.19 |   | Stockholders Agreement, dated as of  December 20, 2006, by and among Protection One, Inc., Tara  Acquisition Corp. and the stockholders named therein (incorporated by  reference to Exhibit 10.1 of the Current Report on Form 8-K  dated December 21, 2006).                                                                           |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.20 |   | Lock Up and Consent Agreement, dated as of  December 18, 2006, by an among Protection One Alarm  Monitoring, Inc., Integrated Alarm Services Group, Inc. and the  noteholders named therein (incorporated by reference to Exhibit 10.2 of  the Current Report on Form 8-K dated December 21, 2006).                                 |
| 10.21 |   | Credit Facilities Commitment Letter, dated as of  December 17, 2006, by and among Protection One, Inc., Protection  One Alarm Monitoring, Inc., Bear, Stearns & Co. Inc. and Bear  Stearns Corporate Lending Inc. (incorporated by reference to  Exhibit 10.3 of the Current Report on Form 8-K dated  December 21, 2006). |
| 10.22 |   | Reorganization Agreement, dated as of  December 18, 2006, by and among Protection One, Inc., POI  Acquisition I, Inc. and the other affiliates of Quadrangle Group LLC  named therein (incorporated by reference to Exhibit 10.4 of the Current  Report on Form 8-K dated December 21, 2006).                                       |
| 21.1  |   | Subsidiaries of POI and Monitoring.+                                                                                                                                                                                                                                                                                                                              |
| 23.1  |   | Consent of Deloitte & Touche LLP.+                                                                                                                                                                                                                                                                                                                       |
| 31.1  |   | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.+                                                                                                                                                                                                                                                                                   |
| 31.2  |   | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.+                                                                                                                                                                                                                                                                                   |
| 32.1  |   | Certification of Principal Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.+                                                                                                                                                                                               |
| 32.2  |   | Certification of Principal Financial Officer  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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*                    Each Exhibit markedwith an asterisk constitutes a management contract or compensatory plan orarrangement required to be filed or incorporated by reference as an Exhibit tothis report pursuant to Item 15(c) of Form 10-K.

+                Filed or furnishedherewith.

(b)   Theexhibits required by Item 601 of Regulation S-K are filed or furnishedherewith.

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**SIGNATURES**

Pursuant to the requirements of Section 13 and 15(d) ofthe Securities Exchange Act of 1934, the Registrants have duly caused thisreport to be signed on their behalf by the undersigned, thereunto dulyauthorized.

PROTECTION ONE, INC.

PROTECTION ONE ALARM MONITORING, INC.

 

| Date:  March 16,  2007 | By:    | /s/ DARIUS G. NEVIN                                   |
|----------------------------------|--------|-------------------------------------------------------|
|                             |   | Darius G. Nevin,                                      |
|                             |   | Executive Vice  President and Chief Financial Officer |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrants and inthe capacities and on the dates indicated.

|                       | **Signature** | ** **                                          | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-----------------------|---------------|-----------------------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
|                  |          |                                                |       |                 |
| /s/ RICHARD GINSBURG  |          | President, Chief  Executive Officer and Director    |       | March 16,  2007 |
| Richard  Ginsburg     |          | (Principal Executive  Officer)                      |       |                 |
|                  |          |                                                |       |                 |
| /s/ DARIUS G. NEVIN   |          | Executive Vice President  and Chief Financial       |       | March 16,  2007 |
| Darius  G. Nevin      |          | Officer (Principal  Financial Officer)              |       |                 |
|                  |          |                                                |       |                 |
| /s/ ERIC A. DEVIN     |          | Vice President,  Treasurer, Controller and          |       | March 16,  2007 |
| Eric  A. Devin,       |          | Assistant Secretary  (Principal Accounting Officer) |       |                 |
|                  |          |                                                |       |                 |
| /s/ ROBERT J. MCGUIRE |          | Director                                            |       | March 16,  2007 |
| Robert  J. McGuire    |          |                                                |       |                 |
|                  |          |                                                |       |                 |
| /s/ HENRY ORMOND      |          | Director                                            |       | March 16,  2007 |
| Henry  Ormond         |          |                                                |       |                 |
|                  |          |                                                |       |                 |
| /s/ STEVEN RATTNER    |          | Director                                            |       | March 16,  2007 |
| Steven  Rattner       |          |                                                |       |                 |
|                  |          |                                                |       |                 |
| /s/ DAVID A. TANNER   |          | Director                                            |       | March 16,  2007 |
| David  A. Tanner      |          |                                                |       |                 |
|                  |          |                                                |       |                 |
| /s/ MICHAEL WEINSTOCK |          | Director                                            |       | March 16,  2007 |
| Michael Weinstock     |          |                                                |       |                 |

 

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